The Role of the Traded and Non-Traded Sectors in Economic Growth

Clare Mc Andrew (Senior Freshman)

The 1989 NESC report on the 1992 single market contended that 'the key to economic growth lies in the internationally exposed trading sectors. Those sectors of the economy which predominantly serve the domestic market, such as private non-traded service activities, cannot be regarded as an independent source of sustained economic growth.' While Clare McAndrew suggests the government should devote more resources to the non-traded sector, she reiterates the widely expressed view that it is the traded sector that provides the 'fulcrum' around which the domestic economy turns.

Introduction

Growth in any economy is determined by the accumulation of its stock of physical capital, the skills and education of its labour force, its natural endowment of resources and the technology it employs in turning these inputs into output. Investment in these stocks is of crucial importance in stimulating the economic growth process. In a small open economy like Ireland, the level of this investment depends on the attractiveness of the traded sector, which is therefore seen as the key to economic expansion. By comparing the roles of the traded and non-traded sectors, first section of this essay will establish the former's primary importance as the engine of growth in a small open economy. As trade is vital for the Irish economy, competition and growth policies have focussed on its open sector, while the role of the non-traded sector is considered of less importance. However, in the second section, I will present the argument that, due to the limited impact of domestic policy on variables within the traded markets, only the performance of the non-traded sector is within the scope of such policy and therefore holds significance as the sector that governments can influence. Finally, I will discuss how the distinctions between the two sectors are changing over time and portray the effects of a single market on accelerating this process.

The Importance of the Traded Sector

The domestic production structure can be decomposed into the traded-goods sector, containing all those production activities in which industries are exposed to international competition (shoes, cars and zinc, for example) and the non-traded sector, comprising all other goods (including construction, public administration and health services). Within the traded sector a further division can be made between a natural resource-based industry, such as agriculture, and a "footloose" sector (manufacturing). The importance of this subdivision lies in the fact that the location of the farmer is determined by the geographical location of natural resources, which imposes constraints on a nation's output, a limitation, which does not arise in the context of the non resource-based sector. While 63.2% of the Irish labour force were employed in the non-traded sector in 1985, the primacy of the traded sector can be acknowledged by the fact that a small open economy such like Ireland must trade its output in order to import goods from abroad. This crucial assumption implies that as national expenditure must equal the total value of the output produced in the economy, any deficits resulting from importation must be paid-for by exporting domestically produced goods to foreign markets. As the non-traded sector serves only internal markets, its output value is limited to the share of natural expenditure within this sector, as surpluses could not be exported.

In the Irish case, due to the limited potential for increasing exports from the main resource-based traded sector (agriculture), we must concentrate on raising production in internationally traded manufactured goods in order to increase domestic consumption and future output growth without pressure on our balance of payments. The vital importance of trade to Ireland is evident since we must import goods for production and consumption due to our limited supply of natural resources and therefore must exchange exports to pay our way. Yet even if we were to imagine an economy that could be totally self-sufficient, differences in consumer tastes and economies of scale would still make it uneconomical to remain isolated. Two important points can therefore be made concerning the relative roles of the traded and non-traded sectors of a small open economy. Firstly the traded sector is vital if the economy needs to purchase imports, and secondly it is this sector that really determines the total level of national output. Total output is determined by production in both sectors, but since the value added to this total from the non-traded sector is determined by its allocated proportion of national spending, it is expansion of the traded sector and its multiplier effects on the protected sector that determine the overall expansion of national output.

Economic policy in Ireland has concentrated on facilitating expansion of output in this sector. As prices for traded good are exogenously given from international markets, policy has focused on attempting to increase the share of world and Irish investment that the domestic open sector can attract. One of the most obvious policy measures that discriminates between the sectors is the differential tax rates on profits, with the non-traded and traded sectors subject to a 38% and 10% tax on profits respectively. Government grants and subsidies have also been directed largely towards developing export industries which are seen as the primary means to aid the balance of payments and to indirectly enhance growth and employment in other sectors of the economy. The generally accepted view of policy makers, therefore has been that enhancing the competitive position of the economy to attract a greater share of world investment to its traded sector is the key to economic expansion.

A Role for the Non-Traded Sector?

The non-traded sector is crucial to attracting foreign investment into our economy. Some economists suggest that domestic policy has a limited influence on the traded sector as it cannot affect the prices of goods traded abroad or the prices of any imports into the economy for use in production. It could be argued that what will really attract footloose investors is the relatively inexpensive input costs in the non-traded sector. Therefore, if the government wants to increase the competitiveness of the traded sector and the economy as a whole, it should concentrate on improving the supply of non-traded inputs to traded-sector industries, and ensure that they are of a comparable price and quality to import substitutes.

Over 900 foreign firms operate in Ireland but less than one-third of their material input needs are met internally. By ensuring foreign firms can be competitively supplied by domestic markets, the output of the non-traded sector as well as the real value added by foreign firms to the economy can be raised. The infrastructure and institutional environment of a country may also serve as important determinants for potential investors, so it is desirable to maintain a supply of utilities. The relative price and quality of labour is also another key competitive factor, and as the most powerful Irish trade unions are based in the non-traded industries, national wage levels are determined to a large extent within this sector. Government efforts to moderate wage levels, therefore, must be directed towards the non-traded sector,and improving education and training services should be at the top of the government's agenda. Finally, it must be recognised that spending on non-traded goods and services accounts for around 60% of national output, which means that policies aimed at price reductions and quality improvements within this sector will not only enhance our competitive position, but also directly improve the living standards and incomes of the population. In essence, the non-traded sector is crucial for the nation's economic welfare and if policy can get the non-traded sector "right", the open sector will take care of itself.

The Traded and Non-Traded Sectors - A New Reality

Although the previous discussion may highlight some important considerations for economic policy, the procedure for comparing the roles of the two sectors and assessing their relative importance in facing a new set of challenges as we move towards the competitive environment of a single European market. The increased integration of markets and elimination of trade barriers has meant that traditionally non-traded industries, particularly services, are now being faced with similar competitive conditions to those in the traded sector. the removal of tariff barriers, quotas and legal regulations and the reduced transport costs within the community has left very few goods and services which are protected from foreign competition.

The effects of a single market are most prevalent in the previously unpenenetrated Irish services sector, which will force many firms to drop prices to remain competitive. In this decade, the services sector will face the same shake-out that took place in manufacturing when Ireland joined the EEC in 1973. Dramatic changes have already come to pass in the distribution, transport and financial services sectors, whilst moves to liberalise public purchasing are beginning to expose the traditionally protected public utilities, such as energy and telecommunications to new levels of competition. The movement towards a common market for telecommunications services and equipment (as spelled out in the European Commission 1987 Green Paper) has coaxed Telecom Éireann to review its cost and pricing structures. Finally, with increased mobility of labour and capital in the EU, the prices of goods that remain non-traded will also become indirectly linked with prices in other countries are increasingly harmonised.

Therefore, it is important to realise that if a non-traded sector's performance is damaging Irish competitiveness, the government may be able to alter the sector into a traded one. Foreign competition may then reduce prices and improve quality if the reasons that the sector is non-traded have to do with government policy. The 1992 programme implies precisely such changes for many service industries that have been non-traded.