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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
  • 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
  • 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
  • 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