Turning Globalization to National Advantage: Economic Policy Lessons from Ireland's Experience.

IRCHSS Funded Project 2008-2011

Patrick Honohan (PI), TCD

Frank Barry, TCD

John FitzGerald, ESRI

Iulia Traistaru-Siedschlag, ESRI

Summary of project plan

Ireland is the most globalized economy in the world, and has consolidated this position over the past two decades, during which aggregate living standards in Ireland rapidly converged to those of the world's leading economies. Ireland's successful navigation through the hazards of the emergent global economy has policy lessons for countries that have found globalization more of a challenge.

This research project will clarify how the forces of globalization influenced the Irish economy and how Ireland managed to cope. Surprising gaps in existing knowledge make conventional interpretations insecure. To help fill these gaps, new quantitative research will be conducted in four strands, covering (aside from trade) the most important economic linkages. Despite the availability of data, some of which have not been analyzed before, important and researchable questions remain open in each strand. Thus we will trace the impact of: inward foreign direct investment on firm productivity and use of technology; of international capital markets on fiscal policy and competitiveness; of openness to the international labour market on wages, employment and skills/productivity of the labour force; and of the institutions that were employed for managing EU structural funds. The four strands will be addressed with different methodologies appropriate to the data relating to the different areas that are, or will be made, available.

The extent to which the Irish experience can be applied in different institutional environments and how the transplantation could be effected will be the subject of a final strand.

In addition to publication of individual research papers on each of the strands, a synthetic report will be prepared, integrating these findings with existing literature. This report will thus offer general conclusions, based on Ireland's experience, on what economic institutions and policies are most relevant if globalization is to be turned to national advantage in other countries also.

Overall aim and central research questions

The aim is to fill identified gaps in the literature on Ireland's economic response to globalization (especially since the mid-1980s), dealing with inward foreign direct investment, foreign aid, the international capital market and labour market openness. Using these new findings (as well as existing evidence), and building on the theoretical literature on institutional reform, applicable lessons for other countries will be presented in the context of an overall synthesis of the Irish experience.

The central research questions fall into five strands:

(i) FDI: how far can productivity growth and the use of technology in manufacturing and service firms in Ireland be attributed to the direct or indirect effects of inward FDI?

(ii) Aid: What characteristics of the institutional arrangements for managing the inflow of foreign aid (EU structural funds) contributed to their effective management and what light does this throw on political economy theories of agency problems in making aid effective?

(iii) Capital markets: How far have international capital markets limited the policy space available for Irish fiscal and monetary policy, or have they enhanced the ability of policymakers to deliver good competitiveness, growth and stability outcomes?

(iv) Labour market openness: What effect has the reversal of international labour market flows had on productivity, the level and structure of wages and unemployment?

(v) Transferability: How might the lessons of Ireland's experience with globalization be transferred to other countries with very different institutional structures?

The wide range of these questions is acknowledged; however, these are key areas where gaps exist in our knowledge. They are researchable and the answers are needed for a coherent and firmly-based overall analysis of the Irish experience with globalization.

Description of individual strands

(i) FDI

The approach for this strand will be primarily based on microeconomic analysis of enterprise level data on firms in Ireland.

Ireland's position as a host for inward direct investment by MNCs is exceptionally high, no matter how it is measured (share of employment, output, exports, etc.). This is especially true for manufacturing, but also for internationally traded services (including financial services through the IFSC). Tax and subsidy policies over more than half a century, supported by an active industrial promotion agency, have been central to this outcome. The research question identified here is based on the debate between the common-sense view that these policies have likely resulted in a beneficial productivity spillover (due for example to externalities associated with new technology), as against the alternative possibility that the huge scale of inward FDI might have been achieved at the cost of so skewing its sectoral and other characteristics that linkages and spillovers have been less.

Somewhat surprisingly – albeit a not unusual finding in the international literature (cf. Görg and Strobl, EJ 2001) – most of the limited econometric analysis that has so far been carried out on the Irish manufacturing data at enterprise level has failed to uncover sizable spillovers (e.g. Görg and Strobl, Eur Ec Rev 2002, Ruane and Ugur, Int J Ec Bus 2006). The topic cries out for a more comprehensive analysis, and this will be done in particular by broadening the sectoral scope, deepening the analysis of productivity and technology, accounting for firm heterogeneity and addressing the problem of transfer pricing which complicates data interpretation. Two CSO micro databases remain totally unexploited in this regard, namely the Annual Services Inquiry – allowing extension of analysis to an important but relatively unexplored sector (in which foreign-owned enterprises are in some respects as prominent as they are in manufacturing), as well as allowing account to be taken of firm heterogeneity and potentially important links between manufacturing and services FDI – and the Survey on E-commerce and ICT that has been conducted as part of an EU-wide effort since 2002. Use of unique firm identifiers allows this survey to be linked with the Census of Industrial Production and the Services Inquiry.

