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58 Seiten, Note: 68 (1,7)
2 The Irish economic miracle
2.1 Reasons for Irelands success
2.2 The Irish tax system as one main reason for the success
2.3 How sustainable is Ireland's success?
3 What is foreign direct investment?
3.1 The basics
3.2 Theories about foreign direct investment
3.3 Greenfield investment
3.4 Advantages of foreign direct investment for economies and companies
3.5 Criticism and disadvantages
3.6 Foreign direct investment in the services sector
3.6.1 The services sector in general
3.6.2 The determinants of financial FDI
3.7 Recommendations for foreign direct investment and expectations for the future
4 Foreign direct investment in Ireland as the reason for economic growth and wealth
4.1 Foreign direct investment as the driving force
4.2 IDA Ireland: A key player
4.3 Linkages into the global economy
5 The international financial services sector as an important foreign direct investor in Ireland
5.1 The main location for financial services foreign direct investment - The IFSC
5.2 The successful Hypo Real Estate Bank International connected with the theory
5.2.1 The Hypo Real Estate Group and the Hypo Real Estate Bank International
5.2.2 The experiences of the Hypo Real Estate Bank International
5.3 Other examples in the financial sector
This dissertation examines the critical importance of foreign direct investment in the growth of Ireland. It explains the reasons for Ireland’s success and identifies the key steps in the history. The analysis is carried out in terms of the role of the Irish government policy in promoting foreign direct investment. Without the influence of foreign direct investment inflows, the economy would not have grown to the extent as it has. This paper will also show how important foreign direct investment is for the Irish economy in the future. The paper describes several theories about foreign direct investment. It addresses the advantages and disadvantages. More in depth this paper investigates the determinants of financial services sector investments abroad. It will also be shown how the Industrial Development Authority as an agency and the International Financial Services Centre contributed to Ireland’s success. The example Hypo Real Estate Bank International illustrates how an investment in Ireland succeeded. This paper should attract readers with an interest in the Irish history and economy, in the role of foreign direct investment for a country’s economy, or in financial services sector investments abroad.
O’Connor and Forde (2003) refer to George Bernard Shaw, who quipped in the 1930s, that he hoped to be in Ireland on the day the world ended, because the Irish were always 50 years behind the times. Over 70 years later, the same can not be said. With an economy growing at a rate consistently above the EU average, Ireland is one of the most favoured locations for foreign direct investment in Europe by multinational corporations. Ireland has been transformed over the recent years. It has witnessed an economic miracle. There has been significant discussion in the business, academic, and popular press about the ‘Celtic Tiger’. Since 1987, there has been a sustained and well-balanced economic boom. This remarkable performance has been in complete contrast to the former development since the foundation of the state in 1922. The boom has changed the country. Ireland has become one of the leading European countries in economic development. One major reason for the success was the change in legislation and thus, a huge increase of foreign direct investment in Ireland followed by economic growth and wealth.
After the introduction, chapter two starts with a description of the recent economic development in Ireland. Then, the reasons for Ireland’s success will be identified and the Irish tax system as one main reason for the success will be illustrated. This is followed by the question: How sustainable is Ireland's success?
In chapter three this paper addresses the questions: What is foreign direct investment, how does it influence a country, and why is it important? The author also explains theories about foreign direct investment and Greenfield investment in particular. From an international finance and macroeconomic perspective, foreign direct investment is seen as a specific form of the flow of capital across national borders. Therefore, the determinants of the flows of investment are of great interest. In addition, the consequences to home and host country are the focus of a critical examination. Next, the focal point will be the services sector. This paper aims to explain the determinants of the financial services sector for investment abroad. In the end of this chapter, the author gives recommendations for foreign direct investment and illustrates future expectations.
The fourth chapter outlines the impact of foreign direct investment in Ireland on economic growth and wealth. It will show that foreign direct investment as the driving force is primarily a success of the IDA Ireland.
The specific content in chapter five is concerned with investments of financial services sector companies abroad supported by the example of Hypo Real Estate Bank International which invested in Ireland. The purpose of this chapter is to show the connection between theory about foreign direct investment in the financial services sector and a successful example in the International Financial Services Centre. Finally, the last chapter outlines the author’s recommendations and conclusions.
