Ireland has faced extremely fast development in many industrial sectors during the last decades. This has not happened by accident and that is what made it for us an interesting case to study in more detail. The Irish government policy towards Foreign Direct Investments (FDI) has affected to a large extent to Multinational Organizations’ investment decisions in Ireland. The FDI is one of the main focuses through the paper as we see that they have had a major impact on the development of Ireland during the ’80s and ’90s.
In this paper, we will focus on three main areas. The first area is a view of the historical development of the country from the mainly agricultural driven society in the 50’s to a highly developed industrial country in the 21st century. The second part of this paper will focus more carefully on the reasons why this development has been possible. We will go through some theories about government policy in attracting Foreign Direct Investments. The last part of this paper will focus on the company’s point of view of FDI. We will go through one company example and discuss this according to an introduced theory of companies doing FDI.
With this paper, the group wants to give the reader a more specific view to the fast and well-planned development Ireland has been able to reach during the recent decades. We hope that this view encourages the reader to take a closer look to the fascinating Irish culture and we hope that the reader will get some perception of what possible tools a government has to attract foreign firms to invest in the host country.
Ireland will go down in economic history as an economic miracle in the last decade of the twentieth century. For most of the 20th century although, even well into the late 1980s, Ireland was in economic terms quite unsuccessful. Chronic unemployment led to large emigration flows and dampened entrepreneurial activity. The country’s economic situation eventually reached crisis levels because of the spillover effects of the two oil shocks of the 1970s and the high-interest rates resulting from the United States’ anti-inflationary policies of the early 1980s. By 1988, the public debt exceeded 140% of Irelands gross domestic product. But the unemployment situation was also serious, emigration resurged, the economy stagnated, and living standards deteriorated. Between 1979 and 1988, the GDP only grew by 2.1% and the unemployment rate reached in the late eighties levels close to 15%. No wonder the country was counted among the sick men of Europe’. In 1987, taking advantage of a broad consensus for change that had emerged among all the major domestic policy actors, the newly elected Prime Minister Charles Haughey pushed through a set of dramatic actions. He introduced large tax cuts, and as GDP growth responded to tax cuts and wage moderation, the budget deficit was slashed and the debt to GDP ratio shrank. By 1990 the budget deficit had dropped from 7.9 percent in 1986 to 0.6 percent of GDP, while the public sector borrowing requirement declined at the same time from 14.2 to 2.8 percent of GDP.
Several other factors also played an important role in Ireland’s spectacular development. These included opening up toward Europe, breaking with British currency, granting massive incentives to foreign direct investment (FDI), engaging in technological development, and investing in education. The result of the Irish economy is quite impressive. From 1991 to 2000 annual real growth averaged 8%, compared with the EU average of 2%, by 1996, Inflation had declined from 11.3% to under 2%. By the end of the decade, the government ran such large budget surpluses, that by 2000 the national debt had fallen to 40% of the GDP. Ireland now ranks as the world’s third-largest world exporter on a per capita basis behind Singapore and Belgium and Luxembourg. For example, one-third of all personal computers sold in Europe are now made in Ireland. In 2000 Ireland’s total trade in goods and services was equivalent to 175 percent of GDP, up from 141 percent in 1995. At the same time, the composition and direction of trade moved away from exports of primary goods, mainly agricultural, to manufactures. In 1987 agricultural produce made up 17.5 percent of exports, but this had fallen to 4.8 percent by 2000. During the same period, industrial products increased from 80.2 to 92.8 percent of trade.
In the following section, we will have a look at different graphs that make the miracle of the Celtic Tiger’ more illustrative. Below, we have a closer look at the policies which made the Irish success possible. Source: CSO, Eurostat, Somers 2000Source: CSO, Eurostat, Somers 2000Source: CSO, Eurostat, Somers 2000Source: CSO, Somers 2000
Reasons for the Irish Success Story
The Impact on Production Through FDI
Although the policies towards higher foreign direct investment were implemented in the 1950ies, the overall production of the Irish economy did grow slowly until the nineties. In the last decade, however, the investments pay themselves out. The strategy, to set Ireland as an export base within Europe for American firms, led to a high increase in production. Affected were namely the electronic and pharmaceutical sectors, which profit from low transport costs. As a result of the booming IT-industry, the overall production of the economy increased from 1995 until 2000 by 200%. Industrial Production (all industries) Index 1995=100 Source: CSO
The Impact of Foreign-Owned Companies
The two impacts of FDI are reflected both in the increased presence of foreign-owned companies in the manufacturing sector and in the degree of concentration in high-tech sectors. The spectacular worldwide growth of this latter type of sector contributed with the boom in the USA economy to Ireland’s recent success.
