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.

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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?

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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)

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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

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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

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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

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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,

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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
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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

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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 )

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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

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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

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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, RD
  policy, and education

22
RD 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

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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,
  RD, policy
• In spite of declining income share, real earnings
  have developed well

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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

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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

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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

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Role of policy 2/3

• Technology policy
• Government spending on RD 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 RD 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

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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