Prof Peter Clinch

Prof Peter Clinch, Chair, National Competitiveness Council of Ireland

Introduction
As Chair of the National Competitiveness Council, my focus is on the ability of the enterprise base in Ireland to compete in international markets. Ireland’s ability to compete and sell goods and services abroad is the key determinant of economic growth, our ability to provide sustainable jobs, the wage rates that people are paid and, importantly, our ability to provide quality public services. Maintaining our competitiveness is the only way to ensure our economic recovery is sustainable and that, perhaps, for the first time, we avoid the boom and bust cycles to which Ireland is so prone.

Ireland has experienced a remarkable economic recovery. Both GDP and GDP per capita have already moved above their pre-crisis levels[1]. The NCC’s Competitiveness Scorecard report, which we published this week, benchmarks Ireland’s performance across a range of indicators and shows Ireland’s relative performance on current economic metrics, such as employment growth, productivity, exports and the public finances, is strong.

We must address factors within our control
However, my concern is that the composition of the economy, particularly our export base, is overstating Ireland’s overall performance and masking weakness in the underlying drivers of future competitive performance, particularly, with regard to infrastructure and productivity. Irish National Accounts data now include a very significant amount of activity carried out elsewhere, but formally recorded as part of Irish GDP and GNP. Metrics from these measures, such as the various fiscal ratios-to-GDP, measures of potential output and the output gap can be misleading.

Therefore, the Council welcomes the launch by the CSO of the Modified Gross National Income Indicator (GNI*) which provides an alternative view of the underlying state of the Irish economy. The new indicator appropriately adjusts for the retained earnings of re-domiciled firms and depreciation on foreign-owned domestic capital assets. Following the launch of GNI*, the National Income and Expenditure Annual results published last week report a 30% difference between GDP and GNI*[2]. It is important to say that GDP is an accurate measure and is still the appropriate measure in regard to several metrics. However, given the complex and highly-globalised nature of the Irish economy, the GNI indicator is an essential supplementary measure for informing and revaluating Government policy development.

The overall economic outlook for Ireland is positive and we should not forget easily how we longed to be in this position during the dark years of 2008, 9 and 10 and we should not forget how many said we would not be in this positive position. However, along with the good news, the economy now faces a significant threat from external factors beyond our control, including the outcome of the Brexit negotiations, a potential shift in trade and taxation policy in the US, and the uncertain nature of the political economy of the EU. This makes it crucial that we address those factors within our control. We are now seeing significant price pressures in property, labour, business service costs and the public faces high prices for consumer goods. We are also seeing hidden inflation in the economy, for example, increased traffic congestion, taxi shortages are returning, and public transport is becoming busier. Ireland’s response to the economic crisis was exceptional political bravery and remarkable policy consistency across three governments of different political colours. There was a relentless focus on bringing our macroeconomic variables back into line – our debt/GDP ratio, the Government deficit, stabilising the banking system. The same relentless focus must now be placed on retaining the competitiveness of the economy. I welcome, therefore, the Taoiseach’s positioning of competitiveness as a key pillar of the Brexit response. We must maintain Ireland’s cost competitiveness and invest in supporting infrastructure and talent. In that context, the decisions made today regarding the use of fiscal space will determine the competitiveness of the economy in the future.

 Fiscal Policy and Competitiveness
Ensuring that the State’s finances are prudently managed is a crucial element in providing a stable business environment in which enterprise can thrive. The government cannot provide services efficiently if it has to make high-interest payments on its past debts. Running fiscal deficits limits the government’s future ability to react to business cycles. Firms cannot operate efficiently when inflation rates are out of hand. In sum, and as we know from painful experience, the economy cannot grow in a sustainable manner unless the macro environment is stable. From the competitiveness perspective, fiscal governance and discussions relating to what has been termed ‘fiscal space’ should adhere to three main objectives:

1. Attaining sound budgetary positions (i.e. implementing a sustainable fiscal policy by avoiding high deficits and/or increasing debt ratios);
2. Reducing the cyclical nature of fiscal policy making; and
3. Improving the efficiency of public spending.

 Attaining sound budgetary positions
Taking the first element, stable and sustainable public finances are a prerequisite for competitiveness. This requires an appropriate balancing of the need to meet our obligations under the Stability and Growth Pact and put in place a sustainable, counter-cyclical, medium-term fiscal planning process with the need to increase capital investment to enhance competitiveness and support enterprise[3].