(ii) Aid

This strand will analyze the mechanisms and institutions employed to allocate and manage EU structural fund receipts by reference to the political economy literature on public expenditure. Structured interviews with current and recent participants in this process will help provide the factual basis.

EU structural funds exceeded 3 per cent of GDP in the mid 1990s and were used inter alia to modernize infrastructure and reduce pressure on the public finances. They are thought to have been relatively well managed (e.g. low corruption and rent-seeking) and to have had a sizable socio-economic rate of return. How have the classic agency problems between the electorate and the politicians (cf. Persson and Tabellini, Economic Effects of Constitutions 2003; Robinson, "Politician-proof policy" 2005) and between the politicians and the bureaucracy (Huber and Shipan Oxford Handbook 2006) been dealt with? How did the institutional procedures that were adopted (including independent evaluations and broadly representative monitoring committees) match with theoretical ideals for employing use of ex ante and ex post information, and engaging different levels of government in decision making? How did they influence the degree to which the clientilist and other welfare-diminishing policy approaches are employed in practice?

(iii) The international capital markets and Irish macroeconomic policy

This strand will use available macroeconomic data combined with news media-based dating of policy and exogenous events to carry out relatively high-frequency macroeconometric analysis of the two-way interaction between fiscal policy and capital flows and interest rates. How far did international capital markets limit the policy space available for Irish fiscal and monetary policy (cf. Rodrik "How to save globalization…" 2007)? What was the relative importance of international capital markets and the EU-wide Maastricht political process in influencing fiscal retrenchment, and policies affecting competitiveness including exchange rate policy? Was there debt overhang? Finally, did periods of heightened international financial market uncertainty (especially in relation to Ireland) dampen investment flows (Bloom, "The impact of uncertainty.." 2007).

(iv) Labour market openness

The methodology here will be a small calibrated general equilibrium model. Calibration will draw on the findings of existing micro and macro studies.

Ireland is unusual in having had a very long experience of an open labour market with a history of emigration for most of the 20th century and, more recently, very extensive immigration. The openness of the labour market has profoundly affected the behaviour of the domestic economy, making labour supply more elastic and, as a result influencing wage formation and productivity growth. The pattern of migration has also been distinctive, with a high proportion of the out-migration of the 1980s being skilled and a high proportion of the immigration of the last decade also being skilled—a pattern different to that of many advanced economies (cf., for the US, Borjas, Freeman and Katz, Brookings Papers 1997).

This study will add to the previous work in this area by taking account of the simultaneous effects of foreign direct investment on the demand for skilled labour. It will also draw together the evidence of a range of recent studies on the characteristics of individual migrants. Whereas the emigration of skilled labour in the 1980s reduced the productive capacity of the economy, the returning emigrants of the 1990s and the more recent inflows of skilled labour from other countries have, in their different ways, brought new skills (even though many members of the latter group have been unable to find jobs commensurate with their educational attainment). The economy-wide effects of this inflow of skilled labour, whatever its nationality, will be analysed with particular emphasis on productivity, but also taking account of the adjustment of relative wages and unemployment. There may well be effects on the wider economy that are not captured in micro-economic studies on the returns to migration for individuals. The methodology adopted will build on a aggregate small-scale focused model of the Irish labour market that includes the supply and demand of skilled and unskilled labour. By incorporating the interaction of labour demand with investment flows and using results from the most recently available micro-economic studies (e.g. Barrett et al., Econ Soc Rev 2006) it will be possible to improve on the calibration of the model and to analyse the experience of both emigration and of immigration.

(v) Transferability

This will be theoretical work building on existing literature such as Dewatripont and Roland (Am Econ Rev 1995), Rodrik (Stud Comp Int Dev 2000) and Roland (Stud Comp Int Dev 2004).

Given the wide differences across countries in the overall environment for policy including the social institutions crucial for growth-enhancing policy formulation and implementation (cf. Acemoglu et al., in Handbook..Growth 2005; Przeworski et al., Democracy and Development 2000) what policy relevance can Ireland's unique experience have other countries? This strand starts from the belief that, properly contextualized, there must be lessons even for countries at a much lower income level and with very different institutional settings. This too is a question about globalization: the globalization of policy ideas. While institutions have internal dynamics, both economic crises and external developments and pressures can induce extensive change (Olson Rise and Decline 1982; North Am Ec Rev 1994). A growing academic literature on institutional change has been employed by international policy institutions to promote modest institutional changes that can serve over time to strengthen the constituency for most substantial reforms (OECD Going for Growth 2007; Olofsgård "Political Economy of Reform…" 2003). Transplanting policy lessons from Ireland would call for similar analysis. This strand of the proposed research will contribute to the academic literature on institutional change. The theoretical modelling here will be focused on capturing the kinds of institution which have proved relevant for Ireland's successful engagement with globalization (including what has been learnt from the other strands). Under what circumstances, it will ask, can the relevant aspects of such institutions be transplanted in a developing country context?