In Part 1 of this paper, data were presented which contradicted the widely-held view that Ireland experienced a sharp loss of export competitiveness vis-à-vis its main trading partners over the period 2000-2007. Ireland actually increased its share of total world exports (albeit marginally) in this period and did better in this respect than seven of Ireland’s twelve main trading partners. In terms of share of global services exports, Ireland’s powerful performance easily surpassed all twelve main trading partners and, while Ireland’s performance with respect to merchandise exports was poor, it was still superior to that of Ireland’s two leading trading partners, the UK and USA, as well as Japan.
Part 2 of the paper showed that, while economy-wide unit labour costs in Ireland rose more rapidly than in Ireland’s main trading partners in the period 2000-2007, this did not have the negative impact on Ireland’s export competitiveness which has bee postulated by economic commentators because unit labour costs in both the export manufacturing and export services sectors moved in the opposite direction. While this was associated with a rapid rise in services exports (and might have been in the case of manufacturing exports were it not for the intrusion of several extraneous factors which had a particularly negative impact on Ireland’s merchandise exports), this should not be construed as establishing a causal link between trends in labour costs and trends in export performance. An examination of the cost structure of Ireland’s main manufacturing export sectors revealed that not only was there was no link between the proportion of total costs accounted for by labour costs and employment change in these sectors, but that labour costs in general account for a low proportion of costs in the sectors in question (as is also the case with export services).
The third and final part of this paper reviews a number of alternative approaches to assessing national export competitiveness which are much more complex and sophisticated than the simplistic – and erroneous – reduction of competitiveness to international differences in unit labour costs. These alternative approaches generally portray Ireland’s competitiveness position in a much more favourable light than has become the norm in public discourse of the topic in Ireland. The paper then raises the possibility that the application of any kind of competitiveness measures to Ireland may be futile due to the high proportion of Irish exports which go into non-competitive markets. The paper concludes by contrasting the calls by leading foreign industrialists for greater investment in productivity-enhancing education and research & development as the key to enhancing Ireland’s future competitiveness with the narrow preoccupation of Irish economic commentators with labour cost reduction. Given the influence these commentators have in the policy-making arena, this preoccupation, and associated government spending cuts, could do profound long-term damage to Ireland’s ability to compete in the high-value-added export markets which are essential if Ireland is to sustain its position as a high-income economy.
Alternative approaches to measuring export competitiveness
The recent reports of the National Competitiveness Council (NCC) have tended to downplay, or ignore altogether, the role of labour costs as a factor in assessing Ireland’s export competitiveness. Of the 18 different indicators which the NCC uses for this purpose, just one relates to labour costs and productivity. This downplaying of labour costs – which is entirely justified on the basis of the evidence presented in this paper – gave rise to an extraordinary and quite outrageous attack on the professional integrity of the NCC staff and advisors by Garret Fitzgerald in the Irish Times on January 30 last. Taking umbrage at the NCC’s failure in its most recent reports to highlight the issue of labour costs which he sees as central to Ireland’s purported loss of competitiveness, Fitzgerald suggested that this might be due to the NCC staff who wrote these reports being inhibited by the presence on the NCC board of members (trade unionists, civil servants) who might have had “difficulties” with an analysis which highlighted the role of wage costs in Ireland’s supposed loss of competitiveness in recent years.
In this context, it is worth looking at the Global Competitiveness Index (GCI) published annually by the World Economic Forum (WEF), the Swiss-based independent think-tank. The GCI was devised by, and is compiled under the supervision of, Michael Porter of Harvard University, one of the world’s foremost authorities on international competitiveness and author of the path-breaking book The competitive advantage of nations (1990).