The following graphic shows how investments of multinational companies (MNC) have contributed to manufacturing value-added and production in Ireland compare to the rest of Europe and the USA. The key to success in FDI companies was the creation of industrial clusters in high growth sectors that the state-agency chose as a target to persuade foreign companies to be potential investors in Ireland. Because Ireland is a key location for the pharmaceutical and chemical industry in the EU nine of the top ten companies in the world have operations there (over 120 overseas companies). Their export represents 29% of total exports.
Share of affiliates under foreign control in total manufacturing value-added and turnover (1999) Source: CSO
The increase in production, due to an increase in FDI, had a huge impact on the export rate. From 1990 until 2001, exports raised by more than 400%. In terms of export and import average in 1994 – 2001 Ireland is the best-performing country compared to the rest of the world. The destinations for exports in 2002 were Great Britain (20%), the rest of Europe (46%), the USA ; Canada (17%), and others (17%). Ireland imports nowadays 31% from Great Britain 26% from other EU countries, 13% from the USA ; Canada, 2% from Northern Ireland, and 26% from others. Source: CSO
Among the several factors in terms of general economic policy, the introduction of deregulation and tax policy that allowed minimizing fiscal certainty was probably the most decisive. The strategy adopted a highly favorable regime of corporate taxation that is subject to agreement with the European Commission. EU funds to support regional investment were essential at the beginning when there were not enough resources to support macro-economic policies. Ireland shows the lowest negative change in the average tax wedge between 1991 and 2000 (-11%) in the world. Source: CSO
Changes in Education
Ireland is not among the leaders in terms of public expenditure per student but the education system seems to meet the ends of a competitive economy pretty well. In the year 2000, only Singapore and Finland were on top of Ireland. Source: Somers 20003. FDI from a Government perception
Policies Attracting FDI
During the ’50s, the Irish government started realizing that the Irish economy needed to be opened up in order to create economic growth, and ultimately, to create employment. Therefore, in 1952, capital incentive systems were introduced to attract foreign investments, followed later on by tax incentives. The IDA (the Irish Investment and Development Agency) was established in 1969 and had to promote Ireland as an FDI destination. From the 70’s it has experienced strong growth and today it is one of the most successful countries in Europe in terms of economic development, thanks to Ireland’s specific government policy. This policy has been focusing on a supply-side reform of the economy in order to attract new foreign investments and to increase the competitiveness of Irish goods around the world.
As the market to attract investments is a very competitive, IDA established itself as a very determined market player. The ultimate focus was to create employment and therefore is focused on growth industries that could create long-run effects for the Irish economy. The main industries targeted are the following:
- Health care, pharmaceuticals, and chemicals
- Electronics and engineering
- Financial services and telemarketing
- Software, data-processing and international services
In the first place, IDA wanted to attract firms that are oriented towards countries within a common market, in this case, the European Union. The target was to promote Ireland as a location for companies across the world that plan an expansion in Europe. As Ireland has close ties with the United States from a historical perspective, especially US firms wanting to set up a European firm got special attention from the IDA. Secondly, also companies that serve the global market from their location in Ireland were considered. What is the strategy followed by the Irish government in competing with other governments (mainly from other European countries) to attract FDI? In order to attract foreign direct investments, governments compete with each other in offering investment incentives that have important implications for companies looking for the ideal plant location. In doing this, governments can follow a pricing strategy, a differentiation strategy, or as the Irish did, a combination of both.
