Case Study: Foreign Direct Investment and Ireland’s Tiger Economy
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Foreign Direct Investment and Ireland’s Tiger Economy
Executive Summary
In analyzing the role of FDI in the Irish economy, this report has taken on the view that, while it was pivotal in contributing to the economic success of the nation, there were other problems and situations arising from the active courting of FDI.
The report also compares two other countries which used similar models to Ireland.
The Role of FDI in the Irish Economic Success
Foreign Direct Investment (FDI) occurs when a multinational company from one country has an ownership position in an organizational unit located in another country[1]. A country’s ability to attract FDI affects its economic fortunes considerably, as such investments create jobs and bring in tax revenues.
Ireland’s economic success is considered to be highly linked to FDI, as concluded by a report by the Enterprise Strategy Group[2]. Both employment data and macroeconomic data also appeared to point towards the strong link between FDI and the strength of the economy[3].
Stopford and Strange (1991) identified four factors that contributed to the attraction of FDI into an economy[4].
1. The search for resources: getting resources like minerals, labour and raw materials more efficiently.
2. The search for markets: getting new buyers for products.
3. The search for efficiency: getting more efficiency in production by locating different aspects of production where it is handled best.
4. The search for strategic assets: getting a distribution network, technology, brand or location.
In the case of Ireland, FDI comes to the nation in search of resources and efficiency, rather than markets or strategic assets. FDI was attracted to Ireland because of its well-educated labour force (resources)[5]. FDI was also attracted to Ireland because of its low corporate taxes and ready access to the European market (efficiency)[6].
While FDI possibly played a major role in the Irish economic success, there were also two other factors that played strong roles as well.
Ø Prudent economic policies on the part of the Irish government[7].
Ø The global economic boom of the 90s, led by the US economy (based on the theory that a rising tide raises all boats).
Even with the two factors considered, the overwhelming importance of FDI in the Irish economy simply could not be ignored.
Why Countries Welcome FDI
FDI brings with it several economic advantages and disadvantages[8].
Advantages
Ø Transfer of technology
Ø Transfer of managerial skills
Ø Development of industry sector/geographical region
Ø Catalyst for change
Ø Provision of employment
Disadvantages
Ø Domination by foreign firms
Ø Technological dependence
Ø Changes in lifestyles
In the case of Ireland, FDI resulted in the development of certain industries in the nation (pharmaceuticals, computer technology and call centres), providing for plenty of employment within the nation. The very influx of FDI, however, resulted in the domination of the local economy by foreign firms. Any threats by foreign firms to pull out are serious threats for the nation.
Still, FDI is particularly attractive for accountable governments, especially since its advantages often outweigh the disadvantages. The development of certain industries, geographical regions and employment are advantages that many developing or impoverished countries simply could not ignore.
There are many ways governments can use to attract FDI, and incentives or subsidies are often used as a carrot to induce corporations to set up shop and do business in the nation. Incentives and subsidies can broadly be classified as regulatory or financial[9].
Regulatory Incentives
Ø Administrative assistance
Ø Reduced impediments to cross-border operations
Financial Incentives
Ø Infrastructure subsidies
Ø Job training subsidies
Ø Relocation and expatriation support
Ø Temporary wages subsidies
Ø Credit for investors
Ø Real estate
Ø Cost participation
Ø Reduced direct corporate taxation
Ø Incentives for capital formation
Hanson (2001) has identified certain issues with assumptions about FDI[10].
Ø In theory, FDI raises national welfare by bringing foreign technology and other foreign resources into an economy, which raises the productivity of domestic factors, but in the absence of externalities there is no justification for taxes or subsidies which are specific to FDI.
Ø In theory, externalities associated with FDI may raise or lower national welfare, depending on whether positive productivity spillovers from multinationals more than offset the loss in profits due to crowding domestic firms out of the market.
Ø Empirical research suggests that FDI is sensitive to both host-country tax polices and economic conditions, including the education level of the labour force, overall market size, and the size of the local industrial base.
