28/9/2013: Real v Imputed Labour Cost Competitiveness Gains: Ireland v EA17

I wrote recently about the problems with Irish competitiveness and the thesis of significant gains in it since the onset of the crisis:

• The main cover is here: http://trueeconomics.blogspot.ie/2013/09/2692013-sunday-times-1592013-what-about.html
• And a bit on labour costs here: http://trueeconomics.blogspot.ie/2013/09/2792013-internal-devaluation-picking.html

However, looking closer at Irish data, one discovers several troubling regularities:

1. Given the rate of improvement in our labour cost competitiveness and the timing of gains achieved, most of the improvement is simply due to destruction of jobs in two domestic sectors. Per chart below: half of all competitiveness gains were completed by Q1 2010 and some 64% were completed by the end of Q4 2010 - in other words during the period of mass unemployment increases fuelled by jobs shut downs in domestic services and building & construction sectors. Since then the rate of improvements dropped dramatically.
2. The gap in our competitiveness relative to EA17 when expressed relative to the base of the year 2000 is much more closely reflective of the gap between EA17 and Irish GDP and GDP per capita than for any other base, suggesting that use of any other base is misleading in capturing true relative competitiveness positions between Ireland and euro area average.
3. Even with the 'gains' achieved, in Q1 2013 Irish economy was some 12 percentage points less competitive than the euro area average for EA17 states.

Controlling for the second point above, I rebased the data set from the Central Bank to two more bases: 2000 base, 2002 base, and compared this against Central Bank-reported 2005 base. Here are the details:

As the chart above clearly shows, the gains achieved in the unit labour cost metrics have been large. However, these gains do not mean that we are now significantly more competitive than Euro area 17 average. Instead, the metric is highly sensitive to the choice of the base year. In other words, if we assume that Irish economy costs were roughly on par with those in the euro area 17 in year 2005, then we are now 11.4 points more competitive than euro area 17. In contrast, if you assume that we were cost-wise on par with the euro area in 2002, then in Q1 2013 we were only 1.8 points more competitive than euro area. If we assume that the two economies were running at similar cost bases in 2000, Irish economy is still about 14 points behind the euro area in terms of competitiveness.

To make the right base choice, we have to look at the GDP and GDP per capita comparatives and these suggest that we were closer to euro area average around 2000 and ahead of the euro area in 2002 and 2005.

Long story short - do not be deceived by the claims of huge competitiveness gains in Ireland. Some 50%+ of these are probably due to jobs losses here, and the rest is due to base year choice and strong performance of Germany during the crisis... Oh, and that is before we start accounting for productivity 'gains' from transfer pricing by the ICT services exporters...