Notes on the Front

Commentary on Irish Political Economy by Michael Taft, researcher for SIPTU

January 22nd Afternoon: The Recession Diaries

January 22, 2009

Finally, some good ol' fashioned common sense is being spoken – and in the Irish Times, as well. Prionsias Breathnach of NUI Maynooth takes on calls for wage cuts head on. He does this through this time-tested process of looking up the facts. In these days, that's almost a revolutionary act. He elaborates three reasons why calls for wage cuts are 'wrong-headed'.

First, Breathnach asks why those who advocate wage cuts to restore our competitiveness 'never explain why the most competitive economies in the world are the ones with the highest pay levels and living standards.' I fear that he, and we, will be waiting a long time for a coherent answer.

Second, he states that the recent decline in our industrial exports has largely come from the electronics sector.

'This is largely due to the emergence of China as a major low-cost producer in this sector. . . There is no way Ireland can compete with Chinese wage rates (or east European rates, for that matter).'

Thirdly, and to devastating effect, Breathnach shows that wage cuts would have little impact on our export sectors for the very simple reason that wages don't make up a substantial proportion of the cost structure.

'According to Forfás data, payroll costs accounted for just 11 per cent of the total costs of foreign manufacturing firms (which produce over 90 per cent of industrial exports) in 2007. The reduction of five per cent in nominal wage costs (as some have suggested) would in fact only reduce their total costs by about half of one per cent.'

This corresponds to research I have done and written about on this blog. There's another way of looking at this – through the effect on turnover. A pay cut of 5 percent would amount to 0.4 percent of turnover in the industrial sector. In other words, for a €100 product, the wage reduction would allow the enterprise to sell that product for €99.60 without losing profit. Wow, 40 cents on a €100 unit.

Can you imagine the conversation between the manufacturer and a buyer:

Buyer: Seamus, your product is too-high priced. Your cost-base is out of control. We can't take this for €100 a pop.

Irish Manufacturer: No, no – we've just screwed over our employees with a five percent pay cut. We can now give this to you for €99.60.

Buyer: Ah, now you're talking. That's what we're looking for. We'll take 20,000 units.

The Irish export sector saved. QED and all that.

Okay, a bit tounge-in-cheek – but you get the idea. What Breathnach calls the 'misguided mantras emanating from the economics profession'is getting louder and all pervasive. You can't pick up a newspaper or turn on a RTE current affairs programme without hearing some 'expert' calling for wage cuts. Yet, few are willing to actually calculate the effect this would have on real-time enterprises.

Nor the effect on the wider economy. Can someone please tell me how cutting wages across the board – public and private – will assist economic recovery. It will worsen the deficit (less income tax / PRSI / spending taxes). It will drive down private consumption even further as people compensate for the fall in income resulting in more job losses in the services sector – which will reduce Government revenue and drive up expenditure with more social welfare payments. How does risking any of this make any sense – especially as wage cuts will have little effect on our cost base or on the public sector payroll?

But Breathnach doesn't just critique. He provides a signpost for future policy. He points out that while the appreciation of the Euro has hurt our manufacturing exports, our service exports have soared despite the Euro and so-called uncompetitive wages. The fortunate thing for the economy is that this is a labour-intensive sector.

Ireland’s future economic growth will depend on the attraction or internal development of high-productivity, knowledge-based, activities in services and advanced manufacturing. This has to be the prime focus of government policy, even through the current crisis.

In other words, if we become obsessed with a non-problem, we will not be focused on the strategies that matter – pro-growth strategies. If we can couple these with strategies to limit the extent of the recession, we will get out of this a lot of quicker and in a stronger position.

One could almost despair – except that now we can hope that more sane voices like Proinsias Breathnach's will come forth and be heard.

Then, we might even be in danger of talking common sense.

9 responses to “January 22nd Afternoon: The Recession Diaries”

James

January 22, 2009

I would add one caveat and one supporting point (this is sadly typical of my comments, I know):
1) the non-wage costs of exporters are to some degree themselves determined by labour costs of others – i.e. every wage is a cost for the consumer. So the cost of non-wage inputs for exporters is partially determined by wage cost component of those inputs.
2) nobody seems to be talking about the impact of wage cuts on our mountainous household debt, which naturally will not be coming down in line with our newly reduced nominal and real wages…

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Gerard O’Neill

January 23, 2009

A bit of a straw man argument there Michael. I don’t recall anyone saying the key to growing Irish exports was to cut wages in exporting companies. I do recall economists (and others) saying that the key to balancing the Government’s budget deficit was to cut back public spending (and, if necessary, raise taxes as well) in order to avoid a mushrooming of our national debt.
The issue of wage cuts is one for the non-traded sector (from civil servants to hair dressers): the traded sector have moved away from low pay dependent business models a long time ago (or went out of business).
Just like the Scandanavians come to think of it. Hence one possible explanation for the alleged ‘mystery’ as to why they are high wage/highly competitive economies. They started out as the opposite, used the productivity gains thus secured and invested in becoming what they are today.
But I doubt it was achieved by paying their sheltered, public sector workers an average of 20% more than workers in the private sector …

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James

January 23, 2009

“I don’t recall anyone saying the key to growing Irish exports was to cut wages in exporting companies.”
But we are constantly being told that our competitiveness needs to be restored by wage cuts – it’s nonsense to say that the question of wage cuts has only arisen in relation to the budget deficit. Indeed one of the arguments for public sector wage cuts has been that this will have a “demonstration effect” on private sector wages (see, eg, Alan Ahearne’s piece in the IT a few days ago).

