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Ireland’s decreasing competitiveness needs to be addressed Back  
The cost of doing business in Ireland is on an upward curve, and with inflation currently running at an annual rate of 4.6 per cent, our rate of price increase is now four and a half times that of the UK, our main trading partner. This needs to be addressed or there will be only one possible outcome - falling output and employment writes Philip Halpin.
Since 1999 the Irish economy has had an exchange rate cushion through market forces driving the euro lower and the harsh reality is that we have taken our eye off the ball on the competitiveness front. If we use traditional measures, the competitive position would appear to be improving. The data shows that unit labour costs in manufacturing industry are declining. The surge in manufacturing productivity has more than offset the impact arising from increases in hourly wages. The data also reveal that the competitive position has also been enhanced by a depreciation of the nominal effective exchange rate. However, this measure of competitiveness is too narrow (manufacturing industry, labour costs) and very misleading in that, it is output weighted and the chemicals and pharmaceutical sectors account for more than half of manufacturing output but only 9 per cent of manufacturing employment. The impact of this is to make our competitive position look considerably better than is actually the case.
The Global Competitiveness Report 2002-2003 focuses on two distinct but complementary approaches to the analysis of economic competitiveness.
The first is called the Growth Competitiveness Index or GCI. It aims to measure the capacity of the national economy to achieve sustained economic growth over the medium term, controlling for the current level of development. The report’s second approach to competitiveness is called the Microeconomic Competitiveness Index or MICI and it uses microeconomic indicators to measure the set of institutions, market structures, and economic policies supportive of high current levels of prosperity. The MICI thus assesses the current productive potential of the same 80 economies as the GCI.
The GCI comprises three sub-indexes: the level of technology in an economy, the quality of public institutions, and the macroeconomic conditions related to growth. Ireland’s ranking on the GCI is 24th in 2002 compared to 11th in 2001 and 4th in 2000. This is a significant deterioration in our overall competitiveness ranking.
The rankings for Ireland on the sub index makes interesting reading. On the technology index we ranked 31st (compared to 28th in 2001), on the public institutions index we ranked 18th unchanged from last year, and on the macroeconomic environment we ranked 9th (2nd in 2001). This is a sharp downward movement in our ranking on this sub-index. Thus our overall ranking of 24th on the GCI was achieved on the back of our relatively high rating on the macroeconomic environment index (albeit well down on 2001), which offset to some degree a poor ranking on the technology index.
The Technology Index comprises two sub-indexes: the innovation sub-index and an information and communication technology (ICT) sub-index. The innovation sub-index seeks to explain the elements of innovation, such as patents that are linked measurably to growth. Ireland ranked 22nd (23rd in 2001) on the innovation sub index and 22nd (18th in 2001) on the ICT sub-index.
The Public Institutions index is based entirely on survey data. We ranked 18th on the overall index. The index has two sub-indexes, the first is a measure of contract and law enforcement Ireland ranked 20th (14th in 2001) on this measure. The second sub index is a measure of corruption. We ranked 14th (19th in 2001) on the corruption sub-index.
The third and final pillar of the GCI is the index of the macroeconomic environment. This index has three main elements: hard data to measure the overall stability of a country’s macro economy, country credit rating and a measure of the share of government expenditures as a per cent on GNP.
On the overall macroeconomic environment index Ireland ranked 9th (2nd in 2001). Our ranking on the macroeconomic stability sub-index was 28th (12th in 2001). In terms of the Government expenditure we ranked 36th (2nd in 2001). This represents an alarming rate of deterioration in our competitive position over the twelve-month period. On the country credit rating index, we ranked 14th. The GCI highlights key problems for Ireland competitiveness. Ireland is not an innovating economy.
This lack of innovation limits our growth potential as we move forward and our scores on the measures of innovation highlight this problem. The
macroeconomic measures show that we have a problem with costs and government spending. Thus we are exposed as a result of this should the currency appreciate.
This is based primarily on survey data. The questions centre on the sophistication of company’s operations and strategy, and the quality of the microeconomic business environment. The questions aim to capture the state of practice or the quality of capabilities in a nation. The focus of the MICI is on measuring sustainable current competitiveness.
One of the key findings from the MICI analysis is that Ireland’s per capita income is high relative to current competitiveness i.e. the level of prosperity exceeds microeconomic fundamentals. In terms of our positioning on the overall MICI we ranked 20th in 2002 compared to 22nd in 2001and 13th in 1998. On the company operations and strategy sub-index we ranked 15th in 2002-compared to17th in 2001 and to 18th in 1998.
