The economy has become more competitive as unit labour costs have fallen but there is still much slogging ahead

‘COMPETITIVENESS IS a meaningless word when applied to national economies. And the obsession with competitiveness is both wrong and dangerous.”

Who wrote these words of apostasy? A rabid anti-globaliser railing against “neoliberalism”? Or, perhaps, a trade unionist who is suspicious that appeals to competitiveness are a precursor to putting pay cuts on the agenda.

But no, this rejection of competitiveness as a concept was not made by a usual suspect. It was, in fact, made by none other than Nobel laureate Paul Krugman, the biggest cheese alive in the branch of economics concerning itself with international trade theory.

Krugman wrote those words in 2004. He repeated the sentiment in his New York Times column last week in response to President Barack Obama’s state of the union address, in which the US leader spoke of competitiveness as a race among nations.

Krugman has a point. Talking about competitiveness in terms of national rivalry can foster an often instinctively held view that free trade poses a threat to national economies. Such fears can foster a siege mentality.

Protectionist instincts, however, are misguided. There is no more important insight from economics than the positive-sum nature of commercial interaction, be it within borders or across them. More trade for one country does not mean less for another’s. Bigger markets allow economies of scale to be exploited. Lower barriers to trade among nations make markets bigger.

In this respect, trade is a driver of productivity growth which, in the end, is all that matters in determining living standards.

If Krugman, though, is on the mark writing for an audience in a large, closed economy in which there are deep-seated strains of isolationism and protectionism, such as the US, he is wide of it in the context of a very small and very open economy fully integrated into a much larger economic area, such as Ireland.

Competitiveness relative to other economies has a much bigger impact on long- term living standards when exports are equivalent to 100 per cent of GDP, as in Ireland’s case, than when they equal just 10 per cent, as is the case for the US.

If there is a reason to think twice about the competitiveness mantra in an Irish context, it is not about the concept itself, but rather how it is measured. There are many different ways to quantify it and none is anywhere near perfect. The imperfection of the various measures is well acknowledged among policymakers here.

The National Competitiveness Council, for instance, uses more than 100 comparative indicators in its annual assessment of this economy’s position vis-à-vis trading partners/ rivals. The imperfection of existing measures of competitiveness is also to be seen most topically in the debate among euro zone countries on including competitiveness indicators in the new set of economic governance rules currently being negotiated and by which all euro participants will have to abide in the future.

In this context, a new emphasis on countries’ balance of international payments has emerged as a measure of competitiveness. This measure, which was completely ignored in the early years of monetary union, tells whether a country is paying its way vis-à-vis the rest of the world.

Despite being a crude measure of competitiveness, government ministers and officials have taken to pointing out that Ireland’s current account balance looks set to swing from deficit to surplus this year. This serves to differentiate Ireland from the Club Med countries, including Greece, Spain and Portugal, all of which suck in lots of foreign capital to pay for their consumption and investment.

It is one measure that gives reason to believe that competitiveness is being regained. Another is inflation. Irish consumer prices hit an all-time high in the months immediately before the detonation of the international and Irish financial crises in September 2008.

Over the following 15 months, when employment and output crashed most dramatically, an unprecedented decline in consumer prices took place. A low point was reached in January 2010.

By the traditional national measure – the consumer price index (CPI) – prices fell by almost 8 per cent from peak to trough. The EU’s harmonised index of consumer prices (HICP), which measures a slightly different sample of goods and services and does not include changes in housing costs related to moves in interest rates, registered a high-to- low fall of 4.5 per cent. This was by far the largest decline in the price level of any of the 27 EU member states.

In 2010, inflation stirred again. In December, the price level as measured by the HICP, was 0.5 per cent above its recession era low in January. It was, however, the smallest increase of EU members.

A better measure of competitiveness than either the current account balance or trends in consumer prices is the labour cost of producing a given unit of output. Unit labour costs take into account not only wage costs but the productivity of workers too.

Economy-wide, unit labour costs fell by a fifth over the past two years, statistics show, owing both to higher productivity growth and lower wages. Here again, though, measurement issues muddy the waters.

This week, Derry O’Brien, an economist at the Central Bank who studies Irish competitiveness issues as closely as anyone, published new research*. He found that more than half of the headline fall in unit labour costs since 2008 was accounted for two factors.

The first was the collapse in the low- productivity building sector. Because a bricklayer produces less than the average assembly-line worker or office drone, the loss of his job drives up average productivity, resulting in lower economy-wide ULCs.

Nobody would advocate laying off brickies as a means of cutting unit labour costs.

The second factor was hyper-productive workers in the chemicals sector becoming even more productive. Although there is no downside to this (unlike the construction collapse), the small size of the industry in total employment terms means its effect on the headline figure could be interpreted as causing a distortion.

The Irish economy has regained competitiveness, but, as with most other economic challenges facing the State, there is still much slogging ahead.

*Central Bank Quarterly Bulletin, January 2011, pages 22-24. financialregulator.ie/publications/