Abstract
The Selected Issues paper analyzes how fast Ireland will grow in the future. The approach of this paper is to consider the catch-up in labor utilization productivity and use independent demographic projections and other considerations to make reasonable assumptions about labor productivity and utilization growth in the future. It uses a simple growth-accounting framework, and discusses the trends in labor utilization and productivity per hour in the past. The paper also describes the spectacular boom of the Irish housing market and its key drivers from an international perspective.
III. The Competitiveness of Irish Manufacturing: An Update1
A. Introduction
1. The manufacturing sector in Ireland has experienced significant gains in competitiveness since the 1990s. The real effective exchange rate (REER) based on normalized unit labor costs (ULCs) of manufacturing, a measure widely used for assessing external competitiveness, indicates a sharp trend depreciation in the 1990s.2 The remarkable gains in competitiveness reflected primarily a sustained decline in Irish ULCs of manufacturing relative to trading partners, which in turn was made possible by impressive productivity growth despite higher inflation in Ireland. Since 2001, strong increases in hourly wages in Ireland and production cuts in the midst of the global slowdown have sharply increased Irish ULCs, thereby arresting the strong trend depreciation. Nevertheless, given the past gains, this measure suggests that the Irish manufacturing sector remains strongly competitive overall.
Exchange Rate Indices
(1990 = 100)
Citation: IMF Staff Country Reports 2004, 349; 10.5089/9781451818802.002.A003
Unit Labor Costs
(1990 = 100)
Citation: IMF Staff Country Reports 2004, 349; 10.5089/9781451818802.002.A003
2. Alternative measures, however, depict a substantial erosion in Irish competitiveness since 2001. The real exchange rate based on consumer prices, broadly used to compare the cost of living across countries, has increased by nearly 20 percent since end-2000. Persistently higher inflation in Ireland than in partner countries raised Ireland’s price level above those of the partner countries and caused the sharp deterioration. More recently, the substantial strengthening of the euro fueled the appreciation of the nominal effective exchange rate (NEER), which previously had been relatively stable since the mid-1990s, and exacerbated the deterioration. A measure based on relative production costs shows a similar reversal trend, albeit to a lesser extent. Focusing on price and wage competitiveness in Ireland, Lane (2004) finds that the GDP deflator-weighted real exchange rate also points to significant losses in competitiveness since 2001. Cerra and Soikkeli (2002) focus on the dispersion in the competitive position across industries and show that the employment-weighted REER deteriorated significantly in 2001. Following the methodology in Cerra and Soikkeli, this note updates the recent developments in Irish competitiveness in the manufacturing sector. It shows that the erosion in competitiveness experienced in 2001 has continued further, with potentially important employment consequences going forward.
Competitiveness
(1995Q3 = 100)
Citation: IMF Staff Country Reports 2004, 349; 10.5089/9781451818802.002.A003
B. Employment-weighted Real Effective Exchange Rate
3. The contrasting evolution of Irish competitiveness stems from large differences across the manufacturing industries. Traditional output-weighted measures of competitiveness in manufacturing in Ireland have been widely criticized because the exceptionally strong performance of a handful of multinational-dominated sectors severely distorts the picture. These sectors’ large gains in productivity often resulted from intangible foreign inputs into production, such as returns on past R&D, patents, and advertising campaigns abroad. While accounting for a large share of total manufacturing production, these sectors were highly capital intensive, with strikingly small shares in total manufacturing employment. Among them, the dispersion between the output and the employment shares has been considerable in the chemical and pharmaceutical industries (classified as NACE industry 24) and, to a lesser extent, in office machinery and computers (NACE industry 30).
Selected Industries: Output vs. Employment Shares
(in percent of total output and employment)
Citation: IMF Staff Country Reports 2004, 349; 10.5089/9781451818802.002.A003
1/ NACE (15-16): food, beverages, and tobacco;NACE (24): chemical and chemical products;NACE (27-28): basic and fabricated metals;NACE (30): office machinery and computers;NACE (32): Radio, TV and communication equipment; and NACE (33): Medical, precision, optical and clock instruments.4. The strong wage increases in recent years have had different implications for the ULCs of manufacturing by industries. More so than capital-intensive industries, which are more immune to the effects of rising wage costs, labor-intensive industries in Ireland have been significantly affected by the recent developments in wages. Weighted by the employment share of manufacturing—rather than the output share—in order to capture the sensitivity of the labor-intensive sectors to wages, the ULCs of manufacturing show only a limited decline up to 2001, followed by a sharp increase. Initially, the strong gains in productivity, particularly in chemicals and pharmaceuticals, masked most of the competitiveness losses in the labor-intensive sectors. Since 2001, however, falling production and an acceleration in wage inflation have driven up ULCs.
ULCs Decomposition Weighted by Employment Share
(1995Q3 = 100)
Citation: IMF Staff Country Reports 2004, 349; 10.5089/9781451818802.002.A003
5. The movement of the REER weighted by the employment share suggests a significant deterioration in competitiveness since 2001. Consistent with the developments in employment-weighted ULCs, the employment-weighted REER remained broadly stable during the second half of the 1990s, followed by a notable appreciation since 2001.3 In contrast, the output-weighted measure shows a steady decline followed by a pause at the depreciated level. The divergence between the two measures has been widening in recent years. The sustained gains in competitiveness shown by the output-based measure were mainly supported by strong production growth in a few industries, which offset the impact of rising ULCs in other industries.
