Sterling's entry to EMU may be good for us

Economics: The evidence collated on Irish manufacturing competitiveness is heartening and contrary to most of the rhetoric one normally hears from the Central Bank

On the face of it, Irish manufacturing could withstand a much stronger

appreciation of the euro than we are likely to see, and the behaviour of

sterling suggests there will be little or no competitive threat through that

channel.

Three weeks ago I wrote about the euro's appreciation, noting that the previous trading range against the dollar (85 to 95 US cents) had given way to a new range, between 90 US cents and parity. A stronger euro has compensations (it should put some downward pressure on Irish inflation) but is also potentially negative for Irish exports and employment.

I also pointed out that the market may be reluctant to push sterling much lower against the single currency. The argument here is that British entry to EMU is becoming of increasing importance in the determination of sterling's foreign exchange value, and that a low entry level would be unacceptable both to British public opinion and to the existing members of the single currency. Similarly, the market is reluctant to push sterling aggressively higher, as this too would imply an unacceptable entry level, this time for the British manufacturing sector.

The implication, then, is that sterling may well trade within a limited range against the euro in the coming year. Interestingly, sterling has generally traded within a narrow £0.64 to £0.65 range against the euro over the past few months, lending some credence to this view.

If sterling is indeed limited on the downside and entry does eventually occur around 2.95 deutschmarks, the implication is very positive for Irish industry, as sterling would be locking in to EMU at a punt/sterling equivalent of 84 pence. This is well below what most would consider as fair value for an exchange rate between the Republic and the UK.

In fact, the gains in Irish competitiveness have been so spectacular in the past decade that it is arguable that the Republic entered EMU at loo low an exchange rate, and that, if still trading, the punt would now be much higher against its major trading partners, including sterling.

Competitiveness in manufacturing is dependent on three factors - trends in pay, changes in productivity or output per worker, and movements in the exchange rate for those trading outside a fixed exchange rate system. Fortunately, the Central Bank of Ireland collates and publishes a handy snapshot of trends in these three factors for the Republic and its major trading partners and the evidence is heartening and contrary to most of the rhetoric one normally hears from the Central Bank itself on Irish competitiveness.

The Bank delineates nine countries as major trading partners. Between them, they account for some 80 per cent of Irish exports. Six of the countries - Germany, France, Italy, Spain, the Netherlands and Belgium - are members of the euro area so no longer carry an exchange rate risk, but three are subject to the euro's external value, namely the UK, the US and Singapore. The latter accounts for less than 1 per cent of total exports but is presumably included because it is a direct competitor in third markets in the IT sector.

Hourly earnings in the Republic have certainly accelerated in recent years, rising by 7.8 per cent in 2001 compared to 6.2 per cent in 2000, taking the average annual rise from 1990 through 2001 to around 6 per cent. In contrast, pay rises in Ireland's trading partners have been lower, averaging around 4.5 per cent per annum through the 1990s.

Yet this higher pay has been more than justified by the superior productivity performance of Irish workers. Output per worker in manufacturing grew at an annual average of 2.8 per cent in our major trading partners in the past decade, against an astonishing 17 per cent per annum for Irish workers.

Of course, this picture is distorted by the multinational sector but is nevertheless real as these companies are part and parcel of the Irish economy.

The end result is that, in 2001, it cost over 40 per cent less than it did in 1990 to produce a unit of output in the Irish Republic. In contrast, it cost 15 per cent more on average in our major trading partners. So, on a relative basis unit, labour costs in Ireland were some 50 per cent lower than in our competitors.

In principle then, Irish manufacturing could have withstood a very sharp appreciation of the punt in the 1990s. In the event, the punt generally drifted lower, particularly from 1999 through 2000 following the euro membership. So competitiveness was given the further fillip of a weak currency, which was important as some two-thirds of exports from the Irish Republic are sold outside the euro area and therefore subject to a foreign exchange transaction.

The recent foreign trade figures also confirm that competitiveness is still not an issue: exports rose by 10 per cent in 2001, against a 2 per cent rise in imports and rose by 5 per cent in the four months to April this year, with imports flat.

On the face of it, Irish manufacturing could withstand a much stronger appreciation of the euro than we are likely to see, and the behaviour of sterling suggests that there will be little or no competitive threat through that channel.

Dr Dan McLaughlin is chief economist with Bank of Ireland