Services now driving growth in foreign trade

Economics: Ireland's membership of the single currency and accompanying loss of monetary sovereignty means that the balance of payments (BoP), the summary of international trade and capital flows, no longer receives the degree of attention it once secured.

The recent publication of the 2004 BoP data, for example, prompted little comment, although the figures were interesting on a number of levels, not least in the light they shone on the declining significance of the multinational manufacturing sector in the Irish economy.

Before addressing that aspect, it is worth commenting on the overall implications of the data. At one level, for instance, the BoP can be seen as a simple reflection of competitiveness, at least for a developed economy. A large and sustained surplus, with exports consistently outpacing imports, implies that the country's currency may be too cheap, with a currency appreciation warranted in order to boost imports.

Similarly, a chronic deficit may point to the need for action to improve the competitiveness of the export sector, including a currency depreciation. In Ireland's case, persistent surpluses were the norm in the 1990s but these gave way to a deficit trend from the year 2000. These deficits were small, relative to national income, however, and last year saw a marked improvement, with a BoP deficit of €650 million against €1.9 billion in 2003, the former equivalent to 0.4 per cent of GDP. There is little evidence here then to back the claim that Ireland has suffered a serious loss of competitiveness in recent years, because, if true, one might have expected a more pronounced deficit trend.

A second, more useful way to view the BoP is as a measure of any fundamental imbalances in the economy. A large surplus in this context, often seen as a positive, actually means that a country is consuming less than it produces, implying that national savings are too high.

The Japanese economy provides a classical example of this phenomenon, with the US providing the flip side: the latter's chronic BoP deficit reflects a nation consuming more than it produces, ie national savings there are too low. Seen within that framework, the absence of a persistent imbalance in the Irish BoP indicates that the economy as a whole has not been over-consuming and that the level of national savings is broadly consistent with the rate of economic growth seen over the past 15 years.

The BoP also measures the flow of exports and imports, which feeds directly into the national accounts and hence influences the growth rate of the economy.

In Ireland's case, the export of goods and services substantially exceeds that of imports, but there has been a notable change in the composition of that trade of late. The value of merchandise exports has been broadly flat over the past few years, in contrast to the extraordinary rates of expansion seen in the past decade, but service exports (such as financial services, business services and computer services) have grown rapidly.

In 2004, service exports amounted to €42 billion, equivalent to 50 per cent of merchandise exports, against only 25 per cent in 2000, highlighting the disparity in relative growth rates.

The outperformance of the multinational manufacturing sector, a feature of the economy in the 1990s, is therefore absent - export growth is no longer outpacing domestic demand, and any impetus from the external sector has also shifted away from manufacturing to services.

This change in the impact of the multinational sector is also evident in another area of the BoP, which captures the flow of profits and interest.

Multinational profits in Ireland in 2004 amounted to €31 billion - a large sum, but broadly unchanged from the previous year. A much higher proportion of the total was repatriated, however, (€17 billion against €11 billion in 2003), possibly reflecting recent changes in US tax legislation.

So retained earnings in Ireland fell last year, and as a consequence, so did the flow of foreign direct investment (FDI). The total FDI inflow in 2004 declined to €11 billion from €24 billion in 2003, with the final quarter seeing a substantial disinvestment. Furthermore, FDI abroad by Irish firms rose substantially, to over €9 billion, so the net direct capital inflow was unusually small.

The overall picture that emerges is one in which the multinational manufacturing sector is no longer the driver of Irish export growth, with internationally traded services now the engine of expansion in external trade.

This shift to services is also apparent in the domestic economy, and most recent forecasts of Irish growth envisage domestic demand rising at least as rapidly as exports.

The corollary is that GNP growth, the output of the domestically owned economy, will generally keep pace with that of GDP, the growth in total output, so rendering redundant the hoary old argument as to which is the better measure of the true rate of expansion in the Irish economy.

Dr Dan McLaughlin is chief economist at Bank of Ireland