Showing posts with label Unit labour costs. Show all posts
Showing posts with label Unit labour costs. Show all posts

Monday, June 30, 2014

30/6/2014: The Euro Plus Pact: Getting Causality Between Current Account and Competitiveness Backwards


Gabrisch, Hubert and Staehr, Karsten, new paper published by ECB and titled "The Euro Plus Pact: Cost Competitiveness and External Capital Flows in the EU Countries" (February 18, 2014, ECB Working Paper No. 1650. http://ssrn.com/abstract=2397789) looks at the effectiveness of the Euro Plus Pact which was approved by 23 EU countries in March 2011 and came into force shortly afterwards.

Emphasis in bold in the quotes is mine.

"The Pact stipulates a range of quantitative targets meant to strengthen cost competitiveness with the aim of preventing the accumulation of external financial imbalances."

According to the authors: "The rationale behind the Euro Plus Pact is evident in its original name, the Competitiveness Pact, and also in its current subtitle: “Stronger economic policy coordination for competitiveness and convergence” (European Council 2011, p. 13)."

In virtual obsession of European policymakers with internal competitiveness expressed in terms of cost of labour and production, "Deteriorating cost or price competitiveness in individual countries is seen as a source of economic and financial instability. This view is directly stated in the conclusions from the European Council meeting at which the Euro Plus Pact was adopted (European Council 2011, p. 5): "The Euro Plus Pact […] will further strengthen the economic pillar of EMU and achieve a new quality of policy coordination, with the objective of improving competitiveness and thereby leading to a higher degree of convergence […].""

The authors use Granger causality tests and vector autoregressive models "to assess the short-term linkages between changes in the relative unit labour cost and changes in the current account balance. The sample consists of annual data for 27 EU countries for the period 1995-2012." This allows them to explore the direction and size of the short term linkages between cost or price competitiveness and external capital flows in the EU countries.

"The analyses are particularly pertinent given the adoption of the Euro Plus Pact… The underlying rationale is that deteriorating cost competitiveness is an important factor behind the accumulation of current account deficits and financial vulnerabilities." Thus, the "participating countries must take measures to improve their cost or price competitiveness and thereby reduce the likelihood of financial imbalances accumulating."

First, authors use Granger causality tests to determine "whether lagged values of one variable help explain the other variable when autocorrelation and country fixed effects are taken into account." The result is: lagged changes in the current account balance help explain changes in unit labour costs, while there is no effect in the opposite direction. The results hold for all 27 EU countries, for the EU15 countries and for 10 EU countries.

Second, vector autoregressive models confirmed "qualitative results are in all cases very similar to those of the Granger causality tests. …"

In other words, "changes in capital flows appear to affect cost competitiveness in the short term, while changes in competitiveness appear to have no effect on capital flows in the short term." This is important, as many policy analysts (e.g. Bruegel) and European policymakers (from Commission to national governments) routinely express the view that external imbalances are the result of poor competitiveness, especially in the periphery and especially in the context of driving the momentum of the financial crisis and the great Recession.

Here is what the authors have to say on this: "Increasing capital flows from the core to the periphery of Europe may partly explain the deteriorating cost competitiveness in many countries in Southern and Central and Eastern Europe as well as the improving cost competitiveness in many countries in Northern Europe [prior to the Crisis]. The reversal of these capital flows after the outbreak of the global financial crisis may lead to ensuring changes in cost competitiveness."

But more crucially, there seems to be no reverse direction of causality: pursuit of greater competitiveness does not seem to be a correct prescription for achieving external balances. "...the measures in the Euro Plus Pact to restrain the growth of unit labour costs may not affect the current account balance in the short term."

Now, wait, that is ECB research paper that says 'restraining growth in unit labour costs' (aka: improving competitiveness) may not do much for external balances… Hmm… did anyone hear that Euro Plus Pact tree fall?

