Since the UK voted to leave the European Union, sterling has fallen by around 10 per cent against the euro, causing problems for Irish business. It has made cross-Border shopping more attractive. Even more important, it has had a serious adverse effect on the competitiveness of Irish businesses selling in the UK.
While these problems will impact on growth this year, they must be seen in the context of the past history of the sterling-euro/punt exchange rate, which has fluctuated within quite wide bands since the link with sterling was broken in 1979. The weakening of sterling in 2008 and 2009 took it to a value even lower than today, causing even greater problems than we are currently experiencing.
The fluctuations in the bilateral exchange rate since 1979 resulted in extensive cross-Border shopping from the Republic to Northern Ireland in the 1980s and from the North to the Republic in the 1990s.
While firms exporting to the UK can insure against these fluctuations in the short term by buying sterling in advance, it is not possible for the retail sector in the Border area to insure itself in this way.
Shocks
The effects of these exchange-rate fluctuations have always been temporary. Up to the start of the Economic and Monetary Union (EMU) in 1999, prices in Irish shops adjusted rapidly when the price in sterling changed. When the change in relative prices between the Republic and the UK was due to exchange rate changes, the prices in Ireland took longer to adjust. However, they did adjust over two or three years, gradually eliminating the effects of shocks to the exchange rate.
Between 1973, when Ireland joined the EU, and 1999, when Ireland joined EMU, consumer prices in the Republic and the UK, measured in a common currency, rose at the same annual average rate of around 8 per cent.
However, since the start of EMU in 1999, prices in Ireland have been much slower to adjust to exchange-rate changes and this is causing problems today. While the average rate of inflation in the UK and the Republic since the advent of EMU in 1999 has been similar at 2 per cent, sterling is today much weaker than it was in 1998.
The effects of weaker sterling, if sustained, will gradually be eroded by higher inflation in the UK
More significant for business is that wage rates today in the Republic are above those in the UK. As with prices, this effect is likely to wear off over time.
Since 1973, Irish wage rates have tracked those in the UK: while major fluctuations have occurred in relative wage rates in individual years due to exchange rates, in the long run Irish wages tend to revert to parity with those in the UK. Provided freedom of movement for Irish workers is maintained after Brexit, this may continue into the future.
What this experience highlights is that changes in exchange rates can bring temporary benefits or costs to an economy. However, they are not a way of permanently improving (or dis-improving) competitiveness.
Restore Irish competitiveness
It has been argued that if Ireland had not been part of EMU, and had been able to devalue at the beginning of the current crisis, the short-term costs of adjustment might have been lower. However, the experience since 2008 shows that domestic costs, including wages, adjusted rapidly to restore Irish competitiveness. (Irish wage rates were static whereas they rose in our competitors).
Also many of the sectors which might have gained from a temporary improvement in competitiveness continued to export through the recession; they would have needed time to invest to exploit further competitiveness gains.
So, for Ireland, the inability to devalue in 2009 probably made little difference whereas the enhanced support for Ireland as a member of EMU was a clear benefit to the troubled economy.
There is extensive debate internationally about the use of the exchange rate as an instrument to enhance a country’s competitiveness. Before the crisis, the US argued that China should revalue against the dollar. However, research shows that if China had done so, Chinese prices and costs would have fallen, negating the effects on competitiveness of the change after two or three years.
Mexico has seen a major competitiveness gain selling into the US as a result of the recent fall in the value of the peso, triggered by the advent of the Trump administration. History tells us that, even without enhanced trade barriers, this is likely to be a temporary benefit.
