EF303: Irish Economic Analysis Lecture 8&9

From last time… We looked at data on foreign-owned vs indigenous industry Specific sectors… High productivity in foreign-owned industry Highest productivity/worker in manufacturing in the world!… Foreign companies based here are hugely profitable… Is it because Ireland is the best place in the world to do business?? Role of transfer pricing, use of technology developed elsewhere… Measuring transfer pricing almost impossible - it’s illegal!

From last time… Foreign-owned industrial sector is hugely important to Irish economy… remember employment figures and wages bill… Also establishes Ireland in high value sectors we wouldn’t otherwise be involved in Export capability we wouldn’t otherwise have… Exports: - multinational exports worth about €80 billion per year - say only about 20% of inputs (value) sourced domestically - net contribution of about €16 billion - indigenous industry exports about €7 billion - say about 75% of input value sourced domestically - net contribution of around €5 billion Remember exports earn foreign exchange, which allows us to purchase imports (net figures above refer to value of exports less value of inputs imported, therefore represent net contribution to FX earnings)

Q this data raises… We also saw foreign companies have high import content and big proportion of output being exported (95%!) This raised the question of why foreign- owned companies remain here…? Why do they/did they come here? What keeps them from leaving?? Irish market irrelevant for many/most Don’t source materials/inputs here

What affects firms’ location decisions Costs Potential market (in this case Europe NOT Ireland… Ireland as a REGION of EU) Tax rates (particularly corporate tax rates) Availability and quality of labour (education) … how many of these are sustainable for Ireland?? And how many, if any represent ‘unique selling points’ (USPs)?? Which ones are crucial? Depends on type of industry/activity

Forfás: ‘Ahead of the Curve: Ireland’s place in the Global Economy’ Begins with some stats on Ireland’s successful growth (Remember report written in 2004) That time: - highest ever numbers in employment - GDP/capita above EU average - Government debt second lowest in the EU (remember massive Gov debt in 1980s) - ‘resilience’ of Irish economy during global downturn … (we might now question this ‘resilience’…)

Real residential investment to GDP ratio Source: IMF

Role of FDI in fostering Ireland’s successful growth We’ve already looked at figures on employment, wages, output, exports etc. from the foreign-owned sector Compare GDP vs GNP growth… In Ireland’s GDP/capita was 125% of the EU average - Ireland’s GNP/capita was 101% of the EU average Why GDP much higher?… role of foreign- owned sector

Role of policy in fostering growth Consistent, long-term policies Low tax regime Fiscal policy - ‘steadying the ship’ after uncertainty of the ‘80s Qualified workforce - education policy (free secondary education since ‘60s, free third level fees introduced in 1995…) Partnership process… collective wage bargaining… wage moderation in exchange for reduced income taxes… competitiveness boost

Policy challenges Over-reliance on FDI sector… (esp. in hi-tech industry and exporting sector)… Risks, threats? - Globalisation - the rise of new economic powers (such as China and India) - Increasing costs in Ireland - Low tax regime unsustainable? Can be emulated elsewhere - *weak indigenous sector* NB - changes coming from EU (tax, state aid) - the shift to services (will look at this again) - the ‘knowledge economy’ These challenges also represent opportunities…

Areas of opportunity (identified in ‘Ahead of the Curve’) Internationally traded services (has been a growth area for Ireland in recent years… esp. financial services - new threats to that sector?) High value-added manufacturing… cost base no longer supports traditional manufacturing activities (competition from low cost locations elsewhere) Promote competition and innovation in locally-traded and non-traded services --> introduce greater competition, ‘deregulate’ (things like electricity, communications etc.) Focus on niche areas… develop expertise in specific sectors

Aims of the report To build on existing strengths - ‘comparative advantage’… Differentiation - why? - modern trade theory… intra-industry trade - reduce price elasticity of demand (command higher values for exports) - trade with other high income countries Develop ‘critical mass’… economies of scale (for the firm), economies of agglomeration/industrial clusters (external economies - for the industry)

