Tuesday, September 23, 2014

23/9/2014: EI Conference: Domestically-Anchored Globally Open Entrepreneurship

Yesterday, I was asked to say a few words on the challenges and opportunities facing Ireland's economy in the near term future for the Annual Conference held by the Enterprise Ireland. Here are my comments.

"Ladies and Gentlemen,

I would like to thank you for this opportunity to speak to such a distinguished group of professionals who represent the organisation that is responsible for helping Irish indigenous enterprises to grow, develop new markets and increase their value added to the economy.

Global economic environment and Ireland

Let me start by briefly outlining the global economic environment in which Ireland operates today, focusing on both the immediate challenges and opportunities in the next 12-24 months, as well as further afield, into 2017-2020. It is worth stressing beforehand that opportunities and challenges go hand-in-hand and should not be viewed as opposing concepts. An opportunity not pursued is a challenge unmet. A challenge met is an opportunity pursued.

Firstly, analysts’ forecasts generally agree that the global economy is currently moving toward the post-crisis growth trend. The worst of the Great Recession is over, but pockets of structural weaknesses and real pain of economic displacement remain.

Our two major trading partners: the US and the UK are
Delivering rates of growth consistent with those at or slightly below the pre-crisis averages of 2.5-3%
But, this growth is still excessively reliant on monetary policy supports, rather than investment, productivity expansion, external trade growth and/or domestic consumption.
The problem of private and public debt overhang still looms, like a dark shadow, over both economies, presenting a risk of a slowdown in the rates of growth toward 2%.
These risks are even more material in the context of potential effects of the monetary policy tightening that the markets currently expect to take place some time in Q2-Q3 2015.

In the euro area, growth is showing some promise of a fragile acceleration starting with Q3-Q4 2014 and into H1 2015.
However, the rates of growth achievable in Europe remain below the already less-than-impressive pre-crisis trends.
Again, looking at consensus forecasts, we can expect growth around 1.2-1.5% in 2015, rising closer to 2% in 2016.
This assumes no significant adverse shocks from either external sources or from those originating in the euro area.
As with the US and UK, lack of investment, slow productivity growth, and debt drag on consumption represent the biggest challenges alongside fragmented financial markets and sovereign debt bubble that is putting a superficial shine on the dire state of public finances.
As with the US and the UK, growth is still reliant on monetary accommodation and is subject to significant forward risks once the accommodative stance by the ECB is reversed in time.

In the rest of the world:
Commodities dependent economies of Australia and Canada are facing significant risks of unwinding large asset bubbles and economic imbalances built up in boom years. Australia is more vulnerable here than Canada, both in terms of the extent of the bubbles in its domestic economy and its exposure to the slowdown in global demand for commodities, especially to downward pressures in demand coming from China.
Amongst BRICS, Brazil, China and Russia are facing structural pressures - all arising from different driving factors, but all substantial and extremely dangerous to regional and global growth prospects.
Brazil is in a recession and is running out of the road finding sufficient credit supply sources to continue funding public investment boom that sustained the economy.
China is facing a gradual de-acceleration of growth toward 5-5.5% per annum, in a 'good' or ‘benign’ scenario, and is nursing a substantial risk of a sudden break on growth if the investments bubble collapses rapidly.
Russia is amidst a geopolitical turmoil surrounding the Ukrainian crisis, but below these immediate concerns, structural growth slowdown is working to push post-crisis longer-term growth rates closer to 2-2.5% per annum.

Overall, we are looking at the global growth rates in the region of 3-3.5% and advanced economies growth rates around 1.5-2.5%.

Ireland’s position in the global environment currently represents an outlier. Stripping out superficial boost to growth in H1 2014 achieved primarily via reclassifications of the National Accounts, our economy is, at last, showing some changes in the previous post-crisis trend. Prior to 2014, our economic growth dynamics could be characterised as flat-lining with some short term volatility around near-zero growth trend. In more recent months, we are witnessing a gentle uplift in the flat trend, which is most certainly a heart-warming experience. Much of the positive momentum today, just as positive growth supports over recent years (since at least 2011) is down to our exports performance, especially in the indigenous sectors. This performance, strong as it may be, is only partially offsetting the negative trends in multinationals-supported exports of goods (the ‘patent cliff’) and is largely obscured in the national accounts by the superficial boom in MNCs-driven ICT services exports. Nonetheless, given much higher employment and national income intensities of indigenous exports, this domestic exports growth is one of the core drivers, in my view, of the improvements in Irish economy.

Looking beyond 2014, we are likely to see continued upward momentum in the Irish economy, albeit still at subdued rates. Growth of 2.5-3%, once we strip out changes in the National Accounts methodology is possible for 2015 and 2016, should we stay the course on fiscal consolidation and reforms, and assuming we are not heading for a new credit and real estate investment bubble. Trade prospects for Irish exporters should remain relatively robust, but rates of growth in our exports to our traditional partners are likely to come under some pressures, while our exports penetration into new markets are at the risk due to the factors mentioned above.

