Comment:One of the key lessons from a review of productivity in the Irish economy published by Forfás last week is that we can't depend on past glory for our future prosperity, writes Conor Kehoe
On the surface, it seems the Celtic Tiger has lost little vigour - the value of goods and services produced by the country grew by 7.4 per cent in 2006 (as measured by GNP) - down on its 10-year average, but impressive nonetheless.
Step a little closer, however, and the big cat looks less aggressive. Absolute GNP growth is strong, but GNP per capita is barely growing. In other words business, workers and the Irish economy overall are producing more, but the value of what we produce for every person in employment is stagnant.
Three-quarters of Ireland's economic growth is simply coming from having a larger workforce. This growth in employment places a greater strain on public services and an infrastructure designed to meet the needs of fewer people - as commuters know to their cost.
The strain on these services, and on those who use them, comes without much of an increase in household spending power to compensate. For GNP per capita to rise, productivity has to improve. Almost all of our productivity growth in the last 10 years has come from foreign-owned companies in a handful of sectors. High-tech components and pharmaceuticals are particularly dominant, but while they are important industries, they employ only 15 per cent of the workforce and they alone can't give us the growth in productivity we need.
We are currently stuck with a productivity paradox: we have highly productive export-oriented manufacturers and service companies but far fewer productive domestic services, which employ most of the population.
One statistic that clearly demonstrates the point is that between 1995 and 2004, there was an overall increase of 441,000 jobs in the services sector (79 per cent of total increase in employment); during the same period, the value produced by each person in the services sector grew at less than 1 per cent a year. If our ambition for the future is to match recent successes, this has to change.
The services sector is what drives modern western economies and is the best source of long-term employment and economic growth. It accounts for 70 per cent of economic activity within the EU (as measured by GDP) and all of Europe's net job creation over the past five years.
This is an economic sector that goes far beyond fast-food and cleaning. It includes industries crucial to economic development such as power supply, transport, retail, construction and telecommunications, as well as a range of high-skill, high-wage occupations from accountants and lawyers to rock stars. Nor does a focus on domestic services mean turning our back on foreign investment.
Efficient domestic services help attract investment. Ireland cannot justify below-par productivity by pointing to the small size of our State or claim a unique economic model: Finland has a similar economy and population but its productivity levels are far in advance of our own.
Higher productivity is usually fostered and nurtured by competitive intensity. Not only does research consistently show a strong link between productivity, economic growth and competitiveness, it has also found significant potential in creating this virtuous circle in domestic service industries.
According to a study of six major European countries by the McKinsey Global Institute, the biggest barrier to increased competition is inappropriate regulation. This makes it harder for new, innovative and often larger players to enter the market and bring their more productive business models with them.
It is a double blow for the economy as consumers are denied the extra choice and potential price benefits of competition, while the economy as a whole misses out on the competitive effects new firms have on those already operating in the market.
Today, too many sectors in Ireland are shielded from competition, including electricity, telecoms, law, pharmacies and the pub trade. A list of domestic and international reports have called for reform in regulations to increase competition, make markets more responsive to change and increase the speed at which innovations diffuse into the economy, thereby boosting productivity. This is a major step in the right direction.
Traditionalists often worry about the lack of a "job for life" in a booming service economy. True, the service sector provides fewer such jobs than manufacturing, but it creates more jobs overall, more high-wage jobs and reduces overall unemployment. The recipe required for the services sector to thrive is clear but not simple. It assumes that companies have flexibility both to expand and contract as appropriate.
Governments need to make it more straightforward to start new firms and close failing ones, in addition to enhancing labour mobility.
Service-sector jobs often require transferable skills that make changing jobs far easier than in the past. Ireland needs to develop such skills at secondary and higher education levels, which will increase choices for those seeking employment as well as enhance labour market flexibility.
This is a critical time for Irish policymakers to examine how to create a competitive environment in domestic services, which have the potential to become a powerful source of wealth creation and jobs.
There will be a period of transition as people move to areas of the economy where demand outstrips supply, but the long-term competitiveness of the country and sustained prosperity of its people is at stake.
• Conor Kehoe is a director of McKinsey & Company in London and a contributor to the book Perspectives on Irish Productivity published by Forfás.
