Ireland’s export competitiveness: myths and facts – Part 2: Myths relating to the role of labour costs in export competitiveness

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 this paper interrogates two further myths relating to Ireland’s export competitiveness i.e. that rising unit labour costs negatively impacted on Ireland’s export competitiveness in the period after 2000 (thereby bringing about Ireland’s postulated loss of competitiveness in this period) and that labour costs are a key determinant of Ireland’s export competitiveness.  However, initially some explanations for Ireland’s loss of market share in global merchandise exports in the 2000s are advanced  – explanations which have nothing to do with trends in labour costs within Ireland.

Explaining Ireland’s loss of market share in merchandise exports 2000-2007

Some special factors contributed to Ireland’s loss of share of global merchandise exports between 2000-2007.  One of these was the rapid rise in the prices of minerals and fuels in this period which boosted the global market share of countries with high relative endowments in these natural resources at the expense of countries, like Ireland, with low natural resource endowments.  Between 2000-2007, the share of global merchandise exports taken by Fuels & Mining Products rose from 13.3% to 19.0%.  By contrast, the share of Ireland’s merchandise exports accounted for by Fuels & Mining Products was just 1.3% in 2000 and 2.3% in 2007.  Thus, even if there had been no change in the technical efficiency of the Irish export sector during the period, Ireland would still have lost market share due to its relative underdowment in a subsector with a substantial and rapidly rising global market share.

A second contributory factor to Ireland’s loss of global market share in merchandise exports was the knock-on impact of the collapse in 2000-2001 of the so-called “dot.com bubble” on the Office and Telecommunications Equipment (OTE) sector, upon which Ireland has had a heavy export dependence.  This was reflected in a fall in the share of global merchandise exports taken by the OTE sector from 15.0% in 2000 to 10.9% in 2007.  This sector alone accounted for one third of Ireland’s merchandise exports in 2000, according to WTO data.  In this case Ireland was penalised for an overdependence on a subsector which experienced a sharp reduction in global demand for reasons over which the Irish economy had no control.

A third factor which contributed significantly to Ireland’s loss of global market share in merchandise exports in the period 2000-2007 was the emergence, in this period, of China as a major competitor, again in the OTE sector. In 2000 China accounted for 4.5% of global OTE exports, but by 2007 this had jumped to 22.9%.  Within the OTE sector, China’s rise was particularly pronounced in the Data Processing & Office Equipment (DPOE) subsector (global share up from 5.0% to 30.3% between 2000-2007) which accounted for over two thirds of Ireland’s OTE exports in 2000.

The key factor here was China’s very low cost base in what is a highly-competitive industry, a factor which affected most western economies as much as – if not more than – Ireland.  Table 4 shows the global share of DPOE exports taken by Ireland and its main trading partners in 2000 & 2007.  This shows that the loss of global market share by Ireland’s main trading partners (excluding China) combined was almost as large as Ireland’s, with seven of the eleven comparator countries experiencing more sharp declines than Ireland while there is evidence to suggest that, in the case of two of the three countries which show a rise in market share (Germany and the Netherlands), this was at least partially due to re-exports from these countries of products originally imported from China.  Thus, Ireland’s loss of market share in this sector cannot be attributed to rising costs (including labour costs) relative to Ireland’s main trading partners, but to the emergence of a new competitor with a cost base profoudnly below those prevailing in the western economies in general.

The role of labour costs in Ireland’s export competitiveness

Our argument, therefore, is that, to a significant extent, Ireland’s loss of global market share in merchandise exports in the period 2000-2007 was due to external developments over which Ireland had no control but which had a disproportionate impact on Ireland’s export performance.  By contrast, the evidence suggests that changes in relative labour costs – the factor identified by most economic commentators as being responsible for Ireland’s purported loss of export competitiveness – had little if anything to do with Ireland’s export performance over the last decade.  While most public pronouncements by economic commentators do not state the sources they are using for their assertions that Ireland has been losing export competitiveness and that this is attributable to rising labour costs, it is assumed that the key sources concerned are publications of the ESRI and the Central Bank which routinely repeat these assertions.

