CORDIS Archive

June
2004

Facing the competition

Domestic inflation, the strengthening euro and the downturn in world trade have exposed structural weaknesses in the Irish economy, reports the country’s National Competitiveness Council.

"Competitiveness”, says Ireland’s National Competitiveness Council (NCC), “is the ability to achieve success in markets leading to better standards of living for all.”

It is important to say this, for market competition is not an end in itself, but a means to an end. We want European firms to be competitive at home and in the world not to notch up points in benchmarking exercises but so we can make Europe a better place to live in. The new member states have embraced the free market because they want their people to enjoy the standard of living that prevails, by and large, across Western Europe. To attain these benefits we must get our economies right, and to do that our businesses must be competitive.

To this end Ireland’s National Competitiveness Council reports annually on the competitiveness of the Irish economy, and makes recommendations to government. According to the Council, the threats to Ireland’s economy are threefold. First, the world slump is hindering the growth of exports. Second, the strengthening euro is making Irish exports more expensive. Third, the competitiveness of Irish companies is being threatened by rising costs at home: it is this which the first report, the Annual competitiveness report 2003, attempts to assess.

Ireland’s pyramid of competitiveness

What makes for competitiveness in a country’s economy? The NCC report uses a particularly enlightening model for understanding the role of competitiveness, which it likens to a pyramid. At the bottom, forming the foundation of the economy, are five “inputs”, the primary drivers of competitiveness. These are: business and work environment, economic and technological infrastructure, education and skills, entrepreneurship and enterprise development, and innovation and creativity. This is where policy-makers can have the greatest effect on competitiveness.

The second level of the pyramid, which the report calls the intermediate stage, contains four building blocks which can be regarded as the direct outcomes of processes at the bottom. They are productivity, prices,wages and costs. Where favourable, they add up to what we mean by “competitiveness”.

At the top level we find the “outputs”, the benefits that we expect competitiveness to bring to society in the form of quality of life, sustainable development and so on. This is the pay-off for getting the bottom level right. Governments cannot affect these directly: their role is to influence the bottom level and, in doing so, create the conditions which, in time, allow the pay-off to be delivered at the top.

The report sets out to assess conditions at all three levels of the Irish pyramid.It does so by assembling economic indicators – 128 of them – compiled by international bodies such as the OECD, the EU, the World Economic Forum, and many others. To benchmark Ireland’s performance against other countries, indicators are also included for six other euro-zone countries (France, Finland, Germany, Italy, the Netherlands and Spain), three non-euro EU countries (Denmark, Sweden and the UK), two new members (Hungary and Poland) plus Japan, New Zealand, Republic of Korea and the USA. So how, then,does Ireland shape up on the world stage?

Inputs: the foundations of competitiveness

The first of the five “inputs” is the business and work environment, which in turn is influenced by government policies on business and labour market regulation, competition, international trade and investment, taxation and macro-economic management. Here there are some very positive indications. Ireland leads the 16 in trade openness and in the stock of foreign direct investment (FDI). At 12.5%, the corporate tax rate is lower by far than any of the other countries, and Ireland comes second only to Finland in freedom from regulatory burden. It also has a relatively flexible labour market and the level of private investment is exceeded only by Spain. These are attractive qualities for business, but employment growth is only middling and the tax burden is uncomfortably high at 43% of GNP, though it is still below the EU average and the tax taken from salaries is low.

A congenial business climate is one thing but the physical requirements for running a business – the economic and technological infrastructure – need to be there as well. By this measure Ireland still has a long way to go. Irish infrastructure is classed as “poorly developed and inefficient”, ranking between Hungary and Poland at the bottom of the 16- nation league table. Tourists may find Irish roads charming but traders do not: the distribution infrastructure is ranked 15th for efficiency, and ports and air transport are also poor.

Somewhat surprisingly for a country wishing to develop a knowledge-based economy, Ireland has slipped to 11th place in " investment in telecommunications (though above big countries like Japan, Germany and Italy) and the take-up of broadband internet is almost invisible in comparison with the other 15 countries.

Years of under-investment have left Ireland with an electricity supply network unable to meet future demand (though the country comes second in energy efficiency). Ireland’s housing stock is also inadequate,with only Korea having fewer houses per head of population. And environmental protection is poor, with Ireland bottom of the table for recycling.

Ireland’s commitment to education and skills has become legendary – it has more science and engineering graduates than the other countries – but investment still lags below the OECD average. The number of students in tertiary education is growing at a similar rate to other EU countries, but is well behind Hungary, Poland and Korea. Irish 15- year-olds are among the most literate in the sample, but the participation of adults in continuing education is strikingly poor, while the extent of staff training is “relatively mediocre” alongside Scandinavia, Germany and the US.

