23/8/2014: Labour Costs and Euro area's myth of 'productivity' gains

Looking back at July 2014 IMF Article 4 paper on Euro area (most of which I covered back when it was published), here is an interesting chart mapping changes in the euro area countries' unit labour costs.

The chart is complex, so let me point out few things in it:

Firstly: improvements in the unit labour costs (ULCs) is reflected in the vertical distance between the black dot (accumulated change in ULCs over 2000-2007 period: higher level of the dot reflects lower competitiveness or higher ULCs compared to EA17 levels) and the black bar (accumulated change in ULCs over 2008-Q3 2013 period).

1. This shows that Ireland has delivered (a) the highest ULCs deterioration of the sample of countries reported over 2000-2007 period, and (b) since 2008, Ireland has delivered the largest improvement in competitiveness (ULCs drop) of the sample. 
2. Second largest improvement in ULCs was recorded in Greece and it is comparable to, but modestly shallower than in Ireland; third and virtually indistinguishable from the second - in Spain and fourth in Portugal.
3. The above two facts suggest that improvements in the ULCs are indeed related to the rates of increases in  unemployment: all countries with significant improvements have seen dramatic rises in unemployment. Jobs destruction 'helps' competitiveness.

Secondly, coloured bars show composition of gains over two periods. Here, the following points arise:

1. Labour costs declines have been responsible for the lion's share of ULCs gains in Greece, followed by Ireland, Italy, Portugal and Spain.
2. Labour costs declines are dramatic in the case of only two countries: Greece and Ireland.
3. The above two facts suggests that jobs destruction impacted dramatically in the sectors that were employment/labour-intensive, allowing for substantial moderation of labour costs across the remaining economy on average. So 'concentrated' jobs destruction 'helps' improve competitiveness a lot.
4. Meanwhile, productivity gains in economy were significant contributors to improved competitiveness in Spain, followed - by some margin of difference - by Ireland, and Portugal.
5. Points 1-2 and 4 together strongly suggest that in Ireland and Spain (and to a lesser extent Portugal) gains in competitiveness came about not because the remaining working population suddenly became more productive, but because the new jobless were working in sectors that were less productive, plus because remaining workers got paid less on average.

One more point: of course, our (and other euro area 'peripherals') gains here are measured not in absolute terms, but against EA17 aggregate levels of competitiveness, so to a large extent, our gains in the chart above are also down to their (other euro area countries') losses in competitiveness. This is exactly what the above figure shows for Austria, Germany, Belgium and the Netherlands.

That's happy times of productivity growth in the euro area 'periphery', then... down to throwing people off the employment bus and bragging about fabled improved productivity for the remaining passengers...

15/6/2014: WEF Misses on Another 'Metric'...

WSJ reported on Finland taking the lead in the EU competitiveness gains:

Link here: http://blogs.wsj.com/brussels/2014/06/10/finland-leapfrogs-sweden-in-competitiveness-new-report-says/?mod=e2tw

And here is my reply...

So Finland is one of the worst performers in the EA18 in terms of actual growth outcomes during the crisis and subsequent recovery. And it was followed by Sweden (stronger performer) and the Netherlands (even worse performer than Finland)...

This just confirms simple fact: World Economic Forum is not a very good indicator of anything other than egos of its participants and 'young leaders'... full stop... 

27/9/2013: Internal Devaluation: Picking a Right Target?

Conventional wisdom of the 'internal devaluation' theory goes as follows: if a country like Ireland were to experience a structural shock, the path of adjusting to this shock lies via reduction in the cost of doing business (improving efficiency). Since adjusting the cost of Government or quangoes or Social Partners in the economy is an impossible task to undertake in a corporatist economy, then the only two things that can adjust to effect the 'internal devaluation' are capital costs (interest rates) and labour costs. In reality, however, capital costs are no longer responsive to interest rates since Ireland is in a major asset bubble bust and banking sector collapse. So we are left with deflating labour costs.