Global trade will suffer in the 'slow burner' global growth environment. Margins are likely to fall, growth is likely to slow down or remain capped at around 3.5%, and the process of trade regionalisation will accelerate, in part driven by higher volatility in the exchange rates, regionalisation of financial services and credit markets, and by on-going shifts in global supply chains. All of the above factors will present significant challenges for our indigenous exporters.

However, the said challenges will also present some significant opportunities for Ireland. And in the longer term, gradual unwinding of the debt overhang in the advanced economies over 2015-2020 will strengthen both the traditional trade channels from Ireland into North American and European markets, while continuing to open new channels to middle income economies of Asia-Pacific, Latin America and BRICS.

What does addressing these challenges and capturing the related opportunities require from the Irish perspective?

The key issues, both on the threat side and in terms of opportunities, over the next 2-5 years will be the following:

1) Shifting economy toward more intensive indigenous growth. Currently, shares of exports and domestic consumption supplied by domestic producers are insufficient to address the threats to Ireland's FDI-based development model. In simple terms, Ireland needs to replicate the successes in the area of FDI, delivered over recent decades with the help of IDA, in a new area, the area of driving up indigenous firms growth and creating, attracting, retaining and enabling a new economy in Ireland: economy based on high quality human capital, world class open model of entrepreneurship, and increased focus on high value added strongly differentiated activities.

2) This challenge is coincident with tax regime reforms that started with G20 and G8 push last year and will continue, in my opinion, beyond the OECD's "Action Plan on Base Erosion and Profit Shifting” that will be unveiled in 2015.

3) Parallel to these, regionalisation of trade is shifting large-volume supply chains closer and closer to end-users. This dis-favours Ireland as a basis for real activity and requires addressing this risk by increasing our product/service differentiation.

4) Related to the above, there is an urgent need to focus on increasing value added in our indigenous agricultural, manufacturing and services sectors, both for domestic markets and exports. So far, we have pursued an early stages development strategy to deliver competitiveness - a strategy of wage moderation. This is driving down domestic demand, but also capping our ability to Create, Attract, Retain and Enable a deeply integrated base of top quality human capital. The result of racing to the bottom in wages costs is holding back indigenous innovation, but also the rate of adoption of innovation and productivity growth in the MNCs and larger indigenous enterprises sectors, reducing quality of production, specialisation and supply in the public and private sectors. It is also supporting growth in wealth inequality and suppresses our economy's ability to meet future challenges mentioned earlier. Ironically, wages competitiveness is also creating huge imbalances in the stock of human capital in Ireland, promoting accumulation/concentration of human capital in firms with superficially high (tax arbitrage-supported) productivity MNCs and restricting flow of human capital to indigenous innovators.

5) A major opportunity, yet to be fully tapped, is presented by focusing on an open entrepreneurship model that favours high value added manufacturing and internationally traded services. We are still less active in the global race for entrepreneurial talent than we should be. And we are lagging in projecting Ireland as thought- and policy-leader in this space. We must make Ireland synonymous with entrepreneurship and openness, not with tax arbitrage opportunities. And we must make Ireland’s ‘brand’ visible to would-be entrepreneurs, investors and trading partners around the world.

6) Related to the point above, there are multiple opportunities open to Ireland to compete more aggressively in developing an economy based on value added through user-experience and industrial design, product and service innovation, creativity and, yes, the perennially talked-about R&D. Ireland lags in presence in the world markets in terms of recognisable brands, products, end-user services that are ambassadors for this economy's productive capacity. With exception of Ryanair, Kerry Group and a handful of others, like Dairymaster, too few of our companies have direct reach into global supply chains with offers that are differentiated sufficiently to withstand regionalisation of trade. The added risk arising from the lack of defined differentiation for our producers in the global markets is the added exposure to the exchange rates volatility and thus to the monetary policy shifts that are likely to come over the next 12-24 months. It is heartening to know that Enterprise Ireland's work has been and remains one common support base for the majority of our most successful companies. But it is depressing to know that our policies on migration, taxation, trade facilitation, R&D and enterprise investment remain focused more on FDI and the adjoining sub-sectors, such as ICT Services, and not on a consistent building up of the entrepreneurship and human capital bases here.

7) Last, but not least, we are facing a continued challenge of growing successful early stage enterprises beyond the tipping point of EUR10-15 million revenues. Scaling up of Irish indigenous firms is neither sufficiently supported nor incentivised by our tax systems, equity and debt markets or by our policy frameworks. Hence, too many of successful Irish early stage companies are prematurely terminated via sales with a resulting loss of Irish 'brand' identity in global marketplaces. This also induces unnecessary volatility in the domestic markets for skills, talent and know-how.

The above list of 7 point is by no means exhaustive, but the key, unifying point of the above opportunities and challenges is singular: Ireland needs to move to a more domestically-anchored, globally open model of enterprise based on high value added outputs generation.

