This is an unedited version of my Sunday Times column from September 15.
Recent experiments in psychology have shown that people routinely distort their interpretation of objective evidence to fit their subjective political beliefs. More ominously, our propensity to ideologically colour evidence appears to be greater the better we are with data analysis.
This ability of humankind to see data through the tinted glasses of our biases is present all around us, including in the interpretation of economic data.
Take two examples.
Recently, the relatively ideology-free World Economic Forum published its annual report on global economic competitiveness rankings for 2013-2014. According to the report, Ireland now ranks 28th in the world in terms of competitiveness, down one place on a year ago. Back in 2005-2006 – at the height of the boom, and amidst rampant business costs inflation, we ranked 21st. Overall, Ireland's global competitiveness has deteriorated by 7 places over the last ten years, with this year's performance just one notch better than the absolute nadir reached in 2011. A more ideologically-informed Heritage Foundation / WSJ Index of Economic Freedom continues to rank Ireland highly in the 13th place in the world in 2013. However, tinted lasses aside, our overall competitiveness score in the latter index declined from around 82-83 in 2006-2009 to below 76 this year.
Meanwhile, Irish political and business elites continue to brag about the remarkable gains in the country competitiveness, brought about by the policies enacted since the beginning of the crisis or at the very least, by the reforms that took place since the last elections. Almost 6 months ago, seemingly unburdened by evidence, Taoiseach Enda Kenny has declared that the government is "making this the best small country in the world to do business in…" Never mind that Ireland ranks outside the top 10 countries in the world in every reasonably comprehensive and objective rankings produced so far. And never mind that our rankings have deteriorated, rather than improved, since the onset of the crisis. The government will still spin the evidence.
The truth, of course, is somewhere in between the two extremes of the opinion.
One core measure of competitiveness is the labour-related cost of the unit of output in the economy, the so-called unit labour costs (ULCs). Based on the ECB data, we achieved substantial gains in this measure, with ULCs falling 18 percent peak-to-trough. However, since the trough was reached in Q2 2012, Ireland’s performance has deteriorated. In 2009-2010, Irish unit labour costs fell by over 7 percent compared to 2008. The rate of cost deflation declined to 2.4 percent over 2011-2012. So far, since the start of 2013, the ULCs are rising. This exposes the underlying causes of changes in the ULCs over the crisis period. Much of the recent gains in labour competitiveness were driven by a dramatic rate of jobs destruction back in 2009-2011. As the jobs market stabilised, competitiveness gains vanished. Exactly the same story is being told by the broader harmonised competitiveness indicators published by the Central Bank of Ireland.
However, the data also shows that the key driver for the deterioration in our cost competitiveness in more recent months is government policy.
As the result of our non-meritocratic approach to labour markets, lack of reforms in core areas relating to business development and entrepreneurship, the use of tax policies to fund wasteful bank crisis resolution measures and public spending, Ireland finds itself in an absurd situation where we rank 12th in the world in capacity to attract talent and 40th in capacity to retain the talent we attract. As our openness to FDI is bringing scores of talented workers into the country, our internal markets policies are pushing talent out of the country. Having had their fill of "the best small country in the world to do business in", globally skilled workers tend to get out of Ireland.
As the result of our inability to keep key skills and talent in the country, labour costs are starting to creep up, even before we see serious uptick in new employment. In 2009-2010, according to the OECD, labour costs accounted for 74 percent of the total inputs costs in production in Ireland. In 2011, the latest for which we have data, this rose above 77 percent. Labour productivity growth, having peaked with unemployment increases in 2009 has fallen back by almost two thirds by 2012.
The latest data from CSO shows that average hourly earnings are now up in eight out of thirteen sub-sectors year on year through H1 2013. Crucially, in the areas under direct Government control, earnings are now rising once again and at speeds exceeding those recorded for the overall economy. Public sector average weekly earnings were up 1.3 percent year on year in Q2 2013 and non-commercial semi-state earnings are up 2.7 percent.
With every new report, the IMF reiterates its advice to the Irish authorities to continue focusing on labour markets reforms. Despite this, the Government staunchly refuses to address the main factors holding back our labour competitiveness. These are flexibility of wage determination (with Ireland ranked 103rd globally), flexibility in hiring and firing (we rank 43rd here) and linking pay to productivity, especially in the public sector (our rank is 38th worldwide). According to the WEF, Ireland ranks 90th in the world in terms of the effect of taxation on incentives to work.
