Economics: For any economy to grow, there must be a rise in employment and/or an increase in the output of the existing workforce, writes Dan McLaughlin.

The latter concept, productivity growth, has preoccupied US policymakers and markets for some time, although it gets little attention in the Republic.

This is perhaps understandable in the 1990s in that the Irish economy saw an extraordinary and sustained rise in employment, but less so now that employment growth has slowed.

Moreover, any discussion on Irish competitiveness tends to concentrate on the currency or wage and price trends, while downplaying or ignoring altogether the impact of productivity growth.

This is all the more surprising as the Republic's productivity record is extremely good, as the recent release of industrial productivity data for last year demonstrates.

Manufacturing output rose by 6.7 per cent in 2003, with production in the multinational sector up 7.9 per cent and output in the indigenous sector up 2.4 per cent.

This occurred despite a rise in the exchange rate and amid dire warnings about loss of competitiveness.

Indeed, output growth accelerated through the year, with production in the final quarter up 15.8 per cent on the same period of 2002, including an 18.7 per cent increase in the multinational sector and a 4.4 per cent gain in the indigenous economy.

These are impressive numbers in themselves but what makes them remarkable is if one adjusts them for changes in employment to derive the change in output per worker.

Data on manufacturing employment for 2003 is only available for the first nine months of the year, but there is enough information there to give credence to the view that employment in that sector fell by around 5 per cent last year.

So. if total manufacturing output rose by 6.7 per cent and employment fell by 5 per cent, productivity grew by around 12 per cent.

Nor is this productivity performance solely a function of the multinational sector.

Employment in indigenous manufacturing fell by 4.5 per cent last year, which implies productivity growth of around 7 per cent given the 2.4 per cent rise in output.

These productivity data highlight how inappropriate it is to draw any conclusions about competitiveness by reference to exchange rate movements alone, as Irish industry has clearly responded to the euro's appreciation by cutting labour while increasing output, therefore sustaining profit growth.

The manufacturing data also throw up a puzzle and a number of implications about the economy's overall productivity growth.

The puzzle relates to the distribution of all this production - where did it go?

The size of the Irish economy is such that a large percentage of manufacturing output is exported, but the figures from the Central Statistics Office (CSO) on external trade point to a double-digit fall in the volume of Irish exports in 2003.

This sits uneasily with the production data and I suspect that the CSO is underestimating the fall in the price of Irish exports in 2003 and, therefore, overestimating the volume decline.

The broader implication of the manufacturing data relates to the implicit productivity growth for the service sector.

It looks like gross domestic product growth in 2003 was 2 per cent at best, and that employment grew by around 1.5 per cent, implying very little aggregate growth in productivity.

Yet, we know that manufacturing productivity surged so the implication is that productivity fell in the service sector, which is all the more understandable given that the public sector saw the bulk of job gains.

One final implication relates to inflation. Manufacturing pay rose by an estimated 6.5 per cent in 2003, which clearly fell well short of predicted growth, implying no inflationary threat from this source.

A similar pay rise in services, however, carries much greater inflationary implications in the service sector, given the productivity performance there.

The dichotomy in productivity performance also serves to explain the problematic nature of any national pay deal, or at least one that carries a flat pay rise across the board.

Such a rise may be far too low for some sectors but far too high for others.

Dr Dan McLaughlin is chief economist with Bank of Ireland