Aside from the knock-on effects such policies might have on aggregate demand and household investment, there is a nagging question of: can they be effective in reducing functional costs faced by businesses? In other words, are reduced labour costs associated with economic efficiency gains?

Logic suggests that even if successful, reductions in labour costs can only be as effective as labour costs' share in total output of the economy. How so? Suppose labour costs fall 10% and labour costs share in the economy is 50%, then, assuming freed resources are used somewhere more efficiently, the output boost can be substantial. If, however, labour costs are only 10% of the economy, then the impact will be smaller.

Now, here's a chart from the Robert Schuman Foundation research paper on Labour Costs and Crisis Management in the Eurozone:

According to this chart, Ireland was the second / third (to Greece and Italy) worst candidate in the euro area to implement internal devaluation policies along the lines of labour costs adjustments. And today Ireland is the second worst candidate (after Greece - the unlabelled purple line).

Yes, Ireland was the best candidate to apply these policies as the place with the worst labour costs competitiveness during the pre-crisis period.

But the adjustments, even though only partially successful, may be not impacting significant enough proportion of the economy to make much of the real difference.

7/9/2012: Ireland is not exactly shining in Global Competitiveness terms

Spot that Highly Competitive economy called Ireland?

Yep, that's right:

• Ireland ranks 27th in the Global Competitiveness Index 2012-2013 a great improvement in rankings from 29th place in 2011-2012 won by the massive internal devaluation on the sacrificial fields of defending the overvalued euro.
• Ireland rnaked 35th in Basic Requirements sub-index, 25th in Efficiency Enhancers sub-index and 20th in Innovation and Sophistication Factors sub-index
• Ireland ranks 131st in the world in Macroeconomic Environment,
• 108th in the world in Financial Markets Development,
• 20th in the world in quality of higher education and training,
• 18th in the world in business sophistication, and
• 21st in business innovation.

All results are, of course, skewed positively by the MNCs operating here. 

1/6/2012: Gains in Competitiveness? Much done, yet even more to do

Much has been made of the fabled increases in Irish competitiveness in recent years. And to be honest, data does show some significant gains. But as this blog has pointed out repeatedly, these gains have not been (a) as straight forward as the Government would like us to believe, and (b) not a significant as to warrant the claims that we are one of the most competitive countries when it comes to labour productivity.

On (a) above, we know that most of the gains in Irish competitiveness during the crisis are accounted for by jobs destruction in heavily overheated construction and retail sectors. In other words, Irish average productivity improved because we pushed less productive workforce into emigration and unemployment, not because our more productive sectors increased their labour productivity.

On (b), here are the latest stats. All data is based on Harmonized Competitiveness indicators, unit labour costs, reported by the ECB. Latest data is through Q4 2011 and higher values reflect lower competitiveness.

Consider first the data for annual average readings:

Chart above suggests relative improvement in Ireland's position vis smaller member states of the euro area, but lack of significant gains compared to some groupings, especially those that combine more advanced economies in Europe. And chart below confirms the same:

Looking at the Q4 data - Irish competitiveness gains through 2011 have been far less impressive than annual averages suggest. Charts below show full sample of countries, followed by the EA12 euro area states excluding the 2004 Accession states.

Considered across the end-of-year figures, Irish unit labour costs remain well ahead of those in our closest competitors. Luxembourg - a country with virtually un-interpretable statistics due to huge imbalance between its workforce and population, as well as its economic output composition - is the only country of the old EA12 group that currently has lower labour competitiveness than Ireland.

What about pre-euro and euro-period changes? Chart below illustrates:

The introduction of the euro has resulted in deterioration in hci-based labour competitiveness metrics in all euro area economies, save for Austria, Finland and Germany. Largest deterioration took place in Slovakia and Estonia (catching up period, due to high entry differential), with Ireland posting third largest deterioration. The same remains even during the crisis period 2008-present, as illustrated in the chart below.

During the crisis, Irish hci-ulc index reading fell from 130.5 at the end of 2007 to 111.5 in Q4 2011 - the largest gain in competitiveness of all EA12 states. However, the rate of gains for Ireland has slowed down significantly in 2011. In 2009, the first year of improvements, competitiveness rose 7.1% on 2008, which was followed by a gain of 9.1% in 2010 and only 2.9% in 2011.