So labour competitiveness improvements of the past are neither a credit to the Government reforms, nor appear to be sustainable over time. Now, lets take a look at other policies-linked metrics.
World Economic Forum report lists the top 5 factors acting to depress our global competitiveness scores. In order of decreasing importance these are: access to financing, inefficient government bureaucracy, inadequate supply of infrastructure, insufficient capacity to innovate, and tax rates. The first two come under direct remit of public reforms aimed at dealing with the crisis. The fourth one, capacity to innovate, is linked a myriad of incentives and subsidies crafted by Irish governments in an attempt to shift the economy away from bricks and mortar toward innovation and exports. The third and the last factors arise from the Government policies since 2008 that saw higher tax burdens and shrinking public capital investment become the drivers of the state response to the fiscal crisis. Thus, by WEF metrics, Irish Government is responsible for dragging down Irish economy's competitiveness, rather than pushing it up.
These findings are broadly in line with the Heritage/WSJ index readings, which shows that we score poorly on Government policies, fiscal performance, and public spending efficiency.
Despite years of austerity and alleged reforms in public sector management since 2008, the WEF report ranks us 55th in the world in terms of wastefulness of government spending, and 29th in terms of burden of government regulation. When it comes to the transparency of Government policymaking, Ireland ranks below 24 other countries around the globe. The latter is a metric directly targeted by the Troika-led reforms and the one where the Irish Government has, allegedly, done most work to-date. We have revamped banks regulation and reporting, significantly altered macroeconomic risk monitoring, fiscal policies oversight, economic policy development mechanisms and more. Yet for all our successes in this arena, we are not even in top 20 worldwide when it comes to policies transparency.
Another obvious flash point of the crisis was the lack of robust audit and oversight over the operations of our banks and some companies. One would expect that 5 years into dealing with the crisis, Ireland would have delivered some serious improvements in these areas. Alas, we still rank 58th in the world in terms of the strength of our audit and reporting standards. In a business oversight metric, the World Bank Doing Business report ranks Ireland 63rd in the world in terms of the enforcement of contracts, with average time to resolve a dispute of 650 days in Ireland, against 510 days for the OECD average. As a legacy of the protected sectors inefficiencies, our legal system imposes average costs of 26.9 percent of the total volume of dispute-related claims on contracted parties, against the OECD average of 20.1 percent.
The current Government came into office with a clear promise to reform domestic sectors to breath in more competition into protected markets. This has not happened to-date. State-controlled sectors, such as professional services, health insurance and health services, energy, transport, education, and so on, remain shielded from real competition. As the result, Ireland ranks 42nd in the world in intensity of local competition, and 24th in effectiveness of anti-monopoly policies, even though much of this effectiveness comes via Brussels. Property regulations, planning and permissions systems are as atavistic as they were before the bust, meaning that the World Bank ranks Ireland 106th in the world when it comes to dealing with construction permits.
Ireland’s performance on the competitiveness side is worrying. In the long-run competitiveness metrics and rankings – imperfect as they may be – help global investors allocate capital investment and productive activities of their companies around the world. Even more significantly, these metrics expose structural problems in the economy and governance systems that are holding back Irish domestic entrepreneurship and innovation.
As economies and fiscal positions of governments around the world improve over time, the competition for FDI and new markets for goods and services exports will heat up, once again. Downward pressure on taxes – Ireland’s core competitive advantage to-date – will re-accelerate too. At the same time, capital investment will remain scarce and costly, while skills shortages worldwide will once again start driving up cost of doing business, including here. This means that global investment flows will tend to be concentrated on the markets with the greatest demand growth potential, and where the profit margins are the highest. The only way Ireland will be able to compete is by becoming a competitiveness haven for product innovation and development, advanced specialist manufacturing, distribution, marketing and sales. Being just a tax haven will not be enough.
