Given the celebratory ethos of the literature on DFI it bears noting that Ireland’s early experience with it was not exemplary. From the mid-1950s on policy was prepared to encourage DFI as long as it did not interfere with indigenous producers. The aim was a dual industrial structure, whereby the multinationals would focus on exporting, something the indigenous sector had signally failed to do since the 1930s. The early experience with the multinationals was not great. There were some scandals (Verolme shipyards in Cork, Potez aerospace in Baldonnell), over‑reliance on products far advanced in their product cycle, vulnerable to the third world.
More recently DFI has been doing the job, and Ireland has been attracting more than its share of US foreign investment in relatively high‑tech sectors, particularly computers and pharmaceuticals. Accompanying this has been a reorientation of manufacturing exports and imports away from the UK. Moreover, over time there has been an increasing concentration of employment in ‘increasing returns’ sectors. Also there are far greater linkages than before in terms of materials purchased.
Perhaps it is still too soon to ask whether this new, more sophisticated form of protectionism has produced any grown‑up infants. Can subsidies to export‑oriented multinationals generate dynamic gains that ISI‑oriented protection cannot deliver? The first generation of multinationals, those introduced in the 1960s and 1970s, certainly failed to deliver on this score. Some researchers, like NUI Galway’s Roy Green, are more optimistic about the current generation: according to Green, the policy of concentrating on high technology sectors and forging linkages with the local economy “has proved to be a winning formula in the development and sustainability of Ireland’s extraordinary economic metamorphosis”.
It bears noting, however, that public policy has led to Ireland being one of the only countries in the OECD in which manufacturing’s share in output has continued to rise. The rest of western Europe has been experiencing de‑industrialisation since the 1970s. While manufacturing’s share in the Republic’s GDP has risen from barely one-fifth in the 1950s to 35.4% in 1970 and 38.4% today (1999), its share in the UK has plummeted from 35% in 1979 to 23.9% in 1999. Some of the rise in the Republic is the product of DFI‑induced transfer pricing, but employment data corroborate Irish distinctiveness in this respect. The proportion of total civilian employment accounted for by industry has fallen throughout Europe in recent decades, but in Ireland it has held its own.
It is striking that the shift in Ireland’s occupational structure is so different to that of the rest of northwestern Europe. Is it because Ireland has bucked the European de-industrialisation trend that it has done so well? Is this a reflection of Ireland’s true comparative advantage, or is it merely a distortion produced by the corporate tax regime? One argument on the side of optimism might be that the ‘rust‑belt’ de‑industrialisation responsible for the decline in the industrial labour force elsewhere (as in Wales and Northern Ireland, of course) is the product of an earlier industrial phase that largely passed the Republic by.
The main economic benefit of sovereignty has been control of fiscal policy. In the past the Industrial Development Authority has attributed Ireland’s success with DFI to factors ranging from the absence of an Irish Communist Party (the IDA ignored the very active Communist Party which has been part of the Irish political landscape since 1922 – Ed.) to the friendliness of the natives and its good golf‑courses. The quality of the workforce, the ready availability of greenfield, well‑serviced sites, and good industrial relations are more important factors, though these factors have been arguably exaggerated too. In the end, I believe, it boils down to low corporate taxation.
Ireland can still get away with its low corporate tax regime because it is a small economy, producing about 1% of EU GDP, and because it was the first to offer foreign investors such tax concessions. If, as a result Ireland’s share of American DFI is disproportionate, it is still a puny fraction of the EU total. Size matters: if Germany or France decided unilaterally to reduce its corporate taxation level to the 12.5% across the board rate being introduced by Ireland in 2003, it would risk breaking up the EU.
Being first matter: Ireland’s position in this near‑to‑zero sum game depends on others, or too many others, not following suit. Whether aspirant EU members states from eastern Europe are likely to compete on this front remains to be seen. That would probably not be in Ireland’s interest. But how much would it hurt?