Specific areas of opportunity Services: - education - software development - tourism - intellectual property Manufacturing: - cardiovascular + diagnostic products - biopharmaceuticals - prepared consumer foods Building on existing strengths, ‘clusters’, niche/specialist areas… ‘differentiating the Irish brand’…

Source: ‘Ahead of the Curve’ p.xiii

New orientation for Irish enterprises Marketing - market development R+D - product development Up to now… - process expertise - operational aspects of manufacturing - particularly in the FDI sector… export platform --> manufacturing plant, products not developed here, higher order services not done here… Goods designed elsewhere, to satisfy market requirements specified elsewhere, for an external market. Selling not done by Irish workers… no connection between Irish operators and the destination market innovation

‘Ahead of the Curve’ p.74

Indigenous sector Food products account for 55% of indigenous exports In general: production led, not market led… declining share of market, declining values… Indigenous exports have not grown substantially in real terms in past decade Remember we said indigenous industrial sector still dependent on UK as main export market R&D is a challenge, particularly for smaller enterprises: - high initial costs of product development – a major barrier - requires scale of operations to justify investment in R&D - finance required is easier to access for a larger organisation (profits, share capital, cheap borrowing) - as we’ve seen most indigenous enterprises are relatively small compared with their foreign-owned counterparts Ireland’s Business Expenditure on R&D (BERD) only 0.88% of GDP – low by EU and OECD standards

R&D As mentioned, this is a challenge for indigenous firms, due to their size How to foster greater innovation and investment in R&D? Forfas report suggests fostering networks between companies… - development clusters (can be physical proximity or in terms of type of production) - joint research projects - sharing of expertise, market knowledge - form lobbying groups to demand infrastructure and policy to enable development of the sector… Why would a firm engage in ‘networking’ with competitors?? (giving away ‘trade secrets’?) - positive externalities of an expanding sector - just as likely to be in direct competition with firms in China as other Irish firms - efficiencies through collaboration - spreading the costs of research

Forfas ‘Ahead of the Curve’ p.xiv Competitiveness Pyramid

Assessing our competitiveness Essential conditions… - cost base - infrastructure - entrepreneurship - management capability Competitive Advantages… 3 areas of existing advantage (protect and build on these): - ‘agile’ government - tax regime - education and skilled labour 2 new areas to be developed - marketing - R&D threats?

How has policy fostered competitiveness by focusing on these priorities? Budget ‘09… Corporate (and income) tax rates Infrastructure Education Idea is to expand potential of the economy - avoid turning recession into depression…add stimulus to economy… Balance against need for ‘fiscal rectitude’ Must also balance economic concerns with questions of equity and social responsibility…

Irish industry: manufacturing base Exports 85% of its output Big % of high-tech exports (ICT/chemicals/pharmaceuticals)… accounts for 58% of exports compared with EU-15 avg of 24% Already looked at FDI… concentrated in high- tech sectors, big % of exports etc. Indigenous industry…

Indigenous industry Ireland as an entrepreneurial society Successes - likes of Ryanair… High number of new start-ups - highest in EU in 2003 according to Forfas report Why might this figure have been inflated? High proportion of self-employed… again, can we explain this? Indigenous sector - highest growth in services, particularly software development Low exporting capability in general Focus on British market for indigenous exports… - path dependence… ‘stick to what you know’ Stagnant export intensity in indigenous sector

Domestically trading enterprises SMEs account for 95% of all trading entities, 80% of workforce 250,000 businesses in Ireland 100,000 have no employees (single person/sole-traders/partnerships etc.) Local service activities: - business services - distribution (transport, wholesale etc.) - consumer services - hotel&catering, entertainment… etc. Tend to operate in sheltered environment - geographic barriers to competition - regulatory barriers - licenses… - result is low innovation - low competitiveness --> higher prices… adds to cost base of the economy

Conclusions Performance driven by small number of large foreign-owned firms Generally poor performance of indigenous sector… Indigenous firms tend to be smaller, export less, concentrated in low-value-added sectors… Competitive pressures and risks to past success… Role of policy in addressing these concerns?