PATHWAYS TO RECOVERY FOR IRELAND

PATHWAYS TO RECOVERY FOR IRELAND

Patrick Lenain, OECD [1]

After four years of decisive efforts to reform and rebalance the economy, signs of a recovery have finally emerged in Ireland. Output is rising, employment is improving, exports are increasing and financial markets have become more confident. Ireland is now frequently quoted as the “success story” of the European periphery, the euro-area member that has chosen the right path. Indeed, a lot has happened since 30 September 2008 — the day when Minister of Finance Brian Lenihan announced a guarantee scheme for the country’s six main banks on the verge of bankruptcy. Ireland returned successfully to the international bond market in July 2012, and ratings agencies have improved their outlook. Financial support from the European Union, the ECB and the IMF has been important, but it is Ireland’s own efforts that made a difference. Restoring the economy to health has not been easy, as shown by lower wages, higher taxes, fewer jobs and a depressed housing sector. The economic recovery will eventually cure these pains, but attention needs to be paid to long-term wounds, especially the risk that large numbers of job seekers are left behind. Action is needed to mobilize the stakeholders in charge of continuing education, labour reform and social protection: more than ever, their goal should be to do what is necessary to foster the return to work of the jobseekers.

Gradual unwinding of past excesses

Over the past four years, Ireland has endeavoured to overcome its difficulties and put the country back on a path of growth. Bold measures have been adopted to reform the Irish state, put the banks back on their feet, improve competitiveness and restore sustainable public finances. International investors have recognized this progress and regained confidence in Ireland’s prospects, as shown by the continuous decline in the “risk premium” that they demand to hold Irish government securities (Figure 1). Better market sentiment means lower interest rates, which in turn implies a lower debt service burden falling on the shoulders of Irish taxpayers. Although one needs to be very prudent in the current turbulent international environment, it is fair to say that some light can be seen at the end of the tunnel.

Figure 1 — Better financial market sentiment towards Ireland
(Government 10-year bond yields, Ireland and Germany, in %)

Source: Thomsom Reuters Datastream

A glimmer of hope is that real GDP and employment are increasing once again, largely thanks to the rebound of exports. Most forecasters, including at the OECD, project that the recovery will gain some momentum in 2013, despite on-going budgetary consolidation (Table 1). Improvements in cost competitiveness will continue to help exports, and a gradual waning of the crisis in the euro area should help to improve demand in partners’ economies. With activity gaining strength gradually, the labour market situation should slowly turn around and unemployment should decline, though at an unsatisfactorily slow speed. Household spending remains depressed, reflecting the ongoing adjustment in balance sheets, and high unemployment. Indeed, the narrowing of macroeconomic imbalances continues to generate headwinds, with house prices and construction activity still falling and household debt remaining high.

 Table 1 – Main Economic Projections

* % of GDP    ** % of the labour force

Source: OECD Economic Outlook, November 2012
Note: Government deficit excludes bank support costs and the impact of the promissory note restructuring.

With bold action, the government has stopped the fiscal crisis and put the budget deficit on a downward path (Figure 2). In 2012, the general government deficit was reduced below 8% of GDP, with measures both to raise revenue (VAT increase, property tax) and cut spending (public pay, infrastructure, etc.). Staying the course of deficit reduction will be essential to stabilise the public debt and then put it on a downward trajectory. Interest payments on the government’s debt have increased sharply and now reach about 4% of GDP. This burden can be reduced by pursuing a medium-term debt-reduction strategy.

Importantly, Ireland’s well-developed social protection policies have been shielded from austerity, and the burden of adjustment has not fallen on vulnerable households. Estimates by Tim Callan and co-authors[2] have suggested that high-income households made the largest contributions to fiscal consolidation in Ireland. In other words, the cost of adjustment was distributed with a concern for fairness and social cohesion, in contrast to the experience of some other countries.

 Figure 2 – A gradual reduction of the budget deficit
(General Government balance excluding bank support cost, % of GDP)

              Source: OECD Economic Outlook, November 2012

Another welcome development has been the improved external cost-competitiveness and the associated recovery of exports. Before the crisis, Ireland’s unit labour costs had risen far in excess of those in partner countries, while in Germany real wages had increased less than labour productivity (Figure 3). Progress has been made in unwinding Ireland’s past excesses, without eliminating them entirely, and some of the decline in unit labour costs reflects “composition effects”, as low-productivity sectors such as construction are contracting while high-productivity export-oriented manufacturing and services keep on expanding. It is striking that the improvement results less from real wage cuts than from the improvement in labour productivity. This testifies to the flexibility and resilience of the Irish economy, where firms are able to improve productivity rapidly, a rare achievement by international standards.

 Figure 3 – Ireland is becoming more competitive
(Unit labour costs, 2000Q1 = 100)

Source: OECD Economic Outlook, December 2012.

