Inquiry needed into how economy lost competitiveness

 

PUBLIC ATTENTION is concentrated on the banking scandal connected with the construction bubble. However, there is a danger that by concentrating on this issue, the proposed commission of inquiry might fail to investigate the reasons why by 2003 our economy had already lost its competitiveness, condemning us to an eventual major economic setback even if there had been no housing bubble, writes GARRET FITZGERALD

This is of fundamental importance because, while a housing bubble and banking crisis may be unlikely to recur in the foreseeable future, we know our economy is vulnerable to successive massive disruptions due to public policy errors. We know this because we have recently been hit by two such major disruptions within a relatively short period of 20 years – in the early 1980s and again in the early 2000s.

Accordingly, a prime object of the proposed commission of inquiry must be an investigation of how and why such a disruption recurred in the early part of this decade, so as to make sure it cannot happen a third time.

The undermining of the competitiveness of our economy is at least as important an issue – in my view even more important in the long run – than the banking crisis. Because this aspect of the matter involves potentially sensitive political issues, I do not believe it can be handled satisfactorily by a parliamentary inquiry.

There is universal agreement that our economic future depends totally upon a recovery in Irish exports as there is no prospect whatever of economic activity being restored by an increase in internally-generated consumer demand.

Unless the volume of exports of goods recovers and the value of exports of services resume their pre-2007 rapid growth, thus expanding employment in exporting firms, we will be condemning ourselves to remain indefinitely a depressed economy.

Between 1993 and 2000 – the Celtic Tiger years – employment in goods manufacturing firms rose by almost 50,000, generating rapid employment growth in many other sectors of the economy. Unhappily, between the years 2000 and 2004 a majority of these additional jobs in goods exporting firms – 30,000 of them, or almost 15 per cent of all employment in such firms – disappeared. Clearly this had nothing to do with the housing bubble, which started only after 2003. Instead what happened was that in those four years we ceased to be competitive in international markets. This was because between 1997 and 2003 the rate of inflation affecting our national output was more than double that of the other countries which joined the euro zone with us in 1998. The IMF index of inflation affecting national output shows our cumulative inflation rate between 1997 and 2003 was 32 per cent as against a rate of 15 per cent for our euro zone partners. That involved a net loss of cost competitiveness of more than 14 per cent.

This phenomenon of much higher Irish inflation was effectively confined to this particular six-year period. In the immediately preceding period, when Ruairí Quinn was minister for finance, our inflation rate had been kept lower than that of the other potential euro participants. As a result, by the end of the 1990s we had become one of the lowest cost exporters in western Europe – and consequently the most dynamic of European economies, with by far the fastest growth of employment. Moreover, after 2003, when Brian Cowen became minister for finance, our inflation rate fell back to the same level as that of our euro zone partners.

Thus the six years of exceptional Irish inflation coincided almost precisely with the period of Charlie McCreevy’s tenure in that office. His decision to double current public spending between the years 1996 and 2003, (increasing it by an astonishing 36 per cent in the two years between 2000 and 2002), was what sparked off our exceptional inflation.

In fairness to him it can be argued that during the earlier years of the Celtic Tiger (1993-1997) we had become more competitive than was strictly necessary. Some let-up was therefore permissible to enable our people to enjoy more of the benefits that had been earned during the early Celtic Tiger period.

However, by 2000 our competitiveness had already been reduced by as much as we could afford and with the achievement of full employment in the year 2000 we were in real danger of overheating our economy. Other potential euro zone countries wisely chose that moment to halve their rate of earnings increase to 2.5 per cent – but in our case (through the social partnership process which had operated successfully in the 1990s but by the end of that decade was starting to become dysfunctional) our rise in earnings was actually allowed to double in 2001 from 5 per cent to more than 10 per cent. And from then until 2003 our pay rates consistently rose twice as fast as in other euro zone countries, making our pay costs grossly uncompetitive.

So, by 2008 our share of the volume of advanced countries’ exports of goods had fallen by 20 per cent – which cost us almost one-sixth of jobs in goods exporting industries. By contrast the value of net exports of services – mainly computer services – rose six-fold in this period, from €5 billion to €30 billion, trebling our share of that section of the market, and generating many thousands of new well-paid jobs.

The impact upon our economy of this loss of competitiveness in goods manufacturing early in the present decade was, however, postponed until 2008 by artificial inflows of credit from abroad, connected with the housing bubble – which, because of the developers and banks, has now turned into a nightmare.

What is of crucial importance is that we tackle our cost competitiveness. This will require a much fuller recognition of the fact that we have priced ourselves out of global markets by unsustainable pay and other cost increases. We require a full inquiry into how that competitiveness was lost and how we need to reconstruct our public policy system to ensure this can never happen again.

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