Both Ireland And Spain Attract Essay, Research Paper

Foreign Direct Investment (FDI) refers to capital expenditures by companies (with their head office in another country) to either acquire assets of an existing firm in a foreign country with the intention of playing a role in managing those assets, or to establish a new firm. Put more simply, a firm in one country invests in another country in order to control and manage an actual productive capacity that will generate output.

There are a number of causes of FDI, some of which can be applied to almost all foreign investment, and others that are specific to the country in which the investment is being undertaken. The more general causes of FDI are:

h Neo-classical theory

This refers to the comparative advantages or natural resource advantages held by a particular country compared to another. If a country has a comparative advantage over another, (i.e. higher factor endowments compared to the other country) then it makes sense for the country with the lower factor endowments to invest in the other country and benefit from the higher productivity there.

For example lower labour costs or higher labour productivity in one country would encourage firms in another country (without these benefits) to invest and produce in this country in order to gain from this comparative advantage.

h Ownership, Location and Internalisation Paradigm

A firm may wish to produce in another country, the OLI paradigm explains why it does this through FDI as opposed to other methods of production such as licensing a domestic firm to produce you good.

The ownership factor indicates that a firm may wish to purchase an existing firm and use takeovers as a means of expansion rather than starting a new firm from scratch.

The location argument implies that a firm may benefit from having production facilities outside the domestic country. By being able to produce in different areas of the world the firm can reduce transportation costs and may open up new markets for its good.

The internalisation argument refers to how the production method or ingredients (etc) may be ownership specific, as a result the firm is unwilling to pass this superior knowledge on to other firms. In addition to this the investing firm may be unwilling for other firms to produce under their brand due to the possibility of poor quality production etc.

The combination of these factors points towards FDI instead of other methods of foreign production.

h New Trade Theories

These theories recognise other determinants of FDI such as:

Economies of Scale

Transport Costs and benefits arising from good infrastructures

Access to other markets (geographical location)

Trade Agreements

h Other Explanations

There are other common factors that vary from country to country that affect FDI. For example tariffs, subsidies, tax levels, regulation, safety standards, international relations, language difficulties etc.

The above determinants of FDI can be applied to both Ireland and Spain (aswell as most other countries receiving FDI). However there are a number of more specific determinants of FDI to Ireland and Spain individually.

Spain:

Lower labour and capital costs in Spain (compared to other EU countries) are thought to have encouraged FDI. However, growth in wage rates during much of the 1980 s meant that this advantage is not as important today. On the other hand, productivity in the 1990 s has risen more quickly than wage rates, meaning that Spanish labour market will continue to attract FDI. In addition to this Spain is considered to have a good human capital resource base, that is to say that there is skilled labour avaliable.

Spain joined the European Community in 1986. This led to unrestricted trade between Spain and other EU members. As a result, there was an increase in attractiveness for firms (wishing to sell in Europe) to invest in Spain. Trade liberalisation, in general, between Spain and other countries has promoted FDI in Spain. It can be seen that trade liberalisation has helped to encourage FDI in Spain

Small to medium sized, family owned businesses make up a large proportion of the Spanish markets. These small firms find it hard to compete with larger firms achieving economies of scale. As a result of this there are few barriers to entry in many of the markets, and so foreign firms can enter the market cheaply and easily. There is also the potential for larger, investing firms to takeover the smaller domestic producers and enter the market in this way. Here we can see how the structure of Spain s markets encourages and enables FDI.

European Monetary Union in Spain will encourage investors from outside of the EU if they wish to aim products at other countries within EU. The risks and problems associated exchange rate fluctuations will be eliminated and so FDI in Spain will be encouraged.

Both the Spanish government and the EU provide incentives for foreign firms to invest in Spain. The Spanish government offers grants to attract FDI away from Barcelona and Madrid in an attempt to develop poorer regions of Spain. The European Union will pay up to 80% of the start up costs of foreign firms who locate in particular Spanish regions.

Spain is a large country and possesses many valued raw materials. Firms may choose to locate in Spain due to the availability of these raw materials.

Spain has a good infrastructure. This means that it has good transport links by road, sea, air and rail to all of Europe. Spain also has close links with other mediterranean countries such as Africa. Spain also has many cultural links with both North and South America. Spain attracts FDI because of its geographical location and good infrastructure.

There are also factors affecting FDI that are specific to Ireland:

Ireland is considered one of the best in Europe for its quality of education. It places a large emphasis on academic achievement. 70% of university students choose engineering, computer science or commerce as a course to study, leaving the country with a highly educated and eager workforce in the areas where industrial growth is at its highest. Dell is one such company that has benefited from these advantages. This highly skilled and educated workforce is clearly a factor that will encourage FDI in Ireland.

Ireland’s operating costs are very competitive. Direct and indirect labour costs are amongst the lowest in Europe. The workforce is flexible and can achieve high levels of productivity. Quality and reasonably priced office and factory premises are available, with low costs for the everyday running of firms (i.e. power and water).