The flip side is, of course, that job losses have been severe and that the number of jobseekers has increased by nearly 200,000 since the onset of the recession (Figure 4), even though 130,000 workers have left the labour force, including by leaving the country. Fiscal consolidation and macroeconomic adjustment are necessary and progress is in the right direction, but the labour-market consequences are severe and should continue to be addressed vigorously, a topic further discussed later in this paper.

Figure 4 – A depressed labour market: fewer jobs and more jobseekers
(in millions of persons)

Source: CSO Quarterly Labour Force Survey.

Ireland’s economic strengths

Until 2007, the Celtic Tiger attracted the admiration (and envy) of the entire world, with high living standards and a spectacular expansion. At the peak of the cycle, in 2007, Irish GDP per capita was among the highest in the world, well above the average in the OECD (by 36%), only surpassed by the United States, Norway and Luxembourg (for special reasons in the latter two countries). In 2011, the latest data available, Irish GDP per capita had fallen somewhat, but was still above the OECD average, by 20%, and only Switzerland and the Netherlands had joined the group of countries that outranked Ireland.

However, one has to be careful when interpreting statistics. It is well known that Ireland’s GDP is boosted by the presence of large multinational companies. These firms create many jobs and are powerful exporters, contributing to Ireland’s economic fortunes in many ways. Being subsidiaries or branches of foreign firms, they remit abroad a large share of their profits and make sizable intellectual property royalty payments, although some of them reinvest part of their profit in the country. These outflows reduce Ireland’s national income. The OECD computes an indicator that takes into account these remittances, and also makes other adjustments – such as for depreciation. Net National Income per capita seems a better indicator to benchmark Ireland’s living standards against other countries. Figure 5 shows that that Ireland’s net national income per capita is 1.5% below the OECD average. While this partially reflects the depressed state of the economy, it nonetheless seems closer to reality than the inflated level suggested by GDP per capita.

Figure 5 — Irish living standards are lower, now close to OECD average
(Net national income per capita, current prices and PPP, OECD=100)

              Source: OECD National Accounts at a Glance.

While these are difficult times, the Irish economy nonetheless still displays considerable strengths. Government policies are market-friendly, the labour market is flexible, Irish workers are well educated and productive, and Ireland retains very strong arguments when it comes to attracting foreign direct investors. The OECD attempts to capture the quality of the government’s regulatory policy with its indicator on Product-Market Regulation (PMR), which measures the degree to which policies promote or inhibit competition in areas of the product market where competition is viable. They measure the economy-wide regulatory and market environments in 30 OECD countries in (or around) 1998, 2003 and 2008, and in another 4 OECD countries (Chile, Estonia, Israel and Slovenia) as well as in Brazil, China, India, Indonesia, Russia and South Africa around 2008; they are consistent across time and countries. The indicators cover formal regulations in the following areas: state control of business enterprises; legal and administrative barriers to entrepreneurship; barriers to international trade and investment. According to this indicator, Ireland had the third most product market-friendly regulatory environment in 2008, after the United States and United Kingdom.

The flexibility of Ireland’s labour market is partly captured by the OECD indicator of Employment Protection Legislation (EPL), which measures the procedures and costs involved in dismissing individuals or groups of workers and the procedures involved in hiring workers on fixed-term or temporary work agency contracts. It is important to note that employment protection refers to only one dimension of the complex set of factors that influence labour market flexibility, including wage bargaining. The OECD employment protection indicators are compiled from 21 items covering three different aspects of employment protection, such as individual dismissal of workers with regular contracts, additional costs for collective dismissals, and regulation of temporary contracts. According to this indicator, Ireland has the sixth least stringent employment protection legislation among OECD countries, between Australia and Japan.

Fighting high unemployment

Despite sound macroeconomic policies and a market-friendly environment, it will take time to go back to normal. Getting people back to work will be the most acute challenge. Between 14% and 15% of the labour force is currently unemployed, more than half out of work for more than one year (Figure 6).

Figure 6 – Ireland’s unemployment rate by duration
(percent of the labour supply)

Source: Central Statistical Office, Quarterly National Household Survey.

Those who lost their jobs have followed different paths: some have gone into retirement; some have emigrated abroad; many look for another job, relying on the jobseeker’s benefit and, if necessary, the jobseeker’s allowance to escape poverty and deprivation. Tim Callan and co-authors (2011)[3] estimated that, without this social safety net, the “at-risk-of-poverty” rate[4] would have increased by 3.7 percentage points (the largest in the EU). Instead, it increased by about 2% between 2009 and 2011, reflecting the protection provided by Ireland’s various welfare programmes. While the spread of poverty has been limited, it is clear nonetheless that the social consequences of the recession are severe. One in four families was subject to some form of deprivation in 2011, as measured by the Central Statistical Office.