And moving beyond the past: is anyone monitoring flows of 'capital' to the 'periphery' in the form of extremely depressed Government debt yields that are prevailing today? Cause you know, that competitiveness might be falling next time we look…

Friday, May 16, 2014

16/5/2014: Competitive Sports of Competitiveness Gains

Yesterday I posted my Sunday Times article on unemployment and skills: http://trueeconomics.blogspot.ie/2014/05/1552014-jobs-employment-lot-done-more.html

Here is an interesting chart via BBVA Research on labour costs competitiveness gains across the euro 'periphery' and other euro states:



BBVA Research chart above is plotting changes in unit labour costs 2009-2013 and decomposing these gains in 'competitiveness' into productivity growth and earnings/wages cuts. Here Ireland is a shining exemplar of improved competitiveness.

Alas, there are some problems with this. Wages/earnings destruction is hardly a good way for regaining competitiveness, especially when this process is associated with sticky prices (real value of income declines). In Ireland's case, we had on top of the said reductions of the purchasing power of income, also higher taxation and extraction of rents by the public sectors and by the banks. All of this 'improved competitiveness' is, therefore, a wee-bit of pyrrhic victory for Ireland. 

And then, of course we have our fabled increases in productivity. What happened here? Have we suddenly discovered major technological breakthrough that allow us to produce more using fewer resources? Err… not really. We took down construction and retail and domestic services sectors and reduced them to ashes. Highly labour-intensive, these sectors employed many producing lower value added than other sectors where few produce huge value added (much of it of course is superficial and accruing to the MNCs, but who cares in this land of magic competitiveness?). When we destroyed domestic sectors, we ended up with an economy producing less, but with even fewer people working. All the social welfare rolls swelling also fuelled our productivity. Of course, were we to fire everyone and just leave around one tax arbitrage P.O. Box in IFSC open, we will have miraculously higher productivity than anyone else in the world.


So where are we, really, if we take out all these superficial and even potentially self-destructive 'efficiency gains'? Probably closer to Portugal - a net gain in competitiveness of around 3-4%. Not bad, but not as wonderful as our heroic 9.5% gain.

Thursday, September 26, 2013

26/9/2013: Sunday Times 15/9/2013: What About Irish Competitiveness?

This is an unedited version of my Sunday Times column from September 15.


Recent experiments in psychology have shown that people routinely distort their interpretation of objective evidence to fit their subjective political beliefs. More ominously, our propensity to ideologically colour evidence appears to be greater the better we are with data analysis.

This ability of humankind to see data through the tinted glasses of our biases is present all around us, including in the interpretation of economic data.
Take two examples.

Recently, the relatively ideology-free World Economic Forum published its annual report on global economic competitiveness rankings for 2013-2014. According to the report, Ireland now ranks 28th in the world in terms of competitiveness, down one place on a year ago. Back in 2005-2006 – at the height of the boom, and amidst rampant business costs inflation, we ranked 21st. Overall, Ireland's global competitiveness has deteriorated by 7 places over the last ten years, with this year's performance just one notch better than the absolute nadir reached in 2011. A more ideologically-informed Heritage Foundation / WSJ Index of Economic Freedom continues to rank Ireland highly in the 13th place in the world in 2013. However, tinted lasses aside, our overall competitiveness score in the latter index declined from around 82-83 in 2006-2009 to below 76 this year.

Meanwhile, Irish political and business elites continue to brag about the remarkable gains in the country competitiveness, brought about by the policies enacted since the beginning of the crisis or at the very least, by the reforms that took place since the last elections. Almost 6 months ago, seemingly unburdened by evidence, Taoiseach Enda Kenny has declared that the government is "making this the best small country in the world to do business in…" Never mind that Ireland ranks outside the top 10 countries in the world in every reasonably comprehensive and objective rankings produced so far. And never mind that our rankings have deteriorated, rather than improved, since the onset of the crisis. The government will still spin the evidence.

The truth, of course, is somewhere in between the two extremes of the opinion.