It has been argued that the taxation argument has been oversold, since in recent years Ireland’s share of US DFI in Europe has risen despite some narrowing in tax differentials. Comparing the tax burden faced by foreign corporations in different economies is not straightforward. In some countries the main attraction may be free sites and initial grants; in others generous depreciation allowances on capital; in some the tax payable is de facto negotiable. However, it is safe to say that the Irish rate is still half or less than in most EU member states. The findings of a recent paper by Roseanne Altshuler, Harry Grubert and Scott Newton (1998) are interesting in this context. Altshuler and her colleagues have produced evidence of an increasing sensitivity of US DFI to tax rates, finding that the elasticity of real capital to after‑tax rates of return doubled from from 1.5 in 1984 to almost three in 1992. They attribute the rise to the increasing mobility of capital and globalisation. Has the elasticity risen further since the early 1990s? If so, this could explain why Ireland has managed to increase its share, but also how vulnerable it would be to tax harmonisation. What scope does Ireland have for increasing corporations profits tax, thereby making the overall taxation system fairer? These issues are worth urgent attention.
What impact has the tax regime had on industrial structure? We first compare the wages and salaries to net output in a range of sectors in both Ireland and the UK in the late 1990s. In Ireland most of the enterprises in the first four sectors are indigenous, whereas the second four are dominated by US multinationals. The UK data operate as rough controls. The most striking feature is the small share of net output going on wages and salaries in Ireland’s multinational sectors. Labour’s small share in Ireland’s NACE 21-22 is explained by the presence of a subsidiary of Microsoft in that sector. These differences, and the concentration of US multinationals in these sectors, underline the importance of transfer pricing for US DFI in Ireland (and the distortions in both Irish GDP and industrial production data). The same goes for much of Ireland’s internationally traded service sector, since 1987 also beneficiaries of low corporation profits tax. More systematic comparisons of sectoral data, embracing all NACE categories and perhaps a few more economies, might help reveal the real size of Ireland’s industrial sector. Be that as it may, so far Ireland has not been a loser by its distorted, though perhaps also somewhat vulnerable, foreign trade regime.
Finally, referring back to our earlier remarks about infant firms growing up, one may also compare the proportions of employees described as operatives (Ireland) or industrial workers (UK) in the same sectors. The high tech sectors dominated by DFI are of particular interest, given the prevailing belief in Ireland that they attract highly skilled and highly educated workers. The strength of white collar in these sectors in both countries is confirmed. Also worth noting, though, is how Ireland lags behind the UK in this respect in all cases (though US FDI also bulks large in the UK).
Can Wales learn anything from Ireland? Arguably not, since much of what has happened in Ireland was catch up. I think the arguments about Ireland’s educational skills have been overblown, so there is really nothing to copy there. Still, if only it could compete with Ireland on the corporation tax front, it would be a very serious rival. I realise this is a political hot potato, so I won’t say any more. It is, however, much better located than Ireland.
But this is no time for complacency. Small open economies, no matter how successful, get buffeted by exogenous shocks. Ireland now faces the double threat of US recession in the short run and of competition from Eastern Europe diverting DFI in the longer run. It may grow faster than the OECD norm for a few more years, but to think that it can do so in the long run is wishful thinking. Most likely, soon the Tiger years will be remembered as the interlude when Ireland made up all the ground it had lost and became a normal European economy.
©: Cormac Ó Gráda, October, 2001.
Cormac Ó Gráda, who is Professor of Economics at University College, Dublin, is the author of several studies on the Great Famine in both Irish and English. This is the text of a lecture arranged by the Wales Famine Forum which was supported and hosted by Cardiff University and was delivered on 25 October 2001.
The original lecture was illustrated with charts, tables and diagrams which have had to be omitted. This has necessitated some changes to the text. However, some references to missing data have had to be retained. He/she that readeth let him/her understand.
Published in The Green Dragon No 10, Spring 2002.