Box-out:
A financial transaction tax (FTT) on derivatives trades came into power in Italy this week, as a follow on to March 2013 introduction of the FTT on equity transactions. Per new law, derivatives will be taxed at rates that vary with the volume and the type of the contracts traded. Equities transactions are taxed at 0.12% for shares traded on a regulated exchange or 0.22% for over the counter trades. Six months in, the FTT is having an effect. As a number of analysts, including myself have warned prior to the introduction of the tax, Italian trading volumes for equities are down significantly, compared to the rest of Europe. Since March, Italian equity market turnover dropped to EUR50 billion from EUR101 billion a year ago. French equity markets experienced exactly the same effect post FTT introduction. At the peak in 2011, French equity market accounted for 23 percent of the European equity markets turnover. Today, it is at around 13 percent. There is also some evidence that wealthier investors are moving their transactions out of FTT-impacted equity markets. Which means that more burden of the levy – popularly mislabeled as 'Robin Hood' tax – is falling onto the shoulders of smaller investors. Falling trading volumes are now expected to undercut significantly Italian and French estimates for the Government revenues that FTT was expected to raise. With projected funding already allocated in the budgets, any shortfall will have to be compensated for via other taxes or cuts elsewhere. Yet, undeterred by the evidence, the EU continues to press on for a cross-border FTT. John Maynard Keynes once said: "When my information changes, I alter my conclusions." Sadly, his otherwise enthusiastic students in Brussels have missed that lesson.
Recent experiments in psychology have shown that people routinely distort their interpretation of objective evidence to fit their subjective political beliefs. More ominously, our propensity to ideologically colour evidence appears to be greater the better we are with data analysis.
This ability of humankind to see data through the tinted glasses of our biases is present all around us, including in the interpretation of economic data.
Take two examples.
Recently, the relatively ideology-free World Economic Forum published its annual report on global economic competitiveness rankings for 2013-2014. According to the report, Ireland now ranks 28th in the world in terms of competitiveness, down one place on a year ago. Back in 2005-2006 – at the height of the boom, and amidst rampant business costs inflation, we ranked 21st. Overall, Ireland's global competitiveness has deteriorated by 7 places over the last ten years, with this year's performance just one notch better than the absolute nadir reached in 2011. A more ideologically-informed Heritage Foundation / WSJ Index of Economic Freedom continues to rank Ireland highly in the 13th place in the world in 2013. However, tinted lasses aside, our overall competitiveness score in the latter index declined from around 82-83 in 2006-2009 to below 76 this year.
Meanwhile, Irish political and business elites continue to brag about the remarkable gains in the country competitiveness, brought about by the policies enacted since the beginning of the crisis or at the very least, by the reforms that took place since the last elections. Almost 6 months ago, seemingly unburdened by evidence, Taoiseach Enda Kenny has declared that the government is "making this the best small country in the world to do business in…" Never mind that Ireland ranks outside the top 10 countries in the world in every reasonably comprehensive and objective rankings produced so far. And never mind that our rankings have deteriorated, rather than improved, since the onset of the crisis. The government will still spin the evidence.
The truth, of course, is somewhere in between the two extremes of the opinion.
One core measure of competitiveness is the labour-related cost of the unit of output in the economy, the so-called unit labour costs (ULCs). Based on the ECB data, we achieved substantial gains in this measure, with ULCs falling 18 percent peak-to-trough. However, since the trough was reached in Q2 2012, Ireland’s performance has deteriorated. In 2009-2010, Irish unit labour costs fell by over 7 percent compared to 2008. The rate of cost deflation declined to 2.4 percent over 2011-2012. So far, since the start of 2013, the ULCs are rising. This exposes the underlying causes of changes in the ULCs over the crisis period. Much of the recent gains in labour competitiveness were driven by a dramatic rate of jobs destruction back in 2009-2011. As the jobs market stabilised, competitiveness gains vanished. Exactly the same story is being told by the broader harmonised competitiveness indicators published by the Central Bank of Ireland.
However, the data also shows that the key driver for the deterioration in our cost competitiveness in more recent months is government policy.
As the result of our non-meritocratic approach to labour markets, lack of reforms in core areas relating to business development and entrepreneurship, the use of tax policies to fund wasteful bank crisis resolution measures and public spending, Ireland finds itself in an absurd situation where we rank 12th in the world in capacity to attract talent and 40th in capacity to retain the talent we attract. As our openness to FDI is bringing scores of talented workers into the country, our internal markets policies are pushing talent out of the country. Having had their fill of "the best small country in the world to do business in", globally skilled workers tend to get out of Ireland.
As the result of our inability to keep key skills and talent in the country, labour costs are starting to creep up, even before we see serious uptick in new employment. In 2009-2010, according to the OECD, labour costs accounted for 74 percent of the total inputs costs in production in Ireland. In 2011, the latest for which we have data, this rose above 77 percent. Labour productivity growth, having peaked with unemployment increases in 2009 has fallen back by almost two thirds by 2012.