Ø Empirical research shows mixed support for the idea that FDI generates positive spillovers for domestic industry, while multinationals tend to be high-productivity firms which pay relatively high wages; on average (in at least some countries) their presence appears to depress the productivity of domestic plants (perhaps by driving them into less profitable market segments).
Based on the research by Hanson, there really is no logical reason favouring either the subsidy or the lack of such in attracting FDI. Countries should not need to subsidise FDI.
For political reasons, however, the ability to attract FDI is normally a strong symbol of a government’s success in running the country, and is still highly trumpeted. Governments tend to greet news of countries moving their factories or HQ to another with great concern. If only to maintain political stability, governments would still tend to attract FDI by offering incentives and subsidies, and would continue to do so, even if they should not.
Learning from the Irish Model
There are certainly lessons for other countries to learn from the Irish approach towards attracting FDI. The Irish approach towards attracting FDI has been manifold[11].
Ø Repositioning of Ireland as the nation with the youngest Europeans.
Ø Favourable exchange rates.
Ø Improving the quality of the labour force.
Ø Revaluation of the Irish pound.
Ø Low 10% manufacturing tax rate.
Ø Persistent and long-term view in courting MNCs for FDI.
Ø Policies supportive of business, irrespective of political party in power.
Of all of these approaches, only four can be copied by other countries and used for their approach towards FDI (the others are out of control of many governments). Two of them are easily controlled by the government, the other two are not.
Easily Controlled
Countries should seek to improve the quality of their labour force if they want to attract quality FDI. Countries experiencing brain drain would find this increasingly difficult to achieve, and should offer incentives for education and for the return of their top talents. Incentives to attract foreigners to form part of the talent pool could also be considered.
All countries interested in attracting FDI should also learn from the Irish model of being persistent and taking a long term view in courting MNCs. Overseas missions should be kept opened, and important contacts nurtured over the years.
Not Easily Controlled
Low tax rates can also be easily offered by other countries, in the form of either tax holidays. Not all countries would be able to offer low tax rates for all industries, however, due to fiscal constraints. Countries able to offer a low tax environment (Hong Kong and Singapore) are certainly at an advantage.
A stable political environment for business is yet another part of the model that is not easily controlled by the government. Many democratic countries are populist in nature, and swings in sentiments could easily bring pro-labour governments into power, resulting in regulatory hurdles for business (and hence hurting FDI). Autocratic governments, like many communist or military governments, tend to be less stable and inclined towards appropriation of businesses. Countries able to offer such stability (Singapore and Japan) are at an advantage in attracting FDI.
Singapore and China
Both the nations of Singapore and China have used some of the arsenals used by Ireland in attracting FDI. In them are references to the Irish model.
Singapore
Singapore offers a stable government, one that has been in power for 43 years, and one supportive of business. In the nation, labour, government and business form a tripartite partnership[12]. In addition, corporate tax rates are low, at 18% for chargeable income above SGD300,000. The quality of the labour force is high, with 33.7% tertiary enrolment and 92.5% literacy rate[13]. The government has also taken a long-term view of courting FDI, establishing the Economic Development Board in 1961[14] (4 years before its independence in 1965).
China
China offers a stable government, the only one allowed to be in power for over 59 years. Since the opening up of China in the 1980s (after the disastrous Cultural Revolution), the government has been very supportive of business. Corporate tax rates are currently high, at 25%, but many businesses are still enjoying contracts which keep tax rates as low as 10% for the next few years[15]. The nation still keeps a preferential tax rate of 15% for industries it wants to attract, like agricultural, environmental-protection, energy-saving and high-tech industries.
Both countries have been very successful in attracting FDI, with big China not needing as much of the carrots as tiny Singapore (which require as many as Ireland). A big market is an advantage in itself.
Interestingly, like Ireland, Singapore suffers from a weak indigenous industry.
Conclusion
The Irish model of FDI has been studied and analysed by others wanting to emulate its success. While it has been successful in transforming the nation, FDI also brings with it problems of its own. Nations wanting to emulate the Irish model would do well to weigh the various options before doing so.