More open system of entrepreneurship and a greater focus on actual productivity, higher levels of products and services innovation, design and creativity are becoming the differentiators for our competitors, like Singapore, Hong Kong, Korea, Chile, the Netherlands, Switzerland, Belgium, Sweden, Denmark, Austria and even the UK and Germany. The same drivers are also being actively embraced by the newcomers to this competition, such as UAE, Slovakia, Estonia and others.

What does the above mean in practical policy terms? 

How do the above challenges and opportunities translate into tangible actions by the Government and the enterprise support agencies, such as Enterprise Ireland?

We, economists, usually talk in terms of 'first best' policies – policies that are optimal from the point of view of economic efficiency – neglecting political and social dimensions of the policies. I do not intend to break away from this tradition. But some of the policies suggestions I put forth here are currently feasible, and more importantly, the objective of achieving a more entrepreneurship-driven and value-added growth is now simply imperative.

Firstly, we need to open up our migration system to entrepreneurs. Not just the so-called identifiable high-potential entrepreneurs, but to a wider range of entrepreneurs.
This means not only issuing more residency permits for entrepreneurs coming from abroad and issuing them faster.
It also means more actively recruiting entrepreneurs from the ranks of our foreign and domestic students and by projecting our thought leadership in this area worldwide.
And it means making entrepreneurs and human capital residency here more meaningful, more closely integrated with the open-borders policies of the EU, and more reflective of the needs of modern commerce for travel, cross-border cooperation and work.

Secondly, we need to move Ireland into the position of being extremely visible internationally in the space of creating, attracting, retaining and enabling entrepreneurs and key talent. We lack international thought leadership in this area to identify this economy and society with pro-entrepreneurial culture and ambitions and not tax arbitrage opportunities.

Thirdly, we need to enhance dramatically entrepreneurial skills training and supports.
Enterprise Ireland already does very important work here, but the scale of its programmes can and should be expanded.
To free resources for more specialist, high-level training and supports, we need to move more general training into our education system. We need to start giving our children basic entrepreneurial skills earlier in their lives and provide tangible supports for younger entrepreneurs coming out of our schools, colleges, ITs and universities.
We need to clearly and visibly position Ireland as a platform for trading into the EU and North American markets for entrepreneurs from outside the EU, not just for established MNCs. Again, positive experiences of IDA (working with the MNCs) and Enterprise Ireland (working with numerous indigenous exporters) are a great encouragement and a good foundation to build upon.
But, as mentioned already, our thought leadership in this area is still lagging. And the scale of our programmes remains too shallow and too narrow to-date to deliver a game changing shift in our entrepreneurship support systems.
To compete in global markets, we will need active programmes to coach and nurse foreign and domestic entrepreneurs and SMEs on how to access foreign markets with their goods and services.
But we will also need programmes facilitating foreign entrepreneurs integration into the Irish system: from simple supports in terms of accessing basic services here, to tax supports, to legal supports and so on.

Fourthly, we need to drastically revamp our systems for accessing development and trade finance funding. We had volumes written about this in recent years by the Irish Exporters Association and other organisations and indeed by the analysts, like myself. And the Government has reacted positively to some of the proposals, despite the funding difficulties faced by the Exchequer. But, the proverbial carriage is still stuck in the same puddle of dysfunctional banking system and equity markets.

Fifthly, we need to stop penalising self-employment and sole-proprietorship in terms of income taxation and start rewarding early stage entrepreneurial endeavours. Our current model is "Higher Tax for Lower Benefits" and it is rewarding pursuit of PAYE job security and penalises pursuit of enterprise. An alternative currently on the table is a model of "Higher Taxes for Similar Benefits" which will continue to do basically the same injustice to early stage entrepreneurs. Addressing this imbalance between risk-adjusted returns to entrepreneurship and PAYE employment we need to eliminate self-employment penalty and streamline the system of tax compliance for the self-employed.

Sixth, we need to re-couple domiciling of innovation and use of innovation at business level. This applies to the MNCs trading from here, but also to Irish firms. The levels of innovation in our economy are still insufficient. The levels of meaningful utilisation of innovation, R&D and IP in this economy are still below where we would like to see them. We need to create a favourable regime for the firms that both on-shore innovation into Ireland for IP purposes, and deploy it on the ground here. This is tricky, I admit. But it is necessary.

Seventh, growth in the value-added of exports of indigenous firms cannot be contemplated in the environment where we are promoting volumes of sales over value, as, for example, in some agricultural sector outputs. We have to relentlessly drive up margins on our goods and services by pursuing higher valuations for our goods and services, even when such a drive implies increased business and investment risks.

Once again, the above are hardly an exhaustive list of things that must be done for Ireland to succeed in increasingly more competitive global environment.

The key themes that permeate the above remain, however, the same as before: Ireland needs to move to a more domestically-anchored, internationally open model of enterprise based on high value added outputs generation.

More open system of entrepreneurship and a greater focus on actual productivity, exponentially higher levels of products and services innovation, design and creativity, and more aggressive transition of enterprises to higher value added production are becoming the real differentiators for our competitors.

We must lead them, not follow.

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