January 22nd Afternoon: The Recession Diaries

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Finally, some good ol’ fashioned common sense is being spoken – and in the Irish Times, as well.  Prionsias Breathnach of NUI Maynooth takes on calls for wage cuts head on. He does this through this time-tested process of looking up the facts.  In these days, that’s almost a revolutionary act.   He elaborates three reasons why calls for wage cuts are ‘wrong-headed’.

First, Breathnach asks why those who advocate wage cuts to restore our competitiveness ‘never explain why the most competitive economies in the world are the ones with the highest pay levels and living standards.’ I fear that he, and we, will be waiting a long time for a coherent answer.

Second, he states that the recent decline in our industrial exports has largely come from the electronics sector.

‘This is largely due to the emergence of China as a major low-cost producer in this sector. . . There is no way Ireland can compete with Chinese wage rates (or east European rates, for that matter).’

Thirdly, and to devastating effect, Breathnach shows that wage cuts would have little impact on our export sectors for the very simple reason that wages don’t make up a substantial proportion of the cost structure.

‘According to Forfás data, payroll costs accounted for just 11 per cent of the total costs of foreign manufacturing firms (which produce over 90 per cent of industrial exports) in 2007. The reduction of five per cent in nominal wage costs (as some have suggested) would in fact only reduce their total costs by about half of one per cent.’

This corresponds to research I have done and written about on this blog.  There’s another way of looking at this – through the effect on turnover. A pay cut of 5 percent would amount to 0.4 percent of turnover in the industrial sector.  In other words, for a €100 product, the wage reduction would allow the enterprise to sell that product for €99.60 without losing profit.  Wow, 40 cents on a €100 unit.

Can you imagine the conversation between the manufacturer and a buyer:

Buyer:  Seamus, your product is too-high priced.  Your cost-base is out of control.  We can’t take this for €100 a pop.

Irish Manufacturer:  No, no – we’ve just screwed over our employees with a five percent pay cut.  We can now give this to you for €99.60.

Buyer:  Ah, now you’re talking.  That’s what we’re looking for.  We’ll take 20,000 units.

The Irish export sector saved.  QED and all that.

Okay, a bit tounge-in-cheek – but you get the idea.  What Breathnach calls the ‘misguided mantras emanating from the economics profession’is getting louder and all pervasive.  You can’t pick up a newspaper or turn on a RTE current affairs programme without hearing some ‘expert’ calling for wage cuts.  Yet, few are willing to actually calculate the effect this would have on real-time enterprises.

Nor the effect on the wider economy.  Can someone please tell me how cutting wages across the board – public and private – will assist economic recovery.  It will worsen the deficit (less income tax / PRSI / spending taxes). It will drive down private consumption even further as people compensate for the fall in income resulting in more job losses in the services sector – which will reduce Government revenue and drive up expenditure with more social welfare payments.  How does risking any of this make any sense – especially as wage cuts will have little effect on our cost base or on the public sector payroll?

But Breathnach doesn’t just critique.  He provides a signpost for future policy.  He points out that while the appreciation of the Euro has hurt our manufacturing exports, our service exports have soared despite the Euro and so-called uncompetitive wages.  The fortunate thing for the economy is that this is a labour-intensive sector.

Ireland’s future economic growth will depend on the attraction or internal development of high-productivity, knowledge-based, activities in services and advanced manufacturing. This has to be the prime focus of government policy, even through the current crisis.

In other words, if we become obsessed with a non-problem, we will not be focused on the strategies that matter – pro-growth strategies.  If we can couple these with strategies to limit the extent of the recession, we will get out of this a lot of quicker and in a stronger position.

One could almost despair – except that now we can hope that more sane voices like Proinsias Breathnach’s will come forth and be heard.

Then, we might even be in danger of talking common sense.

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