University of Iceland May 12th Helga Kristjánsdóttir

Transcription

1 University of Iceland May 12th 2012 Helga Kristjánsdóttir

2 The sagas of Icelanders tell about how Vikings settled in Iceland, with about third of them coming from Ireland (Hallgrímsson et al., 2004). Not only is the population of similar origin, but the two islands are also of similar geographical size (IMD, 2012). Also, being positioned in the North Atlantic, Iceland and Ireland are on the edge of Europe, which offers the potential to analyze economic geography (Krugman, 1991). The economic geography perspective, taken with some features of the gravity model (Markusen, 2004) is here combined with factors in the political environment, to analyze the recent crises in these countries.

3 This is where the saga of this paper begins. The two economies went through some pretty extreme economic crashes. Both are no strangers to difficult times, unfriendly weather, challenges in harvesting from land and sea, and fiercely independent residents rising up against oppressive colonial rule, all testing their tolerance. This has shaped the culture of these countries (Hofstede, 2001). At the time of the crash, one had the Euro, and the European Central Bank as the lender of last resort, one did not. Does this matter in putting a country on the path of recovery? Does it help with political stability, or at least the perception of it?

4 What is of major concern in this research is how the global economic crisis affected foreign direct investment (FDI) in the two different countries? To answer that, the analysis includes variables accounting for political instability and government reaction. How did these countries work it out, and what might come next? What can be taken away from the experience of these countries in the past decade, which can use to make a more informed decision about the future? How did these two countries fare relative to countries outside Europe in terms of attracting FDI during the period studied?

5 Is it possible that this experience offers lessons that can be useful for other countries as the troubled economic times continue? FDI has not been a significant factor for either country for very long. Measurement only started in the 1970s so we re dealing with relatively blank slates, thus allowing us to watch as the market grows up. Plus, such small countries are only in a few different sectors, so it s easier to get a picture on what the major economic players are for each country.

6 We are interested in capturing increasing returns to scale and imperfect competition that are accounted for in the new trade theory and the new economic geography. The economics of scale, extremely important for these two small economies, is accounted for by population size and gross domestic product along the lines of the Bergstrand s (1985) gravity model. Furthermore, we use elements from the Knowledge Capital model introduced by Markusen, Venables, Konan, and Zhang (1996), by incorporating skilled labor, which has proven to be important in this perspective (Kristjánsdóttir, 2010).

7 Several analyses (Halldorsson and Zoega 2010, Benediktsdóttir et al. 2011, and Magnússon 2011) have sought to analyze the effects of the crises on Iceland and Ireland. However this is the first time FDI into these two countries is analyzed specifically, in comparison with a selection of other countries.

8 Going back to the geographical dimension of the Iceland Ireland saga, then Iceland is not only more distant from Europe, but also distances itself more by not having EU membership or the Euro. This last fact may actually have helped Iceland in adjusting itself better to the current economic situation. Our data account for EU membership, and we seek to analyze whether EU or non-eu membership affected the way these countries tackled the problem. We combine the effects of the trade bloc membership with factors like economic size, and language.

9 Since this research focus is on inward foreign direct investment FDI to Iceland and Ireland, the basic model specification accounts for this and is the following: This is the Bergstrand (1985) gravity model specification explaining trade volume from country i to country j, over time t. The trade volume is explained by country s i gross domestic product over time Yit and country s j gross domestic product overt time Yjt. Also, distance between country i and j is accounted for by Dij and the variable A accounts for other factors. Furthermore, ζ_(ij,t) is a log-normally distributed error term, with E(ln(ζ_(ij,t)))=0.

10 The primary focus will be on inward foreign direct investment. To put Iceland and Ireland in an international perspective, not only the other European countries will be considered, but a larger selection of countries. The dataset runs through the eleven year time period from 2000 through This research uses foreign direct investment (FDI) inward stocks, USD million (OECD, 2012). Also gross domestic product GDP at current price and current exchange rates reported in USD million (OECD, 2012).

11 For our analysis we include the 34 member countries of OECD. These are Australia, Austria, Belgium, Canada, Chile, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Israel, Italy, Japan, Korea, Luxembourg, Mexico, Netherlands, New Zealand, Norway, Poland, Portugal, Slovak Republic, Slovenia, Spain, Sweden, Switzerland, Turkey, United Kingdom, and the United States. We also seek to take the G-20 countries into account by additionally including Argentina, Australia, Brazil, China, India, Indonesia, Russia, and South Africa. However, Saudi Arabia is not included since data on FDI is not reported by the OECD (2012).

12 Population accounting for market size is obtained from the infrastructure IMD (2012) in millions. Risk of political instability obtained from data on government efficiency part in the IMD (2012), based on an executive survey based on an index running from 0 to 10. With the risk of political instability being very low if the value is high, based on the statement: The risk of political instability is very low. Also, from data on government efficiency, information on government decisions is obtained with the statement: government decisions are effectively implemented, taken from an executive survey based on an index from 0 to 10 (IMD, 2012).