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Hugh Green

January 23, 2009

‘I don’t recall anyone saying the key to growing Irish exports was to cut wages in exporting companies.’
Kevin O’Rourke says on Irish Economy today:
‘The Government should announce that all public sector wages, which it controls, be cut by x%, where x is determined by real exchange rate considerations. It should strongly suggest that all private sector wages be cut by the same amount.’

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Michael Taft

January 23, 2009

Gerard – I’m not sure it’s a straw man argument. Just to jog your memory, John Fitzgerald writing in the Irish Times (January 12th) explicitly stated: ‘Of course a fall in nominal wages throughout the economy, which was matched by a fall in prices, would leave employees no worse off, while greatly benefiting firms in the export sector.’
Hugh has pointed to another comment on Irisheconomy.ie. I’m sure if one searches around you’ll find a lot of people calling for wage cuts to benefit ‘competitiveness’. I accept, Gerard, that you’re addressing the non-traded sector (unlike Fitzgerald who specifically mentions to the traded sector and others who make no such differentiation). But even in the non-traded sector, the benefit of a wage cut is minimal. As I showed in my January 13th posting – a cut of 5% would result in a reduction of operating costs of less than 1%. I’m not sure how this would benefit ‘competitiveness’ but one thing’s for sure: an across the board cut of 5% would result in lower consumption which in turn would result in more job losses in enterprises dependent on domestic demand and, so, a deteriorating budget deficit.
The better approach would be to figure out how to stimulate demand – both in job creation/retention and in increased incomes. That might start moving things.
James – don’t worry about the dynamic between caveats and support. If our debate was more nuanced and discerning, it would be better informed. I would include loads of caveats to each of my arguments and assertions – but I’m not writing papers and books, just a simple blog.
On the point you raise about inputs – yes, there’s no doubt that would impact on the end-production price and, hence, consumer price. However, Breathnach points out that in the foreign manufacturing sector (which accounts for 90% of total output and goods exports) only 16% of their materials and services are sourced from within Ireland. Therefore, a reduction of wages would have almost no impact on our export sector.
In other sectors, the picture is more complex. Clearly, domestic enterprises source more of their material and services locally. But not all – take the clothing and footwear sector. They source mostly from abroad (and sometimes from exploitative developing world sweat-shops). Our food sector, however, is mostly sourced from here. But even so, a wage cut here would have almost no effect in the manufacturing sector – especially in the process sector (less than 0.2%. So even combining a wage cut at the wholesale and retail level, the final retail price would be practically the same. In other sectors, of course, it would be different.
All this to say, what we desperately need is a more informed picture of our enterprise base. CSO does what it can on the resources it has. But a first step might be to double the CSO budget. Get the researchers, get the research programme focussed on costs and sectors. Making policy proposals on the basis of limited information is a sure recipe for limited, if not at times, perverse results. That goes for me as well as everyone else.

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James

January 23, 2009

Couldn’t agree more on the imperative for more and better data (housing prices/rents comes to mind) as a prerequisite to systematically better policymaking – the sort of thing where a little unsung buck can get a lot of buck.
Fair point on the small proportion of locally sourced inputs among our manufacturing exporters (I commented before readinf O’Mahony’s useful article). This does raise the question as to whether we mightn’t be a lot better off in the long run if our export sector was more closely integrated into the rest of the domestic economy.

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Pavement Trauma

January 23, 2009

We should be aiming for a high wage / high productivity economy but the fact is that right now we have a high wage / less than high productivity economy. Our general level of wages (and prices) has gone well out of whack with our level of productivity as compared to the wages / productivity levels of our competitors. Productivity is not something that can all of a sudden just be made to increase, it take years, and investment in education, training, infrastructure etc., to come about. (I would agree with Michael that not nearly enough emphasis was put on this during the boom, we were too busy selling houses to each other).
Does anyone doubt that if we had an independent currency that it would be rapidly devaluing – like Sterling is right now – and restablishing our competitiveness that way? However that is not an option. General prices have to come down and reducing wages is the main way to affect this.
Raising productivity is the long term solution but right now we are drowning. Lets talk about plugging the leak in the hull before we move on to discussing improvements to the ship’s navigation system.

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Conor McCabe

January 23, 2009

This has nothing to do with the discussion per se, but at the moment I’m wading my way through the Irish Industrial Relations canon. The standard textbook, “Industrial Relations in Ireland” is co-authored by the aforementioned John Fitzgerald, and in it he talks about theory and industrial relations. Fitzgerald and his co-writers poo-poo Marxism and Marxist writers, saying that Marxism has little to offer the study of industrial relations as “Marxism is more concerned with the structure and nature of society than with the actual workplaces which that society accommodates.”
I’m reminded of that scene in “Anchorman” where Ron Burgandy tells his co-worker that San Diego is German for “a whale’s vagina.”
John Fitzgerald and co. have nothing to add to the present discussion, but have all the confidence in the world to back it up. Always a dangerous (if slightly amusing) situation.

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Yvonne

January 24, 2009

So the government are trying to plug a €2 Billion gap in the public finances and stimulate economic recovery?
Coincidentally, the Mental Health Commission last year estimated the cost to the Irish economy of mental health problems in 2006 at over € 3 billion, or more than two per cent of GNP.
“The health care system accounts for less than one quarter of the costs. The main economic costs of mental health problems are located in the labour market as a result of lost employment, absenteeism, lost productivity and premature retirement. There are also costs imposed on the prison service, social services dealing with homelessness and informal care costs as well as lost output and productivity.” (See http://www.mhcirl.ie)
Read this against the Irish Mental Health Coalition’s account of the painfully slow rate of progress on the Government’s programme of reform for mental health services contained in ‘A Vision for Change.'(See http://www.imhc.ie)
I would love if we could move this debate beyond wage cuts and driving down costs.

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