Foreign direct investment and ireland’s tiger economy
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During the early years of its foundation as a nation, Ireland remained dependent on United Kingdom especially in the field of trading. The Civil War in the early 1970s brought significant damages on key industries of Ireland such as the agriculture and industrial sectors which stood useless and unproductive to supply the domestic consumption of Ireland, thereby forcing the infant country to rely much on importation with the British.
But with the aid of political and economic reforms pioneered by Ireland’s government, impressive economic growth was achieved in just a matter of a short period of time. Moreover, foreign investors started to influx towards the domestic market of Ireland and contributed largely for its various sectors to boom. As a result, GDP of Ireland rise robustly between the 1980s and 1990s and GDP growth rate went almost at par with the European Union and United States. In addition to this, the large number of multinational companies operating in the domestic market of Ireland gave an avenue for the Irish government to earn large amount of revenue from corporate taxes, though, Irish corporate tax is relatively cheaper compared to other countries in the European Union and in the United States.
Despite of these benefits offered by the influx of foreign direct investment in Ireland, sceptics kept on stressing out that foreign direct investment offered no improvement at all on the economic growth of Ireland as employment rate plummeted and indigenous industries suffered from stagnant growth while others incurred large amount of investment losses. In addition to this, multinational companies also get resources from abroad leading to the underdevelopment of domestic sub-suppliers of resources available in Irish domestic market.
The weak linkage between the foreign and domestic investors in Ireland made it hard for the sceptics to accept the idea that FDI made a significant contribution on the impressive economic growth of Ireland in the recent decades. In this regard, this paper aims to identify and present arguments on whether indeed foreign direct investment was the reason behind the economic growth of Ireland in the recent decades.
The Role of Foreign Direct Investment
First, the influx of foreign direct investment in Ireland made the Irish government to enjoy large amount of government revenues out of corporate taxes that they levy from multinational companies operating in their market. This enabled the Irish government to incur fiscal surpluses and cut their debts leading to a more stable fiscal management. Moreover, the income generated from the corporate taxes was used by the government to maintain the stability of various sectors of the Irish domestic market, e.g. labour sector. Despite of the fact that corporate tax in Ireland was relatively lower compared to other FDI-destination-country like US and UK, the large number of multinational companies that invested in Ireland was already enough to provide the latter with enough corporate tax revenue to finance its government spending and fund various government programs/projects.
Aside from the tax revenue, another area where FDI made a significant role would be the stabilization of trade balance of Ireland as its export industry boom brought by the export-based multinational companies. This stabilization of trade balance of Ireland made a significant contribution on the smooth currency fluctuation thereby minimizing currency related uncertainties to many multinational firms operating in Ireland. Furthermore, the said stability of trade balance of Ireland made a significant improvement on its GDP growth considering that trade balance is one of the economic indicators of GDP. At the end of the day, foreign direct investment served as the bridged for Ireland to stabilize its trade balance through the development of their export industry.
The last but not the least role of foreign direct investment on Ireland would be the development of the manufacturing sectors of the said country which then contributed largely on achieving impressive economic growth in the recent years. Though the development of was concentrated primarily on three manufacturing sectors namely: chemicals, computers, and electrical engineering, 85% of economic growth of Ireland came from the said three manufacturing sectors. Moreover, considering the small size of Irish economy compared to other FDI-destination-countries such as U.K. and U.S., the launch of even a single new product by a multinational company operating in Ireland would have a positive effect on the latter’s economic growth. In addition to this, competitiveness on the above identified industries was spectacular enough to attract more investors to invest to Ireland. Therefore, it is clear that foreign direct investment in Ireland did bring benefits to the development of its manufacturing sectors in particular with the chemical, computers, and electrical engineering.
Subsidizing Foreign Direct Investment
One of the many reasons why foreign investors such as Pfizer, Intel, Dell, etc. Considered Ireland as one of their investment destinations would be due to the fact that the Irish government provide subsidies to these multinational companies. One form of subsidy did the Irish government provided to multinational companies would be the 10% corporate tax which is relatively cheaper compared to other countries in Europe and United States. The provision of a lower corporate tax means lower costs and higher profits to multinational companies. In addition to this, the cheaper corporate tax rate served as the main source of competitive advantage of Ireland relative to other European Union members and United States. In other words, the subsidy provided by the Irish government in foreign direct investment provided large amount of government revenue, in the form of corporate taxes, and competitiveness. It is now clear that subsidizing foreign direct investment was beneficial on Ireland and on countries with small corporate tax revenue stream and corporate sector.
