pondelok, februára 05, 2007

Silent Promises, Shining Performance - Why Tiger Economies Roar Louder


In a very much popular and well addressed column Thomas J. Friedman of New York Times briefly points out the outcome of Ireland’s rapid transformation to a dynamic, richest and powerfully growing economy:

“Today, 9 out of 10 of the world's top pharmaceutical companies have operations here, as do 16 of the top 20 medical device companies and 7 out of the top 10 software designers. Last year, Ireland got more foreign direct investment from America than from China. And overall government tax receipts are way up.”

Comparably small economies tend to absorb real comparative advantages faster than their larger counterparts. The shift towards the adjustment demanded by a need to sustain higher rates of economic growth is much easier and thus the cost burden of the transformation is not as big as in larger economies. From another perspective, being in a battle of global market game presents an opening challenge to small caps and dynamic companies. On the other side, the role of fiscal policy is sometimes essential. Taking an expansionary approach to fiscal policy could pose a threat to the macroeconomic stability as well as hard pressures on public finance continue to grow when the fiscal policy is on a deep march. A more restrictive approach to managing a fiscal policy could vastly reduce at least a portion of macroeconomic risk. In Norway, where 20 percent of the GDP present oil revenues macroeconomic policymakers relied on a less risky approach to sustaining the macroeconomic situation on keeping low pressures on public finance. Despite pouring revenues from oil companies, a huge amount of welfare spending could continually undermine the ability of the business sector to compete internationally. Going back to small economies, expansionary fiscal policy implies an unadjusted risk to the stability of public finance. Recent trends and research finding have shown that increasingly ageing population has become an influential factor of putting even more pressures on public finance. Italy, Germany and France – all of them are facing a severe situation in which unadjusted and politically powerful decisions are about to be the parallel of the relative stagnation in the future.

Many people are asking upon how Ireland could become an economic tiger of Europe? Several chapters open this particular question. The proponents of statism say that Ireland is an example of how a vast amount of politically financed structural resources can be successful. This statement truly blends the whole story and depicts Ireland as an economy in which government intervention took place in launching a process of real GDP convergence. In contrast to European economies, where trade unions and interest groups abuse their status for maintaining a “status-quo”, trade unions and the federation of employers relied on a different consensus far beyond the continental tradition. They actually decided not to hinder economic growth through the introduction of rent-seeking. The promotion of Foreign Direct Investment coupled with low tax rates on corporate income and significant openness to global competition has resulted in the highest average economic growth rate in Europe. In 1980s, Ireland grew by 80 percent a year. This has paralleled with an astonishing level of economic freedom. Today, Ireland is indeed, the freest economy in Europe.

Why global companies decided to set their facilities in Ireland? First, there is a 12,5 percent corporate income tax rate, which is, after 11 percent corporate tax rate in Cyprus, the lowest in the EU. Irish market offers stimulating enhancements which no other country in Europe can. There is a good transportation connection with both sides of the Atlantic, while logistics connections enable companies to spread their distribution nets to the U.S. and the EU much more flexible than in other European country. As to labor market, dynamic, flexible and propulsive labor market is essential to stimulating economic growth away from restrictive government regulation. The Irish level of productivity has risen dramatically since 1990s. The analysis of labor behavior has shown surprisingly high proportion of responsiveness to changes. If we take a closer look, then we see that high level of high-tech export (53 percent) explains very much about Irish productivity growth. Mr. Michael S. Dell explains how Ireland’s openness attracted Dell to invest in Ireland;

“There's a connection between the humble circumstances of a start-up business and a small country on the periphery of Europe. There's a link between a country that works to become a technology powerhouse and a small company that does the same. And there's a bond among groups of people who have overcome great challenges and great odds to achieve what they dared to dream.”

Today Ireland has achieved much higher levels of prosperity as a result of free-market policies away from burdensome government regulation. It is thoroughly important for small countries to be opened for globalization. Protectionism and the injection of its effect could blur their agility to sustain high levels of economic and productivity growth. In Eastern Europe, Estonia has been the very first country to enact free-market reforms under the leadership of Mr. Mart Laar. At the beginning of economic transition to market economy, Estonia was faced with high inflation rate and a huge decline in GDP. The stabilization program was successfully enacted and economic reforms were ambitious. Progressive tax rates vanished and the flat tax code came into action. Tariffs and trade barriers were almost entirely abolished and in the years that followed, Estonia experienced an economic boom of free market expansion. Capital flows of Foreign Direct Investment increased rapidly. It was very hard to notice fiscal pressures on the stability of public finance. Banking sector, which a complementary component for the market growth in business sector, was completely liberalized and the rigidity of wages did not subvert under government restriction while the price controls were abolished as well. Astonishing economic performance of the country from the East enjoys very much enviousness from Western policymakers:

“French and German leaders complain that Estonia and other flat tax countries practice "tax dumping," using their rock-bottom rates to attract foreign investment. The solution, they say, is for European countries to harmonize their taxes, a proposal that gives most Estonians disquieting memories of their centrally planned past within the Soviet Union.”

It is relatively simple to answer why small economies can grow much faster than their big nanny neighbors. First, small economies tend to adjust to real comparative advantages faster. Second, low compliance costs and sound capital markets enable companies in small countries to feel more dynamic so that productivity growth is implied through the flexibility of labor market. Third, small economies can easily open themselves to global competition. Fourth, human capital investment plays a marginal role in sustaining high level of economic growth. Fifth, transparent and uncomplicated tax systems which have been enacted mostly in smaller economies tend to accelerate the speed of convergence much faster as increased capital flows, low levels of taxation and investment incentives “dynamize” the entrepreneurial development as well as its expansion to go global. Sixth, flexible labor markets enable individuals in small countries to expand their mobility faster. High level of mobility means a higher level of responsiveness to unpredicted changes.

Estonia, Iceland and Ireland have experienced a tremendously rapid economic success in the past decade. It is not just because they have been small; it is also the result of openness to global competition and serious structural reforms that stimulated the economic change at a much higher level. Small countries, such as Estonia, were the pioneers in implementing free-market policies. Nanny-flushing policymakers in Western Europe explicitly oppose tax competition and similar free market reforms. As those countries are faced with negative economic projections for the future, tax cuts and structural reforms will still be needed in a very intense exercise.

Rok SPRUK is a supply-side economist and a classical liberal. He currently lives in Slovenia where he studies economics. His fields of research are economic growth, macroeconomics, monetary economics, international economics, tax policy and international competitiveness. His articles, observations, views and ideas are posted on his blog Capitalism & Freedom