The Irish pricing strategy consists of four different aspects. These consist of the fiscal policy, the incentive system, the export subsidy policy, and other incentives. First, Ireland has a favorable fiscal policy. The Irish government has maintained a prudent fiscal position. Fast economic growth combined with limited growth in public spending has kept Ireland’s general government deficit below 2,5 percent of GDP since 1989. Government surpluses and strong growth of national income have considerably reduced Ireland’s DEBT/GDP ratio from 140% in 1988 to 40% nowadays. The main government tax revenue stems from personal income. In order to continue and increase of nominal income and to make entry-level jobs more attractive than long-term unemployment, the current government lowered personal tax rates and introduced a tax credit system. The VAT rate is 20% and equals European standards. The corporate tax rate on manufacturing, services, and finance was 10 % until 2003, and was then increased to the EU-agreed level of 12,5%: the European Commission argued that the 10% rate was a way of giving anti-competitive subsidies to the industry sector, so, therefore, Ireland had to harmonize its corporate tax to the European rate to eliminate any differential treatment. Still, this is one of the lowest corporate tax rates in the world.
Secondly, there is a wide range of central and local government incentives for inward investors in the form of grants. The Irish government provides many types of grants such as capital expenditure grants, building or renting cost grants, training grants, employment grants, and R;D grants. With respect to these grants, the IDA leaves room for negotiation and there can be differences from firm to firm regarding the grants given, depending on for instance the leverage effect of the firm on the economy or the bargaining power of the firm. In order to determine the maximum amount of money the IDA wants to give, it conducts a cost-benefit analysis. It gives grants per job created so that it is able to create jobs in businesses that do not have an initial job-creating potential. The grants are higher if there is a better fit with the type of industry the IDA wants to attract. Thirdly, the Irish government provides an export subsidy policy. Usually, the government doesn’t provide any support for local exports, however, companies located in designated industrial zones, namely the Shannon Duty-Free Processing Zone (SDFPZ) and Ringaskiddy Port, receive exemptions from taxes and duties on imported inputs used in the manufacture of goods for non-EU countries. Furthermore, before 2003, Ireland applied a special corporate tax rate to the companies producing manufactured goods and services for export to companies out of the SDFPZ and the International Financial Services Centre (IFSC) in Dublin.
Lastly, there are some other incentives, such as the fact that there is no restriction on the movement of money earned in Ireland (in contradiction with other tax havens). Capital and earnings can be freely repatriated – there are no exchange controls in Ireland. Also, labor costs are quite cheap, but the gap with the other EU countries is decreasing.
Ireland’s geographical location and its small domestic market contributed to the focus on high value, low volume industries. Therefore, it was necessary to develop an active policy, directed towards education and infrastructure. The main objective of the economic policy in Ireland is to maintain a low rate of unemployment and an increased average living standard while at the same time income distribution, social cohesion and regional development are important goals.
Ireland is characterized by high levels of investment in education and training. At this time, the country disposes over a unique workforce: 40% of the workforce is below 25 years, highly educated, and motivated. Indeed, Ireland has a higher proportion of young people in full-time education than most other industrialized countries, due to its high investments in education. Of all OECD countries, only the Japanese workforce has a higher proportion of engineers and scientists. A lot of attention is also given to the development of a social consensus on economic policy through national wage agreements negotiated by the government, employers, and trade unions. The last one, the Programme for Prosperity and Fairness, started in 2002.
There is also a favorable infrastructure regarding the property, telecom, and logistics. Ireland has developed the so-called “National Development Plan 2000-2006” which provides a large range of investments in every sector of the economy; the expected amount for structural investments during this period is around 48 billion dollars, mainly financed by the Irish taxpayers. In order to ensure the availability of high-quality property throughout the country, the IDA works closely together with the private sector. Furthermore, Ireland offers exceptional trade and businesses opportunity in sectors like e-commerce. The Irish government created a flexible, market-driven legal and regulatory regime on key issues such as electronic signatures, consumer and data protection, encryption policy, and intellectual property protection for Internet-based industries. It is also largely supporting private and public involvement in the development of the “next-generation Internet”. The “Technology Foresight found”, for example, is an Irish government program to fund basic scientific research projects with potential for commercial development and it will focus on computer and internet-related research.
