Irish Outward Foreign Direct Investment - The Future Impetus for Economic Growth

The rapid globalisation and ever increasing integration of the world economy has made Foreign Direct Investment (FDI) a topical and controversial issue. Historically, the importance of inward FDI has dominated the economic and political agenda in Ireland. Nevertheless, it is the collective view of the authors that the growing importance of FDI from Ireland merits greater consideration. This paper intends to analyse this issue in the following way.

• Colm analyses and explains recent global trends in FDI flows with particular reference to the Irish context;
• Eoghan, quoting recent empirical evidence, examines in greater detail the effects of outward FDI for the Irish economy;
• Connor, using three specific examples, combines empirical evidence with the theory behind corporate FDI decision making.

Benefits and costs to the Irish economy of outward FDI will also be examined in depth.

In essence, FDI is categorised as occurring when capital is provided (either directly or indirectly) by an investor based in one country (the home economy) to an enterprise resident in another country (the host economy). The importance of FDI has become increasingly evident against the backdrop of a rapidly evolving globalised economy.

At a global level, the growing importance of FDI is clearly evident. In 1995, outward flows of direct investment stood at $338.73bn, an immense figure which represents a 68.1% increase in flows since 1992. Given real GDP growth rates of approximately 2.0% during the same period, this represents substantial growth in FDI during the last number of years. Not surprisingly outflows from the developed world have risen significantly. In the period 1985-1995, outflows from the EU tended to rise at a fairly uniform rate with 1992-95 showing an increase in outflows of 34.9%.

Ireland however, follows neither a global nor an EU trend in either outflows or inflows of FDI. Between 1985-95, Ireland was the recipient of huge amounts of FDI inflows. The 648.96% increase during the period 1985-90 is remarkable and reflects the significant changes that occurred in the Irish economy during the late 1980s. Given the magnitude of these foreign investment flows into Ireland it is not surprising that study and research on FDI and Ireland has concentrated upon Ireland's status as a host economy.

Table 1: Inward and Outward FDI Stock as a Percentage of GDP, 1985-95.

Source: UN World Investment Report 1995

Table 1 provides further evidence of why inward investment is of such importance to the Irish economy. Ireland receives considerably more FDI inflows than the EU average. In 1995, FDI into Ireland accounted for 20.2% of GDP. Irish outward FDI is well below the EU average, but given the upward trend evident since the 1980s and the current strength of the Irish economy we anticipate that the 1995 figure of 6.5% of GDP will continue to grow. FDI outflows in 1995 were measured at $820m. For a small economy this represents a significant amount of investment and it is important to ask why Irish firms wish to invest abroad and whether such investment is in the interest of the Irish economy as a whole.

We have also included the statistics for Switzerland to demonstrate the fact that a nation can be both a successful host and home economy for FDI. Switzerland has an inward investment stock of 18.8% of GDP, well above the EU average of 13.2%. More remarkable though is the 47.0% figure for outward FDI stock as a percentage of GDP, more than three times the EU average of 14.6%. Given Switzerland's status as one of the world's most successful and affluent economies, these figures provide clear empirical evidence that both inward and, more relevantly (given the nature of this paper), outward FDI can contribute to the economic prosperity of both host and home countries.

To many, the concept of Irish companies investing abroad is the clearest sign yet of the growth and maturity that the Irish economy has experienced in relatively recent times. Historically, Ireland has always been associated with attracting inward investment; the IDA's record, ever since Sean Lemass altered the country's economic outlook in the 1960s, continues to be impressive to such an extent that Ireland ranks as one of the premier European destinations for multinational corporations (MNCs) to locate. However, in recent times, much has changed, not just from an Irish perspective, but crucially in a global economic context. As the UN World Investment Report stated in 1995:

In general world leaders have begun to look more favourably on free trade thus removing restrictions on Foreign Direct Investment (FDI) and correspondingly paving the way for phenomenal growth in the movement of capital. A series of bilateral, regional, and multi-lateral agreements have been constructed in tandem. Of most relevance to Ireland has been her membership of the European Union. The completion of the Single Market (soon to be further consolidated by a single currency) and the lifting of capital controls after Maastricht in 1992, means that Ireland has become part of a truly integrated economic region, with all the opportunities and challenges that such a scenario entails. The Uruguay Round of GATT (now the World Trade Organisation) also resulted in a number of accords relevant to investment flows and crucially tied in the area of services, a sector that now accounts for over half of all investment flows.