Based on the current trajectory, Ireland is on track to reach the target of a structural balance of 0.5 per cent of GDP in 2018[4]. Economic growth has also contributed to improvements in the debt to GDP ratio[5]. In order to withstand Brexit-related shocks, the Department of Finance had set an additional mid-term goal of achieving a debt-to-GDP ratio of 45 per cent (below the 60% cap in the Stability and Growth Pact). This target has now been amended to 55 per cent, to allow for increasing expenditure on capital formation.

We on the Council recognise the budgetary challenges of reducing the deficit level while at the same time ensuring that fiscal policy supports sustainable economic and employment growth, and facilitates sufficient public investment in productivity enhancing capital projects. This will require some difficult decisions – in some cases forgoing immediate but temporary gains so that we can provide for the future. Taking a longer-term view is often politically unpalatable, particularly in the current volatile environment. If we are to avoid the Irish cycle of boom and bust, however, a medium-term approach is essential.

Reducing the cyclical nature of fiscal policy making
Reducing the cyclical nature of fiscal policy making is a challenge across the EU but a particular challenge in Ireland where GDP growth rates are less stable and, as one of the most globalised economies, our domestic economy is too small to insulate ourselves against shifts in the world economy. In Ireland, the Fiscal Responsibility Act legislated for the implementation of national and EU fiscal rules. Ireland is expected to reach its Medium Term Objective (MTO) by adjusting the structural budgetary position by at least half a per cent of GDP annually and the MTO is a balanced budget in structural terms; and the Expenditure Benchmark requires that government expenditure grows at or below a country’s medium-term potential economic growth rate, depending on the country’s position with respect to the MTO[6].

I think it is important, at this point, to say that it is my personal view that the term ‘fiscal space’ presents a danger. It gives a sense that there is some highly convincing science behind determining such things as structural and cyclical deficits. It also suggests we can accurately predict economic growth. We only need to look back a few years to realise that we simply can’t be sure what the levels of the indicators will or should be. For example, if the world economy continues to grow, if Brexit exposure is not too damaging to the macroeconomy, and growth rates continue, arguably, capital investment is far too low to sustain the economic growth without a sharp loss of competitiveness. However, if the fragile world economy stutters, if Brexit is very damaging to the Irish economy, if FDI flows to Ireland reduce substantially, we can very quickly revert to an unsustainable fiscal position.

In regard to the revenue side, tax policy is a key tool, and a major determinant, of the competitiveness of the environment for enterprise. The tax system in place at the time of the crisis, amongst other contributory factors, made our ability to withstand the crisis without external support impossible. Tax reforms have contributed to Ireland’s recent fiscal adjustment, but there is further scope to improve the efficiency of the tax system. Developments in the National Accounts highlight the potential volatility or unsustainable nature of some rapidly growing sources of recent Exchequer revenues, such as the increase of corporation tax receipts by almost 50 per cent in year-on-year terms in 2015. Past experience highlights the danger of relying on volatile, and potentially transitory, revenue sources, to fund increased levels of public spending, or reductions in tax rates, which can prove hard to reverse. The Department of Finance has recently indicated that the top twenty multinational companies paid 50% of the Corporation tax received in 2016. Ireland’s exposure related to the concentration of corporation tax receipts among a very small cohort of firms remains a huge risk with regard to the sustainability of the public finances.[7]

Maintaining a growth- and entrepreneurship-friendly taxation system, whilst simultaneously broadening the tax base, is critical to maintaining existing levels of employment and creating new jobs. Efforts to secure the tax base should reflect the OECD tax hierarchy for growth, which outlines that taxes on immobile bases, such as property, and consumption are less distortive than those on personal and corporate income.

Improving the efficiency of public spending-infrastructure
Following years of fiscal retrenchment, and a general reduction in living standards, it is understandable that people wish to see a degree of payback from all of the sacrifices made. The Summer Economic Statement sets out that €1.2 billion in spending is available for next year, consistent with achieving a balanced budget. Taking into account the cost of measures introduced last year, in the absence of additional revenue-raising measures, this leaves around €500 million for new measures. €300m of this amount is available for new expenditure increases, which when added to the pre-committed spending will bring the overall expenditure increase to €2 billion. This means that overall public spending will be around €60 billion next year.

