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
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
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
50
100
150
200
250
300
1985 1990 1995 2000 2005
1985
=10
0 Domestic demand
Exports
GDP
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