Globalization and economy: a small country perspective

1. Globalization and economy: a small country perspective Jaakko Kiander Government Institute for Economic Research

2. Globalization and economy: a small country perspective • Old and new globalization • What globalization means? • Drivers and new actors • How small open economies are affected • Conclusions

3. Old and new globalization • There have been periods of large scale economic integration and free trade in economic history • Ancient Rome and the Mediterranean economy • 19th century; especially 1870-1913 • Large movements of goods, capital and labour between continents

4. New globalization • Steps towards free trade since 1945 • GATT, WTO • Financial market deregulation and free capital movements in the 1980s • Regional integrations processes: • EU and NAFTA • Emerging economies • East-Asian tigers, China 1978, CEEC 1989, India etc.

5. What globalization means? • Free movements of goods and capital (and people, to some extent) • The basic logic of economic globalization (and integration) • Economic convergence as a result • Who is going to benefit from globalization?

6. The basic logic of economic globalization (and integration) • Liberalization likely to increase factor movements and trade • More international trade (and benefits from division of labour) • Capital movements from rich to poor countries (FDI) • Labour movements from poor to rich countries (migration)

7. Investment as a vehicle of development • Rapid productivity growth enabled through FDI: • Greenfield investment: more capacity • Transformation of old capital stock: higher productivity • New technology embodied in new equipment • Organizational and managerial skills imported • Rapid access to export markets

8. The process: continuous adjustment to profit opportunities • Faster growth in emerging economies due to cost advantage • New technologies adopted • Structural change: industries in rich countries using unskilled labour shift their production to emerging markets • Increasing flow of cheap imports from emerging economies keep inflation under control

9. Convergence as a result (in long term) • Real wages and price levels in emerging economies grow faster than in rich countries • The larger are factor movements, the faster is the convergence process (but it still takes decades … cf China) • Large effects in emerging economies, only minor effects in rich countries

10. Who is going to benefit from globalization? • Almost everybody benefits in emerging economies; but structural change also likely, and can be costly • will there be any compensation? • Rising income differentials • Capital owners, consumers and skilled workers benefit in rich countries; but some unskilled may be losers • Global income distribution becomes more equal

11. Economy tends to balance itself… • Growing output and exports of emerging economies will be balanced by their growing imports: jobs do not disappear • Adjustment process may require substantial changes in relative prices (exchange rates) • During the period of globalization employment has increased everywhere

12. Economic globalization changes the world • New economic super powers: China and India • New middle-size powers: Russia, Brazil, Mexico, South Africa, Iran, Pakistan, Korea, Indonesia… • Old economic super powers will become smaller: Germany, UK, Japan,…

13. The Finnish growth record: the last 100 years • Finland as an example of a small country benefiting from globalization • An impressive record: catching up from poor to rich • Rapid productivity growth – mostly due to international competition • Increased employment through population growth and higher labour force participation

14. Long-term economic growth in Finland

15. The old post-war model of economic growth: 1945-1990 • Export-oriented: importance of export industries widely understood (cf. Japan and China) • Capital intensive: emphasis on industrialization and heavy industries – high savings and investment rates • Statist: government and state as central decision makers – in co-operation with banks and export industries

16. The old model • Government had a central role: • state-owned companies • aggressive industrial & regional policy • regulation of markets, ownership, capital flows, and investment decisions • systematic investment in education and training

17. The old model • Macroeconomic policy targeted to maintain & improve competitiveness • Flexible exchange rates and incomes policy • …and to support investment • Taxation and corporate governance supported growth targets, not profitability • Corporate finance based on debt • Investment ratio usually close to 30 % of GDP (China: 50 %)

18. Assessing the old model • Not compatible with free markets and free factor movements • Overinvestment: inefficient use of capital • Forced savings: consumption constrained but rapid improvement in living standards • BUT: Good results in terms of growth and employment

19. Transition to new regime • Liberalisation of product and capital markets in the 1980s • Liberalisation of foreign ownership in 1993 • End of bilateral trade with Soviet Union • Financial crisis and restructuring in 1991-94: • rise in unemployment • a wave of bankruptcies • banking crisis • increase in foreign ownership

20. The new regime • EU and EMU memberships as corner stones • Macroeconomic policy cannot be used anymore to improve competitiveness • All sectors opened to competition and foreign ownership • Shareholder value as driving force in corporate governance (instead of growth and investment) • Corporate taxation reformed: no special incentives to investment

21. The new regime • Government not any more active in industrial policy • Large chunks of state-owned companies privatised – less government control • Even more emphasis on innovation system, R&D policy, and education

22. R&D spending

23. Experiences and lessons from the new regime • GDP growth record has been good since 1994 (almost as good as in the old system) • Rapid labour productivity growth has continued (but is has been a bit slower) • Investment ratio has fallen from 25 % of GDP to 17 % although profitability has improved

24. Export-led growth • Policy priority: growth of exports

25. Declining unemployment rates

26. Productivity growth better than elsewhere

27. Experiences and lessons … • Finland has been succesful – thanks to • High technological level and specialization • Good competitiveness (partly due to big devaluations in the 1990s) • Rapid structural change to more high tech production • The Nokia phenomenon: extra bonus to Finnish economy • Lots of innovative activity: education, skills, R&D, policy • In spite of declining income share, real earnings have developed well

28. Finland: adjusting to globalization • So far, Finland has been succesful • Rapid rise of exports • Huge surplus in trade balance • Continuous flow of plant closures: simple manufacturing jobs move to low-wage countries … but total manufacturing is doing well • Specialization to high value added • More competitive pressure: • workers’ bargaining power eroded • Tax competition

29. What explains the rapid growth of exports, productivity and industrial production? • ’Creative destruction’: the recession wiped out 25 percent of jobs in 1991-94 – the least productive firms and plants were eliminated • Competitiveness: hugely improved competitiveness as a result of exchange rate movements, rising productivity and wage moderation (achieved through unemployment & centralized wage setting) • Structural change: shift from resource-based to knowledge-intensive production (IT sector) • New technology: Finnish firms in the frontier of new technology in the 1990s (Nokia) • Luck & smallness: if there is a successful large firm in a small country it has a decisive impact on everything

30. Role of policy 1/3 • National innovation system • There has been a long term commitment to build up innovation system • IT sector development started in the 1970s • Based on broad political consensus • Network of universities and government laboratories in co-operation with private sector • New technologies traditionally adopted in early phase (banking, telecommunications…) • Strong industrial base

31. Role of policy 2/3 • Technology policy • Government spending on R&D 1 % of GDP • Consists of own research & subsidies • Co-operation and competition • Intermediate bodies which link research units and firms • Government subsidies help to form joint projects with small firms • Business sector R&D more than 2 % of GDP • Problem: most of that concentrated in IT sector • Education • Skill formation, with emphasis on engineering and technology • Increasing supply of skilled labour • Abundant resource pool • Moderate wage level

32. Role of policy 3/3 • Maintaining advantage in competition • Price stability: since 1993 inflation less than EU15 average • Wage moderation through long term commitment: falling unit labour cost • Tax policy crafted to face international tax competition: • Corporate and capital income taxation: flat tax since 1993; current rate 26 % • Labour taxation: gradual cuts since 1996, financed by increased corporate tax revenues and higher environmental taxes