Table 4: Share of global exports of Data Processing & Office Equipment (%)

	2000	2007	2007 as % 2000
Belgium	1.19	0.93	77.9
France	2.73	1.57	57.4
Germany	4.63	5.95	128.6
Italy	0.88	0.43	49.0
Japan	9.46	4.54	48.0
Netherlands	7.41	8.83	119.2
Spain	0.50	0.25	49.3
Sweden	0.20	0.48	234.0
Switzerland	0.37	0.19	52.4
United Kingdom	5.92	2.45	41.3
United States	15.48	8.64	55.8
11 Trading Partners	48.78	34.26	70.2
Ireland	4.70	3.15	67.0
China	5.01	30.28	604.5

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Source: WTO

An interesting fact about most of these pronouncements – and indeed many academic papers on the topic – is the absence of any factual data to demonstrate that Ireland has actually been losing competitiveness.  Most commentators appear happy to assume that if Irish labour costs are rising faster than our competitors, then Ireland must be losing competitiveness.

One commentator who has been stating his sources on labour cost trends and who has been presenting data on trade performance to demonstrate what he considers to be the consequences of these trends is Garret Fitzgerald.  In his Irish Times columns, Fitzgerald has shown that unit labour costs (costs relative to productivity) in the Irish economy rose relative to the USA and Western Europe during the 2000s while growth of industrial exports virtually ceased.  From this he draws the conclusion that the latter phenomenon was a direct consequence of the former.

Apart from the fact that, as shown above, factors other than labour cost trends had a significant negative impact on Ireland’s merchandise export performance in this period, there are serious flaws in Fitzgerald’s analysis.  The labour cost indicator which he uses is the OECD’s Total Economy Unit Labour Cost (ULC), which is based on labour costs throughout the economy and not just in exporting firms (direct employment in export activities accounted for only 12% of Ireland’s total employed workforce in 2000).  Apart from the dubious merit of calculating a national average from such a disparate array of economic sectors (many of which are effectively sheltered from international competition), the assumption (implicit in Fitzgerald’s argument) that unit labour cost trends in the export sector reflect those in the economy at large does not hold water.  Fitzgerald makes no reference to the OECD data on Manufacturing ULCs, which provide a more accurate view of labour cost trends in the Irish export sector (as some 80% of Irish manufacturing output is exported).  These data show that not only have Manufacturing ULCs shown an overall downward trend in the period 2000-2007, but they have been falling relative to most of Ireland’s main trading partners.

Figure 3: Trends in Total Economy & Manufacturing Unit Labour Costs (ULCs) relative to the OECD average, 2000-2007 [2000 = 100]

Source: OECD

Figure 3 shows how Ireland fared relative to the OECD average with respect to both Total Economy and Manufacturing ULCs between 2000-2007.  This shows Total Economy ULCs falling slightly between 2000-2003 and then rising consistently between 2002-2007.  Manufacturing ULCs fell sharply between 2000-2002, then rose again to the OECD average in 2005 & 2006 before falling again in 2007.  The overall trend lines show a diverging trend over time, with Total Economy ULCs rising and Manufacturing ULCs falling over the period.

Table 5 shows the change between 2000 and 2007 for both labour cost measures for Ireland and ten of Ireland’s twelve main trading partners (no data available for China and no Manufacturing ULC data available for Switzerland).  This shows that while Ireland’s Total Economy ULC rose more quickly than any of the other countries, Ireland’s Manufacturing ULC actually fell over the period whereas they rose in six of the ten comparator countries, while of the four which experienced a fall in Manufacturing ULCs, only Japan’s and Sweden’s rate of fall exceeded Ireland’s.