References
1. Cullen, JB & Parboteeah, KP 2008, Multinational Management: A Strategic Approach, 4th Edition, Thomson Higher Education, Mason, OH, USA.
2. Alfaro, L, Dev, V & McIntyre, S 2008, Foreign Direct Investment and Ireland’s Tiger Economy, Harvard Business School, Boston, MA, USA.
3. Stopford, JM & Strange, S 1991, Rival States, Rival Firms: Competition for World Market Shares, Cambridge University Press.
4. U21Global 2007, ‘Foreign Direct Investment’, online course materials for MBA640 Managing International Business, U21Global, viewed 24 August 2008, http://university1.u21global.com.
5. OECD 2003, Checklist for Foreign Direct Investment Incentive Policies, OECD Publications, Paris, France.
6. Hanson, G H 2001, Should Countries Promote Foreign Direct Investment?, United Nations Publication.
7. Xinhua 2007, ‘Singapore PM urges workers, employers, government to broaden tripartite partnership’, People’s Daily Online, viewed 24 August 2008, <http://english.peopledaily.com.cn/200701/24/eng20070124_344452.html>
8. NationMaster 2008, ‘Singapore Education Stats’, viewed 24 August 2008, <http://www.nationmaster.com/red/country/sn-singapore/edu-education&all=1>
9. Singapore Economic Development Board 2008, ‘The 1960s: A time of turbulence and economic uncertainty’, viewed 24 August 2008,http://www.edb.gov.sg/edb/sg/en_uk/index/about_us/our_history/the_1960s.html
10. Chung, O 2007, ‘Mixed feelings over China’s new tax system’, Asia Time Online, 21 March 2007, viewed 24 August 2008, <http://www.atimes.com/atimes/China_Business/IC21Cb01.html>
[1] Cullen, JB & Parboteeah, KP 2008, ‘Multinational Management in a Changing World’,Multinational Management: A Strategic Approach, 4th Edition, Thomson Higher Education, Mason, OH, USA, p. 13.
[2] Alfaro, L, Dev, V & McIntyre, S 2008, Foreign Direct Investment and Ireland’s Tiger Economy, Harvard Business School, Boston, MA, USA, p. 1.
[4] Stopford, JM & Strange, S 1991, Rival States, Rival Firms: Competition for World Market Shares, Cambridge University Press.
[5] Alfaro, L, Dev, V & McIntyre, S 2008, Foreign Direct Investment and Ireland’s Tiger Economy, Harvard Business School, Boston, MA, USA, p. 8.
[8] U21Global 2007, ‘Foreign Direct Investment’, online course materials for MBA640 Managing International Business, U21Global, viewed 24 August 2008, <http://university1.u21global.com>
[9] OECD 2003, Checklist for Foreign Direct Investment Incentive Policies, OECD Publications, Paris, France, pp. 17-20.
[10] Hanson, G H 2001, Should Countries Promote Foreign Direct Investment?, United Nations Publication, pp. 14-15
[11] Alfaro, L, Dev, V & McIntyre, S 2008, Foreign Direct Investment and Ireland’s Tiger Economy, Harvard Business School, Boston, MA, USA, p. 6-7.
[12] Xinhua 2007, ‘Singapore PM urges workers, employers, government to broaden tripartite partnership’, People’s Daily Online, viewed 24 August 2008, <http://english.peopledaily.com.cn/200701/24/eng20070124_344452.html>
[13] NationMaster 2008, ‘Singapore Education Stats’, viewed 24 August 2008, <http://www.nationmaster.com/red/country/sn-singapore/edu-education&all=1>
[14] Singapore Economic Development Board 2008, ‘The 1960s: A time of turbulence and economic uncertainty’, viewed 24 August 2008, <http://www.edb.gov.sg/edb/sg/en_uk/index/about_us/our_history/the_1960s.html>
[15] Chung, O 2007, ‘Mixed feelings over China’s new tax system’, Asia Time Online, 21 March 2007, viewed 24 August 2008, <http://www.atimes.com/atimes/China_Business/IC21Cb01.html>
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