The jobseekers normally return to work after short recessions, as the economy recovers and firms increase their payroll once again. After deep recessions, however, notably those caused by financial crises or housing market crashes, unemployment tends to remain persistently high; professional economists say that unemployment becomes structural. This is because jobseekers who remain unemployed for a long period of time become disconnected from the labour market, feel marginalised and demoralised, lose some of their skills, no longer update their competencies, are considered less employable, or give up looking for a job for other reasons.

Recent quantitative analysis published by the OECD[5] suggests that the probably of exit from unemployment for someone who has been seeking a job for 12 months or more in Ireland has declined from a pre-crisis level of 51% to the latest level of only 24%, much less than on average in the OECD-member countries (47%). The long-term unemployed suffer from competition from the newly unemployed, who are more connected and more attached to the labour market and can regain employment more easily. It is thus a concern that nearly 200,000 jobseekers have been on the live register for more than one year, as these people could remain persistently unemployed and, eventually, could stop seeking a job altogether. In a time of scarce budgetary resources, it is important that public spending devoted to fighting unemployment be used effectively. i.e. not only to combat poverty but also to help the unemployed return to work, or at least get ready for the day when the economy will recover. This requires institutional reforms to move from a tradition of “passive” support to the unemployed to “active” forms of support, which focuses on pathways to return to work.

A variety of labour-market initiatives have been recently introduced in Ireland. Perhaps the most important institutional reform is the creation of Intreo centres, one-stop shop services where jobseekers can get their financial and employment supports. The goal is to bring together benefit provision and activation programmes under the same roof, so that all jobseekers can receive individualised assistance to facilitate their return to work, notably through training and job-search assistance. These new centres are part of the government programme “Pathways to Work”, which aims at improving the matching of labour demand and labour supply. “Pathways to Work” relies on mutual engagement of government agencies and jobseekers on individualised return-to-work strategies, with adequate activation and training programmes.

It is essential that these new programmes are rolled out fully and quickly. The deployment of a sufficient number of case workers – officials with the ability and authority to help each job seeker individually — has the potential to avoid high unemployment becoming structural by allowing direct engagement with those most at risk of staying unemployed. For such a strategy to be successful, jobseekers’ adherence to the principle of mutual obligation should be ensured, including with sanctions and penalties, as required. Financial sanctions for non-compliance by the unemployed with activation and training measures were introduced in 2011. The evidence is that the sanctions are being applied, which gives credibility to the regime, but only in few cases.

High unemployment can become structural when the sets of skills supplied by jobseekers do not match employers’ needs. In Ireland, re-skilling those who were formerly working in the construction sector and in low-skilled jobs is a formidable task. Over half of the unemployed were occupied either as craft or plant and machine operatives, and the evidence suggests that these workers are not being re-absorbed in the labour market, while those with managerial, professional, marketing and ICT skills face fewer problems. There even appears to be a shortage of Irish workers with the skills required by employers. The “Vacancy Review” produced for the Expert Group on Future Skills Needs suggest that Irish employers at times run into difficulties filling vacancies, given the set of required skills, and have to advertise abroad. This is particularly relevant for jobs requiring professional-level skills (ICT, engineering, finance and accounting) and for jobs requiring language skills, especially for sales and customer services.

Thus, more needs to be done to re-skill jobseekers in trades for which there is demand in the marketplace. The creation of SOLAS, following the dissolution of FÁS, is a step in the right direction. SOLAS will be responsible for the co-ordination and funding of training and further education programmes, while 16 Education and Training Boards (ETBs) will ultimately be responsible for the delivery of publicly-funded programmes of Further Education and Training (FET). There should be a clear focus on reducing the mismatch between the supply and demand of skills, including a greater focus on growth industries. SOLAS should foster a dialogue between employers and trainers to assess future skill demand and respond to emergent skills needs.

Young people are the most severely hit by the wave of unemployment. They have difficulties entering the labour market and may not be able to acquire the right experience needed to secure long-term employment prospects and rising labour earnings. The focus should be put on combining education and work through vocational programmes, training schemes and apprenticeship. Experience directly in the workplace, through subsidized jobs or apprenticeship, is a safe way for the young worker and the employer to learn to know each other, often leading to longer term employment.

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Irish history has been marked by many ups and downs, including periods of mass emigration. Between the early-1980s to mid-1990s, Ireland experienced high and persistent labour-market weakness – the unemployment rate remained above 10% for 16 years – before Irish governments finally moved decisively in the direction of economic reform. New policies in the areas of taxation, competition, regulation and education gave birth to the Celtic Tiger and, although the tiger was not as resilient as expected, Ireland remains a very attractive place to do business and create jobs. Today, once again, the challenge is clear. A pathway to recovery is available. It should be embraced without hesitation.

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