Table 5: Change in Total Economy & Manufacturing Unit Labour Costs – 2000-2007

	Total Economy		Manufacturing
	2000	2007	2000	2007
Belgium	100.0	113.6	100.0	103.7
France	100.0	114.2	100.0	100.8
Germany	100.0	97.8	100.0	91.0
Italy	100.0	120.8	100.0	120.4
Japan	100.0	85.8	100.0	77.8
Netherlands	100.0	114.9	100.0	102.3
Spain	100.0	124.0	100.0	119.4
Sweden	100.0	110.3	100.0	87.1
United Kingdom	100.0	119.5	100.0	107.1
United States	100.0	115.5	100.0	92.7
Ireland	100.0	125.4	100.0	90.5

Source: OECD

Comparative data on Unit Labour Cost trends in export services are not available, but the relevant trends for Ireland can be estimated from Forfás surveys of the economic impact of state-aided economic activities.  These show that Unit Labour Costs in Export Services (pay costs per worker divided by value added per worker) fell by 26.6% between 2000-2007 in the foreign-owned export services sector (which accounted for 94% of services exports in 2000).

Fitzgerald’s assertion, to the effect that Irish manufacturing exports were negatively affected in the period after 2000 by rising labour costs is therefore based on a false premise, since relative labour costs in the export manufacturing sector actually fell in this period.  It has been pointed out by some commentators that real unit labour costs in manufacturing are understated due to the effect of transfer pricing (whereby TNCs operating in Ireland overstate the value of their output in order to avail of Ireland’s low corporation tax rate) in overstating value added.  However, this refers to the absolute value of unit labour costs – there is no obvious reason why this should impact on the rate of change of unit labour costs over time, which is our concern here.

A more obvious flaw in Fitzgerald’s analysis refers to his treatment of services exports.  While acknowledging their strong growth in the 2000s, he fails to explain why the purported rise in Irish labour costs should not have impacted on these in the same way as he suggests they impacted on manufacturing.  To put this in perspective, according to Forfás survey data, in 2007 labour costs accounted for 9.9% of total costs in the foreign services export sector compared with 11.1% of total costs in the foreign manufacturing export sector (i.e. there was no major difference in the relative cost of labour in both sectors).

This last statistic brings us to what is possibly the biggest flaw of all in the argument of those who assert that labour costs are the key ingredient in export competitiveness i.e. labour costs in fact only account for a relatively small proportion of costs in Irish export activities.  To explore this further, Table 6 presents some relevant data from the Census of Industrial Production (CIP) relating to Ireland’s main export manufacturing sectors for the period 2000-2006 (with the exception of the Food & Beverages sector in which natural resource endowment has a substantial impact on competitiveness).  Due to changes in coverage, the CIP data for 2007 are not directly comparable to previous years and have been excluded from this table.

Garret Fitzgerald in his Irish Times articles has placed much emphasis on the job losses sustained in the 2000s due, in his view, to rising labour costs.  One might expect, therefore, that sectors in which labour accounted for a high proportion of costs to have the weakest employment performance over the period, either due to loss of market share or through substitution of capital for labour.  In fact, the data in Table 6 show no relationship whatever between proportionate labour costs and rate of employment change (Pearson’s R = -0.03).  Thus, for example, the Medical, Precision & Optical Instruments sector, in which labour costs accounted for 25% of total costs in 2000, experienced 41% employment growth over the period, whereas the Electrical Machinery & Apparatus sector, in which labour costs were almost equally important (23%) experienced a decline in employment of 50%.  A distinctive feature of the table is the major differences between sectors in employment performance, which demonstrates the futility of making industry-wide statements about employment trends and their causes.

A further distinctive feature of the table is the relatively low proportion of costs accounted for by labour costs in all sectors, ranging from just 4.1% for Office Machinery & Computers to 28.7% for Machinery & Equipment, with an overall average for the nine sectors of 10.8%.  It may be noted that the very low labour cost share in the Office Machinery & Computers sector did not spare that sector from serious job losses in the 2000s, indicating that China’s meteoric rise in this highly competitive sector is attributable to low costs in general, and not merely low labour costs.