Developing our infrastructure base is a fundamental challenge
The challenge for Ireland is to maintain a sound budgetary position whilst simultaneously increasing capital investment to enhance competitiveness and support enterprise[8]. Therefore, I welcome the commitment set out in last week’s Statement that the Government is prioritising investment in order to address the infrastructural gaps that have emerged in areas such as housing.

Developing our infrastructure base, while complying with the EU’s fiscal rules, is a fundamental challenge. Following a sharp drop during the recession, private investment activity in Ireland has increased significantly. Irish private investment (21%) exceeds the Euro area average (17%), and the level seen in the UK (14%). It should be noted, however, that private sector investment data for Ireland is influenced by a substantial increase in intangible investment mainly attributable to the bringing onshore of intellectual property assets. Moreover, public investment as a proportion of gross fixed capital formation (2%) is below both the UK and Euro average (2.7%). The level of investment projected over the medium term represents a significant challenge in light of demographic pressure, EU budgetary commitments and clear deficits in telecommunications, innovation[9], transport and water infrastructures.[10]

Funds are scarce and investment alone is no guarantee of success.[11] The impact of investment critically depends on its efficiency. Assessing the efficiency of investment requires methodologies to identify projects and programmes with the most favourable cost-benefit ratios. It is critical that we ensure that appropriate value for money exercises are undertaken at the national planning stage rather than simply at project level.

In terms of infrastructure planning, Ireland has a somewhat fragmented institutional framework. IMF research comparing the value of public capital (input) and measures of infrastructure coverage and quality (output) suggests improvements in public investment management (PIM) could significantly enhance the efficiency and productivity of public investment. A more coherent and comprehensive approach across government departments, agencies and local authorities needs to be adopted[12].

Conclusion
In conclusion, Ireland’s ability to sell its goods and services abroad, determines our living standards, employment levels and our ability to finance public services.

Ireland lost approximately 30% of its competitiveness during the period of the credit bubble. It regained about 20% in the aftermath of the crisis. We are now ranked the 6^th most competitive economy in the world. That is a considerable achievement.

However, the concern is that the vast majority of this improvement has resulted from a cyclical cost competitiveness adjustment forcing prices down and external factors beyond our control, including, the low value of the euro, low interest rates and low energy prices. Moreover, when the recovery came, the record level of investment in advance of the crash has allowed the economy to expand rapidly without consequent rapid increases in prices.

Now, things are changing. Our growth prospects overall are still very good but prices are rising, most particularly, the price of accommodation. The external winds are against us, most particularly, Brexit. Some of our public services are not performing, most particularly, the health service which, without reform, will surely continue to balloon in cost as the population ages. In regard to our enterprises, our productivity performance is excellent in the multinational sector but very ‘average’ in the rest of the economy. Our export performance is being driven by a narrow range of sectors and companies. As I said earlier, levels of private investment are exaggerated by multinational activities and our public capital investment is lower than that of our competitors whose economies are growing at a much slower pace. All of this threatens our competitiveness and presents risks for our macroeconomic position.

Therefore, the question arises as to whether Ireland’s current economic model will work in the medium term. It seems inevitable that without expanding our capacity to grow through appropriate investment, without ensuring competitive public services, and without closing the considerable productivity gap between domestic and multinational enterprises, Ireland is very vulnerable.

If we refuse to learn from the lessons of the past, if we do not seize the opportunity to put in place more solid foundations for growth, we are undermining Ireland’s competitiveness and putting at risk our future prosperity. In terms of government spending plans, my personal view is that spending on capital must take priority as raising current spending raises the risk of increasing prices across the economy unless there is sufficient capacity to soak up increasing demand. The dividends from capital investment take time to bear fruit but are absolutely necessary to secure future jobs, wages and the quality of our public services. However, the political system is, understandably, ‘short-termist’. We have learnt to our cost the results of failing to consider fully the future consequences of actions and lack of actions. We must not do that again. Courageous decisions are required to be taken today to secure a sustainable, prosperous tomorrow.

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Notes:
[1] and, crucially, economic activity is more balanced between domestic sources, comprising of consumption and investment, and external sources of growth.

[2] The Results showed that, while Gross Domestic Product at current market prices was €275.6 billion in 2016, the Modified Gross National Income was €189.2 billion, more than 30 per cent lower. At the same time, the debt ratio as measured by GNI* is 106 per cent, substantially higher than the debt to GDP ratio of 73 per cent. Use of the Modified GNI indicator will have a knock-on effect on a number of other growth driven metrics, including, the structural deficit and the expenditure benchmark.