The fourth input is entrepreneurship and enterprise development. Ireland ranks fourth in “total entrepreneurial activity” – essentially the number of new businesses – and ahead of all other European countries. The proportion of women entrepreneurs, on the other hand, is relatively low. Ireland compares well for availability of venture capital and for high-tech investment.

Starting a new business can be costly, and registration costs and the administrative burden in Ireland are still higher than many of its partners and competitors. But legislation is supportive of start-ups, pushing Ireland into first place.

Of course, existing firms need to develop as well, and that requires appropriate management skills. A key indicator for this, “value chain presence”, gauges how well exporting firms add value other than by production. Ireland comes eleventh by this measure,though the result could be skewed by the large number of multinationals using the country as a manufacturing base. Irish managers come fourth in competence, though firms are not so good at marketing and customer satisfaction.

Clustering offers firms in a particular market sector the opportunity to work together to achieve economies of scale, and is seen as an important way of attracting and developing new businesses. For clusters to work, firms need to share “social capital”, a somewhat nebulous concept that includes the shared values and understandings required for effective co-operation. Ireland is middleranking as regards cluster development (Italy, US and Finland are the leaders) and in 12th place for the extent of collaboration among clusters.

The fifth input is a crucial one: without innovation and creativity – by both individuals and firms – we are not going to get the new products and services we need to maintain a competitive economy. Ireland still ranks 12th in the share of researchers in the working population – Finland leads by a long way. Business expenditure on R&D, twothirds of the total, is also well below the EU average, placing Ireland 11th out of the 16 countries in the study. The picture may now be rosier than the statistics reveal, however, since the government has hugely increased R&D funding for 2000-2006, and brought in support for outstanding researchers from Ireland and overseas.

But a competitive economy needs to translate knowledge into saleable technology. Ireland comes tenth out of 14 countries for applications to the European Patent Office and also scores poorly on the UN’s technology achievement index. Other surveys reveal that Ireland’s competitive advantage has relied too heavily on low costs rather than technological sophistication. The number of 25-34 year olds holding PhDs in science and engineering is above the EU average, though interest in science and technology among young people seems to be waning. Finally, new technology has to lead to new products. Ireland comes tenth in the degree of sophistication in production processes, though not far behind the leaders, but has a poor record in obtaining US patents. The recent Community Innovation Survey shows that 40% of Irish firms had introduced or developed at least one new or improved process in 1998-2000, again well below the EU average.

Intermediates: the middle of the pyramid

In the middle level of the pyramid are the four direct results of the five inputs. Improved productivity is a measure not only of more efficient production, but also of better management, training, marketing and so on. On the well-established benchmark of labour productivity, Ireland comes second only to the US by GDP but ninth by GNP,a reflection of the major role played by multinationals in the economy. It comes third in terms of output per hour per worker and second by productivity gains in 2002.

Ireland’s consumer price inflation rate in 2002 was exceeded only by Hungary, pushing prices 12% above the EU average. Although inflation has since slowed, the gap is expected to widen into 2004.

Another intermediate, business costs, reveals a mixed message. Ireland’s telecommunications costs are good for fixed lines but expensive for mobiles and for broadband internet services. Automotive diesel is cheap by European standards but much more expensive than in the US or Japan. Insurance costs are the highest in Europe (other than in the UK). Industrial electricity prices are high though gas prices are somewhat more competitive, at least for small businesses. Office rents are among the highest in the 16 countries.

On the other hand, wages in Ireland are well above the EU average,and are expected to rise faster than in all but one of the 16 countries in 2004. Gains in productivity have offset some of the rising labour costs, though it seems that these gains are strongest among the multinationals, leaving homegrown businesses more vulnerable to wage POLICY REVIEW inflation. Sharp rises in house prices are also putting pressure on wages.

Outputs: the peak of the pyramid

So where does this leave the Irish economy? The report first looks at measures of macroeconomic performance. The well-known statistic of GDP per head is accepted as the best international measure of economic well-being. Here Ireland shines, coming second only to the US and with a clear lead over the 14 other countries. Even if GNP is used instead (taking into account outflows through the multinationals) Ireland still achieves fourth place. So on that measure the country is doing well.

Ireland also does well on unemployment, coming in third place behind the Netherlands and Korea.

Another macroeconomic indicator is growth in exports of goods and services, a good measure of how competitive Irish firms are in world markets. Here Ireland ranks fourth, ahead of all the other European countries, with a 6.2% rise in 2002 compared with the EU average of 0.8%.

So by international standards Ireland’s competitiveness – today, at least – appears in a healthy state. But the whole point of encouraging competitiveness is to make Ireland a better place to live. How successful is the country at sharing those benefits among its people?