In the last 10 years, there were also many investments in the telecom infrastructure so that there is a reliable and fully digital telecom system nowadays – one of the most advanced systems in Europe- and there is a highly efficient distribution network, making efficient logistics possible. In order to reach a competitive advantage in the infrastructure, Ireland introduced competition and liberalization in the economy reducing the number of state-owned industries, especially in the transport, energy, and communication sectors, in accordance with European guidelines.
4 FDI from a company perception4.1 The theory behind – why companies do FDIIn order to evaluate Ireland’s attractiveness as a location for foreign direct investment some theoretical background is needed. Therefore the next part of the paper provides the reader with an interesting perspective on different goals companies try to achieve with FDI.
First of all, let’s define FDI. FDI means that a company is investing outside the home country but inside the actual company. Companies do that for several reasons e.g. the search for new markets, the search for production at a lower cost, or easy access to cheap natural resources. The opposite of FDI would be a portfolio investment, where the company wouldn’t have any other than a financial interest in the bought asset.
According to J.H. Dunning (1993), there are four main types of reasons for a company to use FDI. These reasons could appear separately or together as a complex system within a company. Those reasons should provide us with a company’s point of view on FDI. First of all, there are resource seekers. This type of company searches possibilities to acquire particular or specific resources at a lower cost than in their home country. There are mainly three resources those companies search for: physical resources, cheap labor resources, and specialized human resources. The main reason for companies performing as a resource seeker is to become more profitable and competitive by reducing their actual costs.
Second, we can identify market seekers. Opposite to the resource seekers, those companies are actually going to operate in the host country as a seller. The market seekers make their FDI in order to get access to the host countries and the adjacent countries’ markets. In most of the cases, these customers have been served previously by exports of the now investing company. Additionally to the market access, there could be more reasons such as “going-where-the-business-is”, which means following customers and suppliers, as well as clustering effects in a specific region and also governmental policies, which make a specific market more favorable than another. Furthermore, also transaction cost motives and the importance of local preferences could become a reason to invest in a country different than the companies’ home country. According to empirical studies, these reasons count up to 45% of the global amount of FDI.
Moreover, there are the efficiency seekers, these companies can be characterized as a mix between the resource and the market seekers. They actually enjoy the opportunity of establishing a production site from the perspective of economies of scale and scope, gained by the favorable resource system of the host country and the possibility of well-developed cross border markets. This means that the company is going to produce on one specific location, but supplies from there a multitude of markets. The last type of company is called strategic asset seekers. For them, it is not only achieving cost benefits or finding markets, but FDI is also a part of their long-term strategic objectives. This case is mainly relevant for companies who seek a global presence. Their benefits out of FDI are extended market power, better research, and development as well as production synergies and risk diversification. These companies are more looking for joint ventures and acquisitions instead of establishing their own structures in a specific country.
Moreover, Dunning names a few other reasons for doing FDI such as escape investments from unfavorable conditions in the home country as well as support investments, which could be mainly understood as related to the companies sales activities.
After being provided with the theoretical framework for this part of the paper, the companies point of view is now applied to an actual case in order to relate the information about Ireland mentioned further above in the paper to the actual business life going on in Ireland.
Case – Microsoft Corporation in Ireland
Microsoft Corporation (Microsoft) is a US-based, but global software manufacturer having operations worldwide. The company was founded in 1975 and is nowadays a worldwide leader in software, services, and Internet technologies for personal and business computing. The company offers a wide range of products and services designed to empower people through great software any time, any place, and on any device.
Microsoft European Operations Centre (EOC)Since its foundation in Ireland 1988, Microsoft has gradually added new functions to become a fully integrated operation located at two main sites in Dublin. In the early phase, the company produced only two products into two languages, whereas today the product range consists of 100 products in 27 languages. The Dublin site is where the Manufacturing, Distribution, Logistics, and European Data Centre, including Revenue Accounting and VAT reporting, is carried out for 32 European Subsidiaries. In addition, responsibility for certain markets in Africa, Mediterranean, and Middle East countries (MENA) has been given to Dublin.
