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News : Irish Economy Last Updated: May 26, 2011 - 8:25 AM


Irish Competitiveness: Devaluatio​n the hard way - - a sustainable cost reduction miracle?
By Finfacts Team
May 25, 2011 - 1:17 PM

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Irish Competitiveness: In the absence of currency devaluation, domestic costs in the Irish economy have been reducing at an impressive pace, according to a new report (pdf) on competitiveness by Goodbody Stockbrokers’ economists Dermot O’Leary and Juliet Tennant. Are we seeing a sustainable cost reduction miracle?

The broadest measure of this internal devaluation is unit labour costs: these have fallen by 9% relative to the rest of the Eurozone in the 2009/2010 period and are expected to decline by a further 4% in 2011/2012. This has already started to yield tangible benefits for the Irish economy, with the number of foreign direct investment projects increasing by 18% in 2010, while over twenty separate investments have been announced already by the IDA in 2011 thus far.

Speaking about the report, Dermot O’Leary, chief economist, Goodbody Stockbrokers, said, “Ireland has been steadily reversing the fall in competitiveness the country experienced during the boom years. We have worked hard at pricing ourselves back in to sectors which had all but closed their doors to Ireland because of continuous rising costs. Ireland is now well positioned to compete for IT services and may even see a return to manufacturing, with a potential resurgence in activities such as the manufacture of medical devices and engineering products, as the case for locating in Ireland becomes more compelling from the cost perspective. Already we’re seeing evidence of a potential cluster effect in the IT services sector, similar to that which occurred in the pharma sector in the 1990s, with companies such as Google, EBay, Yahoo, Facebook and LinkedIn all choosing to locate in Ireland.”

“Our views are backed up by the IDA, the agency responsible for attracting FDI into Ireland,” said Dermot O’Leary.
“The arrival of the IMF/EU programme in Ireland in December and the crises over recent years has done some damage to Ireland’s reputation but the work of the IDA in particular has ensured that the impact on prospective inward FDI has been minimised. In fact, 2010 was a very positive year for FDI announcements, with the number of projects increasing by 18%. 2011 has also got off to a strong start, with over twenty projects already announced.”

“The low and transparent corporation tax rate is a cornerstone of Irish industrial policy and the recent pressure on Ireland from some quarters to increase it has not been helpful.” said O’Leary. “Companies need certainty on these issues, and any uncertainty about Ireland’s corporation tax rate must be concluded soon. We also believe the external fixation on the 12.5% tax rate is misplaced, as it does not tell the whole story. A detailed study by the World Bank and PwC on the taxes that businesses face across the world shows that while Ireland has the second lowest headline corporation tax rate in the euro zone, when one accounts for special exemptions, the effective corporation tax rate in Ireland is actually higher than seven other countries in the bloc, incidentally, two places below France which has the sixth lowest effective rate.”

Currency movements have not been helpful to Ireland’s cause during this crisis, forcing Ireland to rely on internal re-engineering of the economy in real terms, which is a slower path to recovery. Unlike past crises, euro zone economies do not have the benefit of currency devaluation to spur an increase in international competitiveness. Our newly constructed trade-weighted index shows that currency movements have been no help in the achievement of an export-led growth strategy since the crisis began.

By contrast, in Sweden and Finland in the 1990s, their respective currencies depreciated by c30% on a trade-weighted basis, triggering a significant export-led recovery in both economies. However, this was  against a backdrop of a positive international environment.

Within the currency constraint, there is no magic bullet for Ireland to achieve its goal. Nevertheless, Ireland has already begun to reap the benefits of falling costs. Exports grew by 10.6% yoy in Q4 2010, while net exports are contributing strongly to growth.

The report says the turnaround in the current account from a deficit of 5.6% in 2008 to an expected surplus this year is a clear signal of the improvement in Ireland’s external competitiveness. This is not the case in Portugal or Greece, which means that these economies are still effectively living beyond their means. “In many ways, the current account deficit was the canary in the coalmine, sounding the alarm that the economic situation was very serious.” said Dermot O’Leary. “Thankfully, the issue of the current account deficit has been resolved and, uniquely among the troubled peripheral European economies, Ireland’s swift and steady economic corrections have enabled us to move from deficit to an expected surplus in 2011.”