Real Effective Exchange Rates
(1995Q3 = 100)
Citation: IMF Staff Country Reports 2004, 349; 10.5089/9781451818802.002.A003
6. Excluding the capital intensive industries, the deterioration in competitiveness has been more severe. While the employment-weighted REER is less biased than the output-weighted measures by the strong performance of the handful of capital-intensive multinational industries, the large sectoral dispersion still remains. By excluding these industries, the adjusted REER reflects better the sensitivity of overall Irish manufacturing to wage developments. As expected, without the large cushion provided by the chemicals and pharmaceuticals sectors (NACE 24), competitiveness losses in Ireland would have been even more pronounced since 2001.
REERs Excluding Selected Industries
(1995Q3 = 100)
Citation: IMF Staff Country Reports 2004, 349; 10.5089/9781451818802.002.A003
7. Ireland’s competitiveness has varied significantly vis-à-vis partner countries. On a bilateral basis, and using the employment-weighted measures, Irish manufacturing has maintained large competitiveness gains vis-à-vis the United Kingdom, Ireland’s largest trading partner, but the gains have been dwindling rapidly since 2001. In contrast, relative to the euro area, Irish competitiveness has been consistently weak, while Ireland has been becoming less competitive with the United States, a development that is broadly in line with the movement of the multilateral REER. The recent competitiveness losses vis-à-vis the United Kingdom have had significant implications for Ireland’s overall external competitiveness, given not only the large share of Irish manufacturing exports to the United Kingdom but also the large volume of consumer goods imported from the United Kingdom. Using the output-weighted measure, however, Ireland has maintained a stable and impressively strong competitiveness position in recent years.
REER - Employment-weighted
(1995Q3 = 100)
Citation: IMF Staff Country Reports 2004, 349; 10.5089/9781451818802.002.A003
REER Output-weighted
(1995Q3 = 100)
Citation: IMF Staff Country Reports 2004, 349; 10.5089/9781451818802.002.A003
8. Irish competitiveness is highly sensitive to exchange rate movements. With Irish membership in the Economic and Monetary Union (EMU), nominal exchange rate fluctuations against the euro area partners have been eliminated. However, currency fluctuations still have a large impact on Irish REER volatility, due to the large proportion of trade with non-euro countries. The employment-weighted REER evaluated at constant 1995:Q3 exchange rates show that competitiveness was stable until 1998, after which the relative ULCs surged by over 20 percent, partly reflecting a cyclical decline in output. Alternatively, by keeping the exchange rate constant at its end-2000 value, we can explain roughly a half of the competitiveness losses since 2001 through exchange rate developments, which have had a larger impact on employment-weighted measure.
Exchange Rate Effects
(1995Q3 = 100)
Citation: IMF Staff Country Reports 2004, 349; 10.5089/9781451818802.002.A003
Exchange Rate Effects
(1995Q3 = 100)
Citation: IMF Staff Country Reports 2004, 349; 10.5089/9781451818802.002.A003
C. Conclusion
9. Looking ahead, the recent deterioration in Irish competitiveness in manufacturing poses considerable challenges. Overall Irish economic conditions remain strong, with low unemployment and resilient employment growth. Notwithstanding the swing in the current account balance from surplus to deficits, the deficit remains small, which suggests that Ireland’s external competitiveness remains relatively strong. However, the analysis in this note suggests that the main factor supporting Ireland’s strong competitiveness has been the high productivity growth in a handful of capital- intensive industries—a development that has masked competitiveness losses in the rest of the labor-intensive sectors. Going forward, with the accession countries gaining strength, Ireland will be facing increasingly stiff competition in attracting FDI inflows. Against this background, controlling wage developments is key to maintaining Irish competitiveness.
10. A number of caveats should be mentioned. While this note follows the same methodology and data sources as in Cerra and Soikkeli, the partner country data on production and employment by NACE industry previously obtained by the OECD have recently been discontinued. At the same time, the current exercise maintains the same export weights, which are based on averages over 1998-2000. Notwithstanding these data limitations, the analysis presents a clear picture about the recent trend in Irish competitiveness.
References
Cerra, V., and J. Soikkeli, “How Competitive Is Irish Manufacturing?”, IMF Working Paper WP/02/160, 2002.
Lane, P., “Assessing Ireland’s Price and Wage Competitiveness”, unpublished; Institute for International Integration Studies (IIIS) and Economics Department, Trinity College Dublin and CEPR, June 2004
Prepared by Keiko Honjo.
An increase (decline) in the real and nominal effective exchange rates denotes an appreciation (depreciation) or loss (gain) in competitiveness. The ULCs are normalized in the sense that productivity data are smoothed (filtered) to take out cyclical components.
A similar result can be obtained by weighting the REER by total hours worked in manufacturing.
