The Irish Plague - Symptoms and Antidotes
Barry O'Donnell~Senior Freshman
The problem of unemployment has plagued economic theorists and politicians for generations. Ireland has the third highest unemployment rate in the EU, despite the authorities overtly seeking to reduce the scale of problem. In this piece, Barry O'Donnell attempts to outline several possible causes of and solutions to the scourge of the Irish economy in a national and international context.
There has been a dramatic rise in unemployment in the 1980's and 1990's throughout the OECD (Organisation for Economic Co-operation and Development). This has been particularly noticeable in some European countries such as Spain and Ireland where unemployment rates are 18% and 15% respectively. Considering that Ireland has experienced high levels of emigration in the past thirty years this figure is even more startling, and has led to the reduction of unemployment becoming a primary objective of consecutive Irish governments. Many emotional speeches have been made regarding this problem without there being a clear understanding of the causes of unemployment. The first half of this paper will try to shed light on some of the causes of unemployment emphasising the phenomenon of long-term unemployment, while the second half will deal with possible solutions to this serious problem.
Traditionally espoused causes of unemployment can be divided into two distinct, but interdependent phenomena; (i) structural rigidities that exist in the labour market, and (ii) a changing global economy. Commentators have put forward three influences in relation to structural rigidities in the labour market; rigid real wage, inflexible labour demand and inflexible labour supply.
Rigid Real Wage
This is the classical interpretation of unemployment where the real wage rate is set above the equilibrating real wage rate. There are two possible explanations for this: pressure from trade unions and an unwillingness on the part of employers to reduce wages to their 'clearing level' because of a desire to reap efficiency gains. As regards the first explanation, studies have shown that there is no positive relationship between the strength of trade unions and unemployment. It seems, however, that non-centralised, across-the-board wage agreements have imposed a rigidity on the labour market and may be causing the rise in unemployment.
In order to reduce labour costs by reducing turnover costs firms pay a high real wage (called an efficiency wage) to discourage workers from being unproductive or seeking higher remunerated work. As yet, there is very little evidence to suggest that efficiency wages are causing unemployment although it must be said that the growing sectors of the economy are those that would generally be expected to have efficiency wages.
Rigid Labour Demand
Two factors which tend to make labour demand inflexible to changes in the real wage are employment protection legislation and the influence of activities in the product market. The former tend to reduce job creation as they discourage firms from hiring new workers. High dismissal costs make employers cautious about hiring workers with little experience. As regards the latter, imperfectly competitive product markets choose supernormal profits over increased employment. This means that market prices are high and employment levels are reduced. This problem can be reduced through effective competition policies.
Rigid Labour Supply
This is a very serious problem in Ireland and it is , in the author's view, one of the main reasons why unemployment in so high. The main factors involved here are the level and duration of unemployment benefits and the high levels of taxation. The 'replacement ratio' is defined as the proportion of an individual's take home income replaced by unemployment income. Many commentators suggest a replacement ratio in excess of 80% represents serious inefficiencies in the tax and social welfare system leading to the discouragement of people from working. Statistics show that one-fifth of families with three or more children face replacement ratios in excess of 100%. Marginal rates of taxation are very high in Ireland, particularly for lower income workers (up to 100% for some individuals) and this seriously discourages potentially lower income labour from searching for jobs.
Over half of Ireland's jobless workers are considered long term unemployed, that is longer than one year without employment. Factors such as a loss of motivation and skills lead employers to regard the long-term unemployed as unemployable. As Colm McCarthy has said, however, before someone becomes long-term unemployed they must first have been short-term unemployed, hence the problem is created by the causes discussed above. One of the reasons that so many drift from short-term to long-term unemployment is the availability of high unemployment benefits.
The second phenomenon which is often believed to be causing high unemployment is the changing global economy and this can be divided into (i) increasing international trade, and (ii) rapid technological change. In reality, these factors are not directly causing unemployment. It is more a case of economies failing to adjust to these changes.
In neo-classical theory, increased international trade will lead to job losses in some sectors and job creation in other sectors with no overall effect in relation to employment. The main impact should be an increase in living standards due to efficiency gains. The problem for countries like Ireland is that some labour and product markets are inflexible and this is leading to unemployment. There is not, however, a great deal of evidence to support this and, in fact, there has been increases in employment, arising from economic growth, that are directly attributable to an improved trade balance.