The continued success has been founded on the commitment of successive Irish governments strongly supportive of foreign direct investment. The change in policy started in the 1950s to support economic development and to attract foreign direct investment. The problems of the 1950s had increased due to a balance of payment crises, as the surpluses that had been built up during the War were wiped out between 1947 and 1956. Thus, the Coalition government of 1954-1957 began to talk to the World Bank and IMF. Finally, policy-makers woke up and engaged in economic planning and encouraged foreign investment. Between 1958 and 1973 there were a wide range of policy initiatives in relation to trade and tariff protection, e.g. the Anglo-Irish Free Trade Agreement in 1965. Economic planning helped in building growth. The first Programme for Economic Expansion (1959-63) was quite successful. The Second Programme (1964-70) set targets for each sector. By the end of the 1960s Ireland had changed from an agricultural country to an industrial one. The oil crises of 1973 and 1979 increased inflation and damaged other economic activity (Sweeney, 1998). In 1977 a review of industrial development was undertaken as part of an expansionist policy. However, the reliance on FDI continued. The period of the 1980s was largely a period of great economic difficulty for Ireland, characterised by severe budgetary problems and very poor economic growth (Wrynn, 1997).
Since the mid-1990s, Irish economic growth rates have been one of the most rapid in the world, surging to over 10 per cent in 2000. Ireland's GDP per head rose from some 60 per cent of the EU average in the mid-1980s to 115 per cent by 2000. In contrast, the Ireland of the mid-1980s was a country of recession, low living standards, a negative trade balance, high inflation, and unemployment of over 17 per cent. The positive reversal in Ireland's fortunes is commonly attributed to actions taken by the government, culminating in a combination of interrelated benefits. In 1987, political consensus enabled drastic measures, as the government party received exceptionally support from the main opposition party. Fiscal stabilization came about through a rapid cutback in government expenditures and an anti-inflationary policy, while a decline in government borrowing requirements reduced the debt-service burden. Government spending cutbacks allowed promised reductions in taxation, while greater influence over aspects of economic policy provided trade unions with an impetus for wage control. The new consensus culminated in an agreement between the social partners, i.e., employers, workers, and government: the Programme for National Recovery (O'Higgins and Rugman, 2002). Thus, the new government in 1987 made severe cuts in public spending and negotiated the first of a series of tripartite social contracts between government, employers and unions. These national agreements provided for moderate wage increases supplemented by cuts in personal taxation and consensus on spending priorities in economic and social programs. These agreements, which continue to the present day, underline a consensus on national development priorities and maintain moderate income movements during a period of rapid growth, protecting national competitiveness (IDA, 2003d).
Competitive operating costs, a favourable tax environment, a skilled workforce, the availability of tax-free grant aided packages from Ireland's investment agency Industrial Development Authority, which will be described in chapter 4.2, a well-developed infrastructure, close proximity to Western Europe and world-class support services have been combined to give investors in Ireland a uniquely high return on their investment. As a small and open market, the promotion and retention of foreign direct inbound investment will always be critical to the success of the Irish economy (O’Connor and Forde, 2003). EU ‘structural funds’ that were allocated to less developed countries and regions to help them catch up economically also helped offset the reduction in Irish government spending. The funds went mainly toward infrastructural investment in areas such as roads, ports, airports, telecommunications, training, and education. In particular, the second round of funding (1994–1999) concentrated on the productive sector (enterprise, productivity, and competitiveness) and on human resources (skill development and education). Government investment in education has been vital in the human capital accumulation that has contributed to Ireland's recovery, starting with the provision of free secondary education in 1967. By the late 1990s, over 80 per cent of workforce entrants had completed secondary education and over 40 per cent experienced some third-level education, compared to 20 per cent in the EU. The English language is also an advantage. Deregulation and government investment have improved international connectivity and information technology penetration. All schools, public and private alike, are now linked to the Internet (O'Higgins and Rugman, 2002).
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Figure i 2.1: The importance of FDI for the Irish economy (O'Higgins and Rugman, 2002)
Ireland pioneered tax-free industrial zones and zero tax on export profits. Thus, it is very successful in attracting foreign investment. It is far less successful in building its own indigenous industry (Sweeney, 1998). Exports were significant in Ireland's economic success in the 1990s, mostly in the high-tech hardware and software information technology, engineering, and pharmaceutical sectors that have enjoyed exponential global demand growth. Foreign-owned firms, which introduced capital, technology, and world-class management techniques, accounted for 95 per cent of export growth, comprising three-quarters of total goods exports. The overseas parents receive payments in royalties, licenses, and other remittances, which results in a large services trade deficit (O'Higgins and Rugman, 2002).