Countries that have large corporate sector and corporate tax revenue stream would find it hard to offer lower corporate taxes as Ireland could since their revenue depend much on tax collection, including corporate taxes. Slashing corporate taxes as for this matter would create large fiscal imbalances which then later on results to the ballooning of budget deficit. It was the advantage of Ireland to have no domestic corporate sector and depend less from the corporate tax collection to finance their projects and programs. Therefore, subsidizing foreign direct investment on countries with large corporate sector and who’s budget depend much on corporate tax collection is not a wise idea at all. Only few countries, like Ireland, can only subsidize foreign direct investment in the form of offering lower corporate tax rates.
Pros and Cons of foreign Direct Investment
Foreign direct investment provides industry/sector development. As for the case of Ireland, it was identified that manufacturing sectors such as chemicals, computers, and electrical engineering experienced robust development as multinational companies started investing into the domestic market of Ireland. Multinational companies provided technologies and machineries that are vital for industry development which host countries, FDI destinations like UK, US, and Ireland, could learn and develop.
Moreover, another benefit than one can get from foreign direct investment would be the higher government tax revenues in the form of different tax collections like corporate taxes (U.S. Department of State 2006). There are those countries that charges higher corporate taxes on multinational companies relative to domestic companies as part of their protectionism strategy. Nevertheless, any country that experiences large influx of foreign direct investment can enjoy higher tax collection which can be used in financing various government project and programs.
Foreign direct investment also provide enough rooms for labour sector to develop as multinational companies offers additional job opportunities in the labour market. Consider the case of China wherein its labour market had been optimally utilized and experienced significant development as multinational companies hire Chinese labourers leading to a record-high employment growth (Fung, Iiazaka & Tong 2002). For as long as multinational companies hires domestic labourers, then, host countries of MNCs will enjoy high employment rate and labour sector development.
On the other hand, one unfavourable effects of foreign direct investment would be the vulnerability of the host country to external shocks or liquidity of the international market. Countries whose economic growth depend much on foreign direct investment is susceptible to risk of investment withdrawal of foreign investors as business environment of the host country and the international market become uncertain. Foreign investors can easily pull-out their investment in one country and invest it elsewhere based on his market speculation and forecast of the business environment. Therefore, the liquidity of foreign direct investment also offers high risk to countries that depend much on it like the case of Ireland.
In addition, multinational companies have the competitive advantage compared to their domestic counterparts. Especially for the case of infant industries, multinational companies find it easy to outperform domestic companies thereby harming the domestic industry of the host country. Domestic companies will surely earn losses if the government of the host country will not provide any protectionism to their domestic industries usually in the form of trade barriers like higher tariffs, quota, etc. Nevertheless, government only provide protection to those industries that do not have the capacity to compete at par with multinational companies. Competition is sometimes healthy to the market and that is why government only restricts their intervention on the relationship of FDI and domestic investment.
Replication of Irish Model
As noted earlier, only those countries that have a small corporate sector and do not depend much on corporate tax revenues can replicate or apply the model that Ireland use in order to attain impressive economic growth. Countries that has a large corporate sector and depend much on corporate tax collection to finance their projects and programs would find it hard to implement the Irish model since it requires a lower corporate tax collection. On the other hand, countries can implement the strategy of Ireland for establishing an organization that will specialize on dealing with multinational companies to attract them to invest – IDA. Yet, at the end of the day, it is not advisable for countries to use the model of Ireland or become dependent on foreign direct investment considering the world wide crisis that is presently happening that melts even the economic superpowers like United States and United Kingdom. The volatility of the international market is already alarming that investors tries to become more vigilant regarding the condition of the business environment.
Theoretically speaking, foreign direct investment indeed provides net social benefit to the economy of a given country. But due to the mismanagement of the Irish government, the full potential of foreign direct investment was not utilized due to the weak link between the domestic industries and multinational companies. If only the Irish government will be able to establish the said link between its domestic industries and multinational companies, then, that is the only time when they will be able to optimally extract the benefits that foreign direct investment offers into their economy.
U.S. Department of State (2006) How Foreign Direct Investment Benefits the United States [online] available from http://www.state.gov/r/pa/prs/ps/2006/63041.htm [Accessed 17 August 2008]
Fung, K. C., Iiazaka, H. & Tong, S. (2002) Foreign Direct Investment in China: Policy, Trend and Impact [online] available from http://www.hiebs.hku.hk/working_paper_updates/pdf/wp1049.pdf [Accessed 17 August 2008]
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