[3] The general government deficit continued to fall in 2016 to 0.6 per cent of GDP down from 2 per cent in 2015 and below the threshold of 3 per cent of GDP set out in the Stability and Growth Pact.

[4] Department of Finance estimates indicate that the structural balance in 2016 was -1.9 per cent of GDP.

[5] While the debt to GDP ratio remains high, it has decreased substantially from its peak of 119.5 per cent in 2012-2013 to 75.4 per cent in 2016. It is important that this downward trajectory continues if Ireland is to achieve the Stability and Growth Pact target of a 60 per cent debt-to GDP ratio.

[6] Any spending increases beyond this rate must be matched by additional discretionary revenue measures. Furthermore, the Government must on an ongoing basis assess whether the budgetary stance is appropriate from a macroeconomic stability perspective. It may reassess the fiscal stance in order to ensure budgetary policy does not contribute to any overheating should the economy grow at a faster pace than expected. While the application of defined and prudent fiscal rules is welcome, there is a concern that any underestimation of Ireland’s medium-term growth potential, for example, could limit our ability to increase capital investment and could, therefore undermine competitiveness.

[7] It is important to ensure our fiscal position remains sustainable in the face of an uncertain international trading and investment environment. Ultimately, the revenue generated through the taxation system funds our public services. We must ensure that our public finances support competitiveness, growth, entrepreneurship and rewards employment.

[8] Our past investment in capital was a crucial ingredient in our rapid recovery, and we support efforts to have the restrictions on capital investment eased. We encourage that the fiscal space remaining goes towards investing in the competitiveness enhancing areas in innovation capacity, broadband and transport infrastructure, costs and productivity. Public investment is essential to maintain and expand Ireland’s capital stock; it is also a significant driver of long term productivity growth and plays a crucial role in driving competitiveness. The gains from public investment accrue not just to those undertaking the investment, but to a wide range of people and enterprises.

[9] From a competitiveness perspective, the returns from knowledge based capital (KBC) are a vital component in securing productivity growth, diversifying and broadening the enterprise and export base, growing foreign direct investment, and creating new competitive advantage in intellectual property and commercial products and services. In terms of the public role for supporting KBC, OECD research suggests that the strongest evidence for private under-investment exists for R&D-related spending – suggesting a continued important role for public investment. Competitive economies require sufficient and effective investment in R&D, especially by the private sector; the presence of high-quality scientific research institutions; extensive collaboration in research between universities and industry; and sophisticated business practices and effective clusters. However, overall levels of investment in research and development in Ireland remain below the best performing countries.

[10] There was a significant reduction in public capital expenditure over the course of the recession although weaker demand for infrastructural services (e.g. reduced road traffic, declines in energy demand), partially mitigated the impact of this reduction. Absolute levels of Irish investment are recovering. Over the medium term, capital investment as a percentage of GDP is projected to increase but will remain low relative to pre-crisis levels. However, as noted by the Council and other bodies such as the Irish Fiscal Advisory Council, the provision for investment in the Capital Investment Plan 2016-2021 will focus largely on maintenance and upgrading of existing stock and will only facilitate a limited increase in the stock of public capital over the medium term.

[11] Because investment projects tend to be large-scale and costly, these investments can have a long lead-in time and efficiency and effectiveness in terms of project selection and appraisal is essential. Delays in delivering planned infrastructure compound current bottlenecks, increase congestion costs, and undermine the competitiveness and productivity of enterprise. From a policy perspective, effective planning, delivery and financing is critical to reap the dividends from investment in the longer term. The scope to improve physical infrastructure stock and improve the effectiveness of delivery in the medium term as set out in the Capital Plan must be guided by adequate levels of investment. Investment must also address identified enterprise needs and bottlenecks.

[12] At present responsibility for planning, delivery and maintaining infrastructure is shared between government departments, regulators, local and regional authorities, state agencies and state-owned providers of infrastructure. Deficiencies in co-ordination and fragmented planning and coordination can contribute to cost overruns and delays, duplication of resources and weaken the ability to prioritise projects and locations for capital investment. Ensuring an effective, integrated and coherent approach to State led infrastructure planning and delivery is necessary to facilitate improved efficiency and enhance the effectiveness of capital investment at minimum cost.