The latest data from CSO shows that average hourly earnings are now up in eight out of thirteen sub-sectors year on year through H1 2013. Crucially, in the areas under direct Government control, earnings are now rising once again and at speeds exceeding those recorded for the overall economy. Public sector average weekly earnings were up 1.3 percent year on year in Q2 2013 and non-commercial semi-state earnings are up 2.7 percent.
With every new report, the IMF reiterates its advice to the Irish authorities to continue focusing on labour markets reforms. Despite this, the Government staunchly refuses to address the main factors holding back our labour competitiveness. These are flexibility of wage determination (with Ireland ranked 103rd globally), flexibility in hiring and firing (we rank 43rd here) and linking pay to productivity, especially in the public sector (our rank is 38th worldwide). According to the WEF, Ireland ranks 90th in the world in terms of the effect of taxation on incentives to work.
So labour competitiveness improvements of the past are neither a credit to the Government reforms, nor appear to be sustainable over time. Now, lets take a look at other policies-linked metrics.
World Economic Forum report lists the top 5 factors acting to depress our global competitiveness scores. In order of decreasing importance these are: access to financing, inefficient government bureaucracy, inadequate supply of infrastructure, insufficient capacity to innovate, and tax rates. The first two come under direct remit of public reforms aimed at dealing with the crisis. The fourth one, capacity to innovate, is linked a myriad of incentives and subsidies crafted by Irish governments in an attempt to shift the economy away from bricks and mortar toward innovation and exports. The third and the last factors arise from the Government policies since 2008 that saw higher tax burdens and shrinking public capital investment become the drivers of the state response to the fiscal crisis. Thus, by WEF metrics, Irish Government is responsible for dragging down Irish economy's competitiveness, rather than pushing it up.
These findings are broadly in line with the Heritage/WSJ index readings, which shows that we score poorly on Government policies, fiscal performance, and public spending efficiency.
Despite years of austerity and alleged reforms in public sector management since 2008, the WEF report ranks us 55th in the world in terms of wastefulness of government spending, and 29th in terms of burden of government regulation. When it comes to the transparency of Government policymaking, Ireland ranks below 24 other countries around the globe. The latter is a metric directly targeted by the Troika-led reforms and the one where the Irish Government has, allegedly, done most work to-date. We have revamped banks regulation and reporting, significantly altered macroeconomic risk monitoring, fiscal policies oversight, economic policy development mechanisms and more. Yet for all our successes in this arena, we are not even in top 20 worldwide when it comes to policies transparency.
Another obvious flash point of the crisis was the lack of robust audit and oversight over the operations of our banks and some companies. One would expect that 5 years into dealing with the crisis, Ireland would have delivered some serious improvements in these areas. Alas, we still rank 58th in the world in terms of the strength of our audit and reporting standards. In a business oversight metric, the World Bank Doing Business report ranks Ireland 63rd in the world in terms of the enforcement of contracts, with average time to resolve a dispute of 650 days in Ireland, against 510 days for the OECD average. As a legacy of the protected sectors inefficiencies, our legal system imposes average costs of 26.9 percent of the total volume of dispute-related claims on contracted parties, against the OECD average of 20.1 percent.
The current Government came into office with a clear promise to reform domestic sectors to breath in more competition into protected markets. This has not happened to-date. State-controlled sectors, such as professional services, health insurance and health services, energy, transport, education, and so on, remain shielded from real competition. As the result, Ireland ranks 42nd in the world in intensity of local competition, and 24th in effectiveness of anti-monopoly policies, even though much of this effectiveness comes via Brussels. Property regulations, planning and permissions systems are as atavistic as they were before the bust, meaning that the World Bank ranks Ireland 106th in the world when it comes to dealing with construction permits.
Ireland’s performance on the competitiveness side is worrying. In the long-run competitiveness metrics and rankings – imperfect as they may be – help global investors allocate capital investment and productive activities of their companies around the world. Even more significantly, these metrics expose structural problems in the economy and governance systems that are holding back Irish domestic entrepreneurship and innovation.
As economies and fiscal positions of governments around the world improve over time, the competition for FDI and new markets for goods and services exports will heat up, once again. Downward pressure on taxes – Ireland’s core competitive advantage to-date – will re-accelerate too. At the same time, capital investment will remain scarce and costly, while skills shortages worldwide will once again start driving up cost of doing business, including here. This means that global investment flows will tend to be concentrated on the markets with the greatest demand growth potential, and where the profit margins are the highest. The only way Ireland will be able to compete is by becoming a competitiveness haven for product innovation and development, advanced specialist manufacturing, distribution, marketing and sales. Being just a tax haven will not be enough.