Such world-wide liberalisation has increased international competition on nearly all fronts - as a result, investment abroad for firms is now a serious consideration to counter substantial domestic competition as well as enabling firms to establish themselves in new and potentially fertile markets. This liberalisation of trade has resulted in a huge rise in the number of firms establishing themselves outside their home environment, thereby reducing market niches and increasing competitive pressure everywhere. Given these changes all developed economies, including Ireland's now realise the need for a liberal outward FDI policy, to ensure that domestic firms continue to be competitive and to exploit cost advantages in other countries. Outward FDI is therefore a strategic option that can benefit not just the firms involved but also the national economy.

Realising the importance of FDI, governments now tend to actively encourage outward investment, although there are a number of exceptions, most notably Japan. However, the Irish government tends to offer little more than informational and technical assistance. Tangible financial support for prospective investors must generally be sought from EU agencies such as the European Investment Bank. In 1988, the European Community Investment Partners Programme was created. Extended in 1992, the programme helps to finance all stages of an investment project. Grants, interest free loans and even co-financing of investment projects are all considered. Critical though, is the fact that large MNCs are ineligible for the scheme, which is aimed exclusively at small and medium sized companies, which most need assistance to compete internationally.

Ireland's leading companies have expanded abroad successfully, largely by foreign acquisition. The main targets have been the US and the UK, locations which boast strong and politically stable economies, no language barriers, and large markets that can be strategically targeted. As Alan Doherty of AIB Corporate Finance recently confirmed:

However, as can be seen in table 2, Irish companies have not restricted themselves purely to Anglo-American ventures, and indeed the vertiginous collapse of the communist system in Eastern Europe has presented further opportunities.

Table 2: Examples of Foreign Acquisitions by Irish Companies during 1997.

Source: The Irish Times 31 December 1997

It is the collective view of the authors that an expanding Irish economy provides opportunities for firms to seek higher social returns on capital abroad rather than at home. Furthermore, profits earned by Irish multi-nationals can be repatriated homeward, thus benefiting the exchequer and shareholders alike.

The recent zeal, with which outward FDI has been pursued, has been driven by the strength of the Irish economy. Many companies have reduced their debt levels and this, coupled with the strength of the equity markets, has freed pent-up capital resources.

As outlined earlier, governments increasingly recognise that, given the reality of the global economy, domestic firms must be given the opportunity to establish themselves abroad, if they are to benefit from economies of scale and compete effectively against foreign competition. Outward FDI is therefore a strategic option that must be left open to firms. An excellent example of an Irish firm that has successfully expanded its operations abroad to compete internationally is the Smurfit Group. If Smurfit had been limited to simply investing and operating in the Irish market, the firm would never have benefited from economies of scale and the huge global market to which it now has access.

This study found that a 1% increase in FDI to a 'host' led to a 0.25% increase in exports from the 'home' country to the 'host'. Thus, there is strong empirical evidence that outward FDI is positively correlated to improved export performance.

Such powerful motives for encouraging outward FDI must be balanced with what certain commentators see as costs of FDI to the Irish economy. One of the major critiques of investing abroad relates to the question of employment. Many, especially in political circles, view outflows of FDI as little more than an export of jobs, especially in the form of de-localisation, which can entail the transfer of production facilities abroad and therefore the loss of jobs in the home economy. Given that employment is such a sensitive issue in both political and economic terms, this can provide a major problem for governments. This was well illustrated recently in the USA during the debates which surrounded the NAFTA negotiations. Many in the USA, including Presidential candidate Ross Perot, felt that the cheaper Mexican labour market would draw investment and jobs away from the US. The ensuing controversy prompted a number of studies on potential employment effects, however the US Department of Commerce ultimately concluded that:

Nonetheless, in an Irish context, there are many who claim that 'exporting' jobs and capital is a poor use of resources considering that the Celtic Tiger is still plagued by long term unemployment, external debt, large pockets of poverty, and deprivation. There is also evidence that supports the claim that certain overseas ventures have been both unwise and costly to the Irish economy.

