Globalization and economy: a small country perspective Jaakko Kiander Government Institute for Economic Research

Globalization and economy: a small country perspective Old and new globalization What globalization means? Drivers and new actors How small open economies are affected Conclusions

Old and new globalization There have been periods of large scale economic integration and free trade in economic history –Ancient Rome and the Mediterranean economy –19th century; especially Large movements of goods, capital and labour between continents

New globalization Steps towards free trade since 1945 –GATT, WTO Financial market deregulation and free capital movements in the 1980s Regional integrations processes: –EU and NAFTA Emerging economies –East-Asian tigers, China 1978, CEEC 1989, India etc.

What globalization means? Free movements of goods and capital (and people, to some extent) The basic logic of economic globalization (and integration) Economic convergence as a result Who is going to benefit from globalization?

The basic logic of economic globalization (and integration) Liberalization likely to increase factor movements and trade More international trade (and benefits from division of labour) Capital movements from rich to poor countries (FDI) Labour movements from poor to rich countries (migration)

Investment as a vehicle of development Rapid productivity growth enabled through FDI: –Greenfield investment: more capacity –Transformation of old capital stock: higher productivity –New technology embodied in new equipment –Organizational and managerial skills imported –Rapid access to export markets

The process: continuous adjustment to profit opportunities Faster growth in emerging economies due to cost advantage New technologies adopted Structural change: industries in rich countries using unskilled labour shift their production to emerging markets Increasing flow of cheap imports from emerging economies keep inflation under control

Convergence as a result (in long term) Real wages and price levels in emerging economies grow faster than in rich countries The larger are factor movements, the faster is the convergence process (but it still takes decades … cf China) Large effects in emerging economies, only minor effects in rich countries

Who is going to benefit from globalization? Almost everybody benefits in emerging economies; but structural change also likely, and can be costly –will there be any compensation? –Rising income differentials Capital owners, consumers and skilled workers benefit in rich countries; but some unskilled may be losers –Global income distribution becomes more equal

Economy tends to balance itself… Growing output and exports of emerging economies will be balanced by their growing imports: jobs do not disappear Adjustment process may require substantial changes in relative prices (exchange rates) During the period of globalization employment has increased everywhere

Economic globalization changes the world New economic super powers: China and India New middle-size powers: Russia, Brazil, Mexico, South Africa, Iran, Pakistan, Korea, Indonesia… Old economic super powers will become smaller: Germany, UK, Japan,…

The Finnish growth record: the last 100 years Finland as an example of a small country benefiting from globalization An impressive record: catching up from poor to rich Rapid productivity growth – mostly due to international competition Increased employment through population growth and higher labour force participation

Long-term economic growth in Finland

The old post-war model of economic growth: Export-oriented: importance of export industries widely understood (cf. Japan and China) Capital intensive: emphasis on industrialization and heavy industries – high savings and investment rates Statist: government and state as central decision makers – in co-operation with banks and export industries

The old model Government had a central role: –state-owned companies –aggressive industrial & regional policy –regulation of markets, ownership, capital flows, and investment decisions –systematic investment in education and training

The old model Macroeconomic policy targeted to maintain & improve competitiveness –Flexible exchange rates and incomes policy …and to support investment –Taxation and corporate governance supported growth targets, not profitability –Corporate finance based on debt –Investment ratio usually close to 30 % of GDP (China: 50 %)

Assessing the old model Not compatible with free markets and free factor movements Overinvestment: inefficient use of capital Forced savings: consumption constrained but rapid improvement in living standards BUT: Good results in terms of growth and employment

Transition to new regime Liberalisation of product and capital markets in the 1980s Liberalisation of foreign ownership in 1993 End of bilateral trade with Soviet Union Financial crisis and restructuring in : –rise in unemployment –a wave of bankruptcies –banking crisis –increase in foreign ownership

The new regime EU and EMU memberships as corner stones –Macroeconomic policy cannot be used anymore to improve competitiveness All sectors opened to competition and foreign ownership Shareholder value as driving force in corporate governance (instead of growth and investment) Corporate taxation reformed: no special incentives to investment

The new regime Government not any more active in industrial policy Large chunks of state-owned companies privatised – less government control Even more emphasis on innovation system, R&D policy, and education

R&D spending

Experiences and lessons from the new regime GDP growth record has been good since 1994 (almost as good as in the old system) Rapid labour productivity growth has continued (but is has been a bit slower) Investment ratio has fallen from 25 % of GDP to 17 % although profitability has improved

Export-led growth Policy priority: growth of exports

Declining unemployment rates

Productivity growth better than elsewhere

Experiences and lessons … Finland has been succesful – thanks to –High technological level and specialization –Good competitiveness (partly due to big devaluations in the 1990s) Rapid structural change to more high tech production The Nokia phenomenon: extra bonus to Finnish economy Lots of innovative activity: education, skills, R&D, policy In spite of declining income share, real earnings have developed well

Finland: adjusting to globalization So far, Finland has been succesful –Rapid rise of exports –Huge surplus in trade balance Continuous flow of plant closures: simple manufacturing jobs move to low-wage countries … but total manufacturing is doing well –Specialization to high value added More competitive pressure: –workers’ bargaining power eroded –Tax competition

What explains the rapid growth of exports, productivity and industrial production? ’Creative destruction’: the recession wiped out 25 percent of jobs in – the least productive firms and plants were eliminated Competitiveness: hugely improved competitiveness as a result of exchange rate movements, rising productivity and wage moderation (achieved through unemployment & centralized wage setting) Structural change: shift from resource-based to knowledge-intensive production (IT sector) New technology: Finnish firms in the frontier of new technology in the 1990s (Nokia) Luck & smallness: if there is a successful large firm in a small country it has a decisive impact on everything

Role of policy 1/3 National innovation system –There has been a long term commitment to build up innovation system IT sector development started in the 1970s –Based on broad political consensus –Network of universities and government laboratories in co-operation with private sector –New technologies traditionally adopted in early phase (banking, telecommunications…) –Strong industrial base

Role of policy 2/3 Technology policy –Government spending on R&D 1 % of GDP Consists of own research & subsidies –Co-operation and competition Intermediate bodies which link research units and firms Government subsidies help to form joint projects with small firms –Business sector R&D more than 2 % of GDP Problem: most of that concentrated in IT sector Education –Skill formation, with emphasis on engineering and technology –Increasing supply of skilled labour Abundant resource pool Moderate wage level

Role of policy 3/3 Maintaining advantage in competition –Price stability: since 1993 inflation less than EU15 average –Wage moderation through long term commitment: falling unit labour cost –Tax policy crafted to face international tax competition: Corporate and capital income taxation: flat tax since 1993; current rate 26 % Labour taxation: gradual cuts since 1996, financed by increased corporate tax revenues and higher environmental taxes