On the quality of national business environment sub-index, we ranked 22nd in 2002 unchanged from last year and compared to 14th in 1998. These rankings highlight the impediments to growth due to poor infrastructure and rigidities in the labour market. The overall index displays the deterioration in our competitive position in recent years.
It is useful at this point to put the current euro rates against the dollar and sterling into perspective. A euro rate of $0.98 and UK?0.63 equates to an Irish pound equivalent of $1.24 and UK?0.80 respectively. Back in 1995 and 1996 we were operating at rates of approximately UK?1.02 and $1.60 or to put it another way euro rates UK?0.8 and$1.26. We are a long way off these levels at current rates. We have not witnessed a sudden and sharp rise in the euro but a relatively steady and not unexpected one given that the dollar was widely recognised as being overvalued. The problems with respect to competitiveness lie elsewhere and are compounded by the currency issue.
The rate of inflation is currently running at an annual rate of 4.6 per cent. Using the EU harmonised index of consumer prices our rate of inflation was running at more than twice the EU average in September of this year (4.5 per cent compared to 1.9 per cent for the EU area as a whole and 2.1 per cent for the euro area). On this measure our rate of price increase is four and a half times that of the UK, our main trading partner.
In terms of contribution to the overall CPI change over the twelve months to October period, transport accounted for 0.50 per cent of the overall 4.6 per cent increase, recreation and culture 0.54 per cent, miscellaneous goods and services 0.86 per cent, and restaurants and hotels 1.34 per cent. These items accounted for 70 per cent of the rise in the index over the period and these price increases were primarily domestically generated. We now have high inflation embedded in the mindset of the Irish population. The sources of these inflationary pressures flow from the sheltered non-traded sector. It is price increases in health, education, pubs, restaurants etc that the general public are focussing their attention and here the annual rate of price increase is running between 7.5 per cent to 11.5 per cent. This is the rate of price increase wages will chase.
The Government has fuelled the inflation problem. Over the five-year period 1997-2001 net expenditure by the Government on current goods and services grew on average by 5.7 per cent in volume terms at a time when the economy was expanding rapidly. Spending should have been curtailed in a buoyant economic climate. Government spending should not be pro-cyclical. Last year current government expenditure rose by 22 per cent and in the first nine months of this year this rate of increase in current expenditure continued at just over 20 per cent. Spending of this magnitude is unsustainable and highly problematic.
There is no imminent rebound of economic activity in prospect in the euro zone. Therefore the performance of the euro zone economy and the US economy will not be so divergent to merit a surge in the Euro against the dollar. At the end of the day real GDP growth in the US will exceed real GDP growth in the euro zone area both this year and in 2003. Thus the outlook for economic growth is not supportive of a major surge in the euro.
At the time of the rise of the dollar against the euro in 1999 and 2000, interest rate differentials both at the short and long end of the market favoured the dollar. There is now a differential of 0.57 per cent in favour of euro ten-year bonds over their US equivalent. However, this is unlikely to result in a major switch out of the US and into euro bonds as the premium is not large enough given that there is not an expectation of significant currency appreciation.
Of significance, are the unfolding financial problems in Germany. The banking sector has been badly hit and the sharp downturn in equity markets has hammered the valuations of banks’ equity holdings and they have been adversely affected by rising bad debt charges. These matters are of huge concern to investors and will keep them shy of the euro to some degree. The dollar is unlikely to take off either, as the US equity market still looks vulnerable. There is also the fact that the US is running a balance of payments deficit of 5 per cent of GDP. This will act as a constraint on the US currency.
Overall we look to be in a trading range of $0.95 to $1.05 over the next twelve months. Bad news on the US economy or conflict in the Middle East could push the euro to the top of its trading range. However, a sharp and sustained appreciation of the euro is not on the cards. In the longer term the dollar may prove to be a better bet.
The euro is still some 15 per cent below the level it traded at against the dollar when it was launched. Back in 1996, we were operating at euro equivalent rates of $1.26 and UK?0.80. Current cross rates are nowhere near these levels. A depreciating euro post launch helped disguise a serious erosion of our cost competitiveness. Current rates of both wage and price-increases are unsustainable. Excessive Government current spending has seriously compounded the problem. Given the economic fundamentals a significant and sustained breach of parity by the euro against the dollar is unlikely. However the issue of cost competitiveness must be addressed. We operate in a fixed exchange rate regime and at the end of the day if we do not face the issue ourselves, there is only one possible outcome i.e. falling output and employment.

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