Cause and Effect of Macro Environmental Forces on Foreign Direct Investment in Ireland
Once regarded as amongst the poorest member of the European Union, Ireland’s political economic development from the 1960s to 1990s saw an incremental growth of the nation’s economy based on foreign direct investments (FDI). Capitalising on a change of their political economy and their cultural ties to the United States, Ireland was capable of attracting large amounts of FDI, driving gross domestic product (GDP) level to a peak of almost 10% between 1995 and 2000 (Alfaro, Dev & McIntyre, 2010:1), along with a decline in unemployment to 5% of the labor demography.
Ireland’s utilization of FDI is a prime example in modern history of how political decisions can affect legal policies which in turn help drive economic growth to become globally competitive. The purpose of this essay is to investigate the macro-economic forces that acted as a catalyst for the exponential growth in Ireland in a globalization context and its effect on FDI. This investigation is based on the case study on Ireland with reference made to the importance of FDI host nations to establish stable fiscal policies to sustain economic growth.
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Furthermore the essay will critically assess the impact of the Global Financial Crisis (GFC) on Ireland, in particular to its banking system, property sector and domestic consumptions. Finally a judgment will be made on whether Ireland will continue to remain as an attractive FDI host nation in light of their economic slowdown One of the most significant contributing factors to Ireland’s exponential economic growth can be attributed to its change in its political economy system.
It also provides a case for analysis of how political decisions can directly affect a nation’s economic outcome. Prior to the 1960s Ireland’s economic activities were managed under a collective, protectionism political atmosphere where the focus was to prevent external forces from influencing the native industries. protectionism of indigenous assets as its political ideology. In the face of Wall Street crash and the Great Depression this near totalitarian control led to the result that tariffs were double that of the United States and 50% higher than the United Kingdom (Alfaro et al. 010: 2), which posed a significant barrier of entry into Ireland for foreign entities. By the 1950s Ireland was in a stage of economic stagnation and a pro-market political ideology was becoming more favorable.
This shift in political atmosphere meant that Ireland was moving towards a more liberal economic system, along with the announcement from the finance minister in 1958 to advocate a shift from protectionism to free trade, combined with encouragement of tax concessions and incentive grants, (Alfaro et al. 010: 3) Ireland quickly benefitted from an increased scale of FDI injection in the 1960s as a result of its more fiscal and financially appealing environment than other European countries. The legal aspect of Ireland as a result of the political decision to divert away from protectionism also played an important part in being able to attract FDI.
The Finance Act of 1956 introduced exports profits tax relief which allowed a 50% tax exemption on profits earned from manufacturing goods, along with a low 10% corporate tax rate allowed foreign companies to significantly reduce their cost of operation and increased their power. Ireland’s decision to enter the European Union (EU) in the 1970s further assisted Ireland in quickly becoming a prime destination for foreign entities such as the United States to use as a stepping stone into the European market. Buckley & Ruane, 2006: 5) However, the influx of FDI and foreign entities posed an implication for the host’s economic management. One of the biggest management problems for a FDI host nation is to be able to balance those foreign entities with the competitiveness of the native industry. (Wei & Balasubramanyam, 2004: 184) Prior to Ireland’s opening to free trade indigenous industry was protected under its government policies. However, with the entering of foreign entities combined with various taxation and incentive benefits native industry faced direct competition that held a competitive advantage.
An inquiry into Ireland’s industrial policy by the National Economic and Social Council in 1982 found that jobs created by foreign entities was not capable of replacing the jobs being lost by the less competitive native industries (Alfaro et al, 2010: 5) and that foreign entities cannot source supplies and labor locally due to a lack in technical and mechanical expertise. This is mostly indicative of a lower level of education within the native industry not being able to meet the higher job requirements of the foreign entity.