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Figure ii 2.2: GDP and GNP - Development in Ireland since 1960 (CSO, 2003b)
The recent success is visible almost everywhere. Irish growth rates have been the highest among the 15 EU and the 29 OECD member states for several years in the 1990’s. Growth in GDP exceeded a spectacular 10 per cent in 1995 and is still high today. However, Ireland has an unusual and specific problem when its rate of growth is examined. Unlike most countries there is a large divergence between Gross National Product (GNP) and Gross Domestic Product (GDP). The difference is called ‘Net Factor Flows’. For example, in 1997 the gross outflow for Ireland amounted to a massive £9.7 billion, from which inflows of £3.9 billion must be deducted. The net factor flows of £5.6 billion deducted from GDP of £45.9 billion, gives GNP of £40.3 billion. Thus, GNP is a better measure than GDP of the value added accruing to residents of the country. In 1960, the reverse was the case with GNP higher, because of income flows to Irish residents. As a result of this turnaround, GNP growth has been somewhat slower than GDP growth. Since 1960, real GNP has increased about five times while the GDP increase was more than six times (CSO, 2003b). Thus, the GDP is inflated and makes Ireland look richer than it really is (Figure 2.2). However, the unemployment has fallen in recent years. Industrial production is still booming, and foreign investment grew substantially, attracting in some major industries like Intel, IBM, and Hewlett Packard. The US investment firm Morgan Stanley coined the phrase ‘Irish Tiger’. Then the name “Celtic Tiger” emerged because Ireland has been growing in recent years as fast as the four Tiger economies of south-east Asia – South Korea, Taiwan, Hong Kong and Singapore (Sweeney, 1998).
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Figure iii 2.3: National income (CSO, 2003a)
Ireland is now at a very interesting and important stage in its economic and social development. On the positive side, Ireland now has one of the lowest levels of unemployment in the industrialised world and a highly entrepreneurial culture. On the negative side, the health service is of a pretty low standard, the public transport is still terrible, the physical infrastructure in general has failed to keep pace with rapid economic growth, and personal safety and security have been diminished. In addition, a form of inequality is in the disparity in income and living standards between different parts of Ireland. Thus, the right choices have now to be made (Power, 2003c).
To date the corporate tax system has played an important role in influencing market and export-oriented investment. Reforms to Ireland's corporate tax rate necessitated by its EU membership have resulted in the application of a 12.5 per cent corporate tax rate to all trading profits, thereby further enhancing Ireland's overall attractiveness as a location for higher risk/higher reward activities. In addition, this 12.5 per cent rate is set to stay, because in the absence of qualified majority voting, an EU-harmonized tax rate is a highly unlikely possibility. In brief, Ireland's favourable corporate tax system ensures that it will feature very strongly in a company's considerations when assessing strategic locations. The corporate tax rate and the facility (in most cases) to repatriate Irish profits free of further Irish tax offers significant opportunities to companies seeking for locations (O’Connor and Forde, 2003).
Although keen to encourage foreign investment into Ireland, the Irish revenue authorities are very conscious of the need to protect the 12.5 per cent rate from consequent challenges from the EU or other jurisdictions. In this regard, the Irish revenue authorities have recently issued guidance on what constitutes trading. In the current international climate of investment, Ireland is increasingly being selected as a primary location in a number of key global corporate structures that are commercially viable and serve to defer or minimize worldwide tax. The introduction of an EU-approved 12.5 per cent corporate tax rate applicable to all trading operations further enhances Ireland's attractiveness as a location for a broader range of higher risk/reward activities (O’Connor and Forde, 2003). However, Sean Dorgan, the IDA chief, knows that Ireland can’t sell on tax alone. Several Eastern European accession states have lower corporation taxes than Ireland. An Asian example would be Singapore which has a zero per cent tax for ten years for pharmaceuticals (Curran, 2004).
In general, according to the latest edition of Revenue Statistics, the tax burden in Ireland is now the second lowest in the OECD and the lowest in the EU. Between 1985 and 2002, the tax burden as a percentage of GDP in Ireland fell from a high of 35 per cent in 1985 to 28 per cent last year. With 12.5 per cent Ireland has one of the lowest corporate tax rates in the OECD, a rate which compares with the 40 per cent companies pay in the USA (Boyle, 2003).
O'Higgins and Rugman (2002) cite the Economic and Social Research Institute (ESRI 2002) which predicts that the Irish economy is poised to grow more rapidly than its EU neighbours in the medium term, even if there is a temporary slowdown. In recent years, Ireland had benefited from a weak euro, in exports and attracting FDI. Today a stronger euro, while potentially adversely affecting exports, could have its compensating advantages. It makes raw materials and large service import bills less costly. In the year to the end of December 2003, the euro appreciated by more than 21 per cent against the dollar, but in the two-year period to the end of 2003, the euro appreciated by a massive 42 per cent. The equivalent euro gains against sterling have been 8 per cent and 15 per cent respectively (Power, 2004). The appreciation of the euro has made Irish exports more expensive in dollar and sterling terms, but has made Irish imports from those markets cheaper in euro terms. Jim Power (2004: 23), chief economist with Friends First, expects that ‘it is likely to be 2005 before the dollar regains any real strength’. The ESRI predicts that, despite a combination of the world economic situation, currency exchange rate reversals, and falling labour force expansion as the population ages, Irish growth rates will nonetheless achieve 4 to 5 per cent in the medium term, thanks to compensating rises in productivity (O'Higgins and Rugman, 2002).