Table 6: Labour costs and employment change, main export sectors – 2000-2006

Sector	Export % 2000	Labour % Input Costs 2000	Empl Change 2000-2006 (%)
Reproduction of Computer Media	97.2	21.1	-27.5
Organic Chemicals	99.8	8.2	+23.3
Pharmaceuticals	96.0	16.4	+35.3
Perfumes & Toilet Preparations	98.5	27.8	-28.5
Machinery & Equipment	71.6	28.7	-22.7
Office Machinery & Computers	86.0	4.1	-36.4
Electrical Machinery & Apparatus	83.1	23.2	-50.3
Communications Equipment & Electronic Components	93.3	13.2	-43.4
Medical, Precision & Optical Instruments	95.4	25.0	+41.2
Total	92.7	10.8	-14.8

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Source: Census of Industrial Production (CIP)

Economic commentators appear to be unaware of the low share of labour costs in the total cost structure of Ireland’s exporting firms, frequently pointing to the high share of GNP accounted for by labour remuneration as indicative of the importance of labour costs to competitiveness.  Thus, in a recent article dealing specificially with the measurement of labour cost competitiveness by Central Bank economist Derry O’Brien in that institution’s prestigious Quarterly Bulletin, the following passage appears on page 105: “The largest costs incurred by firms are typically labour costs”.  This is presented as a self-evident truth with no supporting data, yet as is obvious from the data presented above, labour costs account for only about ten per cent of total costs in the export activities which were the very focus of the paper in question.  This means that the five per cent reduction in wages which the ESRI’s John Fitzgerald sees as being necessary to restore Ireland’s competitiveness (see quotation above) would have the effect of reducing the overall costs of the average exporting firm by less than one half of one per cent – hardly likely to have a major impact on competitiveness.

Conclusion

This part of the paper has shown that, while economy-wide unit labour costs in Ireland did rise more rapidly than in Ireland’s main trading partners in the period 2000-2007, unit labour costs in both manufacturing and export services 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.

Reference

O’Brien, Derry (2010) Measuring Ireland’s Price and Labour Cost Competitiveness Central Bank Quarterly Bulletin, 2010 No 1, 99-113.

TO BE CONTINUED…

Proinnsias Breathnach

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Electoral Politics in the NAMA era 2: Who will win the next general election?

Having discussed when the next general election will take place (see below), the next question is: who will win this election? A number of commentators have almost taken it for wrote that Fianna Fáil will lose power after the next general election, while others suggest that the Green Party could lose most, if not all, of their seats in Dáil Éireann. But will this prove to be the case and is a Fine Gael-Labour coalition virtually certain to take power after the next election?  I’d suggest that we can consider a number of potential scenarios here:

The Zombie scenario aka the “It’s Not A Case Of If But When” scenario: This scenario effectively mirrors the situation in the UK in the mid-1990s where John Major’s Conservative government clung to power until the bitter end before getting hammered by Labour in the 1997 election. This sees the current government’s popularity levels continuing to remain low, with Fianna Fáil support ratings remaining in the low-to-mid 20s and Green Party support falling below the 2 percent level. The election proves to be a nightmare for the government parties. Fianna Fáil end up practically losing a seat in every Dáil constituency (bar Laois-Offaly!) and even losing two seats in some constituencies, leaving the party without a TD in some constituencies such as Kerry North, Dublin South East and Dún Laoghaire. The Green Party fails to even come close to holding any of their six Dáil seats, most of which fall into the hands of the resurgent Fine Gael and Labour. With the number of Fianna Fáil Dáil seats left in the mid to high 40s, their only hope of retaining power lies in a left-wing coalition with Labour and Sinn Féin dashed by Labour’s reluctance, even in the face of being promised “the sun, the moon and the stars” by Brian Cowen, to be the party that revives the zombified corpse of Fianna Fáil. Brian Cowen becomes the first ever Fianna Fáil leader to leave his post while the party is in opposition, and the party faces into an uncertain future, facing the prospects of being out of power for longer than one Dáil term.

Likelihood: Given the volatile nature of the Green Party support base and the party’s dependence on vote transfers from Labour and Fine Gael in recent general elections – which are likely to dry up in 2011/2012, the prospects of a Green whitewash at the next general election are real. But, as we get closer to the next general election, I would expect Fianna Fáil support levels to recover on their currently low levels and the 25% level recorded in last year’s local elections.     

