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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

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Globalization and economy a small country perspective

Globalization and economy: a small country perspective

Jaakko Kiander

Government Institute for Economic Research

Globalization and economy a small country perspective1
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
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
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
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
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
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
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
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
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
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
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
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
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
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 model1
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
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
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
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 regime1
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
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
Export-led growth

  • Policy priority: growth of exports

Experiences and lessons
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
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
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
Role of policy 1/3 industrial production?

  • 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
Role of policy 2/3 industrial production?

  • 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
Role of policy 3/3 industrial production?

  • 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