The long-term effect of technological change should be increased living standards. For countries like Ireland, however, there may exist short-term effects such as increased unemployment resulting from the labour market's inability to accommodate technological change. Countries like the US and Japan have experienced huge technological change and yet have still managed to adapt quickly to keep unemployment low. In order to be able to adapt quickly to these changes the economy must be able to upgrade the skills of the labour force and redesign firm organisation. This had been a serious problem in some OECD countries and has led to high unemployment.
Let us now concentrate on possible policy solutions to the unemployment problem in Ireland. Short-term answers to the problem are difficult to implement and it must be adduced that in the face of many policy solutions, substantial numbers are likely to remain unemployed, throughout the next ten years at least. However, it is generally better to secure modest progress than no progress at all. We will consider the short-term strategic options available to Ireland and then the longer-term options. First, however, the author wishes to analyse Irish people's dependency on governments to accomplish necessary changes.
Ever since independence there has often been a tendency on the part of the Irish people to view governments as the answer to all of their problems. As Kennedy points out, "Even economists of the far right, with strongly held views about the power of the market, will, when confronted by a problem, instinctively respond by reference to what governments are expected to do about it." There are, of course, many factors which constrain the power of governments, not least the unwillingness of the electorate to support necessary remedies.
As regards short-term solutions, the key areas are (i) infrastructure, (ii) disincentive effects of taxation and public expenditure, and (iii) the moderation of restrictive practices.
While the EU structural funds have been valuable in providing additional funding for the development of the economy's infrastructure, a dependency mentality has been created. With the expansion of the EU, the funds are set to dry up in the late 1990's, and this will test Ireland's ability to take care of itself. The Culliton report emphasised the need to develop Dublin Port which has been mismanaged in the past.
One of the major problems with the system of tax incentives/disincentives in Ireland is they are often contradictory in operation e.g. a tax incentive is given to encourage manufacturing such as the 10% corporation tax rate, but its impact in improving the relative attractiveness of manufacturing is nullified by such measures as Section 23 relief for construction. There are too many taxes in the Irish system which encourage 'rent-seeking' activities and these need to be abolished or, at least, reduced.
There is a need to encourage competition and break down restrictive practices in professions (law, medicine, etc.) and in financial services. This will encourage efficiency, and bring about employment opportunities. It has been pointed out that government regulation of various services may restrict entry and limit employment opportunities.
In considering long-term options, it is useful to keep and eye on whether there are any other countries which offer a model of what Ireland may wish to achieve. The range of possible options can be clarified into four broad categories. The first two models- the Korean and American models- are very ambitious but essentially for independent trade blocs, and in the author's opinion, are not quite appropriate for a country that is part of a large organization such as the EU. The third option- the Scandinavian model- would be to increase labour intensity of production, not in the market sector, but through publicly funded activities. Productivity growth would continue to be strong in the market sector, but the resulting income gain could be used to finance pro-active manpower policies. Ultimately, the idea is to use the after-tax incomes of the employed to give useful work to the unemployed. The best example of this is in Sweden, where long-term unemployment has been curbed through the implementation of manpower programmes. A key element of this policy is a restrictive approach to paying unemployment benefits in order to ensure co-operation in responding to these schemes. Problems which Ireland would probably encounter in trying to implement this policy include strong opposition from trade unions, very high costs and the sheer scale of the unemployment in Ireland
There is a fourth model which suggests upgrading the traditional Irish way of coping with surplus labour by not only tolerating emigration but actively encouraging it. This, however, could give rise to strong anti-government feelings which would be damaging to national morale. It is also doubtful if the approach would enable Ireland ever to catch up with the rest of the EU in terms of living standards.
In reality, there is no quick and easy solution to the unemployment problem in Ireland. In addressing the possible causes, in particular the real rigidities in the labour market, we may turn to such policies as further alteration of the existing tax and welfare system and perhaps more radical moves such as erecting some of the Nordic prescriptions. Of course a large cultural gulf still exists here, yet we must seek a pro-employment agenda.
Browne, F. (1992) The causes of Irish Unemployment in Central Bank of Ireland Research Departmen.
Kennedy, K. (1993) Facing the Unemployment Crisis in Ireland, Cork, Cork University Press
O'Hagan, J. (1995) The Economy of Ireland, Dublin, Gill & MacMillan.