Proinnsias Breathnach: The extraordinarily blinkered and simplistic preoccupation of Irish economists with labour costs was once again in evidence in a book review by Michael Casey, former Chief Economist of the Central Bank, published in the January 4 issue of the Irish Times. Reviewing Graham Turner’s No way to run an economy (Pluto Press), Casey offered the following observation: “multinationals are now more or less beyond the control of the authorities and will shift production to any country in the world to avail of lower wage costs”. This gives the impression that the main consideration of multinational companies (MNCs) in choosing overseas locations is wage costs.
In fact, when one strips out investment in oil-rich economies such as Saudi Arabia and the United Arab Emirates, tax havens such as the Cayman and Virgin islands and the traditional four Asian tigers (Hong Kong, Taiwan, Singapore and South Korea – still included among the “developing economies” by the World Bank etc), the proportion of global foreign direct investment stock located in low-wage economies is of the order of 15%, and even in these cases, much of the investment is oriented towards serving local markets (China, India, Mexico, Brazil) rather than exploiting cheap labour. The fact is that the vast bulk of overseas investment by MNCs is located in high-wage economies, demonstrating that low wages are, at best, a minor factor in influencing multinational investment patterns.
In the same book review, Casey offers a second observation which is so off the mark as to be downright risible: “The lack of demand in the US economy is also due to the compression of wages. This was caused by multinationals leaving en masse for cheap-labour countries.” That someone who is currently a board member of the IMF could offer such a simplistic and erroneous view of what is a highly complex phenomenon is actually quite disturbing.
The idea that US multinationals have been relocating jobs en masse to low-wage economies is simply not true. For a start, the great bulk (70%) of employment in US MNCs is actually located within the USA itself. An even greater proportion (80%) of overseas employment in US MNCs in located in other developed countries. This is reflected in the fact that (according to UNCTAD data) the average overseas employee of a US MNC earned almost $38,000 in wages/salaries in 2005 i.e. 86% of the average salary of all US employees in that year. These are crude averages, but the orders of magnitude are nonetheless indicative. When one allows for overseas investments by US MNCs which are primarily designed to serve local markets, it is likely that the search for cheap labour accounts for less than ten per cent of all overseas employment in US MNCs.
In 2005, overseas employment in US MNCs was the equivalent of 8 per cent of total employment within the USA itself. This suggests that, if all jobs relocated overseas to access cheap labour were to be repatriated, it would increase employment in the USA by less than one per cent. Clearly, such relocations have had, at best, a marginal impact on US wage levels. If Michael Casey is looking for causes for the compression of US wage rates (which are lower now in real terms than they were forty years ago), he might do better to look at other factors such as large-scale immigration of unskilled workers from abroad, low education and skill levels among large swathes of the indigenous population, anti-trade union legislation and the absence of the social protections for marginal groups which are found in more civilised societies elsewhere.
18 comments:
An informative piece. And quite a good line of argument. On this Blogsite are we talking to ourselves on the relevance of wage costs? After the report of the Three Wise Men calling for pay freezes, back in 1984, was demolished by the Socialists Economists "Jobs and Wages, the True Story of Competitiveness," the consensus eventually became much more sophisticated on the complexity of the issue. Now after the A bomb was dropped on the world eocnomy by the bankers, it seems we, rather, most mainstream economists, are back in a class of Stone Age economics of wage costs. Or is it simply Class War economics? They dont even talk of unit labour costs!
An excellent piece. The US is also a major centre for inward investment. The Irish based multi-national CRH has 46,000 employees in the US. This is amount 9 times the number of employees of the 2 largest US employers in Ireland, Wyeth-Pfizer or Boston Scientific.
The US has also attracted major investment from many German companies,including all of the larger renewable energy companies and Mercedes. A skilled workforce close to large markets makes the US an attractive location for well paid jobs.
In the same way, Boston Scientific, Abbott and all of the other stent makers are located in Ireland.The vast majority of the world's stents are now made here and the pool of knowledge and manufacturing experience that that strength gives is huge. Wages are generally only a very small part of a MNC's cost base. The quality of an appropriately educated and skilled workforce, at all of the levels of the manufacturing process is far more important.
Clearly, such relocations have had, at best, a marginal impact on US wage levels.
You're underestimating the deterrent effect provided by the mere existence an offshore operation. The simple fact that say an IT company has an offshoot in India, or even Ireland, is often sufficient for the US-based employees to moderate their wage demands, and generally incearse productivity. The off-shore element may be small in comparison to the company's overall size, and there may not even be the skills-base available to take over certain functions. But you can be sure that the prospect (however unrealistic) of one's job being off-shored concentrates the mind wonderfully. I've observed this effect myself at first hand.
