Bad Investment Explains Ireland's Productivity Problem

​As part of my final research for my masters, I decided to carry out a study on the effects of gross fixed capital formation (GFCF) on labour productivity in Ireland from 2000-2022. GFCF is capital investment in roads, railways, factories, infrastructure and other productive assets. It is widely regarded as one of the best predictors of long-term economic growth.

​In recent years productivity in the domestic economy has been fairly poor by EU standards. We are currently ranked 20th out of 28 EU countries in labour productivity terms. The divergence in labour productivity growth between SMEs and MNEs in Ireland over the last decade is also worrying which the chart below illustrates. While the foreign sector experienced significant productivity gains after the financial crisis, productivity in the domestic economy has flatlined. Not surprisingly, only a small group of multinational firms are a significant contributor to Ireland’s aggregate productivity.

While Ireland scores higher on productivity compared to the euro area, two-thirds of the gap is explained by the pharmaceutical and chemical sector and ICT services. In terms of the domestic economy, labour productivity is almost 10 times less than the foreign sector. As measured by gross value added per hours worked, the foreign sector has labour productivity of around €485, whereas the domestic sector has just €51. Productivity in the domestic economy stagnated since the financial crisis but increased dramatically in the foreign sector.​

Given these stats, I wasn't at all surprised to find a very weak correlation between GFCF investment and productivity in my regression results. Overall, only 7.9% of productivity could be explained by changes in GFCF over the past two decades.
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Consumption and domestic demand in the economy showed very weak links with GFCF as well. The relationship between these variables is effectively zero. Moreover, GFCF has followed a pro-cyclical trend meaning that the Irish government invests during good times but slams on the breaks during downturns. I provide the chart from my Stata regression results below to illustrate. Notice how the government’s investment in GFCF fell dramatically during the financial crisis and is still well below pre- crisis levels. This is in sharp contrast to the other wealthier nations in the EU and OECD who maintain steady investment throughout the business cycle regardless of recessions. Germany, France Denmark and Finland, for instance, fare far better than the Irish in this regard. 

Source: Reideconomics

​If GFCF investment follows boom and bust cycles it's a clear that the government lack the courage of their convictions and are far too reactionary. That won't come as a shock to Irish readers given the history of poor planning over many years. 
 
Sadly, when the government do invest, they also tend to make a mess of it. Cost overruns have plagued the Irish economy for decades. The original cost of the National Children’s Hospital, for instance, was €650 million but the final cost is estimated to be approximately €1.7 billion. Other examples of financial mismanagement include the Dart underground project which was eventually scrapped, the Luas, the Dublin Port Tunnel, the national broadband plan, and so on. Instead of providing first rate public services, the return on investment has given us poor broadband in rural areas,  inefficient public transport (officially the worst in Europe according to a report by Greenpeace) incompetence at the DAA, and of course the on-going debacle in housing and healthcare. These are not new problems.

For decades the Irish public has rightly bemoaned the government’s inability to properly manage public services and avoid cost overruns. Some of our basic infrastructure needs are still not being met, yet prices in Ireland are 25% higher than the EU average. This negatively affects our competitiveness and living standards. 
 
While we enjoy a relatively stable political system in Ireland, Irish people are growing weary of ineffective government nonetheless. The lack of real political competency in this country is obvious. To move us forward in any meaningful way we need radical thinkers, political courage and a vision for the country that spans well beyond a 4 year political cycle. If Sinn Fein are regarded as radical it’s probably more to do with their taxation policies or their vision for a united Ireland. I’ve heard very few credible policies from Sinn Fein regarding long term economic planning. They are not alone. 

Why is housing taking so long to fix, for instance? If available land is an issue, why are we not incentivising land owners through tax credits instead of  threatening them with punitive taxes? I don’t agree with other economists on this point. Human nature says "attack and I will defend." Land owners will dig their heels and use every legal trick in the book to delay paying the tax and releasing land. We need to play it another way given the urgency of the situation. Carrot over stick. A tax credit is guaranteed to produce much quicker outcomes than a “use it or lose it” approach.
 
In terms of labour supply, we have lost 40% of our construction workers since 2008 while our population in recent years has grown rapidly. It is estimated that approximately 180,000 construction workers are needed for the government to satisfy their Housing For All scheme and their National Develop Plan. If we haven’t enough builders, why aren’t we attracting immigrant workers back to Ireland to alleviate supply issues and cost pressures? This could be achieved by offering low-income taxes and rental subsidies. If we have nowhere to house these workers, prefab villages and modular homes could be erected by the state on a temporary basis. Irish immigrants built London and New York. Indians and Pakistanis built Dubai. We need similarly bold plans to fix the housing crisis once and for all and prevent the economy from overheating and eventually stagnating. That is now a genuine concern.

Policy that fudges around the edges making it look like something is being done will end in failure. Half measures won’t do. We need to allocate huge resources over the next 5 – 10 years to hard-nosed decisions as a matter of national emergency. Given record budget surpluses in recent years and more predicted in the future, for once money isn’t an issue. The only obstacle is our political will.