Here the results for sustainability and social capital are not so good. Ireland ranks tenth out of 13 for equality of income, with only Italy, the UK and the US having greater differences between the haves and the havenots. Another indicator, quality of life, puts Ireland again in tenth place, ahead of the UK but behind Sweden. Life expectancy is poor by world standards (Japanese citizens live almost five years longer, on average) and house prices are high. More encouragingly, Ireland comes sixth in its level of sustainable development.

But the positive outputs measured today are the consequences of policies put in place some years ago. The effects of those policies work their way up from the bottom level of the pyramid which, as we have seen, is no longer as strong as it should be. What can the Irish government do about it?

The NCC’s recommendations for action are set out in their second report, The competitiveness challenge 2003, which has two broad priorities: the short-term need to improve cost competitiveness, and the medium-term challenge to establish “a more entrepreneurial, dynamic and innovationdriven economy.”

Action for cost competitiveness

By historical standards inflation in Ireland is low, but it is still higher than other EU countries, and has made Ireland one of the most expensive countries in Europe in which to live and work. This makes it difficult to attract overseas business and hinders Irish companies competing in world markets. Rising costs are, says the NCC, “the most serious threat currently facing the Irish economy.” The Council calls upon the Irish government to cut inflation to below 2% in 2004,by minimising further increases in customs and excise duties, VAT and administered prices. Public services need to be made more efficient through modernisation, offering better value for money. Any carbon tax or other measures to implement the Kyoto protocol should cover all sectors of the economy and be introduced in a planned fashion, making full use of trading in emissions credits. But other costs arise from the generally low level of competition in domestic markets, and the Council believes Ireland could be as competitive as other small economies such as Sweden and New Zealand. More competition is needed in financial services, transport, distribution and wholesaling, waste management, communications and energy. A strengthening of competition law is also called for.

Ireland’s poor transport system is also a burden on competitiveness and the Council calls for an overhaul of the planning system, which is hindering infrastructure projects such as the building of new roads,and expresses concern at the lack of skills in managing major construction projects.

The Council is particularly concerned by Ireland’s very poor record on broadband communications, an essential service for an island country on the edge of Europe, and believes the government needs to intervene. Competition in telecoms is poor,with slow progress in allowing private operators to use the existing networks. The Council wants the state-owned networks to be made available to telecoms operators at competitive rates. Local authorities are deploying their own broadband Metropolitan Area Networks which should introduce further price competition. Demand for broadband should be stimulated by accelerating the government’s own online services and by putting pressure on broadband suppliers to reduce their retail prices.

Action for an innovation-driven economy

The second thrust of the Council’s recommendations is to build an innovation-driven economy by focusing on education, enterprise, and research and innovation.

In education, they want to keep more young people in schooling after the age of 16 – a fifth drop out at present – which will require a cultural change as well as more resources. A leaving certificate more oriented towards vocational qualifications would be a great help. The curricula at both primary and secondary level need be geared more towards the world of enterprise, with stress on science, mathematics, modern languages and ICT. At tertiary level, there is an “everincreasing need”for investment in research centres.

The Council also wants to expand the numbers of mature students entering tertiary education (less than 9% of entrants compared with the OECD average of almost 25%). The present fees policy discriminates against part-time students, an anomaly which needs to be removed.

Enterprise policy has already shifted from a focus on grants and tax incentives to a more sophisticated understanding of the climate in which businesses grow and flourish. But the Council argues that the economic downturn calls for a further change in priorities. First of these is better support for clusters, recognising that the success of innovative companies often owes as much to the local industrial community than to the company itself. The state has a role in working with others to foster the conditions that allow clusters to develop. Foreign direct investment should also be used to “fertilise” indigenous clusters.

A major programme to encourage entrepreneurship is also proposed, to remove obstacles on start-ups, develop skills, consolidate support programmes and increase seed capital.

Finally, the Council urges further support for innovation and creativity. Despite the importance of high-tech industry in the economy, Ireland still has a relatively poor record for innovation. Government only has a limited role to play in supporting research, but the Council notes that the planned large increases in public funding for research infrastructure have faltered, raising doubts about the government’s commitment to building a knowledge-based economy. The Council calls for better monitoring and evaluation of publicly funded investment. Growth in private R&D spending has slowed in the last few years, and the Council urges the government to introduce tax credits for company R&D activities, in line with many other OECD countries. Despite many policy initiatives, collaboration between industry and academia has hardly grown in the past decade, and the Council recommends these schemes be reviewed and new ways sought to involve small businesses who cannot afford to take part in conventional research partnerships. In his preface to the report, Bertie Ahern, the Irish Taoiseach (Prime Minister), said the government would give “careful consideration” to all the recommendations. “Enhancing the ability of Irish firms to compete in the future for investment and new markets in an ever evolving and increasingly competitive environment will be essential if we are to emulate our past success.”