We can easily argue that Microsoft’s investments in Ireland are Foreign Direct Investments (FDI). The company has found out that Ireland provides many resources for an English speaking company that many other countries in Europe don’t do. According to the introduced theory, we could say that Microsoft is a resource seeker. Inexpensive, highly skilled, and English speaking labor in Ireland is a major advantage for a software company like Microsoft. The Irish government has put a lot of resources in education since the ’70s and the consequences can be seen today when it has been able to attract global companies to invest in Ireland. As mentioned earlier in part II, an important issue for software companies is the accurate IT infrastructure that Ireland has constructed. This has also had a major impact on Microsoft’s investment decision.
As a US-based company, Microsoft would not be able to operate in the EU without tariffs if it wouldn’t have established operations inside the EU borders. According to this, we can also identify the company as a market seeker. By having operations in Ireland it has an entrance to the free trade zones EU, EFTA, and of course a location in an EMU country.
By making the operations more efficient it operates also to the African and the Middle East markets from Ireland. By this fact we can conclude that the company operates also as Efficiency Seekers. Low proximity to the actual markets, can reduce transaction costs and also by serving the whole European and Middle East Area markets establishing economies of scale and scope.
IDA’s Effect on the Microsoft’s Investments to Ireland
The investment in Ireland is not done by accident from a global company like Microsoft. As we mentioned earlier on the company had only some operations in Ireland in the late ’80s. After that, it has expanded its operations enormously.
We can conclude that the Irish government policy has affected the decision to a large extend. Low taxation, educated labor, investments in construction, and some other incentives given to companies who invest in Ireland has increased the FDI’s to Ireland during the last two decades. As already mentioned in part II, Guisinger (1983) calls this governmental strategy as Aggressive Combined Strategy of both pricing and differentiation. These issues have been major factors also for Microsoft where it has been looking for possibilities and a location to enter the European economic area. The company has gained from low taxation as well as from the well educated English speaking workforce. IDA has also given some grants to Microsoft for example a sum of money per each new job created. In the end, we could conclude that the overall government policy towards the software and telecom industry has affected largely in Microsoft’s decision to invest in Ireland.
In reference to our general topic “economically viable regions,” Ireland seems to be a miraculous example of a very fast, successful, and sustainable economic development, which changed the Irish economy and the European economic geography tremendously. In recent years the Irish government succeeded in establishing such an attractive environment in terms of economic needs that finally led to the investment of 1,200 over-sea firms in the Irish Republic. A lot of these companies furthermore started to run their European operations from-out their Irish affiliates. One example, therefore, is the Microsoft case mentioned further above. All this of course had a huge impact on the Irish economy and resulted moreover in the reach of the policy’s main goals to reduce unemployment as well as the national debt as mentioned before.
Facing such a successful development some questions might arise. In the following, we will shortly present the most urging questions, which haven’t been answered so far.
First of all, since the Irish economy is closely tight to the American as mentioned above, it is therefore also closely tight to the economic development on the other side of the Atlantic Ocean. Even if the general economic downturn hasn’t reached Ireland so far, it will be interesting to observe how Ireland is going to deal with that.
Secondly, as Ireland is very much focused on investments in the software and data-processing industry as well as sector-related education, we also have to take into account the recent global development in that sector. As we observe nowadays a stabilization on growth rates in the sector, it is questionable whether Ireland has been overestimated the requirements for the workforce in this sector and therefore is on the way to educate and even over-skilled workforce. By this, we mean that this could lead to structural unemployment. Thirdly we can mention the aspect of the EU-membership of Ireland, which could turn out also as a disadvantage- even if the IDA is promoting Ireland right now as the gate-a-way to the EU. Since the common markets are established within the EU, there are more and more regulatory directives to establish a harmonized system of policies. For example, this could be a further harmonization of the taxation policies. This already made Ireland increase its’ corporate tax rate by 25%. Furthermore, the common market can put some pressure on the prices of labor, goods, and services, which could finally destroy the now promoted fact of the cost-advantage companies receive by investing in Ireland.
Finally, we have to ask ourselves, whether the Irish success will be a never-ending story or if there is some evidence that the boom is over and now Ireland has to face the same problems most of the other countries in the world are facing right now.
Nevertheless, one issue can be taken for sure, namely that Ireland managed to become a competitive player in the global economy and successfully took part in the global economic development in the recent decades.
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