Economics: Employers and trade unions are squaring up for the (probable) start of pay talks to cover the second 18 months of the national agreement, writes Cliff Taylor.

Arguments are being traded about inflation rates, productivity and competitiveness, as the two sides set out their positions. However, there is a risk that in the debate about preconditions for entering talks and percentage increases here and there, the context is being lost - that we are examining every ring on the trees without seeing the wood.

The wider picture is the huge change sweeping through industrial economies - including Ireland - as manufacturing operations move east. There is an enormous debate about this in the US - indeed it will be a central issue in the presidential debate - but little enough focus on it in general discussion here. This will surely change over the next year or so as the impact of these international economic forces become more apparent due to EU enlargement and, more significantly, the rise of economies such as China and India.

Already the signs are there. Take the chemical/pharmaceutical (pharmachem) sector, for example. Huge growth in output in this sector - much of it based on soaring productivity in a small number of plants in Cork and its environs - has boosted growth over the last few years.

A number of firms have invested and re-invested to produce valuable patent drug lines, leaving cheaper locations to produce less profitable generic products.

However, the lure of lower cost locations - primarily Singapore and India in the case of pharmachem - is growing all the time. Exports from the sector fell by 8.5 per cent to €35.7 billion last year. Much of this was due to falling receipts, reflecting the strength of the euro and pressure on product prices. Looking at volume industrial production figures, however, confirms that something is changing. Output from the basic chemicals and "other chemicals" sectors is strong, but production from the pharmaceutical and chemical products sector was 25 per cent lower in January this year than the same month in 2003.

The movement of manufacturing "eastwards" and the drive by industry here to automate to boost productivity is also reflected in jobs figures, notably in a fall-off in what the Central Statistics Office defines as the "modern" sector - mainly pharmachem, electronics and electrical equipment.

This sector has been responsible for the bulk of job losses in manufacturing in recent years - what is difficult to estimate is the extent to which the fall-off has been cyclical, related, in particular, to the downturn in the tech sector, and to what extent it is structural.

There are some encouraging signs. The huge Wyeth project in south Dublin, for example, is the kind of high-end biotechnology project that could attract follow-on investment in the future. And just this week Merck, Sharpe and Dohme announced new investment plans for Ireland, including a research function. However, the era of regular announcement of big job-creating inward investment projects is surely coming to an end.

The challenge is to replace the production jobs that are inevitably being lost with higher-end activity, much of it research-based or involving highly advanced production processes. The risk is that the new jobs will not come on stream quickly enough - or in sufficient quantity - to replace those that are being lost.

Some observers believe there is a risk of a "gap", with the Republic still battling to establish its status as a research centre, while at the same time the shift of manufacturing and other administrative and support functions eastwards accelerates relentlessly. So far, however, major closures here have been rare.

The key to long-term economic growth, as an analysis in the recent Central Bank bulletin points out, is productivity in all its aspects. Labour productivity - the amount produced by each employee - has risen strongly in recent years, underpinning the rise in living standards.

The Central Bank paper , written by Mark Cassidy, says GNP per employee per hour is the best measure and that the growth rate of this measure was the highest in Europe during the 1990s. Interestingly, it asserts that because people here work generally longer hours than the EU average, the absolute level of GNP per employee hour is still around 7 per cent below the EU average. In other words, we have to work a bit harder to maintain the same living standard as our European neighbours.

This is a contentious area, of course, mainly because the Irish productivity figures have, as previously mentioned, been heavily affected by the rapid growth in a small number of companies, particularly in the pharmaceutical sector; and because the relative position of Ireland has probably disimproved over the past couple of years as rising costs and the difficulties of the high-tech areas have weakened the Irish performance and led to significant job shedding in manufacturing. This squeeze on exporting companies has been intensified by the strength of the euro, explaining the tough line being taken by IBEC heading into the pay talks.

The talks are more than a sideshow, of course. Wage developments are one important element of cost-competitiveness. However the pay debate is really about sharing out the economic cake, with employers on the one side seeking to maximise profits and the unions trying to get the largest possible share of the cake for their members.

From the point of view of our economic prospects, the short time period covered by the negotiations and the fact that many sectors of the economy will do their own thing anyway mean that the importance of the ritual dance now under way should not be over-estimated.

Three per cent per annum, perhaps and let's get on with it? And if they don't do a deal, the pay increases for many employees may not work out much different in local negotiations than they would under a central deal.

Rather than the division of the cake, the key issue is how to keep it growing.

In an era where competition is increasingly coming from countries with vastly lower labour costs, the key factors in our productivity performance come from other areas.

As the bank analysis points out, Government policy cannot directly control long-run productivity growth, which depends on the performance of individual firms. However, it has a key role in setting out the pitch on which the productivity game is played through economic policies in areas such as education, tax, infrastructure, competition and, crucially, the fostering of entrepreneurship.

These issues are being examined by the Enterprise Strategy Report Group, which will report to Mary Harney over the next couple of months.

The Irish economy has performed remarkably well over the past couple of years. But the game is changing quickly and we need a plan which goes beyond the usual platitude of "moving up the value chain".