2/09/2011: Competitiveness in the long run: did the euro help?

Another look at the evolution of euro area competitiveness: in the chart below I plot ECB’s Harmonized Competitiveness Indicators for the euro area since 1995 as measured by the average annual HCIs deflated by unit labour costs. The higher the value of the index, the lower is competitiveness.

Here are some interesting points to observe, based on the data:

• The period since introduction of the euro witnessed deterioration or no improvement in overall competitiveness in all countries, save Germany, once the lags are accounted for (note, there is strong path dependency in many countries’ wages/labour costs due to long term contracts and generally sticky wages). Hence, for the period 1995-2001, euro area HCI averaged at 98.8, while for the period 2002-2010 the HCI averaged 99.8. Similarly, for France, HCI averages for the two sub-periods were 99.1 against 101.7, for Italy: 97.0 against 107.1, for Spain 98.4 against 108.3, for Finland, the Netherlands (Nordics) & Austria: 99.91 against 99.94 (statistically identical), for Ireland: 100.2 to 117.5 and for the rest of the euro area: 99.2 to 113.0.
• The period of highest competitiveness for all countries, except Germany, coincides with the period when pre-euro qualification period forces of improving competitiveness reach their peak: 2001-2002. This overall euro area competitiveness peaks in 2001, France’s competitiveness peaks in 2001, Italian, Spanish, Nordics’ & Austrian, Irish and Rest of euro area competitiveness peaked in 2001.
• After 2001, losses of competitiveness become pronounced across all economies, except Germany, with lowest competitiveness post-2000 points reached around 2008 (France, Spain and Ireland) or 2009 (all other countries, plus euro area as a whole).
• Since the onset of the crisis (again, accounting for lags) there have been significant gains in competitiveness. As I noted elsewhere, in some cases (Ireland and Spain, for example) these gains came primarily due to a wholesale destruction of a number of non-competitive domestic sectors (construction and retail).
• Gains in competitiveness have been very shallow in France (decline in HCI off the local pre-crisis peak of just 2.4%) and Italy (-3.2%), moderately weak in Germany (-5.22%), Nordics + Austria (-4.69%), Rest of Europe ex-Ireland (4.5%). Gains were close to euro area overall average (-9.2%) in Spain (-7.2%) and spectacularly strong in Ireland (-17.1%). It is worth noting once again that Irish gains in competitiveness came to a large extent from destruction of jobs in sectors that were least competitive before the bust (construction and domestic retailing and hospitality).
  

Overall influence of impressive German economic performance over the 2000s in terms of competitiveness can be clearly seen from the chart below.

But what the two charts above clearly suggest in terms of analysis for Ireland is really rather disturbing. Despite significant gains in competitiveness, Ireland remains well behind its peers in terms of absolute levels of HCIs – according to the latest data, we are lagging behind Germany, France, Italy, Spain, Finland, the Netherlands, Greece, Cyprus, Luxembourg, Malta, Austria, Portugal and Slovenia.

More importantly, delivering a similar magnitude decline over the next 2 years (a task that will either require unemployment rising to over 22% or a gargantuan effort in terms of productivity growth not seen in modern history of any state) will get us to the level of competitiveness comparable to 2001 – achieving HCI of ca 96.2.

It might be not bad, but should the trends across the other euro area countries also remain identical to those over the last 2 years, Ireland (with projected HCI under this scenario reaching 98.8) will be still less competitive than the euro area as a whole (92.9), Germany (82.8), the Nordics and Austria (98.7). If anyone expects this type of miracle to occur, good luck to them, but if anyone expects the result of this miracle to be a huge boost to our economic growth, let me point out the last little factoid that the data reveals: back in the 1990s our average HCI was 102.7 – below the euro area average of 104.2. With two consecutive ‘miracles’ we are not even aiming to get to parity of the euro area average.