It has a sophisticated and competitive telecommunications infrastructure that offers low tariffs to volume users; high regulated competition keeps these costs down. In recent years over $15bn has been invested in its telecommunication infrastructure, leaving Ireland with one of the most advanced digital networks in Europe.

These wise investments in infrastructure allow rapid access to world markets for manufacturers.

Ireland also has a good transport infrastructure. This means that it has good transport links to Europe, especially by sea; there is scope for large-scale, low cost, exporting of goods to Europe and further abroad. These infrastructural advantages encourage FDI.

In Ireland there is a very low corporate-profits tax rate, (currently around 10 percent, compared to an EU average at least three times as high). This replaced an earlier policy (which had to be changed under EU rules) of zero corporate profits tax on manufactured exports. These low levels of taxes where and still are very conducive to FDI in Ireland.

The Irish government offered investment grants to foreign firms locating in Ireland during the 70 s and 80 s. These investment grants remain in various forms today and are set at levels close to the EU average rate. Therefore there are financial gains for firms locating in Ireland, encouraging FDI.

Successive Irish governments have been committed to keeping the business environment competitive. It has been most noticeable in the last 10 years when a growth rate in excess of 10% per annum has been observed. 70% of GDP is exported to established European and US markets, Ireland is the only English speaking country in the EMU that has a export orientated economy. These facts will especially encourage FDI by English speaking firms so as to avoid potential problems associated with language difficulties. English is the most widely spoken language in the world and so firms are unlikely to be discouraged from locating in Ireland on these grounds.

Ireland developed an Industrial Development Authority (charged with the attraction of foreign industry to Ireland) which is second to none in the world in carrying out this task. The IDA tends to target particular sectors in accord with its strategic vision. In recent decades these have tended to be relatively high-skill sectors, particularly in the fields of computers and chemicals. Obviously this direct attempt to encourage FDI in Ireland will and has helped to encourage firms to locate in Ireland.

European Monetary Union in Ireland will encourage investors from outside of the EU if they wish to aim products at other countries within EU. The risks and problems associated exchange rate fluctuations will be eliminated and so FDI in Ireland will be encouraged. Ireland is a member of the European Community. As a result there is unrestricted trade between Ireland and other EU members. This increases Ireland s attractiveness for firms (wishing to sell in Europe). Trade liberalisation, in general, between Ireland and other countries (e.g. US) has promoted FDI in Ireland.

Ireland is located towards the edge of the EU and is in an ideal geographical location for export (by sea because on an island, which is cheaper than road) orientated firms wishing to develop markets in Europe.

Ireland has a liberal policy towards FDI regulation. There are no limits on how much a single firm is allowed to invest in Ireland. Irish policies also allow the return of almost all (minus taxes) profits to the home country. These policies are conducive to FDI.

Consequences of FDI in Ireland:

There has been spectacular growth in the Irish economy in recent years. Ireland s average annual growth rates of real GDP (7.4% between 1992 and 1998) by far outstrip the growth rates of the US and EU over the same period (3.1 and 1.9% respectively). Multinational firms (MNC s) accounted for almost 47% of total employment and 77% of total net output in Irish manufacturing in 1996. The growing gap between GDP and GNP indicates the importance of foreign owned firms in Ireland.

There are many advantages and disadvantages of FDI and MNC s:

Advantages:

Foreign direct investment can lead to the inflow of superior knowledge into the economy, which can be adapted by host country firms. Multinational companies find it profitable to invest abroad because they own firm-specific assets, one of which is the multinational’s access to superior production technology. The inflow of superior knowledge can lead to technology spillovers to host country firms, improving their productive efficiency as they learn from the MNC s. Technology spillovers can occur through different channels, for example, through relationships between the host country s suppliers and MNC customers, where suppliers learn new production technologies through contacts with customers, or through staff movements from MNC s to host country firms. Of particular relevance to the Irish case is that since foreign companies use the EU periphery as an export base rather than as a targeted market, positive spillover effects are likely to be less diluted by negative crowding-out effects associated with competition between foreign and indigenous firms. Technological and efficiency improvements are a distinct possibility as a result of FDI and the presence of MNC s.

The most striking consequence of the FDI inflow was that it facilitated the de-coupling of the Irish economy from an almost total dependence on the United Kingdom as an export destination. The Irish economy is no longer dependent on the UK, MNC s in Ireland export all over the EU and further abroad. Therefore the risks associated with relying on one economy as your sole market are removed.

