One of the more disquieting aspects of the current economic crisis is the almost complete absence of any debate on the question of Ireland’s ability to resume its economic dynamism via export-led growth whenever the global economy recovers. There is almost complete unanimity among Irish economists in support of the following propositions:
• Export competitiveness is a function of Ireland’s level of unit labour costs (labour costs relative to productivity) vis-à-vis those countries with which Ireland competes in international markets (usually seen as being equated with Ireland’s ‘main trading partners’).
• Ireland’s labour costs became increasingly uncompetitive in the decade since 2000 due to wage levels rising too fast relative to productivity growth.
• This led to a massive loss of export competitiveness over the last decade.
• As a result, economic growth in Ireland during that decade was based almost entirely on the construction-led consumer boom whose collapse has resulted in the current sorry economic mess.
• Ireland therefore needs to reduce wage costs in order to restore competitiveness so that Ireland will be in a position to exploit the next upturn in the global economy through resumed export growth.
What is remarkable about the unanimity surrounding these propositions is that they are almost entirely unsupported by the available evidence. In what follows, evidence is presented in support of two key arguments which contradict the received wisdom as outlined above:
• That the widespread view that Ireland experienced a major loss of competitiveness over the last decade vis-à-vis its main trading partners is, for the most part, erroneous.
• Following from this, that labour costs are a factor of, at best, minor importance in determining the competitiveness of export businesses operating in Ireland.
Let us begin by examining the data relating to Ireland’s export performance over the last decade, drawn mainly from the OECD and World Trade Organisation (WTO) websites.
Between 1998-2003 there was a substantial acceleration in the rate of inflation in Ireland which has generally been attributed to a major expansion in public spending in this period. Between end-1997 and end-2003, Ireland’s nominal GDP, after allowing for real volume growth, grew by one third, three times the rate for the Eurozone and the USA, and over twice the rate for the UK. This was reflected in a sharp rise in Ireland’s economy-wide relative unit labour costs (output relative to pay) which rose at twice the rate for the Eurozone and 1.5 times the rate for the USA.
The fact that Ireland’s rate of export growth fell dramatically in the early 2000s (to as low as one half of one per cent in 2003) led to the easy – and widely-held – conclusion that Ireland experienced a massive fall in export competitivness vis-à-vis our main trading partners in this period and that this was attributable to the rise in relative labour costs which coincided with the sharp fall in the rate of export growth. However, this conclusion is simply not supported by the available data. Between end-2000 and end-2007, Ireland’s exports of goods and services grew by 48.3% in volume terms, ahead not just of the overall rate of growth for the OECD (39%) but for eight of Ireland’s ten leading trading partners (the exceptions being Germany and China).
The star of the show in this respect were services exports, which more than doubled (to 2.6%) their share of global services exports in this period. If one excludes the relatively low-tech travel and transport subsectors, Ireland’s share of global services exports reached 4.6% in 2007. This rapid growth embraced a range of sectors including software services, insurance and other financial services, merchanting and operational leasing. The picture was not so positive as regards merchandise exports, where Ireland’s share of global exports fell by over one quarter over the period. However, this overall decline masks significant intersectoral differences – while Ireland’s share of global exports of office and telecoms equipment fell by 40% over the period, our share of pharmaceuticals exports rose by almost 20%.
The sharp fall in Ireland’s exports of electronics hardware which commenced in 2001 can be attributed largely to two factors. The first of these was the dotcom collapse of 2000 which induced a substantial fall in the demand for electronics products – in 2001 global exports of office and telecom equipment were 13% lower in nominal value terms than a year previously, and did not regain the 2000 level again until 2004. The second factor in the fall-off of Irish electronics exports was the emergence of China as a major competitor in the sector (China’s share of global exports of office and telecoms equipment jumped from 4.5% to 23% between 2000-2007). Ireland was not alone in experiencing market share loss to China’s ultra-low production costs in routine electronics production – in fact, all of Ireland’s nine main trading partners (other than China) lost market share to China in the office & telecoms equipment sector except Germany and Netherlands, and there is evidence to suggest that the export growth recorded in the latter two cases consisted of re-exports of products which originated in China.
Because of the very high proportion of Irish merchandise exports accounted for by electronics products (40% in 2000), the sharp contraction in exports from this sector in the early 2000s had a substantial impact on Ireland’s overall export performance in this period. However, this contraction had nothing to do with rising labour costs vis-à-vis our main trading partners. This is borne out by the relatively strong export performance of our other main manufacturing export sector (pharmaceuticals) and the powerful export performance of a range of services sectors in this period. It is further borne out by the fact that, while Ireland’s unit labour costs rose by 80 per cent more than those of the USA between 2000-2007, Ireland’s exports grew by 60% more than those of the USA (in volume terms) in the same period.
Of course, while economy-wide trends in unit labour costs are widely cited as evidence of Ireland’s declining export competitiveness, they bear little relationship to labour cost trends in exporting industries (especially where, as in Ireland, most of these sectors have an ‘enclave’ nature with few links with the rest of the economy). In the Irish case, calculation of unit labour costs for manufacturing industry may be significantly distorted for some sectors by transfer price manipulation which exaggerates value added in Ireland. However, trends over time may have more reliability than fixed point calculations. Thus, whereas Ireland’s ‘total economy’ unit labour costs rose by over 10% relative to the OECD average between 2000-2007, unit labour costs in manufacturing (most of whose output is exported) actually fell by 9% relative to the OECD average in this period. However, this again is an overall average which does not allow for varying trends between manufacturing sectors, and when calculated for individual sectors is a poor predictor of export performance. Thus, unit labour costs (labour costs as a proportion of gross value added, calculcated as a three-year average) rose by 20% in the pharmaceuticals sector and fell by 9% in the office machinery and computers sector between 2000-2005. Yet it was the former which experienced significant growth in market share in the period while the latter sector lost out substantially.
Overall, therefore, we contend that the extraordinarily high levels of export growth which Ireland enjoyed in the 1990s were unsustainable in the long run, and the fall-off observed in the 2000s to a considerable extent reflects an adjustment to more ‘normal’ levels of growth. Even in this period, Ireland’s export growth outstripped that of most of our main trading partners, and, in the one major sector where Ireland lost significant market share (electronics hardware), we argue this was due to specific circumstances which were largely beyond Ireland’s control.
We find no evidence that labour costs had any significant bearing on Ireland’s export performance in the 2000s (apart from the exceptional case of very low Chinese costs in electronics). Rising general labour costs relative to our main trading partners have not prevented very rapid growth in services exports or superior export performance on Ireland’s part compared with countries whose labour costs have fallen substantially relative to Ireland’s. Furthermore, export performance in the main export sectors in manufacturing has been inversely related to unit labour cost trends in these sectors.
The preoccupation of many economists with labour costs as the key to export competitiveness is difficult to fathom given the minor role played by such costs in the overall cost structure of Ireland’s main export sectors. In manufacturing as a whole, labour costs amounted for just 15.5% of total direct costs of Irish manufacturing plants in 2006 (the latest year for which the relevant data are available in the Census of Industrial Production). This figure varies intersectorally, and ironically was lowest of all (at just 3%) in the office machinery and computers sector, which has experienced substantial loss of market share, while it stands at 18% and 22%, respectively, in pharmaceuticals and medical devices, our two most successful manufacturing export sectors in recent times. According to Forfás data, labour costs in foreign-owned service export firms (which account for the great bulk of service exports) were, at 10% of total input costs, even lower than in export manufacturing.
It is noteworthy that labour costs are given a very minor role in the computation of the authoritative Global Competitiveness Index compiled annually by the World Economic Forum (WEF) under the direction of Harvard University competitiveness guru Michael Porter. This index is compiled from no less than 113 indicators which are given different weightings depending on a country’s level of development. For countries at Ireland’s level of development, the key to competitive success is seen by the WEF as the ability to produce new and different products employing cutting-edge production processes. In the system of weightings applied to this group of countries, labour cost factors account for just 1.7% of the total value of the competitiveness index. Based on these criteria, Ireland has actually been moving up the WEF’s competitiveness league table, from 30th position in 2002 to 22nd in 2009.
This positive view of Ireland’s competitiveness performance is shared by other influential international league tables. Thus, in its report for 2010, the World Bank’s annual Doing Business survey placed Ireland 7th out of 183 countries in terms of ease of doing business (labour costs are not among the 40 variables used in compiling the table). Similarly, IBM’s Global Location annual report for 2009 rated Ireland as the most successful country in the world (up from 10th place in 2008) for attracting foreign investment, measured in terms of jobs per 100,000 population. This undoubtedly is related to the profitability of foreign firms operating in Ireland. In 2007, the average rate of return on investment by US firms in Ireland, at 22.5%, was up 3.5 percentage points since 2000 and was the fourth highest in the world after China, India and Singapore.
It is also noticeable that spokespersons for foreign firms operating in Ireland rarely make reference to labour costs when reflecting on their operations here. This was brought home in the recent address by former Intel chief Craig Barrett to a meeting of the Royal Irish Academy. In this address, Barrett specifically rejected the notion that Ireland could strengthen its competitiveness on the basis of cutting costs, emphasising instead the need to expand investment in the development of high-tech activities and in enhancing educational provision in science and mathematics. To be competitive, we need to be smart and innovative, not cheap, according to Barrett..
There is a real danger that, encouraged by the economists’ chorus on the need to cut costs as the way to get us out of our current economic troubles, the government will actually undermine Ireland’s long-term competitive position through cutbacks in research and education (in fact, such cutbacks are already being imposed). We desperately need to substitute serious evidence-based analysis for the rote incantation of inherited mantras which currently passes for expert economic advice in the realm of competitiveness policy in this country.