The complex and thoughtful methodology employed by the WEF in constructing the GCI contrasts sharply with the simplistic perspective on this issue held by so many Irish economists and politicians. In its Global competitiveness report for 2008-09, the WEF employed no less than 113 different indicators in measuring the GCI for 134 different countries. These comprise a mix of quantitative data derived from official sources, and qualitative data relating to assessments of various aspects of the business environment in each of the subject countries obtained from some 12,294 business leaders and analysts from around the world (including 59 from Ireland). These 113 indicators are divided into twelve “pillars” of competitiveness (institutions, infrastructure, education, financial markets, etc.).
The relative weights given to these indicators vary depending on each country’s level of development. In the WEF’s view, competition based on cost is only appropriate for countries at a low level of development, for whom cheap labour or resources are frequently their only source of competitive advantage. For countries at an intermediate level of development, the keys to competitiveness are production efficiency and product quality, while for countries at the highest development levels, the key factor is the ability to produce new and different products employing cutting-edge production processes. In the system of weightings applied to this group of countries (in which the WEF places Ireland), labour cost factors account for just 1.7% of the total value of the competitiveness index.
Contrary to the view of most Irish economic commentators, the GCI actually saw Ireland’s competitiveness improving throughout most of the 2000s, reflected in movement from 30th position in 2002 to 22nd in 2009. In its country report on Ireland for 2008-09, the WEF identified Ireland’s key competitiveness weakness as lying in infrastructure, along with small market size and the country’s current macroeconomic stability problems. Labour costs were not mentioned.
Ireland has done even better in a number of other recent international rankings related to competitiveness. 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). The IBM Global Location Annual Report ranked Ireland as the most successful country in the world for attracting foreign investment in 2009 when measured by jobs per 100,000 population, up from 10th position the previous year. The Lisbon Council’s European Jobs and Growth monitor ranked Ireland as the second most competitive economy in Europe in 2008, up from fourth place in 2007, while the London-based Centre for European Reform ranked Ireland as the sixth most competitive economy out of the 27 EU states in 2008, two places higher than in 2007. All of these bodies employ a range of criteria in composing their rankings.
How competitive are Ireland’s export markets?
A final key factor relating to Ireland’s export competitiveness is the fact that, to a very large extent, the markets served by Ireland’s exports are not competitive at all. For a start, a large proportion of Irish merchandise exports consists of intermediate goods destined for further processing, frequently by other branches of the Irish-based firms in question. According to UN trade data, Ireland’s ten largest four-digit export sectors accounted for almost 60% of Ireland’s merchandise exports in 2007, and over half of the value of these sectors’ exports consisted of intermediate products (e.g. chemical compounds, electronic components, drink concentrates).
In total, over half of Ireland’s merchandise exports arise in the chemicals and pharmaceuticals sector which is dominated globally by a relatively small number of major multinationals (most of which have an Irish presence). Due to their sheer size and control of patents, these firms do not operate in truly competitive markets and tend to be highly profitable – profits as a percentage of revenues for pharmaceuticals firms in the US Fortune 500, on average, are typically 4-5 times greater than for other firms (expenditure on R&D goes nowhere near explaining the difference). This high profitabilitty makes Ireland’s low corporation tax rate very attractive while making the firms in question less concerned about costs than in more competitive sectors.
Oligopoly is also a feature of other Irish export sectors. Microsoft (whose main Irish subsidiary had a turnover of €11.3bn in the year to June 2008 – the equivalent of 7.5% of Ireland’s total exports in this period) is an obvious example, with profits amounting to 30% of revenues in 2008, over six times the average for Fortune 500 firms (the profit margin on Windows and Microsoft Office is reputedly of the order of 80%). Google, whose Irish operation has enjoyed spectacular growth since it was established in 2003, had a 2008 profit rate which was only slightly less than Microsoft’s.
Apart from oligopolised markets, a large proportion of foreign-owned operations in Ireland are largely involved in providing services to other units of their parent companies – they are not selling in open markets. This applies to units engaged in R&D and software development for their parent firms or providing centralised support services for affiliate units elsewhere in Europe and adjoining regions, and to IFSC operations providing insurance and treasury management services to affiliates. It is impossible to quantify the extent of such activities, but they certainly make up a substantial proportion of service exports which in 2008 accounted for 42% of total exports.
