Latest report on competitiveness warns that Ireland's economic cost base must be lower to compete with India and China, writes Marc Coleman, Economics Editor

A chill wind is blowing through the country and it's time to wrap up warmly. But as far as the National Competitiveness Council (NCC), a Government-appointed body that includes academics, industry and trade union representatives, is concerned, it comes from the Far East and not the Baltic. In its latest Competitiveness Challenge report, the NCC puts the issue of Latvian sea workers in perspective. A far bigger threat is emerging from the economies of China and India that make events at Irish Ferries look like a little local difficulty.

Each year, the NCC looks at how competitive our economy is and then, after going through the causes of source of our new-found prosperity, it prescribes policy action where it finds there is unfinished business to be done by Government.

Aside from the usual mantras that are always found in such a report, no punches are pulled about the southerly direction of our competitiveness indicators: "Employment in manufacturing and other production industries, the sectors of the economy most exposed to international competition, fell for the fourth successive year in 2004," the report says.

The causes of this trend are both international, over which we have no control, and national, over which we have control. One of the first charts shows China's growing share of merchandise trade and foreign investment.

China's share of the world's merchandise exports has jumped from just under 4 to 6.5 per cent in the four years between 2000 and 2004. Its share of global foreign direct investment has trebled from 3 per cent to 9 per cent during the same period.

For anyone who thinks this trend will stop once all sock and shirt factories have moved to Guangdong, there is a rude awakening.

With capital and technology now rapidly transferable, China is telescoping into a decade the transition from low to high technology production that used to take decades. From having zero foreign research and development (R&D) units in 1993, 10 years later, China had 700. Since 1996, R&D has climbed from $21 billion (€17.8 billion) to $84 billion in 2003 - in Europe R&D spending remains stubbornly low in spite of brave targets set by the Lisbon agenda.

India is also rising, but with more emphasis on the services sector. Take the software technology company Wipro, for example. This company employs around 15,000 staff and its customers include General Electric and Hewlett-Packard.

It has written software for American companies and has moved on to high value added applications such as global supply chain systems. It has even started hiring local nationals in developed countries to give it local presence. So as far as our economy is concerned, India might as well be 50 miles from our coast. But the report is not about China or India, but about how Ireland must react to the challenges they present. The report is quick to get to the point: Ireland's rising cost base and its impact on the cost of Irish labour. Between 1995 and 2005, the cost of Irish workers has risen by 35 per cent, whereas in the euro zone it has risen by 10 per cent. And that comparison is with one of the world's higher cost economic zones.

Fortunately, we can use positive policy levers. One is helping the economy to shift from traded goods to traded services.

Traded goods are easier to replicate, but the knowledge underlying service provision is harder for competitors to replicate. The report is positive here and shows how between 1993 and 2004 our share of world trade in the services sector has gone from 0.7 per cent to 2.2 per cent. Not bad for a country with less than 0.1 per cent of the world's population.

The services sector now dominates our economy as well as the EU economy and will, the report argues, provide an opportunity to replace jobs being lost in manufacturing at the lower end of the value-added spectrum.

The report also implies that the Government should back progress on the controversial services directive. This directive aims at liberalising trade in services with the EU. Its defenders say it will generate jobs and lower prices in the long run. But, as the case of Irish Ferries makes clear, in the short run at least, liberalising trade in services has implications for working conditions that are controversial.

It is unsurprising that the council's qualified support for the directive caused some open dissent amongst its members. Peter McCloone and Paul Sweeney of Ictu both entered their objections regarding the services directive into the text of the report.

They also objected to the report's findings in relation to taxation and regulation. The NCC has always argued that Ireland's environment of low taxation and regulation has been a major source of competitiveness.

The latest report is not different. It says that maintaining this environment is crucial to future competitiveness. So much so that it recommends broadening the tax base to ease pressure on income and corporation tax. McCloone and Sweeney agree with broadening the tax base. But the text of their dissent strongly disagrees with the idea of a low taxation and regulation economy.

They point to the good competitiveness record of high tax and highly regulated Nordic countries as examples of how Ireland could combine high taxation with high productivity. There is some irony here: Two weeks ago, a delegation from the Confederation of Swedish Industry visited Ireland in an effort to see what Swedish economic policy could learn from Ireland's experience.

The NCC agrees with the goal of higher productivity and spending on R&D, but puts a different emphasis on where the money should come from.

This leads to one of its more controversial recommendations: the partial restoration of university fees to assist the funding of research in third level universities. It also calls for the reintroduction of a property tax. The report's authors recognise the political difficulties in these proposals - proposals have no chance of implementation before the next election and little chance thereafter. But in advocating them they feel they are doing the right thing.

One of the report's less impossible but still controversial proposals is to abolish property tax breaks.

One of the major factors behind our high cost base is the cost of accommodation and the NCC sees these reliefs as biasing the housing market against owner-occupiers. The Department of Finance is finishing a general review of tax reliefs and this issue will be dealt with in the forthcoming Budget.

Concern has been expressed by several interests, most recently at by the AIB, to the effect that any move here could destabilise the housing market.

There has been recent evidence from the OECD and the Economist magazine that the Irish property market is overvalued. The imminent prospect of interest rate increases makes this a hot issue on Budget day.

If economic policy making is a walk through a dense forest, then the competitiveness challenge report forces policy makers to climb a tree and take a more extended view. The Budget, Irish Ferries and the property market will dominate the news in the short-term, but the insights of the report will remain as valid next year as they are now.