Host nations need to be able to minimize this gap through education and training programs if economical development through FDI injections is to be sustained. Another problem faced by host nations is the management of the types of foreign entities. Ireland as an example has a high 80% grant rate to attract FDI (Ibragimova, 2009: 35) however as foreign company presence in Ireland grew exponentially the Industrial Development Authority (IDA) realized that Ireland needed to selectively pursue investment in specific sectors to maximize economic growth potential.
As a result the IDA planned four criteria in selecting companies which included picking those that can meet social and economic criteria, offer the best chance of stability and strong growth, those with high dependence on human resources and skilled labor and those that can make use of natural resources available locally (Alfaro et al. 2010: 3). In essence this meant that host nations should select stable foreign entities to provide a solid foundation for growth and being able to utilize local resources, labor and meeting basic social and economic criteria will help promote the growth within the nation.
Even though Ireland’s economy was speculated to be one of the most successful in the world (European Commission, n. d. ), it was also amongst the hardest hit by the Global Financial Crisis (GFC). As the direct effect of the collapse of sub-prime mortgage market in the United States which resulted in a credit crunch, the contagion spread to Europe, causing the collapse of the banking system in Iceland and Ireland in 2008 (Adair, Berry, Haran, Lloyd & McGreal, 2009: 3). This is primarily contributed to the fiscal policies that Ireland introduced during the peak of their economical growth.
New taxation rule, ‘Section 23’ was introduced which encouraged property development by offsetting their construction costs against tax, this combined with aggressive lending by the Irish banks to developers and home owners with low interest mortgage rates and no deposit as security caused the development industry to explode. (Westmore, 2009) When the GFC erupted in August 2007 the Irish banks were left vulnerable from excessive lending and as the property bubble busted the banking system suffered huge losses on their loan (European Commission, n. d. ).
With the crippling of the banking system and reversal of Ireland’s fortunes domestic consumption experienced a drawback and in turn a loss of confidence within the banking system. Ultimately Ireland experienced a GDP decline of 21% between 2007 and 2010 due to the GFC. (Westmore, 2009) The impact of the GFC meant that the political economy of Ireland had to change to combat its continual losses. A three year deal was agreed with the International Monetary Fund and EU in return for the injection of contingency funds worth eighty five billion Euros to combat rising sovereign debts and restoring sustainable economic growth. Lane, n. d. ) This was combined with a sharp reduction in government spending, rise in tax and the establishment of a National Asset Management Agency (NAMA) to recover bad debts with face value up to ninety billion Euros (Westmore, 2009). In light of the GFC and the catastrophic impact on Ireland’s political economy, it can be observed that for a long while Ireland will be recovering from its losses and developing sustainable fiscal policies for economic growth. As Ireland raise its taxation rates and lose liquidity on its financial system it may no longer represent the best option as a FDI host nation.
However, corporate tax is still low compared to other European nations, standing currently at 12. 5%, (Davies, 2010) combined with its English speaking labor force, ease of access, fiscal and financially friendly economy and geographical location as a stepping stone into the European market it still present a viable opportunity for foreign entities. Entities investing in Ireland have to consider risk factors in times of instability such as changes in fiscal policy and the push from UN for Ireland to raise taxation rates to become more in line with those in the Organisation for Economic Co-operation and Development (OECD) countries.
Conclusion Ireland through its exponential growth provided for an excellent example of how economic management can be influenced by changes in the political economy and fiscal policies. The essay explored that FDI host nations have to consider providing a fiscal and financially friendly environment for foreign entities but also cater for the costs of FDI into a nation such as direct competition with indigenous corporations and loss of sovereign control over the nation’s economy.
Ireland’s decline in the face of the GFC is an excellent example of not overly relying on FDI for economic growth as well as establishing fiscal policies that will protect the stability of the host nation’s economy against external turbulences. The essay finally made an assessment of Ireland’s attractiveness for future FDI and concluded that Ireland still remain an attractive FDI option, however considerations must be taken into account against country risks such as changes in fiscal and taxation policies.
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