Box-out:
A financial transaction tax (FTT) on derivatives trades came into power in Italy this week, as a follow on to March 2013 introduction of the FTT on equity transactions. Per new law, derivatives will be taxed at rates that vary with the volume and the type of the contracts traded. Equities transactions are taxed at 0.12% for shares traded on a regulated exchange or 0.22% for over the counter trades. Six months in, the FTT is having an effect. As a number of analysts, including myself have warned prior to the introduction of the tax, Italian trading volumes for equities are down significantly, compared to the rest of Europe. Since March, Italian equity market turnover dropped to EUR50 billion from EUR101 billion a year ago. French equity markets experienced exactly the same effect post FTT introduction. At the peak in 2011, French equity market accounted for 23 percent of the European equity markets turnover. Today, it is at around 13 percent. There is also some evidence that wealthier investors are moving their transactions out of FTT-impacted equity markets. Which means that more burden of the levy – popularly mislabeled as 'Robin Hood' tax – is falling onto the shoulders of smaller investors. Falling trading volumes are now expected to undercut significantly Italian and French estimates for the Government revenues that FTT was expected to raise. With projected funding already allocated in the budgets, any shortfall will have to be compensated for via other taxes or cuts elsewhere. Yet, undeterred by the evidence, the EU continues to press on for a cross-border FTT. John Maynard Keynes once said: "When my information changes, I alter my conclusions." Sadly, his otherwise enthusiastic students in Brussels have missed that lesson.
@ Constantin,
ReplyDeleteI wrote this in a different context, and on a matter of a very specific nature and application. But some of what I have read now above, with labour market reform and policies, does ring a bell with me, when I relate it back to my own sector in construction.
I think, that what we have in that sector at least, is a very inefficient use of the labour that we have at our disposal. A very inefficient, and not very modern way of doing business. And, from what I can tell, the same problem exists on both sides of the Irish sea right now. Namely, it is this thing whereby a government introduces some huge, new thing like 'carbon saving', and it results in a plethora of young to middle aged professionals using that as a springboard to create a new business, a new brand, built around this new government policy. And it is a rubbish way to create new business. A rubbish way. Yet so many talented and skilled young-ish professionals, get side-tracked into doing this.
In my contribution to that debate in a British context of low carbon design services in the UK context, I submitted the following amongst other ideas and thoughts on it.
I think what should happen a lot more with construction professional services, . . . is a model whereby the mature layer that started their own brands thirty years ago, or more, . . . should 'lease out' that brand to the younger middle tier. The younger middle tier would then not have to waste their resources and best years having to compete against existing brands to split up the pie. The middle tier could then hire younger people and spend more time with them, in a more productive relationship, so that the overall skill levels across the profession are improving in quality.
The people who SHOULD be creating the start up companies then, are not the young, . . . but rather, the older layer, who have 'leased out' their practice in order to run the smaller, feeder organisations, that would provide services 'back' to their larger established brands. The cash flow to create these small, local feeder service providers in areas of new technology and development, would be there, because the older mature professionals are leasing out their practice. So they can take that cash flow and use it to target a small idea, a small start up effort, where they had discovered something viable, that they could not apply themselves to, back when they had the big practice to manage and run each day.
This would be the 'smart' thing to do.
I would compare it maybe to gold mining, or oil drilling. Where the earlier generation of 'oil man' owns his mining or drilling lease, and gives it out to whomever is able to make a go of it. What happens then, very often, is it releases the older 'diggers' to go out and explore un-chartered new ground, using all of the instincts that they have developed over decades. While the younger, fitter people apply the resources that they have in making the machine wheels turn, that generate the cash flow to support everything.
That would be my take on it - but we do not see enough of this. Rather, what we see instead is the mature layer holding on too long. Then they 'lose' their best middle layer, who try to start out on their own, often in disaster, because best engineers often don't have the make-up need to do successful start ups. The old organisation loses its value too, because it has to replace that middle tier it lost with something less effective. Many consultant practices I have seen have fallen for that trap, of just filling seats to stay operational and trading off of an old name, or the fact there is shortage of choice locally. So it becomes a decreasing spiral, instead of an increasing one.