Reduced pay could be silver lining of crisis

 

The recession is reversing some of our self-inflicted damage to competitiveness

THROUGHOUT THE 1990s, successive governments held the growth of current public spending to just over 7 per cent a year – well below the 12 per cent rate at which the value of national output was then rising. By 1999 that prudent policy had reduced the burden of public spending by one-quarter. However, in the year 2000 it was dramatically reversed, and during the subsequent five years current spending was recklessly boosted at a rate 50 per cent faster than the increase in national output.

At that time full employment had just been achieved, which was starting to put pressure on wages, with the result that we were already beginning to lose our advantage as a low-cost western European country.

The post-1999 public spending splurge greatly aggravated these already emerging market pressures on pay. As a result, the EU labour cost index shows that between 2000 and 2007 our labour costs rose almost twice as fast as in the rest of western Europe – by 43 per cent as against 22 per cent. This reduced our competitiveness in labour cost terms by a massive one-sixth.

This development was reflected dramatically in our export performance. Between 1993 and 2000 we had trebled the volume of our exports – increasing the numbers at work in manufacturing by 56,000. But since then the increase in the volume of our exports of goods has been marginal, and their value has actually declined.

As a result, before the housing bubble burst, and well before the advent of the global credit crunch emerged, no less than four-fifths of the additional manufacturing jobs created in the 1990s had been lost – an employment collapse that evoked little attention in our media.

What makes the inflationary policies of the 2000-2005 period so exasperating is the fact that their adoption coincided with our preparations for joining the euro. For, a key element of euro membership is that with the loss of the power to devalue its currency, each euro zone state became individually responsible for protecting competitiveness by avoiding inflationary policies.

Unfortunately our government chose to ignore completely this crucial constraint of euro zone participation, which should thereafter have been the dominant consideration in our national policy-making – as, of course, it was in most other euro zone states. Instead, its public spending policies promoted a rate of inflation which in the early years of this decade well exceeded that of any other western European country. Long before the housing bubble burst and the credit crunch hit us, this was making it very difficult for an exporter like Ireland to thrive.

Difficult, but not, perhaps, totally impossible. For the economic crisis has now created a situation in which what normally would have seemed impossible is actually taking place: reductions in pay rates.

Recently some attempts have been made to assess what the scale of such pay reductions might be. The Economic and Social Research Institute model of the economy suggests that over the period of this crisis market forces might reduce private sector pay by about 7 per cent, and the institute’s recently published Spring Economic Commentary suggests that the first effects of this may be seen in the form of an average reduction of 3 per in pay rates this year.

Moreover, the recently published Central Bank bulletin contains a graph which indicates that it believes that our private sector pay rates may fall this year by 4.5 per cent. Elsewhere in western Europe they might continue to rise at the same rate as in other recent years – namely by 2.5 per cent. If correct, that would yield a 7 per cent improvement in labour cost competitiveness in the year.

At this very early stage both the ESRI and Central Bank estimates of pay reductions are little more than well-informed guesses, but these first efforts to assess the future trend of private sector pay in Ireland suggest that we can now anticipate some belated relief on the competitiveness front – which could assist and accelerate our recovery in exports and employment when global demand for the hi-tech goods our modern industries produce increases.

In its commentary this week, the ESRI also says that in its April Budget the Government may once again have underestimated the scale of its financial problems. The institute has suggested that this may involve borrowing of €20 billion, as against the €18 billion proposed.

However, the institute believes that the amount by which the Government plans to reduce the deficit is about right, and it accepts that given the limited time available for the preparation of the April Budget, it was understandable that it focused on tax. In subsequent measures the balance should, it feels, shift to the expenditure side.

A particularly interesting section of the commentary analyses the re-distributional effects of the measures so far taken. Using a model of the economy that employs a representative microcosm of our population, the study shows that the average 4 per cent reduction in household incomes effected by the October and April budgets has affected people with different levels of income in different ways.

The richest one-fifth of our population is suffering a reduction of about 7 per cent in purchasing power. By contrast, those already on social welfare retain the advantage of the October budget’s 3 per cent increase in social welfare, as well as the benefit of the impending drop in consume prices, so that the poorest one-fifth of our population could be about 5 per cent better off. It is encouraging that the distributional effects of the measures so far taken have been progressive. But that is little consolation for the many tens of thousands of people losing their jobs. It is on helping this group that efforts now need to be concentrated.