Globalization and economy: a small country perspective

Jaakko Kiander

Government Institute for Economic Research

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

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

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.

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?

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)

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

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

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

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

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

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,…

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

Long-term economic growth in Finland

0

500

1000

1500

2000

2500

GDP

GDP per worker

GDP per hour

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

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

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 %)

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

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

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

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

R&D spending

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0,5

1

1,5

2

2,5

3

3,5

1980 1984 1988 1992 1996 2000 2004

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

Export-led growth

• Policy priority: growth of exports

GDP, domestic demand and export volumes

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1985 1990 1995 2000 2005

1985

=10

0 Domestic demand

Exports

GDP

Declining unemployment rates

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24

6

810

12

14

1618

20

Finland

Sweden

Denmark

Productivity growth better than elsewhere

60

80

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160

Finland

France

USA

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

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

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

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

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

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