One-off upward adjustment to wages could be productive

Inflation is top of the worry list for many at the moment and, according to recent polls, could even be an election issue

Inflation is top of the worry list for many at the moment and, according to recent polls, could even be an election issue. Next week it is likely to shoot above 5.5 per cent and may even go as high as 6.5 per cent before the end of the year. The Government has imposed some price controls on bars and has banned price increases by State institutions for the rest of this year.

Exporters are worried despite their competitiveness and have added their voice to the cry that something must be done. But is this an overreaction?

Employers, unions and others worry that rising inflation will feed into rising wages, erode competitiveness and could end in a bust for the economy. But it is also quite possible that inflation is in fact quite welcome, or, if not welcome, certainly not unambiguously bad news.

The ESRI's Prof John FitzGerald is now in the ironic position of calling for wage rises and a renegotiating of the Partnership for Prosperity and Fairness. Davy Stockbrokers' Mr Jim O'Leary has a similar standpoint. The argument is that prices and hence wages will rise more quickly in peripheral countries in a monetary union as they catch up with the higher prices and wages pertaining in other areas of such a monetary union. As a result, Irish prices have to undergo a once-off adjustment to price levels in France and Germany simply because we are part of the one currency area.

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On top of this, there is pressure for wages and prices to rise because of the increasing importance of the technology sector, international in nature, where wages are on the increase, given the close relationship between that sector of the economy and Silicon Valley. There is going to be pressure on this front almost no matter what policies the Government implements.

The problem is that the rises may prove excessive and could erode competitiveness too far and too quickly. The bogey man is the wage price spiral; nobody wants to go back to the days when the economy was a complete basket case. But, if properly handled, large wage and price rises should not be greeted with horror, these economists argue.

Basically, there are three ways that increasing wage and price pressure on the economy could be harnessed productively. The first is to accept the reality and let prices rise. Already, most of the private sector is ignoring the Partnership for Prosperity and Fairness. According to Prof FitzGerald, wages are likely to rise by around 8 per cent this year but this could just as easily be 10 per cent, he says.

If the private sector got wage rises of 10 per cent, there would probably be a substantial knock-on effect in the public sector with people leaving for expected higher earnings elsewhere. There would also probably be a good deal of unwelcome industrial unrest. Of course the Government's promised benchmarking study is meant to address this in some what but it is still a long way down the road. Social partners such as IBEC insist any increase in public service pay has to wait for this exercise to be completed but this may not be the best option.

The second is to keep hammering away at the old deal. This would mean keeping a lid on wage rises by delivering tax cuts - a policy that has worked for more than a decade. However, now that most workers are getting larger wage rises, it seems inappropriate also to use the taxation system which keeps the growing differentials in place.

Far better could be a renegotiation of the partnership agreement. Wages should rise very substantially but it should be made clear that this would be a once off adjustment to higher levels and that double-digit wage rises could not be expected every year. Tax cuts should be foregone until later in the cycle. After all, the partnership deal has always been to forego large wage rises for tax cuts: giving the former should make the latter unnecessary.

Social welfare payments have to keep up at least so as not to widen the gap even further.

The case for paying public servants large increases seems obvious. After all no one wants to have demotivated or second-rate teachers, nurses or indeed civil servants. The quid pro quo would have to be a serious new deal on working arrangements. Even the most unionised private sector workers are only getting large wage rises in return for smaller numbers at work, flexibility and productivity.

As Mr Jim Power, chief economist, Bank of Ireland, points out, this approach would dramatically change the face of the Irish economy. He points out that many indigenous firms would simply not be able to afford large wage rises. Those in the services sector would be able to pass it on in prices and with the productivity of multinationals, it should not be a problem. For indigenous manufacturing and the agricultural sector, the outlook would be less comforting. They would not be able to compete and would simply find that their staff would leave in order to work in the more lucrative services sector.

Davy's Mr O'Leary points out that this is going to happen in any event. If the economy is now Silicon Glen, or at least moving in that direction, high tech firms will move in and displace those at the lower end.

This is already happening. Last year, there were record job losses among IDA Ireland sponsored companies. Such was the rate of growth in other areas that, this year, there are likely to be up to 90,000 new jobs created gross in the economy.

The choice is really about the speed of this change. If the facilities are there to quickly retrain and re-skill people, there seems little point in arguing against the fast track. After all a more skilled workforce will naturally command higher wages.

Ireland is now so competitive that we simply do not need to compete on the basis of cheap labour. Corporate taxes are still the lowest in the OECD for all companies, we are English speaking, we are in the euro zone and the general regulatory environment is positive. The recent e-commerce legislation is seen as ground breaking.

The largest high tech firms, such as Microsoft and Intel, are here and are expanding. A recent report form Davy Stockbrokers found that links between the high-tech firms and the national economy were growing and expanding all the time.

With all that, do we really need a cheap labour force to boot? As Mr O'Leary says, the economy is now hyper-competitive and it cannot cope. A better paid labour force and some inflation is perhaps the best way we have of cooling it down to a level where it can continue growing in a sustainable fashion.