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‘Tiny open economies like Ireland are more vulnerable than most to negative technology shocks’

Monday, February 13, 2017 6:45
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Last week, Hewlett Packard announced it was removing 500 jobs from one of its Irish facilities. The move reminded many of Dell’s decision to move its production facility from Limerick to Poland in 2009, and threw Ireland’s relationship with the many multinationals who use us as an export hub to the European Union into sharp relief.

Multinationals are good for the Irish economy. They bring many benefits, not the least of which are hundreds of thousands of high-value jobs and billions in tax revenue for the state. They promote good management practices and provide at least some knowledge spillovers to domestic firms.

We’re also really good at attracting multinationals to Ireland. Since 1958, despite being a tiny economy, Ireland has developed as a foreign direct investment (FDI) giant. In 2016, the stock of inward investment was €796 billion and, after the US, Ireland is the largest recipient of foreign direct investment in the world when measured by the flow of FDI into a country.

This success is a consequence of the export-led growth strategy Ireland has followed for almost 60 years. Multinational employers create one in every ten jobs in Ireland. That’s 174,000 people in work. They are responsible indirectly for another one in ten jobs. These jobs are typically ‘high value’ jobs and Ireland led the world when ‘high value’ investments for 2015 were ranked.

However, multinationals also deform our economy and make it hard to measure. They can damage the reputation of the Irish economy through tax avoidance practices. Financial services firms can add enormous risk to our tiny nation’s balance sheets.

Many of the investments made in 2015, for example, were in financial services, and brought a lot of money but relatively few jobs. When new jobs are measured against population size, Ireland lags behind Macedonia, Serbia and the United Arab Emirates.

Of the metropolitan areas absorbing serious flows of FDI, Dublin is 16th on the list for 2015. That’s hardly the spectacular performance we’re all used to hearing about.

I find it useful to think about the development of Ireland’s multinational policy in historical terms. In a 2002 paper, UCD economic historian Prof Cormac Ó Gráda reminded us that: “In the 1960s, Ireland scrapped much of the protectionist apparatus built up since the 1930s. Tariffs were reduced unilaterally, and the Industrial Development Authority, originally an arm of protectionist policy, was transformed into an agency to attract foreign capital. But what emerged was hardly free trade. Instead Ireland shifted from one form of trade distortion to another: export-subsidising industrialisation replaced import-substituting industrialisation.”

Let’s not forget we pay the multinationals to be here, in direct subsidies, R&D credits, special tax arrangements, or simply very low corporate tax rates. Economic theory suggests corporations should be taxed at a zero rate, because they can just pass any tax levied on them onto their customers or, if they are big enough and have enough accountants, they can move their money offshore, which is precisely what they do.

Reality is somewhat more complicated than economic theory. Let’s say the optimal place for a certain multinational to locate is Germany, whose corporate tax rate is 29.72 per cent, but they locate here in Ireland, where the corporate tax rate is somewhere between 0 and 12.5 per cent, say 10 per cent. Ireland saves the multinational 19.72 per cent.

It depends on the country and the multinational company, of course, but Ireland may well subsidise US exports by making them more competitive through lower corporate tax rates and a more appealing business climate, together with market access to the European Union and a weak euro.

An Irish disease

At the macroeconomic level, FDI is an inflow that stimulates output and employment without raising the debt to gross domestic product ratio. Essentially, the savings of other countries are being used to buoy demand and employment in Ireland. The result is growth without inflation.

Trinity economists Prof Frank Barry and Aoife Hannan studied multinationals as an example of an ‘Irish disease’, whereby indigenous manufacturing was ‘crowded out’ by the influx of multinational investment.

They studied the period between 1973 and 1994. In 1973, indigenous employment was double the multinational sector. By 1994 it was about half and half, but the total number of manufacturing jobs remained roughly constant. Multinationals have grown by much more since the mid 1990s, as have the range of activities they do here in Ireland.

