Economics 30/12/2009: Competitiveness - it's a long term thingy

We hear often about the loss of competitiveness in Ireland over time. Can we illustrate it? And if so, what can we learn from it?

Here are the charts. Do keep in mind - higher values reflect lower competitiveness.
In terms of unit labour costs, Ireland has not been competitive relative to its peers within the EU15 since Q2 2004 when we crossed over the Netherlands. I ignore Luxembourg here as it is a statistical aberration. We've managed to lose all competitiveness gains incurred since Q1 1999 by Q1 2003. Majority of our peers have done so only 5 years later. while our competitiveness has deteriorated by a massive 22% since 1999 (and this is reflective of the significant gains in competitiveness over the course of 2008-2009), the average for peer countries was 6.2% and absent Ireland and Lux from the sample the rise was just 3%.

Oh, and by the way - there is no evidence that we were competitive in 1995-1999 either...

Chart above also shows that we have not posted a stellar performance against the latest additions to the Euro area. While Slovakia beats us hands down in terms of decline in competitiveness, remember - these are normalised series, so having started from a much lower cost basis than Ireland in 1999, they have been gaining significantly faster in terms of unit labour costs. Of course, notice that before 1999, Ireland was starting from a higher cost point in 1995 than Slovakia.

Is the cost of labour all there is to competitiveness? Well, no.
Consumer prices draw another comparative. But strangely enough, the picture is virtually identical. Except, here pre-1999, more specifically in 1993-1995 - we were performing really pretty well. Having gone off the rails slightly during the mad days of the IT bubble - end of 1996- end of 1998, we then again performed rather well in terms of CPI until things gone out of control for us in the end of 2002.

And just for completeness - a chart on the new entries into the Euro zone:
So what can we really learn from these four charts?

1. Ireland's loss of competitiveness is dramatic and at this stage, seemingly irreversible;
2. Ireland's loss of competitiveness is concentrated in the labour costs/productivity area where deterioration in competitiveness was much more pronounced compared to the Euro area average than in the CPI component;
3. Ireland's loss of competitiveness is not a new phenomena - it has been accelerating since around 2002 and it was firmly in sight of our policymakers at the time;
4. Ireland's loss of competitiveness is a long-term problem and requires long-term solutions - not a one-off cut in wages.

On a different train of thought: an interesting idea that can be explored in 2010. Can we use the proceeds from our carbon tax to supply a long-term economic stimulus to the private sector economy? Here is a thought going in the right direction.

Carbon tax in theory should be behavior-altering, so as consumers and producers reduce their emissions, the tax revenue should decline. To incentivise such behavior, carbon tax induces higher costs on energy use from non-renewable resources. But the revenue raised from the tax can be used to further enhance the incentives - if it is rebated back on the basis of lower emissions. This can also be done within a Cap-and-Trade system.

In the case of Ireland, such a system would involve the following:

• Using revenue from carbon tax to provide direct income tax credits to households proportional to their annual per-capita heating, electricity and gas bills shortfall on the average. Having put into place a system for capturing data on such transactions, a rebate allowance can be estimated for each household at the end the year and this can be credited against the annual income tax.
• The system will provide net subsidy to those who use less CO2 emitting resources.

The main advantage of the system is that it will allow to offset some of the regressive effects of the carbon tax:

• Younger households with children can obtain a rebate that is reflective of the larger size of the household;
• One-off housing and remotely located households will benefit from all and any renewable energy production they can generate on their properties;
• Urban households - who actually do have an option of altering their behavior significantly - will be rewarded for doing so - incentivising more growth in the higher value-adding urban economies;
  
• Businesses will also be allowed to obtain a rebate, implying lower cost for doing business and investing in new technologies precisely for companies in the more productive services exports and modern manufacturing sectors.

Best of all - the Exchequer will not get to treat carbon tax as just another regressive tax revenue raising measures that will simply increase the cost of living and working in Ireland. Of course, those not in the tax net should also receive the deductions, implying that some of them will become net earners from the tax system. As long as they are not enjoying lower cost of overall energy-related expenditure courtesy of state subsidies.