Ronan Lyons | Personal Website
Ronan Lyons | Personal Website

Five things you need to know about Ireland’s competitiveness

For the vast majority of the fifty years since T. K. Whitaker convinced Seán Lemass that Ireland was better off embracing rather than shunning the world economy, Ireland as a whole has been acutely aware that, as a small open economy, whether it thrives or not depends on its ability to sell on world markets. The only time we seem to have forgotten this was in the last days of the Celtic Tiger, when we convinced ourselves we could get rich selling properties to each other.

Now we’re out the other side, where does Ireland’s international competitiveness stand? At this point, many people reach for the latest IMD or WEF rankings. These rankings certainly have their uses. Particularly for countries that do not have comprehensive statistics services, surveying the opinion of executives can usefully highlight strengths and weaknesses. However, for OECD countries in particular, I think the debate can be informed by a much higher level of statistical rigour.

One I pay a lot of attention to is the IBM Global Location Trends Annual Report. The report uses FDI announcements globally to build up a picture of what companies are setting up what operations where, and with how many jobs. The 2009 report reveals that Ireland created more jobs per capita through FDI than any other country in 2008, with 225 jobs per 100,000 people, more than any other country including long-standing FDI rival Singapore and more recent competitors Bulgaria and Slovakia.

The IBM report is very much results-focused. A manager will also want to understand what is driving those results, however. To that end, last month, the National Competitiveness Council published The Costs of Doing Business in Ireland 2010. The aim of the report is to analyse Ireland’s relative cost competitiveness performance across four key business inputs, labour, property, utilities and business services. The NCC’s study is based on analysis of KPMG’s “Competitive Alternatives 2010” report, which looks at seven main cost headings: labour, property, utilities, transport, interest and depreciation, total taxes (net of grants), and location-insensitive costs (e.g. machinery).

For anyone interested in Ireland’s competitiveness, the NCC report is compulsory reading. Here are five things from that report that I think could do with being understood better in public debate:

  1. Costs set locally, not globally, are more important now than ever.
  2. The cost of utilities like electricity and broadband doesn’t matter as much as you might think.
  3. Especially when it comes to services, labour costs really really matter.
  4. Of other local costs, property costs matter most.
  5. Even with recent taxes levies, Irish workers are well paid.

Locally-determined costs matter a lot

Every set of facts about Ireland’s trading sector, from export statistics to the IBM report above, is telling the same story: Ireland is a services hub. “Servicization” is a global trend, with technology enabling a range of new business activities to be traded internationally. And in the next year or two, Ireland will become the first major economy in the world to have more than half of its exports come from services. (In fact, it has already happened briefly, in the final quarter of 2009.)

Given the growing importance of services for Ireland’s future, the chart of page 17 of the NCC report takes on a greater significance. The chart shows the relative weight of each cost heading across manufacturing, services and R&D operations. In manufacturing, over half of all costs are “location insensitive”, i.e. raw materials or machinery whose price is set on world markets, not locally. In services and R&D, however, barely 10% of costs are “location insensitive”. The vast majority of costs for FDI operations in services and R&D are determined locally.

In a €10m manufacturing operation, if local costs rise 10% over three years, that results in higher costs of about €500,000. In a €10m services operation, 10% higher local costs means a rise of €1m. The importance of our cost competitiveness is becoming amplified.

The cost of utilities doesn’t matter that much

Earlier this week, when the Government announced it was introducing its public service obligation levy on electricity, thereby increasing the price by 5%, there was much talk of how this would cost Ireland jobs. Naturally, lower costs are more attractive than higher ones. But of the four main headings in local costs (labour, transport, property and utilities), based on the mix of FDI that Ireland attacts, utilities matters least.

I’m not saying the higher price of utilities will be good for Ireland’s competitiveness. The cost of utilities is a factor but its importance should not be overstated. The price of utilities matters most in chemicals and even then it is a distant fourth in local costs, after wages, taxes and interest/depreciation.

Labour costs really really matter

Taking into account the whole cost profile, both locally and globally set costs, labour costs make up about one quarter of all costs in the typical manufacturing operation. For services and for R&D, labour costs are three quarters of all costs. At the risk of over-simplification, for Ireland’s cost competitiveness in the 2010s, what level of wages we seek is three times as important as it was during the 1980s and 1990s.

Pages 26-29 of the NCC report compare salary levels in Ireland for various occupations with other countries, from skilled and unskilled production operatives through IT and engineering managers to head of finance. Across all eight occupations, (gross) wages in Ireland are almost always very close to the eurozone average. The more general picture given on page 24 has average labour costs per person in Ireland as 10th highest in the OECD and about 10% above the eurozone average.

Property costs matter

The importance of property costs varies across different types of operation. As a general rule, the KPMG report suggests that property costs form about 5% of all local costs for manufacturing and for services, and about 10% in R&D projects. Over the coming decade, the mix of Ireland’s FDI projects will probably be something in the region of 50% services, 25% R&D and 25% manufacturing. Taking that mix, property becomes the (distant) second most important cost for Ireland’s competitiveness after labour.

Pages 33-35 of the NCC report go through the recent changes in commercial property costs in Ireland and how these costs now compare with other countries. It shows how the adjustment in Ireland’s commercial property market has helped boost our competitiveness in the last three years.