The Frankenstein scenario aka the “Sure, It Could Be Worse” scenario: Popularity ratings for the government parties start to improve somewhat during the final years of their term in office, re-electrified by evidence of a recovery in the economy, to the point that, after a competent campaign wherein Fine Gael and Labour fail to delver a killing blow, support levels for Fianna Fáil and the Green Party in the general election are down on their 2007 levels, but not dramatically so. While the Greens lose over half their seats, only retain two of their seats (Dublin North, Dublin South), their electoral performance proves to be better than expected and they also poll respectably in constituencies such as Clare, Cork South Central and Louth, leaving the party with hopes of regaining their lost seats and claiming new seats at a subsequent general election after another period in opposition. Fianna Fáil percentage share of the vote falls in the mid-to-high 30s and, though this represents the party’s lowest share of the vote since they first won power in 1932, the better than expected electoral performance means that they remain the largest party in the state in terms of Dáil seats and the party engages vigorously in post-election negotiations to form a government. While Fine Gael and Labour win a sufficient number of seats to from a government with a small majority in Dáil Éireann, Fianna Fáil manages to stay in power by offering Labour a deal that “they can’t refuse”, including an acceptance of virtually all aspects of Labour’s election manifesto and an agreement to rotate the post of Taoiseach.

Likelihood: Not by any means beyond the realms of the possible, especially given the existence of a residual personal, or localised, for individual Fianna Fáil candidates (“good constituency workers”) even at the worst of times. While Fianna Fáil (at 22%) currently trail Labour (at 24%) in the opinion polls, as we saw with the local elections, when it comes down to the actual voting Fianna Fáil will tend to outpoll Labour significantly mainly because of Labour’s weaker party organisation and the significant areas within the state where Labour Party support is minimal or non-existent. As for Labour going into power with Fianna Fáil, well that’s not likely surely…oh hang on, what about 1992!!!

The Dracula scenario aka the “They Haven’t Gone Away, You Know” scenario: With an unexpected sudden recovery in Irish economic prospects in the lead up to the general election, Fianna Fáil’s support levels improve dramatically over a very short period of time, motivating the party faithful while demoralising the opposition who are left wondering if they will ever manage to get Fianna Fáil out of power. The reinvigorated Fianna Fáil machine manages to capture all the kudos from the resurgence in government popularity, with the Greens lacking the political nous to likewise capitalize, and a strong campaign sees the party’s support levels returning to the levels enjoyed in 2002 and 2007. While the Greens face into the political wilderness, with few or no Dáil deputies, Fianna Fáil is able to form a new government with support from independents and/or Sinn Féin. Fine Gael and Labour are left stunned by yet another electoral reverse, especially after having enjoyed a massive mid-term lead in the polls, and the prospect of permanent Fianna Fáil government starts to look very, very real.

Likelihood: This scenario looks about as likely as a Laois All-Ireland win at the moment, but remember that Fianna Fáil also experienced a mid-term slump in popularity and a bad local/European elections (albeit not to the levels experienced in 2009) during the lifetime of the last government, but ended up winning almost the same level of support in the subsequent general election (2007) that they did in the 2002 General Election. There are two rules to observe here. The first is that most governments experience a loss of support in mid-term, second-order elections (such as local and European elections in Ireland/the UK, or Senate/Congressional elections in the USA) before gaining support again at the following general election. Based on this rule, some degree of a resurgence in Fianna Fáil support in 2011/2012 is likely and the election may ultimately boil down to how skillful the Fine Gael and Labour leadership is in facing/resisting this. The second rule of thumb is the “it’s the economy stupid” and the fact that government survival at general elections ultimately depends on the state of the economy – in which case, a persistently weak Irish economy over the next two or three years will leave Fianna Fáil with little prospect of retaining power, although their support levels will probably recover somewhat relative to their current low ratings.

(A post containing a geographcial perspective on the next general election contest can now be viewed on the companion NUIM Geography’s Eye On The World blog.)

Update: Do great minds think alike? This blog posting proved to be very similar in tone to a piece in this week’s (Sunday, February 14) Sunday Tribune!!!

Adrian Kavanagh