Contrary to claims by Ibec, pay curbs could see a recession become a depression by weakening prospects of economic growth, writes Manus O'Riordan.
IT IS REMARKABLE how in the space of little more than a month a sense of proportion proposed in one ESRI publication can be totally destabilised by media overreaction to another. The ESRI itself can be absolved from most of the blame for this.
Commentators failed to take account of the fact that, whereas the ESRI Quarterly Economic Commentary of June 23rd forecast a downturn in national output for this year, it also forecast a resumption of growth next year and had very sensible observations to make on the National Development Plan, the need to prioritise investment for training and upskilling, and the need to retain a sense of perspective about the overall health of the public finances.
This included showing that a breach in the 3 per cent borrowing ceiling of the Stability and Growth Pact for 2009 would not have the negative consequences that might apply in other economies.
Far too often the "growth" component of the pact is forgotten, together with the necessity for fiscal policy to sustain that objective.
This is not to say that all is well with the ESRI's own analysis. I believe that the ESRI, in common with the general body of economic forecasters, has seriously underestimated the extent to which the current high rate of inflation is likely to persist well into 2009. And, in common with the general body of economic commentators, the ESRI has seriously misread the extent to which pay increases were already falling behind inflation last year. The competitiveness of labour costs to meet the export challenge that is required to ride out the current economic difficulties also needs to be assessed. The restoration of living standards has an important role to play in preventing a collapse in private consumption and in making its much-needed contribution to a recovery in overall growth next year.
Rising labour costs have not aggravated the competitiveness of Irish manufacturing, as is evident from OECD data released last month. Ranking the year-on-year changes in industry's unit labour costs for December 2007, Ireland was the fourth most favourably placed of the 20 OECD economies for which data was available.
But even this exaggerates Irish hourly labour costs. Eurostat data for 12 out of the EU-15 countries for whom data is available shows that in the fourth quarter of 2007, Irish hourly labour costs amounted to only 89 per cent of that EU-12 average and ranked as low as tenth out of the 12. Ireland's hourly labour costs were only 69 per cent of Sweden's, 78 per cent of France's, 80 per cent of Germany's and 81 per cent of the UK's.
But if Irish wages have not risen fast enough to threaten export competitiveness, have they risen fast enough to sustain domestic consumer demand? The overall pay increases for the full 27 months of the national agreement mask an actual decline in the real value of earnings that took place during the course of last year - even for those who received the full terms of that pay agreement, not to mind workers who did not have access to its terms.
The Consumer Price Index increased by 4.7 per cent in the year to December 2007. Yet the CSO data released on May 22nd showed that average full-time weekly earnings increased by only 3.4 per cent in distribution and by a mere 2.3 per cent in business services that year - half the corresponding rate of inflation.
Public sector employment and earnings data, released on May 23rd, showed an overall increase of just 3.6 per cent in average weekly earnings in 2007. Even the pay of civil servants increased by just 4.0 per cent, failing to match inflation, and in semi-State companies it rose by a mere 0.8 per cent. This represented a decline in the latter's living standards of 4.0 per cent.
Turning to the manufacturing sector, the overwhelming majority of unionised workers received their full pay entitlements under Towards 2016. But their increasing substitution by a host of workers on temporary agency contracts has undermined the overall earnings performance of manual workers in the sector.
While average hourly earnings for clerical and sales staff increased by 5.0 per cent, and managerial and professional earnings by 5.1 per cent, the average increase in manual workers' earnings was only half of that, at 2.5 per cent.
When we come to assessing future prospects for consumer price inflation, it should also be realised that at present gas prices are 8.3 per cent lower than they were a year ago, and electricity prices are 5.4 per cent lower. Consequently, their combined effect is keeping the CPI rate of increase 0.1 to 0.2 percentage points below what it might otherwise be. If Bord Gáis succeeds in securing approval for a 17 to 19 per cent price increase, this would add 0.2 per cent to the CPI from October. And if the ESB secures a 30 per cent price increase, this would add a further 0.5 percentage points to the CPI from January.
For these reasons, I believe CPI inflation will be 5.0 per cent for 2008 rather than the 4.5 per cent forecast by the ESRI and will not dip below 4.5 per cent until the latter half of 2009. Average inflation for 2009 as a whole is therefore more likely to be above 3.5 per cent rather than the 3.0 per cent currently forecast by the ESRI.
The failure of the ESRI to grasp that real earnings fell in both the private and public sectors during 2007 meant it noted the fall in consumer confidence but missed the more serious threat posed by Irish workers' increasing inability to pay, that has resulted in such a retail sales setback. The ESRI has forecast a modest return to 2.0 per cent growth in the volume of consumption for 2009. But if the ESRI has underestimated the rate of consumer price increase for 2009, and not adequately factored in the rate of wage increase required to ensure a recovery in living standards, its forecast of a modest consumption recovery will not be forthcoming.
Meanwhile, the Government must do nothing to choke off resumption of economic growth by 2010. The ESRI Medium-Term Review envisages Budget 2010 increasing income tax by 1.0 per cent, while simultaneously introducing a carbon tax that will increase consumer prices by 1.0 per cent. Quite apart from workers resisting such a double hit, the negative impact on consumption would further damage economic recovery. Whatever the pros and cons of a carbon tax, 2010 is not the appropriate year for this initiative.
Manus O'Riordan is head of research at the trade union Siptu