Social partnership is under strain. Increased industrial unrest throughout the economy is evident in recent weeks, mainly involving public-sector workers, and stemming from dissatisfaction with the pay element of the Programme for Prosperity and Fairness (PPF).

The rejection of the wage conditions is not confined to the public sector. A group of private-sector journalists, that most self-restrained of professions, voted to reject the PPF wage terms this week. Amid calls for wider trade-union debate on withdrawal from the agreement, the question of whether the social partnership process can survive is increasingly being pondered. Social partnership has evolved over the past 13 years to be more than just narrow national pay agreements. However, while measures from social inclusion to environmental sustainability are given prominence in the PPF, the wage and tax elements remain, as always, the cornerstone of the agreements.

The inception of social partnership in the late 1980s was motivated by the need to address the crisis in the public finances and the chronically high levels of unemployment. Against these criteria they must be considered an unqualified success given the large public finance surpluses and an unemployment rate at levels rarely witnessed in the history of the State.

Ironically, this very success in moving towards full employment is the most potent threat to the continuation of the social partnership process. The rise in inflation throughout this year has been mirrored by the unemployment rate falling rapidly to a level of just 3.7 per cent last month.

A tight labour market will certainly contribute to higher consumer prices, but it also means that the pay terms in any national wage agreement are likely to be non-binding. Firms will bid up wage rates in excess of those specified in the national agreement to attract and retain scarce labour.

This process is well under way in the Irish economy, with wage growth considerably in excess of the terms of the PPF. The growing unrest among workers in those sectors where the PPF terms are, at least notionally, expected to bind is explained by their perception of falling behind other groups in terms of relative pay.

The existing wage bargaining structure, designed to ensure employment expansion in return for wage moderation achieved through income tax cuts, is exaggerating this tension. The rigid wage element is providing a starting point for salary negotiations in many enterprises and for personal contracts.

Calls for higher wages in compensation for the erosion in real incomes from inflation will serve to raise this negotiating base, pushing wages higher. This has the potential to set in train a damaging wage-price spiral.

The alternative to centralised bargaining between the social partners is unco-ordinated negotiations at local level. While there is much merit in letting market forces determine wage rates, the realities of the macroeconomic policy environment for Ireland suggest that some form of co-ordinated pay determination is preferable.

As part of EMU, the Irish economy displays many features of a regional economy, the most notable the absence of independent monetary and exchange-rate policy, the small scale of its domestic market and its extreme openness to international trade.

The performance of any regional economy depends on its ability to be a profitable export base. This is determined by how competitive the economy is and how flexibly it can respond to changes in its trading environment.

As we argued in the last Quarterly Economic Commentary, the reality of being a regional economy within a monetary union with full employment requires flexibility in the wage structure. A move away from rigid prescription of wage levels, as the current model of social partnership tries to provide, to one that still provides predictability, but in a conditioned manner is what is required.

This will help to prevent wages overshooting levels consistent with the economy's competitiveness. Wage rises beyond those justified by productivity increases will quickly erode competitiveness and may eventually affect the location of foreign investors.

Therein lies the rub. The potential for productivity improvements and the capacity to measure them differ markedly between sectors. Wage growth is more easily justified in sectors where productivity growth is measurable.

The non-market services sector, including many public-sector occupations like nursing and teaching, traditionally finds it more difficult to demonstrate productivity growth. The high-technology firms tend to be export-oriented, with high productivity levels making them capable of bidding up wages in the domestic economy.

Shifts between sectors towards high-technology industries have been important factors in the evolution of the Irish labour market. The wage moderation achieved through the national agreements has allowed Ireland to avoid a situation whereby the capacity to pay higher wages in the traded sector spills over into higher wages not justified by productivity in the non-traded sectors. The declining wage share in Ireland since 1987 could be interpreted as an indication of the success of the partnership agreements in avoiding this outcome and achieving the objective of employment growth.

The trend for wage share to fall seems unlikely to persist over the medium term in a full employment economy where the scarcity of labour can be expected to raise its price.

As the editors of the ESRI book published this week, Bust to Boom? The Irish Experience of Growth and Inequality noted: "Some reversal in this trend appears inevitable: the question is how fast it can happen and how far it can go without derailing the engine of economic growth".

The challenge for the social partners is to find a controlled way to harness the benefits of full employment without damaging the economy's long-run growth potential through wage overshooting, and to ensure a reasonable balance of skilled labour being retained in the non-traded sectors. Any future agreements or reviews will need to introduce mechanisms for flexibility to get economy-wide gain-sharing. Flexibility on the pay mechanism would have to be symmetrical, however, in that wages may need to fall to restore competitiveness, particularly if the exchange rate were to strengthen substantially. The warning that what goes up can go down will have some resonance with the Irish people from recent stock-market experiences and may be unpalatable for that.

Holding social partnership together may be the limit of short-term ambition until inflation moderates. In the longer term the process that has, in the phrase, now much hackneyed, "served the economy well", will have to reinvent its wage elements in facing up to the reality of a full employment economy. That certainly will not be an easy task.

Danny McCoy is editor of the Quarterly Economic Commentary at the Economic and Social Research Institute (ESRI)