The consulting company PricewaterhouseCoopers has the same opinion. It thinks that Ireland will return to the long-term target of 5 per cent growth in 2005, because Europe finally recovers from its prolonged downturn. The PwC European Economic Outlook report forecasts that growth for Ireland, measured by GDP, will pick up to around 3.75 per cent in 2004 and to 4.75 per cent in 2005 (Keenan, 2004). Bank of Ireland economist Dan McLaughlin expects a similar growth rate. He thinks that the Irish economy will grow by 4.5 per cent this year and move closer to the type of growth rates enjoyed during the boom years of the Celtic Tiger. The economist based his prediction on a positive outlook for the global economy, which will lead to a rebound in export levels, business investment and consumer spending. Interesting is that both GDP and GNP will grow by 4.5 per cent in 2004. The forecast would make a sharp upturn from the recent growth figures which show that both GDP and GNP expanded by 2.8 per cent in 2003. Finally, the Irish economy will move closer to its 6 per cent potential growth rate, reviving the image of the Celtic Tiger, which some had thought was gone for good (Boyle, 2004).
Ireland's creaking infrastructure is an unintended outcome, as tax cuts exchanged for wage restraint were achieved through public spending cutbacks. This is manifested in shortcomings in public services, including the absence of state support for childcare, lengthening waiting lists in the public health system, resource constraints in education, and the poor quality of physical infrastructure, notably in transport. The same opinion has Austin Hughes, the chief economist of IIB Bank. Hughes (2003: 18) recommends that ‘the Government must ensure that our infrastructure is not that of a developing country’. The Annual Competitiveness Report 2003, published by the World Economic Forum, shows that Ireland is among former Communist countries of Eastern Europe sandwiched between Hungary and Poland with a low infrastructure quality. And there are other topics which give Ireland similar rankings on broadband use, energy facilities, distribution efficiency and adult education and training. Thus, there is still a lot to achieve (Keenan, 2003).
Government investment to rectify those serious infrastructural deficiencies will put a strain on the public finances, especially if promises to reduce taxes are to be kept. In fact, already in April 2002, the OECD criticised Ireland's rising inflation, well above the euro area average, and government fiscal policy, which had turned a sizeable budgetary surplus into a deficit by the end of 2002. However, a National Development Plan for the 2000–2006 period aims to remedy the various inequalities and socioeconomic ills, with a total investment of €52 billion of public, private, and EU funds (10 per cent of the total) in health services, social housing, education, roads, public transport, rural development, industry, and water and waste services. Much remains to be achieved over the next time (O'Higgins and Rugman, 2002).
Recently Porter (Power cites Porter, 2003b) warned that too many Irish take prosperity for granted. The Irish economy moved sideways over the past two years and now the Republic will come under increasing pressure from emerging Eastern Europe states. Due to rising cost levels, Ireland’s traditional position as a low-cost location to serve European markets will become untenable. Porter concluded that the country has identified many of the key steps that need to be taken - now it is a matter of persistence and implementation. In addition, an Accenture survey found that companies face strategic choices about how to position themselves in a bigger and potentially more competitive EU market. The nature of foreign direct investment will also change, which means mergers and acquisitions, partnerships and outsourcing activities are expected to increase. For some Irish companies this might mean expanding to the accession countries, but it could also mean that the accession countries become a huge competitor for Ireland for foreign direct investment. The benefit to Ireland in particular is that the potential to increase growth in exports is massive. It is expected that the accession countries become wealthier and have increases in disposable incomes. Thus, they will become new and good markets for Irish products (Larkin, 2004).
Which issues does Ireland have to consider in the future? There are several threats to the boom. The government could undermine the boom with inappropriate policies. If there is an over-dependency in one industry, a fall in demand could hit the economy hardly. Tax changes in the US or in the EU might cause disinvestment by multinational companies. A general downturn in world economy could also hit Ireland hardly. These are only some examples. Many of the potential problems can be dealt with by the Irish themselves, thus they have their future in their own hands (Sweeney, 1998).
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