Hunting for woolly mammoths

Michael Taft: In a previous post, where I disputed the economic benefits of cutting wages, Professor Alan Mathews and Pavement Trauma questioned aspects of my analysis, raising important issues which deserve a considered response. For this goes beyond ‘what wage levels are best’; it is about defining what the critical issues behind our competitiveness and prospects for future employment really are. We we may put a lot of time, energy and resources going down one path only to discover that is dead-end, that we should have gone down an altogether different path. We may go hunting for woolly mammoths and may end up finding ourselves being the hunted.

Indeed, we have to be sure we are addressing the same issue. The argument that we should reduce wages to increase employment is not quite the same as the argument that we should reduce wages to increase competitiveness. The first assumes that wage ‘correction’ will facilitate new, more employment-friendly market conditions. The second assumes that wages are a structural part of the ‘loss of competitiveness’. So which are we addressing – or, if we cut wages, do we get a two-for-one?

Wage Share and Final Demand

Both Alan and Pavement Trauma suggested my use of wages was too restrictive, not taking into account the economy-wide benefits of a general wage reduction. I had argued that, taking one example, cutting wages in the computer services sector would have little effect since wages make up only 13 percent of total operating costs in that sector.

Alan stated that a more correct approach would be to look at the totality of wage cuts – for in a firm, wage cuts will not only affect its particular labour costs, but affect the labour costs of those companies sourcing it:

‘. . . think about those purchases of goods and services which the computer service firms have to make. Some of these goods and services will be imports, whose price is not affected by Irish wage levels. However, to provide the domestically-sourced goods and services bought by the computer services industry, other firms have to combine both imported and domestically-sourced raw materials and inputs with domestic labour and capital. So a reduction in wages in the industries supplying the computer services sector would also reduce the cost of its purchases of domestically-sourced inputs . . Thus the problem in your analysis is that you do not take into account the indirect as well as the direct effects of a general reduction in wages across the economy.’

Alan goes on to suggest using the CSO’s input-output tables to get a better assessment of the impact of a generalised wage cut:

‘ . . .the economy-wide ratio can be calculated as pay costs (€66.0bn) as a percentage of final expenditure (€232.6bn) or 28%. The other shares are imports (38% contribution to the final price) and gross operating surplus (33% contribution to the final price) with taxes not related to products playing a negligible role.’

In this construction, wages make up 28 percent of the final expenditure of all industries and services. Even so, cutting wages by 5 percent (the figure I used in the previous post) would still only reduce economy-wide final expenditure by 1.4 percent.

Therefore, the impact on direct and indirect inputs from a 5 percent general reduction is questionable. There are many inputs which would be unaffected by a wage reduction. As Alan pointed out, imports are one. 38 percent of final expenditure goes on imports but in many areas – notably, our modern export sectors – imports make up considerably more.

• Chemicals / Pharmaceuticals: 58.4 percent
• Office Machinery: 88 percent
• Recorded Media: 52.2 percent

In these sectors, dominated by import consumption, not only will reductions in direct wages have little effect, wage reductions among domestic suppliers will have little effect as well, since these, and the general multi-national sector, source so little from Ireland.

Moving to the enterprise level we would find inputs that would be little affected by the reduction in wages (that is, if we had more than just sketchy data). For instance, wages in Dublin retail enterprises are considerably lower than retail enterprises in Maastricht – considerably so. Yet, operating costs in Maastricht enterprises are lower. One reason is commercial rents which are six times less than in Dublin. Cutting wages will have no effect on this input.

We might even look to the energy sector, as these costs are high. But with the main supplier – the ESB – you could slash wages by a considerable amount with no effect on prices, since the Regulator sets ESB tariffs at a high non-market rate to facilitate private investment.

In conclusion, if wages were cut by 5 percent, the total amount of final demand would fall by 1.4 percent (and for key export sectors – even less). It is not unreasonable to ask whether this fall would result in enhanced competitiveness.

Comparative Wage Costs

In any event, to suppose that competitiveness will improve with a reduction in wages presupposes that wage increases are, themselves, an issue in competitiveness. How can we measure this? One way of doing this is by comparing labour costs. The latest figures come from the Destatis, the German Statistical Board – 2008 4th quarter:

Irish labour costs in the private sector are below – well below – labour costs (measured in per hour) than all other countries, bar one, in our peer group (that is, the top 10 EU economies).

Even the one exception – the UK: it’s not that Irish wages are rising faster but that Sterling is deteriorating. Destatis states that UK private sector wages fell by 10 percent in the year up to 2008 4th quarter but this didn’t happen in the UK – it happened in the currency markets. In the UK, wages actually increased by 4.4 percent (compare that to Irish wage increases of 3 percent according to Destatis).

The important point here is that if Irish labour costs are already substantially below those of other countries, how can reducing our overall labour costs even further contribute to an increase in our ‘competitiveness’? It’s interesting to note that a spokesperson for Failte Ireland which commissioned a study on costs in restaurant (where wages do make up a significant proportion of costs), was somewhat blasé about the role of wages.

‘“While the recent economic slowdown has moderated cost pressures and, in some cases, led to cost reductions, concerted action will nevertheless still be required on the part of restaurants to contain costs.”

Asked if wages should be reduced, Mr Pender said wages were not all that high to start with. Of the restaurants surveyed, the average hourly rate was €11.67 for chefs, €9.49 for kitchen porters and €9.78 for waiting staff. Ireland’s current minimum wage is €8.65 per hour.’

Understandable. It’s not like anyone could argue that an annualised wage of less than €25,000 per year for trained chefs could be considered ‘too high’.

Will What is Happening Continue to Happen?

Another argument is that reducing wages will contribute to employment creation, thus cancelling out any deflationary effects (e.g. lower consumption, less tax revenue per head). But this contains a number of assumptions that may not play out in the economy – never mind, the Irish economy – in the way that it is intended. Let’s take one small look at what is happening with earnings and employment in the manufacturing sector – always remembering that is just a snapshot which might not reflect longer-term trends.

• In the first quarter of this year, the hourly earnings of production workers fell by nearly 1 percent. The number employed fell by 7,000, or by 5.8 percent.

• In that same quarter, the hourly earnings of management rose by 6.5 percent and experienced no job losses.

Interesting that the sector that saw their hourly earnings fall was also the sector that saw job numbers fall. I wouldn’t push this too far – we’ll have the opportunity to review a longer time span when the new quarterly earnings survey comes out in a few weeks.

The point here is that we shouldn’t automatically assume that a wage decline will, of its own, create the conditions for increased employment. From this snapshot, we see that wage decreases and job losses among production workers have helped the management sector to increase their earnings and maintain their job numbers.

In other words, going forward in our analysis we will have to be careful to distinguish a labour market that is the totality of inputs that readjusts on the basis of changes in the supply-demand curve, and a labour market where outcomes are dependent on relative power-relations between certain, sometimes competing groups.

* * *

None of this is to dismiss the role that wages can play in economic recovery. But what it may require is a more forensic approach, combined with complementary social and industrial policies, rather than the mere fiat of wage reductionism. I will be addressing this issue shortly, for clearly in a relatively low-waged economy (relative to our EU peer group) with a high level of wage and income inequality and a very limited ‘social’ wage – action will need to be taken. If, however, we assume the ability of the market to ‘correct’ itself to the benefit of lower unemployment, we had better be on strong ground. Otherwise, we might end up making matters worse without addressing the real issues behind ‘competitiveness’ and unemployment.

We could get stampeded by a horde of woolly mammoths. And not a lot of good ever comes from that.