In answer to Proposition Joe, the fact remains that, as Proinsias Breathnach points out, there are other far more important factors in average wage movement in the USA. In relation to the main point of Proinsias's blog, the question is why Michael Casey wrote what he wrote. MC must know, as PB indicates, that the situation is more complex than he suggests. So, is he simplifying in order to make political or ideological points? This seems to be a regular habit, sometimes even unconscious, among establishment economists.
Very good piece.
In the Irish context, the clamour for wage reductions is based on three entirely spurious notions:
1. That wages determine investment, including FDI, demonstrated in this article from Proinnsias
2. That relative unit labour costs are either high or rising in Ireland. They aren't as refered to in the recent Martin Wolf article in the FT.
3. That MNCs, or even the small number of large Irish firms are calling for lower pay. They aren't. They are calling for increased investment.
That section of Irish business, the smaller producers that IBEC represents, export very little by comparison, as the CSO export data demonstrate. Their call for lower wages is the age-old plea of the backward proprietor who cannot/dares not compete abroad, and attempts to stave off marginalisation by gouging workers and consumers alike.
@ Proposition Joe
It depends on the industry. If it is a software development company, then it practically has zero transport costs and can threaten relocation. At the other extreme a mining MNC can't threaten to relocate.
The majority of FDI is between rich countries, and MNCs usually trade off the cost of transporting a good towards their target market and the cost of establishing a plant in that country.
However as most developed economies are dominated by the non-tradable sector I am not very convinced that offshoring has a major impact on wages in any developed economy.
One can understand why indigenous Irish business and its economics spokespersons (sometimes hiding behind the guise of business journalists) would use the need to cut labour costs to improve foreign competitiveness as a smokescreen to improve their own profitability. But one might expect a more enlightened contributions from our academic economists who are also almost unanimously tied to the simplistic and dangerously erroneous “competitiveness equals low labour costs” formula.
The fact that the National Competitiveness Council in its recent reports has played down the labour costs issue while highlighting other aspects of competitiveness has met with one or other of two responses. The most common response is to simply ignore the NCC. Thus, in a setpiece lecture to an invited audience of the great and good in Galway during the week, government adviser Alan Aherne once again emphasised the importance of labour costs in restoring Ireland’s competitiveness, even though the previous week the NCC issued a major report which made no reference to labour costs in this respect.
The other response is to attack the NCC reports. Writing on the latest report during the week, Pat McArdle of the Irish Times expressed surprise that the report said nothing about wages in general and the minimum wage in particular, which he reckons is hindering our competitiveness. A reduced minimum wage might be good for the profitability of Irish shopkeepers, hoteliers and contract cleaning firms but it is hard to see what relevance it has for the chemical workers, stent and software producers and financial services workers who are our main sources of exports. Meanwhile over on the Irish Economy blog I see Paul Hunt has been dismissing the NCC as a government mouthpiece whose reports lack analysis and “crunch recommendations” and querying its very purpose and existence.
As for Proposition Joe’s suggestion that multinationals use the threat of overseas relocation to contain wages in the USA, as Rory O’Farrell suggests, relocation to low-wage economies is only an option for a very narrow range of manufacturing industry. Most US industry is non-tradable due to natural resource orientation, perishability, transport costs, and the increasing emphasis on customised production and just-in-time delivery of components. A large proportion of the tradable sector involves skilled high-tech work which generally can’t be moved to low-wage economies. Furthermore, the routine assembly and packaging which has been the typical kind of work favoured for offshoring is the kind of work which is most amenable to automation using new technology.
In any case, Michael Casey in his book review was referring to US wages in general, and not just manufacturing wages. Manufacturing accounts for just 13% of total US employment. There are very few service activities that can be relocated to low-wage economies. The idea that the threat to relocate might have a significant bearing on the low level of wages in the USA has very little basis.
@Rory
What sort of activity is an American NMC in Ireland more likely to be involved in, software development or mining? Baring in mind while you answer that, we're no Western Australia. I should think software development is the more relevant example to consider by several orders of magnitude.
Which leads me to question the relevance of the stats Proinnsias uses to support his original post. I fail to see the value from an Irish perspective in comparing say wage levels in a US-owned banana plantation in Costa Rica, or a vanadium mine in South Africa, to a basket of US wages across the entire indigenous US economy (the bulk of which, as you say, is not amenable to off-shoring anyway).