One core measure of competitiveness is the labour-related cost of the unit of output in the economy, the so-called unit labour costs (ULCs). Based on the ECB data, we  achieved substantial gains in this measure, with ULCs falling 18 percent peak-to-trough. However, since the trough was reached in Q2 2012, Ireland’s performance has deteriorated. In 2009-2010, Irish unit labour costs fell by over 7 percent compared to 2008. The rate of cost deflation declined to 2.4 percent over 2011-2012. So far, since the start of 2013, the ULCs are rising. This exposes the underlying causes of changes in the ULCs over the crisis period. Much of the recent gains in labour competitiveness were driven by a dramatic rate of jobs destruction back in 2009-2011. As the jobs market stabilised, competitiveness gains vanished.  Exactly the same story is being told by the broader harmonised competitiveness indicators published by the Central Bank of Ireland.

However, the data also shows that the key driver for the deterioration in our cost competitiveness in more recent months is government policy.

As the result of our non-meritocratic approach to labour markets, lack of reforms in core areas relating to business development and entrepreneurship, the use of tax policies to fund wasteful bank crisis resolution measures and public spending, Ireland finds itself in an absurd situation where we rank 12th in the world in capacity to attract talent and 40th in capacity to retain the talent we attract. As our openness to FDI is bringing scores of talented workers into the country, our internal markets policies are pushing talent out of the country. Having had their fill of "the best small country in the world to do business in", globally skilled workers tend to get out of Ireland.

As the result of our inability to keep key skills and talent in the country, labour costs are starting to creep up, even before we see serious uptick in new employment. In 2009-2010, according to the OECD,  labour costs accounted for 74 percent of the total inputs costs in production in Ireland. In 2011, the latest for which we have data, this rose above 77 percent. Labour productivity growth, having peaked with unemployment increases in 2009 has fallen back by almost two thirds by 2012.

The latest data from CSO shows that average hourly earnings are now up in eight out of thirteen sub-sectors year on year through H1 2013. Crucially, in the areas under direct Government control, earnings are now rising once again and at speeds exceeding those recorded for the overall economy. Public sector average weekly earnings were up 1.3 percent year on year in Q2 2013 and non-commercial semi-state earnings are up 2.7 percent.

With every new report, the IMF reiterates its advice to the Irish authorities to continue focusing on labour markets reforms. Despite this, the Government staunchly refuses to address the main factors holding back our labour competitiveness. These are flexibility of wage determination (with Ireland ranked 103rd globally), flexibility in hiring and firing (we rank 43rd here) and linking pay to productivity, especially in the public sector (our rank is 38th worldwide). According to the WEF, Ireland ranks 90th in the world in terms of the effect of taxation on incentives to work.


So labour competitiveness improvements of the past are neither a credit to the Government reforms, nor appear to be sustainable over time. Now, lets take a look at other policies-linked metrics.

World Economic Forum report lists the top 5 factors acting to depress our global competitiveness scores. In order of decreasing importance these are: access to financing, inefficient government bureaucracy, inadequate supply of infrastructure, insufficient capacity to innovate, and tax rates. The first two come under direct remit of public reforms aimed at dealing with the crisis. The fourth one, capacity to innovate, is linked a myriad of incentives and subsidies crafted by Irish governments in an attempt to shift the economy away from bricks and mortar toward innovation and exports. The third and the last factors arise from the Government policies since 2008 that saw higher tax burdens and shrinking public capital investment become the drivers of the state response to the fiscal crisis. Thus, by WEF metrics, Irish Government is responsible for dragging down Irish economy's competitiveness, rather than pushing it up.

These findings are broadly in line with the Heritage/WSJ index readings, which shows that we score poorly on Government policies, fiscal performance, and public spending efficiency.
Despite years of austerity and alleged reforms in public sector management since 2008, the WEF report ranks us 55th in the world in terms of wastefulness of government spending, and 29th in terms of burden of government regulation. When it comes to the transparency of Government policymaking, Ireland ranks below 24 other countries around the globe. The latter is a metric directly targeted by the Troika-led reforms and the one where the Irish Government has, allegedly, done most work to-date. We have revamped banks regulation and reporting, significantly altered macroeconomic risk monitoring, fiscal policies oversight, economic policy development mechanisms and more. Yet for all our successes in this arena, we are not even in top 20 worldwide when it comes to policies transparency.

