David McWilliams: There will be no relief for the squeezed middle

The price of third-level education has risen by 131 per cent since 2005, while the price of computer games has fallen by 63 per cent. The cost of clothes has fallen dramatically in the past decade and a half, while the cost of healthcare has risen exorbitantly. The price of furniture is much lower now than it was at the height of the boom, yet the price of childcare has gone up by 34 per cent.

These are the latest trends in prices and costs in Ireland. What is the reason for these huge disparities and what does this mean for the economy, the electorate and the political cycle?

Education, healthcare and childcare are people businesses, and people are expensive. These services can’t be outsourced to cheaper countries or replaced easily by robots. In contrast, manufacturing is hugely affected by transformational technological innovations. New technology has caused productivity in manufacturing to surge upwards, allowing prices to come crashing downwards. Productivity is the alchemy of economics: when a company can produce much more with much less, not only can its prices fall while remaining profitable, but wages in high-productivity areas can rise and the company can still make money.

Productivity explains how there can be more computing power in your tiny phone than in a giant 1970s space rocket, but the phone is a fraction of the cost of the Apollo; at the same time, there are far more people employed in tech at higher wages than in the 1970s.

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Spare a thought for people working in jobs such as teaching, healthcare and childcare. Productivity can’t go up in these sectors because robots can’t do the job of looking after babies, treating sick people or teaching children. (In some cases, robots could do parts of these jobs, but what government would want to introduce such a brave new world?)

There are other ways of increasing productivity in education, but they mightn’t be palatable. For example, we could increase class sizes to 100 or maybe 200, if we wanted to be more cost-effective. This would dramatically increase productivity and we could pay teachers lots more, but the electorate wouldn’t stand for it.

Similarly, we could increase doctors’ productivity by extending waiting lists fivefold, but that’s hardly a runner. And while we are at it, we could industrialise childcare by stipulating a minimum of 500 infants per creche, but that’s not going to happen.

You get the picture.

More machines

In the people’s eyes, better phones, laptops or cars means more machines at lower costs, driven by technology.

Better means more.

However, in the people’s eyes, better teaching means fewer children per teacher; better healthcare means fewer patients per doctor and better childcare means fewer infants per caregiver.

Better means less.

Fewer pupils, patients or infants per worker pushes productivity down. The lower the productivity, the higher the cost of the service and the higher the price of the service.

The reason the economy is growing quicker than most is that some parts of the Irish economy are incredibly productive

These thoughts went through my head listening to the teachers' unions giving out about wages this week. These classroom revolutionaries are members of the "squeezed middle" – large sections of the Irish middle class, hemmed in by high levels of income tax and high costs of living. At the end of the month, the squeezed middle has no money left. This is particularly the case for working parents with children still at home, which we know these days can last for a long, long time.

But why is this happening now, just when the economy is growing?

Interestingly, the answer lies in the fact that the economy is growing quickly. A growing economy is a counterintuitive beast. The notion that all boats rise on the growth tide is unfortunately only that, a notion. The reason the economy is growing quicker than most is that some parts of the Irish economy are incredibly productive. Transformative changes in technology are making some industries, such as multinational manufacturing industries, more and more productive.

In productive areas of the Irish workforce, where the level of wages is already high, wages are rising very quickly.

So far so good, but there’s a hitch: most Irish people don’t work in the multinational or tech sector. So what happens to them?

As wages rise in the tech and multinational sector, something strange happens in the economy, particularly when the economy is small and at full employment. The higher wages in high-productivity sectors actually drag wages up in low-productivity areas, making them expensive because (a) people simply leave the areas where productivity is low and head to the area where productivity is high, so these places have to raise wages to retain staff or (b) higher wages in the tech sector push up houses prices and this forces workers in low-productivity sectors (such as teachers) to agitate for a pay rise to maintain their standard of living. (This process is called Baumol's cost disease, after the economist William Baumol.)

Political practicalities

Lower productivity areas of the economy are forced to pay higher wages to retain employees. If they can’t offer higher real wages, they must attract workers with better conditions, more job security or longer holidays. This has the effect of driving up prices and costs in the lower-productivity sectors.

Now think about who supplies big sectors such as education and health in Ireland. The State provides these services. As the cost of these services goes up, so too does the State budget outlay.

However, if costs are rising more quickly than the price of other services,  the amount of tax the government has to levy to pay for these more expensive services also goes up.

Now let's go back to the squeezed middle or, as they have also been called, "the people who get up in the morning". How can their income tax bills be cut if the cost of things such as education and health are going up? They can't, unless the State finds something else to tax – or cut spending on health and education services. And that's not going to happen  – for the Fine Gael minority Government, or any party, it would be politically impractical, now that we are facing into another election cycle.

The squeezed middle is going to be squeezed for some time to come.