Of all four property costs shown (buy/rent a industrial unit/office), the most relevant for Ireland – given our likely FDI profile – is the cost of renting an office. Rents per square metre were €500 in 2009, a significant fall from the €800 or so in 2006 and 2007. €500 per square metre is not dissimilar to a range of other countries, including Germany, the Netherlands and Spain – and not too far off prime office space in China (about €400). The adjustment in Singapore – from almost €1,000 down to €450 – has been greater than in Ireland, though. It will be interesting to see how 2010 figures – and beyond – compare with those for 2009.

Irish workers are still well paid

Page 24 of the report has one of the most important perspective-giving graphs in the whole report. It is tempting to think, given what we were taking home in pay during the 2000s, that the recent increases in taxes/levies and falls in wages, have turned us into one of the poor-men of Europe. In fact, in 2009, Ireland had the fifth highest net wage in the OECD-28 (i.e. the OECD excluding Mexico and Turkey), with typical earnings more than 35% above the OECD-28 average.

Much as it may make anyone who points it out unpopular, Irish people still enjoy higher than average wages and lower than average taxes.

I’ll finish with a graph. It compares the cost of a hypothetical mix of FDI plants – one half services, one quarter each manufacturing and R&D – in Ireland with the big eurozone four (Germany, France, Spain and Italy). It accounts only for differences in labour, property and utilities costs, as documented in the NCC report and uses headline figures for each. Thus, it’s only meant to be indicative, not authoritative.

I’ve presented two scenarios: one with wage restraint, the other with no increase in the cost of utilities. In “Ireland A”, labour costs grow at 1% a year until 2012, while the cost of utilities grows 5% (the levy mentioned above). In “Ireland B”, there is no levy on electricity but labour costs grow at an average of 3%. (In both, a further fall in office rents of 20% is assumed.) This is set along side the same hypothetical mix of plants in the eurozone four, where labour costs are assumed to grow at an average of 2.5% a year (their recent norm) and property at 3% a year.

Ireland's competitiveness compared: a hypothetical mix of FDI projects
Ireland's competitiveness compared: a hypothetical mix of FDI projects

The gap between Ireland and the average of the big eurozone four in 2009 was driven by labour costs. Through wage restraint, this gap could halve in the next couple of years, boosting Ireland’s competitiveness in the age of services-driven FDI. If instead we get distracted on to things of lesser importance for competitiveness, like utilities, the gap could be every bit as big.

  • Arthur Doohan ,

    Lucid, informative and helpful.

    Thank you.

    • Ronan Lyons ,

      Hi Arthur, thanks for the comment, delighted you found it helpful.
      Ronan.

      • Labour costs - not electricity costs - the key to competitiveness ,

        […] […]

        • Manuel Ryan ,

          very informative, well thought out and logical
          It confirms my feeling that we are not hopeless but have been led by our political,clerical,trade union and banking elites into this awful situation

          • Pat Hynes ,

            The more I read from you Ronan the more impressed I become, in a sea of media and other national economic negativity, your contributions are persistently balanced and well written.

            • Ronan Lyons ,

              Hi Pat, thanks.
              I’m liking today’s commenters!

              • Observer ,

                I’m not sure I get this.

                Isn’t the PSO only being charged on SMEs and consumers?

                And isn’t the NCC data on the cost of doing business only related to the internationally traded goods and services?

                • Declan Heery ,

                  Hi Ronan,

                  Really enjoyed reading your article – agree with the others… well written, informative. In case you’re not aware of it, I thought I’d point you to the World Bank’s Doing Business Report (www.doingbusiness.org), which looks at competitiveness from the perspective of ease of doing business vis-a-vis business regulations (and ranks countries accordingly). For the past two years Ireland has ranked at number 7 out of 183 economies…

                  • Dermot ,

                    Ronan

                    ave a whole slew of comments on this.
                    I worked for the ESB for a few years. Common knowledge within the board back then was opening up the market would increase the price of electricity. Ireland went from cheapest electricity in EU to one of most expensive – might be an interesting analysis to compare relative unit costs of electicity in EU over the past 25 years if the data exists. Without the current regulatory strucutre electricity costs would be substantially lower than they are. Think there is a whole other discussion here on the provision of infrastrure in a modern economy as well.

                    Second comment is that the cost of electricty feeds into the Labour costs in that people see the cost of certain things rising and that is more likely to feed into demands for increased wages which feeds into the inflation. When I look at the inflation figures at the moment by big concern is not the the overall deflaction – it is the structural inflation in Education and Health that scares me.

                    Health costs continue to increase as do Education costs. And by very large amounts. Given that the government is primary provider of these services what the hell is happening here. In the Education space all teachers and lecturing staff have had wages cut in addition to additional levys etc. (in real terms at least a 20% cut). Similarly in the health sector, though there are areas that drive medical inflation such as new drugs and new technology. So I’d love an explaination of what is happening here, as inflation here will never be eliminated, and over the longer term will drive labour costs. Some comparisons between Canada and US have shown that the healthcare reigme in Canada is a cost advantage compared to the US as it lowers unit labour costs for employers and moderates wage demands.

                    Long way of saying the I agree with your premise that Labour costs are critical. And to keep them low need to understand what drives them and work on those as well.

                    • Kevin Murray ,

                      Ronan

                      I found this very interesting and credible. I don’t think we can afford to take our eye off pushing utility costs down, but I do agree that we continue to pay ourselves too much.

                      Kevin Murray

                      • misu insurance ,

                        Pamela, I doubt it 😛

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