Another obvious flash point of the crisis was the lack of robust audit and oversight over the operations of our banks and some companies. One would expect that 5 years into dealing with the crisis, Ireland would have delivered some serious improvements in these areas. Alas, we still rank 58th in the world in terms of the strength of our audit and reporting standards. In a business oversight metric, the World Bank Doing Business report ranks Ireland 63rd in the world in terms of the  enforcement of contracts, with average time to resolve a dispute of 650 days in Ireland, against 510 days for the OECD average.  As a legacy of the protected sectors inefficiencies, our legal system imposes average costs of 26.9 percent of the total volume of dispute-related claims on contracted parties, against the OECD average of 20.1 percent.

The current Government came into office with a clear promise to reform domestic sectors to breath in more competition into protected markets. This has not happened to-date. State-controlled sectors, such as professional services, health insurance and health services, energy, transport, education, and so on, remain shielded from real competition. As the result, Ireland ranks 42nd in the world in intensity of local competition, and 24th in effectiveness of anti-monopoly policies, even though much of this effectiveness comes via Brussels. Property regulations, planning and permissions systems are as atavistic as they were before the bust, meaning that the World Bank ranks Ireland 106th in the world when it comes to dealing with construction permits.


Ireland’s performance on the competitiveness side is worrying. In the long-run competitiveness metrics and rankings – imperfect as they may be – help global investors allocate capital investment and productive activities of their companies around the world. Even more significantly, these metrics expose structural problems in the economy and governance systems that are holding back Irish domestic entrepreneurship and innovation.

As economies and fiscal positions of governments around the world improve over time, the competition for FDI and new markets for goods and services exports will heat up, once again. Downward pressure on taxes – Ireland’s core competitive advantage to-date – will re-accelerate too. At the same time, capital investment will remain scarce and costly, while skills shortages worldwide will once again start driving up cost of doing business, including here. This means that global investment flows will tend to be concentrated on the markets with the greatest demand growth potential, and where the profit margins are the highest. The only way Ireland will be able to compete is by becoming a competitiveness haven for product innovation and development, advanced specialist manufacturing, distribution, marketing and sales. Being just a tax haven will not be enough.




Box-out:

A financial transaction tax (FTT) on derivatives trades came into power in Italy this week, as a follow on to March 2013 introduction of the FTT on equity transactions. Per new law, derivatives will be taxed at rates that vary with the volume and the type of the contracts traded. Equities transactions are taxed at 0.12% for shares traded on a regulated exchange or 0.22% for over the counter trades. Six months in, the FTT is having an effect. As a number of analysts, including myself have warned prior to the introduction of the tax, Italian trading volumes for equities are down significantly, compared to the rest of Europe. Since March, Italian equity market turnover dropped to EUR50 billion from EUR101 billion a year ago. French equity markets experienced exactly the same effect post FTT introduction. At the peak in 2011, French equity market accounted for 23 percent of the European equity markets turnover. Today, it is at around 13 percent. There is also some evidence that wealthier investors are moving their transactions out of FTT-impacted equity markets. Which means that more burden of the levy – popularly mislabeled as 'Robin Hood' tax – is falling onto the shoulders of smaller investors. Falling trading volumes are now expected to undercut significantly Italian and French estimates for the Government revenues that FTT was expected to raise. With projected funding already allocated in the budgets, any shortfall will have to be compensated for via other taxes or cuts elsewhere. Yet, undeterred by the evidence, the EU continues to press on for a cross-border FTT. John Maynard Keynes once said: "When my information changes, I alter my conclusions." Sadly, his otherwise enthusiastic students in Brussels have missed that lesson.

Friday, June 1, 2012

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.