A view is emerging that the Republic's incomes policy has, to use the words of the Financial Times newspaper, "outlived its usefulness and should be phased out". Although dissatisfaction with the State's experiment of more than a decade with social partnership is understandable, we believe that it would be a great risk to abandon it now. The essence of the sequence of social partnership agreements, which began in 1987, has been the offer of tax relief in exchange for wage restraint. Moving to a more centralised bargaining model also allowed industry unions to take into account the economy-wide and often self-defeating implications of their wage demands.
The formula worked well in the relatively depressed and over-taxed economy of the late 1980s and early 1990s, underpinning one of the most remarkable turnarounds in recent economic history. The facts of the Irish success story are well known: eye-popping growth driven by a disproportionate share of foreign direct investment; an unemployment rate that went from one of the highest to one of the lowest in the OECD; negligible inflation (until last year); and a dramatic improvement in the public finances. Of course, it would be a mistake to give too much credit to the wage agreements. Many other factors were at work.
Whatever its contribution, it is undeniable that the social partnership approach is showing its age. With clear signs of overheating, tax cuts and spending increases are probably not what the economy needs at this time. Yet, with the latest agreement in danger of collapsing just prior to last December's Budget, the Government offered small additional wage increases and a massive fiscal expansion, much to the displeasure of the Republic's European partners.
Of course, saving the partnership agreement was not the only reason for the loose fiscal stance. Large budget surpluses, urgent spending needs in areas such as infrastructure, and a looming election were all at work behind the Budget give-away.
Many of the commentators who advocate abandoning the incomes policy view upward wage adjustment as the natural way to adjust to excess demand in a monetary union. This supposes that the wage adjustment occurs in a smooth way. Even with the incomes policy, however, the Republic is showing signs of entering a wage-price spiral - notwithstanding the recent fall back in inflation due to temporary factors. We should also remember that the reason governments pursue active demand management in the first place is that the "natural" adjustment mechanisms often work slowly in recessions and overshoot in the correction of unsustainable expansions.
The concentration in the Republic on the local consumer price index inflation measure - in contrast, most Americans have no idea how the local inflation rate differs from the national rate - increases the risk of a wage-price spiral and an ultimate hard landing.
Moreover, falling unemployment and a falling wage share are relatively easy to achieve when productivity growth is outstripping anticipated wages gains. This was the situation during most of the 1990s.
The Republic is almost certainly entering a period of slowing growth. Yet anticipations of living-standard improvements are still rising. The irony is that centrally negotiated wage restraint might not have been so important while the economy was vastly exceeding expectations, but it might be much more important as the economy's potential to deliver double-digit growth declines.
Having defended the Republic's pursuit of an incomes policy, we hasten to add that the social partnership process needs substantial reform. First, the Government needs the option of providing concrete but deferred compensation, such as negotiated contributions to individual retirement accounts. To the extent that this deferred compensation has a smaller impact on demand than direct compensation but is significantly valued by workers, it gives the social partnership a needed second instrument. The Government can then continue to "buy" wage restraint, but without stoking demand by putting money directly into workers' pockets. We agree that important longterm issues such as pensions policy should not be dictated by the contingencies of short-term demand management. But, given the limitations of the Republic's flat-rate pension system, limited occupational coverage and low private savings, a system of individual retirement accounts would be a valuable supplement to the existing system. The social partners also need to speed up the introduction of "benchmarking" proposals for basing public sector relativities on appropriate private sector benchmarks. Although this process risks a general escalation in public sector pay, growing shortages in key sectors will be a drag on living standards. Warranted dissatisfaction with national wage agreements in some sectors could also undermine the process. The Republic is on the verge of a formal rebuke for its fiscal stance from its European partners. With the State accounting for a tiny fraction of the EU aggregates, it is more an issue of principle and precedent rather than of practical concern.
Overly expansionary fiscal policies in a significant fraction of euro-zone states would push the European Central Bank to run a tighter monetary policy, so that the other members are forced to pay a price for their partners' profligacy. Indeed, the Republic could pay a price for setting a precedent of unco-operative behaviour. We think that it is a mistake, however, to jump from dissatisfaction with the Republic's fiscal stance to the conclusion that the incomes policy should be abandoned. The latter is an under-appreciated asset heading into the next stage of economic development.
While fiscal and incomes policies are entwined in undesirable ways, it should be possible to disentangle them with some innovative policy initiatives.