Foreign-sector expenditures within the economy have increased dramatically since 1983. A high proportion of this spending is on labour-intensive services. Ireland has had a long-standing problem with low levels of job creation. By 1997 there were 23 per cent more jobs in the economy than in 1987. The foreign sector in Ireland is also relatively heavily engaged in R&D. Its R&D expenditures as a proportion of GDP have doubled since 1986, so that Irish manufacturing now spends the same proportion as Denmark and the Netherlands on Research and Development. Not only are the foreign-owned manufacturing sectors amongst the most highly skilled sectors in the economy (and so amongst the most highly paid, for both skilled and unskilled labour) but the growth in skill levels has exceeded that in indigenous industry. It is reasonable to believe that Irish industry is rapidly growing in productivity, which promotes real convergence towards the income levels of the country s trading partners.

FDI has not only created many jobs in the Irish economy but it has also helped to raise the levels of productivity by Irish workers. The recent increases in productivity have contributed significantly to economic growth of the economy. The increased productivity of workers has also facilitated the increase in wages. This economic success has led Irish living standards to converge on average European levels. Irish GNP per head in 1987 stood at 59 percent of the EU average, largely unchanged from its 1960 position. Ten years later it had risen to 88 percent.

High levels of FDI can compensate for low investment from domestic firms. The investment by foreign firms may be very welcome in situations in an economy where there is little investment by domestic firms. The lack of investment by domestic firms means that little development would be possible. So, investment by foreign firms allows expansion and development where it would not have occurred previously. This is the case in Ireland, indigenous firms tended not to invest and FDI has helped to compensate for this lack of domestic investment.

The presence of exporting MNC s has helped the Irish trade deficit, the foreign firms export huge quantities of goods and help the balance of trade. Without these MNC s there would be a trade deficit in Ireland.

Disadvantages:

The extent of profit repatriation has led to a negative balance of payments on current account. Ireland runs a large deficit on net factor income, the main element of which arises from the distribution of branch profits to their foreign owners. This introduces a wedge of some 10-12 per cent between GDP and GNP.

The dependence of the Irish economy on the UK s has diminished considerably with the development of MNC s in Ireland. However the overall health of the Irish economy is now dependent on the performance of the foreign-owned manufacturing. If at any time this performance falls there may well be devastating consequences for Ireland.

The international-trade literature suggests that national welfare can be reduced by FDI inflows if MNC s capture market share from indigenous firms and reduce the latter s profits. However these events are in any case highly unlikely to characterise the

Irish experience given that Irish-based MNC s largely use Ireland as an export platform, and that domestic industry pre-free-trade had a comparative disadvantage in precisely those sectors in which foreign industry grew.

An arguably more plausible hypothesis is that the strong FDI inflows led to excessive wage demands, through the impact on wages of the high productivity growth of the foreign sector. This could have led to an excessively rapid decline of the traditional manufacturing sectors (who display slower productivity growth), and an increase in unemployment. Only over the last decade, has the decline in indigenous manufacturing employment been halted and strong growth in indigenous exports achieved.

Grants and subsidies offered by the government allow MNC’s to offer lower prices and higher wages than indigenous competitors. Existing Irish firms may be displaced or the emergence of new firms hampered. This has a negative effect on competition in the domestic markets, subsidies gives the MNC s an advantage over the indigenous industries.

Large amounts of tax revenue are created by MNC’s but in Ireland this is overstated as many of the MNC’s engage in transfer pricing, which is declaring the corporation’s profits in a country with low taxes. In many cases, the corporation tax paid by foreign firms is actually outweighed by the subsidies and grants it receives from the government.

It is possible that the unemployment rate may increase, as MNC’s introduce technology developed elsewhere in capital abundant countries, which may act as a labour shedding technology.

The presence of MNC s in Ireland may be a problem if only assembly plants are built. These plants may import components from elsewhere and merely use Ireland as an assembly and distribution site. In these circumstances the benefits to the Irish economy will be less than those benefits if a full scale producing facility was built.

Conclusion:

From the early 1930s to the late 1950s high tariff barriers and policies working against foreign ownership of firms operating in Ireland were the cornerstone of policies designed to promote growth of domestic manufacturing from the very low base inherited at independence in 1922.

By the late 1950s it was clear that protectionism had long outlived its usefulness and that few of the so-called infant industries had matured and become sufficiently competitive to generate much in the way of exports.

The changes forced on Irish policy-makers by economic collapse in the late 1950s were fundamental and far-reaching. The Control of Manufactures Act, which prohibited foreign ownership in Ireland, was abolished and replaced by a policy that systematically cultivated FDI through a zero corporate profits tax on manufactured exports (replaced over the course of the 1980s by a flat rate of 10 per cent on all manufacturing), attractive investment grants and a dismantling of most tariff barriers.

Much of the history of the Irish economy during the following three decades can be explained in terms of the quite phenomenal growth of export-oriented FDI in manufacturing, from a zero base in the late 1950s to a situation where almost 65 per cent of gross output and over 45 per cent of employment in manufacturing is in foreign-owned export-oriented firms. Over the last decade the decline in indigenous manufacturing employment has been halted and strong growth in indigenous exports achieved.

In the long run Irish policies to promote FDI have benefited its economy.