Surely to inform policy-making here in Ireland we should:
(a) concentrate our attention on MNCs engaged in those activities which dominate the FDI sector here (ICT, pharma, medical devices, financial services)
and:
(b) compare only against wages levels in those same sectors of the domestic US economy.
No investment decision taken in a US boardroom is ever going to be driven by comparing average wages across the entire US domestic economy, against average wages across the foreign operations of all American NMCs. Rather, the only wage comparison worth doing would focus on the individual economic sector, or even just to wage levels within the company's existing operations. I've certainly seen tabulations of ballpark per-engineer cost (base salary + benefits + payroll taxes + office space + administrative support) across existing development sites in different geographies. I doubt these data wouldn't be consulted at least when making micro-investment decisions (i.e. whether to base this role or small project at site A or B).
Similarly I think Proinnsias takes too wide-angle a view when dismissing the domestic wage-pressure argument. Obviously this phenomenon only holds in those US companies either with current or potential future off-shoring. Zooming out to mask this effect within the data relating to the broad economy (including the vast bulk of firms who will never off-shore) doesn't really stand up as argument on the existence or otherwise of this phenomenon. The point isn't whether the phenomenon is widespread among US firms in general, more whether its prevalent in the small subset of US corporations who are likely to ever invest in Ireland.
@ Proposition Joe
I agree that US MNCs are mainly in the export sector. I also agree that using statistics for the average may be misleading.
I consider that when making overall cross country comparisons of wage costs the appropriate measure is real unit labour costs. Nominal unit labour costs are really only relevant for export sectors. Unfortunately to calculate nominal unit labour costs for the export sector we would need some form of relative price index for that sector, which to the best of my knowledge is not available. However I would be surprised to find that nominal unit labour cost in the Irish export sector were particularly high.
I am surprised however that you focus only on US MNCs. I believe Ireland has a fixation on US MNCs. Perhaps this is due to our generally poor language abilities in Ireland that we do not look more to other European countries for inward investment. Also, US MNCs in Ireland usually export to other EU countries, so we should benchmark against costs in other EU countries rather than the US. As labour costs are usually a small proportion of overall costs for these companies we really need to take more action on costs such as transport, rent, finance etc rather than labour.
While exports are essential for long term growth, Ireland does have one of the highest export/GDP ratios in the world. This suggests there is some scope for import substitution and/or growth that relies on domestic demand (though it should not be exagerated).
@Rory
I am surprised however that you focus only on US MNCs. I believe Ireland has a fixation on US MNCs.
Well, our FDI outreach is fixated on the US for a very good reason. There are a number of strong pull factors to US firms (access to EU market, common language, compatible culture, closest European timezone) that aren't in play at all when trying to attract investment from our continental European neighbours.
Ireland does have one of the highest export/GDP ratios in the world. This suggests there is some scope for import substitution
Much of these "exports" are in fact temporary imports of profit to bask awhile under the warm glow of our low corpo tax regime. So I don't think this correlates strongly to potential for import substitution.
The determinants of the decision to locate US FDI in Ireland was examined by Patrick Gunnigle and David Magure in and Economic and Social Review (Volme 32, No, 1) 2001. The findings are fully consistent with the tenor of Prionsais's excellent post. Ireland's corporate tax regime was found to be of critical significance in this regard. The study concluded that "Labour costs was not
a critical factor in the location decision of the multinational companies studied" (2001, p.61)
@Eoin
I don't have access to the paper by Gunnigle & Magure, but just going by the date of publication, I'd imagine their conclusions are based on data a decade old or more.
There have been many crucial changes since then:
* massive changes in the US economy (the dot com boom & bust followed by rampant financialization)
* a boom in the Irish economy diminishing the hyper-competitive position we held when Gunnigle & Magure study was done
* transformation in the share and type of FDI we've been able to attract (our share of worldwide FDI has declined by half and the tech commodity manufacturing sector, typified by Dell & Gateway2000 at the turn of the century, no longer exists here)
* transformation of the competitive landscape within the EU (with the accession of countries with lower taxes, lower wages and educated workforces)
So unless we invent a time machine and travel back to the nineties, I don't see that Gunnigle & Magure's conclusions would have much weight in the current debate.
@ Proposition Joe
I agree that export figures may be suspect, but not import figures.
In Q3 2009 Irish imports were 68% of GDP (so even more of GNP). Belgium, which is also a small country had about 71%. Belgium is sandwiched between France, Netherlands and Germany, so I would expect a high import share.
Austria's import share is 46%, Denmark's 42%, and Finland's 33%. So for our size we import more than average. Given our peripheral location I would expect we import even less. I do believe we have some scope for import substitution (but again I say this is limited).
To be honest I don't agree with some of the arguments of why we attract US FDI. In Netherlands most people can speak English (and its probably easier to understand than the English spoken in Cork!). I don't really believe that our culture is sufficiently different from that of France of Germany to attract FDI from the US.
I suppose a reason we don't attract more FDI from France and Germany is that proximity to markets is a huge factor in determining plant location, and, apart from in the Gaelscoileanna, a low emphasis is placed on language learning.
Data from the Bureau of Economic Analysis provides an interesting perspective on this debate.
Between 1999 and 2007 the average dollar cost of compensation of US MNCs in Ireland doubled. This brought us from a position of below EU (15) average to just above EU (27) average and roughly inline with the UK. However, over the same period the number of US affiliates located in Ireland increased by approx 40 percent, the value of capital investment, plant and asset values etc all increased by multiples of compensation costs and the EU expanded to include a number of lower income countries. Neither the level of investment nor its returns on show much relationship to the level of compensation costs.
If they did we should expect all investment to move to China where compensation is much lower (it hasn't) and returns (potentially though not always) higher. The reality repeated studies have shown that this doesn't happen.
@Damian
Does the Bureau of Economic Analysis have anything to say on how Ireland's share of total US-originated FDI changed over that period?
Certainly our share of worldwide FDI declined precipitously, from something like 4% to 2%.
This is the key trend to look at. Not the raw dollar amount, which may be growing while at the same time our share of total FDI declines.
@Rory
Given our peripheral location I would expect we import even less.
There's something proto-Lemassian about this argument. Is peripheral location really such an issue? Have you looked at the labels on the fruit & veggies in your local supermarket lately? If the produce is coming all the way from Africa or the Middle East, I don't think the extra distance from France to Ireland is really such a big issue.
But if we were really hot on import-substitution, the first thing we should look at is energy imports. Building ourselves a couple nukes would enable an enormous about of import substitution.
Even so, I'm not sure Irish-style Juche thinking is that appropriate to our situation given our current ultra-open economic posture.
I suppose a reason we don't attract more FDI from France and Germany is that proximity to markets is a huge factor in determining plant location
What about the small matter that companies in France and Germany already have access to the single European market?
Thus neutralizing one of the biggest selling points we have when courting US-originated investment.
@ Proposition Joe
With regard to French and German MNEs I agree that one reason they do not set up in Ireland is that they already have access to the EU markets. They are closer to the core EU markets in both a geographical sense and in terms of transport/market adaptation costs. However I do feel we are putting most of our eggs in one basket by concentrating too much on US FDI.
I consider our above average level of imports to be a sign of imbalance in our economy. I agree that energy is the main sector that is responsible. Even in the troughs of a recession the oil price remained much higher than 10 years ago, and the price will only go up. Instinctively I am not a fan of nuclear, but I would welcome a debate that included the nuclear option.
As oil prices go up import substitution will be forced upon us. We can prepare ourselves however, and try get ahead of the curve. I notice that you mention food. Though we will never produce figs and pineapples here, we can substitute Irish chicken for Thai imports. As oil prices increase it will become uneconomical to import chicken from Thailand anyway.
I am in no way looking for a return to De Valera era policies of autarky, and as I stated exports are crucial the crucial factor for our long term growth. However, we should not completely ignore the domestic market.
Joe, my point of highlighting the BEA data is to further demonstrate that the link between wage levels and investment is at best tenuous. Government policy needs to reflect this.
Your point about shares of global FDI is interesting. We know that globally FDI has expanded dramatically over the past decade. Some of this has been driven by developing markets, and more accounts for the growth of international mergers and acquisitions, including once off acquisitions (e.g. Royal Dutch Shell in 2005 had a massive once-off effect on UK FDI data for that year). That Ireland might decline in this environment does not tell much us much about competitiveness.
One advantage of the BEA data is that it is non-bank based and can be benchmarked against other countries where US non-bank investment is reported. You might be surprised that between 1999 and 2007 Ireland's proportion of US affiliates, percentage of capital investment in all countries, assets, value of net plant and equipment have all increased (e.g. capital expenditures in Ireland increased from 1.9% to 2.6% of expenditures in all countries). As with all datasets there are weaknesses, but the trends in the data are very interesting.
This is not an argument to say that we don't have competitiveness issues, but we need to identify clearly where they are.
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