The IDA is the Government body responsible for attracting FDI into Ireland. The IDA currently supports c.1,000 companies with c.140,000 employees directly. The IDA also notes that these companies support a further c.100,000 jobs in the wider economy. The success of the IDA as an organisation is borne out by the quality of the companies that have set up operations in Ireland. In the ICT/Content area, these include Google, Facebook, Intel, Microsoft and IBM. In fact, 8 of the top ten ICT companies have operations in Ireland. 9 of the top 10 pharmaceutical companies are based in Ireland, including Pfizer, GlaxoSmithKline and Johnson & Johnson. Meanwhile, over 50% of the world’s leading financial services firms have set up operations in Ireland.

As expected, the most dramatic fall in domestic prices has been in the property sector. The capital value of offices has fallen by 59%, while rents have fallen by 42%. Similar declines have been experienced for retail and industrial units. From being among the most expensive in 2006, Ireland is now placed mid-table in rankings of office and industrial property costs.

Finfacts Comment: Unit labour costs have fallen mainly because exports from the Irish pharmaceutical/medical devices sector, accounting for 60% of merchandise exports and 33% of total tradeable exports, rose 38% in the period 2004/2010 but employment in the low 40,000  hardly changed .

The pharmaceutical output has a high import input and with patents parked in Ireland to avail of a favourable tax regime, there may be limited processing involved in some of the output. 

From 2009, Germany's unit labour costs rose because it had up to 1.5m in its Kurzarbeit short-work scheme, at its peak.

In Nov 2010, Prof. Patrick Honohan, governor of the Central Bank said: “With the structural shift towards high-productivity sectors during the 1990s and again since 2007, unit labour costs tend to fall even if wage costs for any individual firm or industry are increasing. Because of this shifting composition effect, as has been well-known for decades, but is routinely forgotten by superficial analysts, unit labour costs are a false friend in judging competitiveness developments for Ireland.”

In the protected professional sector, the big firms have not been seriously impacted by the recession and the leading law firms in revenue terms are still among the European elite.

Full-time jobs in the foreign owned sector fell in 2010 and at 139,000 are 14.4% below the level in 2000 - -  back to the same level as in 1998.

Ireland has a large stock of FDI because in the 1990s, the country with 1% of Europe's population, was attracting 25% of US greenfield investment in Europe. There is evidence that in recent years the size of new projects is smaller than in the past.

This is related to our past success and the fact that a location in Ireland is generally to service the European market.

A key question as regards Irish costs is how much is a reflection of a brutal recession and how much through sustainable structural reform? 

There has been no significant reform in Ireland since the onset of the international credit crunch almost 4 years ago.

Finfacts article: Devaluation: Panacea for troubled Euro economies from architect of Irish State bank guarantee

 - Michael Hennigan

Main points of the report:

Unlike previous crises, Eurozone economies do not have the benefit of currency devaluation to aid an improvement in international competitiveness. However, in the absence of such devaluation, domestic costs in the Irish economy are reducing at an impressive pace. We detail the progress that has been made to date in relation to competitiveness in this note.

Adjustments to key costs of labour... - The broadest measure of the internal devaluation is unit labour costs: these have fallen by 9% relative to the rest of the Eurozone in the 2009/2010 period and are expected to decline by a further 4% in 2011/2012.

...and property... - The capital value of offices has fallen by 59%, while rents have fallen by 42%. Similar declines have been experienced for retail and industrial units. From being among the most expensive in 2006, Ireland is now placed mid-table in rankings of office and industrial property costs.

...are already yielding results, with exports up... - Our newly constructed trade-weighted index shows that currency movements have been no help in the achievement of an export-led growth strategy since the crisis began. With this constraint, there is no magic bullet for Ireland to achieve its goal. Nevertheless, Ireland has already begun to reap the benefits of falling costs, with exports up strongly and the current a/c expected to be in surplus in 2011, unlike other economies facing similar challenges. Without large currency devaluation, the export-led recovery in Ireland is unlikely to be a V-shaped one similar to that enjoyed in Scandinavia in the early 1990s.

...and FDI trends remaining strong - The arrival of the IMF/EU programme in Ireland in December and the crises over recent years has done some damage to Ireland’s reputation but the work of the IDA in particular has ensured that the impact on prospective inward FDI has been minimised. For example, the number of foreign direct investment projects increased by 18% in 2010, while over twenty separate investments have been announced already by the IDA in 2011 thus far. Many considerations come into the decision-making process for multi-national firms, but the uncertainty about Ireland’s corporation tax rate is not helpful and must be concluded soon.

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