Reduced costs are not the route to export competitiveness

Proinnsias Breathnach: I sent the following to the Irish Times in early December but it wasn't published:

The ability to penetrate export markets is the crucial ingredient upon which Ireland’s recent economic success was built. Today, exports of goods and services are the equivalent of over 80% of gross domestic product compared with less than 30% in 1960. However, the basis of Ireland’s exporting success is very poorly understood by most Irish economic commentators and by the politicians who come under their influence.

There is an extraordinary unanimity among economists that Ireland has been losing international competitiveness and that this is attributable to rising wage levels relative to our main trading partners. This view of Ireland’s competitive position is not only simplistic and erroneous but could be profoundly damaging to this country’s economic future.

In the modern global economy the recipe for competitiveness is a complex mixture of a wide range of ingredients. Up to now Ireland has managed to produce a good blend of these ingredients and, while the unsustainable boom conditions of the 1990s are now well behind us, the export sector has, for the most part, continued to perform quite solidly. Contrary to what appears to be a common view, Ireland’s exports grew in real terms (i.e. allowing for price changes) in each year between 2000-2007. Export volumes did fall by one per cent in 2008, and have fallen further in the first six months of 2009. However, the rate of export decline has been much lower than for the EU and OECD countries at large, which means that Ireland’s share of export volumes in both these regions has actually been growing.
Between 2000-2008 Irish exports grew by a total of 47% in real terms. While Ireland’s share of total world exports (in current value terms) did fall slightly in this period, this was due mainly to contraction in the electronics sector arising from growing competition from Asia, and particularly China. By contrast, Ireland has increased its share of global exports in six key sectors which, between them, now account for one half of our total exports: computer services (mainly software), insurance, financial services, other business services, odourifous mixtures (mainly drink concentrates) and heterocyclic compounds. Ireland’s share of global exports in some of these sectors is extraordinarily high, ranging from 18% (insurance services) through 21% (computer services/software) and 28% (heterocylic compounds) to 40% (odouriferous mixtures).

Strong growth in these sectors clearly has not been inhibited by rising labour costs. It could be that, unlike elsewhere in the economy, productivity is rising more quickly than wage costs in these particular sectors. However, in order to properly understand why Ireland might have a competitive advantage in sectors such as these requires a somewhat more sophisticated analysis of the nature of competitiveness than has generally been offered to the Irish public by our politicians and economic commentators.

The National Competitiveness Council (NCC) was established in precisely to provide such analysis, which it does in its annual Competitiveness Report. Unfortunately, the fruits of the NCC’s labours appear to have never troubled the gaze of those who seek to influence or formulate Irish economic policy. In its Competitiveness Reports, the NCC uses 18 different indicators (just one of which relates to productivity and labour costs) to assess Ireland’s competiveness. These include, inter alia, business environment and performance, physical and knowledge infrastructure, prices and costs, productivity and innovation. However, the NCC does not quantify these indicators in a way which would allow them to be compared with each other, or combined together to create a composite competitiveness index which would allow Ireland’s overall competitiveness to be monitored over time.
However, such an index is produced in the Global Competitiveness Report published annually by the World Economic Forum (WEF), the Swiss-based independent think-tank organisation. The WEF’s Global Competitiveness Index (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 GCI is compiled from no less than 113 different indicators, divided into twelve “pillars” of competitiveness (education, efficiency of labour and product markets, business sophistication, innovation, 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.
What is more, while Irish economists have been decrying Ireland’s declining competitiveness, the WEF have been moving Ireland up its competitiveness league table, from 30th position in 2002 to 22nd in 2009. From their point of view, Ireland’s key competitiveness weakness lies in infrastructure, along with small market size and the country’s current macroeconomic stability problems. Labour costs are not mentioned.

Evidence from other sources vindicates the WEF’s relatively sanguine view of the direction in which the Irish economy is moving. According to the IDA, the rate of return on US investment in Ireland rose from 19% to 22.5% between 2000-2007. This is over twice the EU15 average and is only surpassed by China, India and Singapore. In 2008 Ireland was the most successful country in the world in attracting foreign investment, up from tenth place the previous year. These are hardly the signs of a country in competitive decline.

Ireland’s economic future lies in maintaining and enhancing the country’s attractions for high-end inward investment. Inward investors repeatedly highlight the skillsets of Irish workers in this context. Spokespersons for the foreign sector have regularly emphasised the importance of continued and expanded investment in education – at all levels – and technological know-how. This was the key message in an article by Jim O’Hara, General Manager of Intel, published in the Irish Times on November 13 last.

Yet the Government appears to have swallowed, hook, line and sinker, the argument that reduced costs are the key to enhanced export competitiveness. This argument is being routinely used to help justify the current programme of spending cutbacks. While there is an obvious need to contain costs, it would be misguided to do so on the basis of false premises. The way to strengthen Ireland’s competitiveness is through expanded spending in education. Spending cuts in this area in order to balance the books in the short term could have very negative long-term consequences.