As stated above, for many companies, FDI is a strategic option. However, in the context of a small open economy (such as Ireland), FDI is imperative if indigenous companies are to grow into successful global corporations where the potential of economies of scale can be realised.

Technological patents, brands and legal rights to raw materials often form the ideal base for corporate expansion. For example, many companies that develop expensive in-house software and IT systems can extend that technology to their foreign operations at a relatively low marginal cost. Skilled labour and access to finance are further examples of corporate assets that can be readily transferred to foreign operations. Ownership advantages are essentially competitive assets that can only realise their full potential if utilised on a global scale. Thus, they are often a powerful force behind FDI.

Due to the presence of market imperfections, many companies are simply unable to sell their ownership advantages, i.e. new technology to other firms. Therefore, the original owners are left with no option but to exploit the advantage themselves.

• Market imperfections are pervasive and omnipotent;
• The costs of negotiation, especially legal costs and stamp duty, are often prohibitive;
• Opportunism poses a great difficulty. How does one sell a new technology without revealing all to the potential bidder?
• Offer price will not reflect the true value of the new product, as the buyer cannot be certain a priori that the new technology will be valuable.

Such market imperfections often compel companies to internalise their competitive advantages, thus leading them to engage in FDI activity.

Many companies engage in FDI activity in order to benefit from locational advantages such as low transport costs, government assistance, and various factor endowments. The essence of competitive advantage is whether it is optimal for a company to expand abroad or domestically, thus, it is purely a question of comparative advantage.

Indeed, by analysing the aforementioned companies in greater detail, it is our contention that further aspects of outward FDI from Ireland can be revealed.

Waterford-Wedgewood's FDI policy has been a function of capitalising on ownership advantages in the form of brand and reputation, while seeking to create a competitive advantage through geographical diversification, so as to reduce its exposure to regional cycles. Internalisation advantages do not appear to have been a force behind the company's FDI policy, as they have been able to license their products successfully.

It is ironic that Smurfit PLC, who were originally against free trade in Ireland, have now become, arguably Ireland's most successful multinational. Since going public in 1964, Smurfit have diversified geographically, by seeking to realise the benefits of both locational and ownership advantages. For example, Smurfit have sought to realise locational advantages through investing in the timber rich Americas. Smurfit has also enjoyed ownership advantages through its management skills and via access to relatively cheap, finance such as junk bonds, for a time. Given the complexity and competitive nature of the paper processing industry, Smurfit has been reluctant to license its technology and so has sought to internalise its competitive advantages. The Smurfit group has global operations across five continents.

The above evidence demonstrates the following points about Ireland's pattern of outward FDI:

• Outward FDI is geographically dispersed, with a heavy preference towards the US & UK;
• The importance to the home economy (i.e. Ireland) cannot be overestimated as can be seen from the above figures;
• Manufacturing companies have been quick to invest abroad, but in recent times, financial service companies have adopted aggressive FDI strategies too. It is worth noting that many of the largest recent acquisitions have been by services companies, i.e. AIB's take-over of Dauphin Deposits, and Capital's take-over of Hermes Property. This final feature reflects the increasing importance of the services sector to the Irish economy.

Theory has shown that capital movement and flows of international investment are beneficial to both the home and host country, Ireland is no exception in this respect. In 1995, outward FDI stock from Ireland stood at 6.5% of GDP (see table 1) and although this represents significant growth, Ireland still lags well behind the EU average of 14.6%. Therefore, given Ireland's convergence towards EU norms in other economic areas, it can be anticipated that the current upward trend evident since the 1980s in outward FDI flows will continue.

In the final analysis, we would concur with the 1995 European Commission White Paper, which concluded that: