Doing the State some service

ECONOMICS:The importance of the services sector is often underestimated, but this year the economy is banking on further strong growth in services exports for its salvation, writes Paul Tansey.

SERVICES ARE Ireland's biggest business. The services sector employs two out of every three people at work in Ireland, while services account for more than three-fifths of the gross value added (GVA) generated in the economy.

(GVA measures the contribution to the economy of each individual producer, industry or sector and is used in the estimation of gross domestic product.)

In recent years, the services sector has assumed an even more important role in the economy. Services are now the engine driving the State's export growth. In the last year alone, services exports increased by almost €10 billion to close to €65 billion. This year, the economy is banking on further strong growth in services exports for its salvation.

The Economic and Social Research Institute forecast last week that real gross national product would grow by 1.6 per cent this year. But even the attainment of this anaemic growth rate assumes a near-10 per cent volume increase in non-tourism services exports during 2008. If services exports fail to deliver on expectations this year, then economic growth will be even slower than current forecasts indicate.

The economic importance of the services sector is often underestimated. However, services accounted for more than three-fifths of all GVA generated by the economy in 2007. In terms of its value-added contribution to the economy, the services sector is seven times more important than construction and almost 2½ times as important as industry.

The pre-eminence of services is also reflected in the economy's employment profile. In 2007, the national workforce numbered 2.1 million. Of these, 1.4 million work in the services sector.

Services have also been the principal source of employment growth since 2000. The numbers at work in Ireland increased by 425,000 between 2000 and 2007, and the services sector delivered almost 350,000 of these jobs. Thus, four out of every five jobs added to the workforce since 2000 stemmed from services.

However, in spite of their contributions to both GVA and employment, services enterprises have been seen traditionally as second division. In part, this reflected an archaic materialism that rated only physical output as serious business. In part, it mirrored a sense that services, with the exception of tourism, were quite literally insular, tied largely to the home market.

However, this traditional view has been usurped by the exceptional performance of services exports since the millennium. Between 2000 and 2007, the value of total Irish exports increased by 52 per cent to €149 billion, a good, but not a great, performance.

However, as shown in the table below, aggregate export growth over these years masks two quite different trends.

The value of merchandise exports advanced by just 4.4 per cent between 2000 and 2007, reflecting, among other things, continuing downward pressure on export prices for goods and the erosion of Irish price competitiveness in commodity-type product markets.

In marked contrast, the value of services exports increased 3½-fold during these years, rising from €18.3 billion in 2000 to €64.8 billion last year.

This surge in the overseas sales of services has completely transformed the profile of Irish exports. In 2000, services exports comprised just 18.7 per cent of all foreign sales by Irish-based businesses. Seven years later, the share of services in total exports had risen to 43.4 per cent.

This great leap forward in services exports has touched every segment of internationally traded services. In value terms, exports of business services increased sixfold between 2000 and 2007, exceeding €20 billion last year.

Exports of business services include trade-related merchanting, operational leasing, and research and development services. Overseas sales of computer services, principally software, more than tripled over the same period, reaching €19 billion in 2007. Together, these two services segments generated €39 billion in foreign sales last year - equivalent to almost half the value of all merchandise exports.

In similar fashion, exports of insurance services have risen sevenfold since 2000, while foreign sales of financial services have almost tripled over the same period.

The domestic boom is drawing to a close. Ensuring steady growth over the medium term requires a reallocation of the economy's resources from home demand to export sales.

However, judging from trends since 2000, the scope for expanding merchandise exports is quite limited. With new entrants crowding the global marketplace, competition in commodity-type product markets is growing in intensity. At the same time, Ireland's ability to compete on price in such markets is hamstrung by a high domestic price level, above-average inflation and a strengthening euro exchange rate.

A recalibration of the State's export drive should centre on services.

Over the past seven years, services have demonstrated a capacity for sustained export growth. Services exports are increasingly concentrated in markets that are sophisticated and where products are both knowledge intensive and highly differentiated. They offer Irish exporters a greater opportunity to avoid the commodity trap, where competition is based primarily on price. And price wars on export markets are battles that Irish exporters are destined inevitably to lose.