13 Moreover, from the business efficiency section of the IMD (2012) investment risk is obtained as Euromoney country risk overall (scale from 0-100) and the variable for skilled labor represents: Skilled labor is readily available and comes from and IMD executive survey based on an index from 0 to 10. Furthermore, country credit rating is from a rating on a scale of assessed by the Institutional Investor Magazine. The country credit rating comes from the section on corporate tax rate of the IMD (2012).

14 The European Free Trade Association EFTA was founded in 1960 by Austria, Denmark, Norway, Portugal, Sweden, Switzerland and the United Kingdom. In 1961 Finland joined EFTA, and in 1970 Iceland also joined. In 1972 Denmark and the United Kingdom leave the EFTA trade bloc to join the European Economic Community EEC. Portugal leaves EFTA in 1985, and Liechtenstein joins EFTA in In 1995 Austria, Finland and Sweden choose to leave EFTA and join the EU. In 2009 Iceland applies for EU membership (EFTA, 2012). Member countries of EFTA as of 2012 are Liechtenstein, Iceland, Norway, and Switzerland.

15 The North American Free Trade Agreement NAFTA went into effect in 1994, with member countries being Canada, Mexico, and the United States. Before that the Canada-US Free Trade Agreement FTA was concluded in 1988 (Britannica, 2012). The NAFTA dummy used in this research applies to both FTA and NAFTA, with the US and Canada having membership for the whole period analyzed and Mexico joining in 1994.

16 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 p Q1 Q2 Q3 p p Figure 1: FDI Inflows Q Q US$ billion World OECD G EU Source: OECD (2012).

17 p US$ million Figure 2: FDI Inflows in Iceland and Ireland Iceland Ireland Source: OECD (2012).

18 ln(fdi j,t ) = β 0 + β 1 ln(gdp j,t ) + β 2 ln(pop j,t ) + β 3 SKILLS j,t (1) + β 4 CREDIT 2 j,t + β 5 RISK 2 ij,t + β 6 INSTB 2 j,t + β 7 GMT 2 j,t + ε j,t Table 1. The Basic Model Specification Estimation Results Robust lnfdijt Coef. Std. Err. t P> t [95% Conf. Interval] lngdpjt lnpopjt SKILLSjt CREDITjt RISKjt INSTBjt GMTjt _cons Number of obs = 367 F( 7, 359) = Prob > F = R-squared = Root MSE =.6031

19 ln(fdi j,t ) = β 0 + β 1 ln(gdp j,t ) + β 2 ln(pop j,t ) + β 3 SKILLS j,t (2) + β 4 CREDIT 2 j,t + β 5 RISK 2 ij,t + β 6 INSTB 2 j,t + β 7 GMT 2 j,t + β 8 EU j,t + β 9 EFTA j,t + β 10 NAFTA j,t + β 11 English j + ε j,t Table 2. Trade Blocs and Language Added to the Specification Robust lnfdijt Coef. Std. Err. t P> t [95% Conf. Interval] lngdpjt lnpopjt SKILLSjt CREDITjt RISKjt INSTBjt GMTjt EU EFTA NAFTA English _cons Number of obs = 367 F( 11, 355) = Prob > F = R-squared = Root MSE =.57564

20 ln(fdi j,t ) = β 0 + β 1 ln(gdp j,t ) + β 2 ln(pop j,t ) + β 3 SKILLS j,t (3) + β 4 CREDIT j,t + β 5 RISK ij,t + β 6 INSTB j,t + β 7 GMT j,t + β 8 EU j,t + β 9 EFTA j,t + β 10 NAFTA j,t + β 11 English j + ε j,t Table 3. Time Period from , Iceland and Ireland Excluded. Robust lnfdijt Coef. Std. Err. t P> t [95% Conf. Interval] lngdpjt lnpopjt SKILLSjt CREDITjt RISKjt INSTBjt GMTjt EU EFTA NAFTA English _cons Number of obs = 232 F( 11, 220) = Prob > F = R-squared = Root MSE =.54952

21 Table 4. Time Period from , Iceland and Ireland Excluded. Robust lnfdijt Coef. Std. Err. t P> t [95% Conf. Interval] lngdpjt lnpopjt SKILLSjt CREDITjt RISKjt INSTBjt GMTjt EU EFTA NAFTA English _cons Number of obs = 117 F( 11, 105) = Prob > F = R-squared = Root MSE =.56792

22 Table 5. Time Period from , only accounting for Iceland and Ireland. Robust lnfdijt Coef. Std. Err. t P> t [95% Conf. Interval] lngdpjt lnpopjt SKILLSjt CREDITjt RISKjt INSTBjt GMTjt EU _cons Number of obs = 12 F( 8, 3) = Prob > F = R-squared = Root MSE =.59054