Bermuda triangle of competitiveness

The simplest way to tell the story is not always the right one. Forget the debate over lowering wages – our capital spending needs to rise.

Ireland is a small open economy that sells lots of stuff to the rest of the world. The central fact of our economy is its size and its openness to the vagaries of the world economy. A simple rule to sell lots of stuff to the rest of the world might be to produce that stuff more cheaply than elsewhere. This is the central plank of competitiveness and the sort of thing we teach undergraduates in economics. Countries should specialise to a degree that gives them an advantage, and then control costs like rent on capital and wages for labour. The argument goes that if rents or wages go too high, prices will rise, and competitiveness will be lost, harming growth and living standards in the future. But it’s usually pretty hard to control rents, so really we’re talking about wage control, unions being bad things, and so forth.

This view is simplistic and incorrect, but for some reason it has found its way into the reporting of the National Competitiveness Council’s recent report. Perhaps this has happened because of the recent sabre-rattling of the public sector unions on pay, or the change in Ireland’s position from black sheep to best boys in class in the eurozone, or simply because it’s the easiest way to tell the story, keep wages low.

The report shows a pyramid of competitiveness. This pyramid is an ugly, 3D thing designed to get across the basic idea that ‘competitiveness’ is a complicated idea with many factors affecting whether or not a nation can sell lots of its stuff in other markets.

It’s worth describing the pyramid. At the bottom of this pyramid thing, in a solid blue, where ‘bread, cereal, and potatoes’ would be if this were a food pyramid, are ‘business environment, physical infrastructure and knowledge infrastructure’.

Nothing appears on prices or costs until the next ‘fruit and vegetables’ layer of the pyramid, done out in a weird yellow, and even then costs are supplanted by things like productivity and the supply of available labour.

At the top, where the meat and fish goes, in a sort of weird pink, sits ‘sustainable growth’. The whole thing looks like a powerpoint slide got drunk and accidentally ate a management dictionary instead of a kebab after a night out.

As confused as it is, the pyramid thing illustrates one thing beautifully: you get competitiveness from good regulations (check: we’re one of the most business-friendly places on Earth), physical infrastructure (big ‘X’: we’ve been crap at infrastructure since the foundation of the state) and knowledge infrastructure (check, our further and higher education systems, which have been performing well while being starved of cash since 2008).

Looking at physical infrastructure, think about the roads joining Limerick and Cork. (The roads programme, by the way, is probably the only example of successful sustained capital investment since the 1950s). The average amount of expenditure on capital in Ireland since the 1970s is about 3.2 per cent of GDP, a good bit less than we’d assume for standard depreciation of about 5 per cent, meaning much of our capital stock must be rotting. At its very peak, in the boomiest of boom years, 2008, capital expenditure was only 5.2 per cent of GDP.

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We just don’t invest enough in our capital stock. Now let’s think about a motorway joining Cork and Limerick. This will be expensive, yes, but in addition to raising GDP, it will also create the capacity for ventures which were previously not profitable between Cork and Limerick to become so.

Think about next-generation wireless technologies or new clean water plants, new fourth generation manufacturing plants and ICT infrastructure for the health system. All of these are big-ticket, multi-annual projects, but once they are completed, they enable much, much more to happen.

Which is why the sensible people at Ibec are calling for more capital investment first, and tax cuts later.

Let’s look at ‘knowledge infrastructure’ – our schools, our further education and higher education facilities. The higher education capital budget has been reduced by 85 per cent since 2008. Student numbers have increased by 25 per cent, with per-student contributions rising to €3,000 in the higher education sector. The Higher Education Authority, a body which I have the privilege to be acting chair of at the moment, estimates the sector requires well over €5 billion of investment over the next ten years in order to address substandard conditions and continued growth in student numbers, and a recent Royal Irish Academy report bares this conclusion out.

Are profits being squeezed by wage increases? One way of measuring the ‘profits’ or rents would be to look at the share of gross national income going to domestic companies, adjusting for inventories and other things.

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The long run average of this ‘profit share’ is about 7.6 per cent. In 2014, the share was 9.4 per cent. So profits aren’t being squeezed by any wage increases. And you wouldn’t expect to see a squeeze when unemployment is hovering around 8 per cent.

So don’t believe the hype. Wages don’t need to fall right now. Capital spending needs to rise, and in a really big way. That’s the real route to national competitiveness. But don’t believe me. It’s all in the triangle.