Productivity and competitiveness
This is not to say that foreign firms operating in Ireland are unconcerned about their operating costs here. However, their approach to this issue is very different from that of Irish economists. Real labour costs are made up of two components – levels of remuneration (including social security payments) and productivity levels. Where productivity rises more quickly than remuneration rates, real unit labour costs fall. High relative productivity explains why the countries with the highest pay rates in the world also possess the world’s most competitive economies. While Irish economists have focused on wage reductions as the key to lowering labour costs, foreign companies operating in Ireland have been emphasising the need to raise productivity.
Thus, speaking at the announcement by ABB of an expansion of their Irish operations in 2003, company vice-president Dinesh Paliwal said “It is not low costs that attracts international companies to invest in certain countries. It is high productivity, quality and innovation that are crucial to their decision – and Ireland clearly stands out in these areas” (IDA Ireland: Business Ireland 2003 No 3). Similarly, in an Irish Times article on July 4, 2008, Paul Rellis, General Manager of Microsoft Ireland and then President of the American Chamber of Commerce in Ireland wrote: “We need to add value faster than we add costs…Faster productivity growth provides the clearest route to higher living standards in the future – the time is now appropriate to design and implement clear and co-ordinated policies that will quicken productivity growth in the years ahead”.
Other leading American industrialists have recently gone further in spelling out what Ireland needs to do in order to strengthen its position as a location for export activities. Writing in the Irish Times on September 17 last, Martin Murphy, Managing Director of Hewlett Packard Ireland, called for the formulation of a national industrial strategy focused on the creation of an enterprise culture and education system capable of making Ireland “a global hub for knowledge, innovation and know-how” characterised by enterprises built on high-quality and high value-added exports of goods and services. Murphy pointedly added: “Competitiveness will not be achieved by cutting costs alone. We have to also deliver a better service at a lower cost through innovation.”
These ideas were echoed by Craig Barrett, former Chairman of Intel Corporation, in an address to the Royal Irish Academy in February of this year. Decrying the notion that Ireland could recreate the Celtic Tiger by simply cutting costs, Barrett emphasised the need to concentrate on the creation of value-added jobs requiring major increases in investment in education and research & development (R&D). Expanding on this theme in a subsequent interview in the Irish Times (February 12, 2010), Barrett argued that in the modern global economy, “the only ways you compete are in the new industries, the value-added jobs where intelligence and training and skills are important”,
The need for increased investment in education and R&D was also the focus of an article in the Irish Times on November 13 last by Jim O’Hara, General Manager of Intel Ireland, Ireland’s largest industrial employer. The thrust of O’Hara’s argument is encapsulated in just two pithy sentences: “Unless there is the foundation of a highly educated workforce and an internationally recognised commitment to and reputation for research and innovation, Ireland will not be considered competitive… We must have a world-class, digitally connected education system and a clear government strategy across all four levels of education and on into lifelong learning.”
Clearly these arguments by key industrial leaders at the coalface of the global market place have had minimal impact on the economics profession, many of whose practitioners act as key government advisors and shapers of public opinion. Their focus on cost minimisation is reflected in across-the-board cuts which are having a devastating impact on Ireland’s education system at a time when the need for expanded investment in this system was never greater. A continued preoccupation with cutting labour costs will have little impact on the competitiveness of our existing export sector in the short term, but will inevitably undermine Ireland’s ability to create and maintain an innovative, high-productivity and high-income economy in the long run. In the short run, the main beneficiaries of a policy of labour cost reduction will be the owners of small, labour-intensive, low-tech indigenous firms operating in sheltered (and frequently cartelised) business sectors. In the long run, even these firms will find that it is not in their best interests to simultaneously reduce the incomes and spending power of most of their customers.