Ultimately, foreign direct investment growth relies on globalisation, which I like to think of as an ever-greater integration of markets. We know there are serious risks to assuming globalisation keeps going forever. We need only look at the likely economic fallout from Brexit and from trade-treaty cancelling US president Donal Trump to see that a re-nationalisation of foreign business interests is increasingly likely.

Think about this. As Ireland emerged from the 2007/8 recession, it rode a wave of growth largely driven by the presence of profitable foreign multinationals. The ‘multinational’ sector, because it was unmoored from the domestic economy, did not suffer the same levels of austerity as the rest of the economy. This is not to say people working in multinationals didn’t suffer – they did – but relatively speaking, things were better. This kept taxes higher than they would otherwise have been, and so helped the Irish economy through the worst of the austerity years.

When the domestic economy began recovering, the contribution of the multinationals to our growth faded. Multinationals do not ‘sync’ with the Irish economy, and that is a good thing. But without a diverse and strong indigenous set of companies able to compete internationally, when conditions change they will leave.

The savings of other countries are being used to buoy demand and employment in Ireland. The result is growth without inflation

History repeats itself. Take Limerick as an example. In 1978, the region’s major employer, Ferenka left, costing 1,900 jobs and devastating the local economy. In 1998, Krups, the region’s major employer, left, with the loss of 1,400 jobs. In 2009, Dell left, and at least 4,000 jobs were directly and indirectly lost.

And now, with technological change a constant in high-tech firms, we have HP leaving Leixlip.

This growth and decline cycle poses recurring questions regarding the long-term durability of the ‘industrialisation by invitation’ approach.

If Ireland is to benefit from the presence of foreign firms in the long run, there needs to be significant transfer of knowledge between foreign and domestic firms. Thus domestic firms can emerge as global competitors in their own right, and there is some evidence of this happening in the biomedical sector. Whether this transfer has taken place across the entire economy is another question entirely, and for the 500 workers at HP, the prospect of setting up their own firms may not be a runner.

At a more general level, technological change and automation are coming to the entire world and to every industry. Tiny open economies like Ireland are more vulnerable than most to negative technology shocks. We should expect to see more announcements like that of HP.

It is also the case that multinational firms are here to make a profit. This might seem like a stupid thing to say, but it isn’t. When they make these profits, the funds are transferred abroad, to be used in whatever way the profit-maker sees fit.

When an economy produces stuff, some of the value that gets added in production goes to the workers as wages, and some of it goes to employers as profits. In Ireland, the share labour gets across the entire economy is about 37 per cent of our national output, and is forecast to stay at about that level for the next five years.

Ibec’s Gerard Brady has looked carefully at the share of added value that labour takes home from domestic Irish firms and multinationals. There is a lot of variation by sector, as you might imagine. In some cases the Irish firms have a lower labour share than multinationals. For example, in legal and accounting activities, Irish firms have a lower labour share (51 per cent) than multinationals (70 per cent).

Overall, however, the pattern is very clear. Across all the sectors, the average labour share is 65 per cent for domestic industries, and 26 per cent for foreign owned multinationals. That is, for every euro added in value in a multinational firm, 26 cents go to workers, and 74 cents go to the multinationals. Now, don’t get me wrong. I’m not saying multinationals shouldn’t make profits, or that they are doing something wrong. It does strike me that of the 35 cents the average Irish firm is taking home, it is probably reinvesting a lot of those profits in Ireland. That is certainly not the case for our multinational friends.

Don’t pick favourites

We always tell our children we don’t pick favourites. What happens when we do?

Government agencies jostle for ministerial attention all the time, in much the same way that children seek their parents’ attention. The route to preferment is usually through fulfilling a strategic priority for the government. Who do you think is the government’s favourite: the IDA, or Enterprise Ireland? I would argue EI needs a vast increase in its budget over the next few years to cope with Brexit and to help build a diverse indigenous sector.

The policy of export-led growth has run its race. It exposes our tiny economy to lots of volatility. We should focus on empowering domestic firms to compete abroad if we want to succeed in the 21st century.


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