PAUL TANSEY ECONOMICS:THE CONTINUING slide of sterling and the dollar against the euro is destroying the profitability of Irish firms facing competition from British and US producers in both domestic and foreign markets.
The precipitous slide of sterling and the dollar against the euro began suddenly last summer. Since the sub-prime lending crisis crystallised last August, the euro has appreciated by almost one-fifth against both currencies.
Movements of this magnitude would not matter much if Britain and the United States were peripheral players in Ireland's foreign trade. Unfortunately, this is not the case.
Despite the diversification of Ireland's foreign trade away from Britain following EEC accession in 1973 and our subsequent entry to an economic and monetary union within the euro zone in 1999, Britain and the US remain Ireland's two principal trading partners.
During 2007, Britain regained its position as Ireland's premier foreign market for merchandise exports, purchasing almost one-fifth of all Irish goods sold abroad.
While the US has slipped to second place, it still accounted for 17.8 per cent of all foreign sales of Irish goods last year.
Together, Britain and the US are almost as important as the whole of the euro zone as an export destination. As shown in Table 1, 36.5 per cent of Irish merchandise exports were sold to Britain and the US last year, whereas the euro zone purchased 41 per cent of all Irish goods sold abroad.
Moreover, the raw data understate the importance of the British market to indigenous Irish exporters.
Whereas goods exported to the euro zone are dominated by Irish-based multinational companies, for many Irish small- and medium-sized firms, Britain is their only export market.
On the imports front, Ireland's dependence on Britain is even more pronounced. Ireland imports more goods from Britain than from the whole of the euro zone. Last year, one-third of all goods imports originated in Britain.
In textbook terms, a currency appreciation makes exports more expensive while at the same time it reduces the cost of imports.
But it's the dynamics of this process that do the damage. For indigenous Irish exporters to Britain, the appreciation of the euro against sterling has raised their selling prices in Britain by a potential 20 per cent.
However, where markets are competitive and demand responds quickly to price changes, a 20 per cent price increase would cause sales to plummet.
Thus, to stay competitive in the British market, Irish exporters are forced to bear most of the costs of the exchange rate change themselves, absorbing it initially in lower profit margins and subsequently in reduced operating costs.
Where margins cannot take the strain and costs cannot be reduced sufficiently, the only alternative is to exit the British market altogether.
In this way, it can be seen that the immediate effect of the exchange rate appreciation is the shredding of profit margins.
On the imports side, the appreciation of the euro against sterling should reduce the basic costs of goods imports from Britain by almost 20 per cent. And we're talking big money here.
Last year Ireland imported more than €20 billion worth of goods from Britain. Given the size of this import bill, reduced import costs, consequent on the exchange rate change, would cause a material fall in the Irish rate of inflation.
However, since the consumer price inflation rate for the year to March accelerated to 5 per cent, there is little sign that the depreciation of the sterling exchange rate against the euro is being passed on to Irish consumers in lower prices.
Clearly, this area is not being adequately policed and super-normal profits are being generated as a result.
It might be argued that this analysis concentrates unduly on merchandise trade. After all, services have been the fastest-growing segment of Irish exports in recent years and they now account for over two-fifths of all Ireland's foreign sales.
But Ireland's foreign trade in services is even less focused on the euro zone than merchandise trade. In 2007, just one-third of Ireland's services exports were earmarked for euro-zone markets, while one-quarter of Irish services imports originated in the euro zone.
Data for Ireland's total foreign trade in both goods and services are combined in Table 2.
As can be seen, the single currency zone, where exchange rate stability is guaranteed, buys less than two-fifths of all Irish exports and supplies Ireland with just over one-quarter of its total imports.
Ireland has been a member of an economic and monetary union for almost a decade. The sad reality, illustrated in Table 2, remains that the euro zone is still not an optimum currency area for Ireland.
It is for this reason that fluctuations on foreign exchanges are causing Irish firms such pain.
