The Celtic Tiger’s Tale: Ireland’s Information and Communication Technology Cluster Rene Leon Wrede Petersmeyer Vicente Piedrahita Jules Walter Dimitri Zaninovich Microeconomics of Competitiveness Harvard Business School Professor Michael Porter May 2010 1 A. Executive Summary This paper charts the roots, rise, and symbiotic struggle of the Irish economy and its most prominent sector. The first part of the paper explores the causes and consequences of Ireland’s economic miracle. It looks at how the coordinated efforts of society and government, European economic integration, a young and well educated population, favorable tax structure and macroeconomic stability underpinned an uninterrupted boom for decades only to stall in recent years. The section then outlines our thesis that Ireland’s current challenges requires refocusing its competitiveness agenda in innovation, improving coordination between actors in charge of R&D and its commercialization and moving into new activities of the value chain according to a redefined value proposition. The second part of the paper focuses on the ICT cluster itself, outlining the global sector and players, tracing the roots of Ireland’s rise and looking at how the effects of the Celtic tech boom and current microeconomic challenges are undermining Ireland’s competitive position today. The section finishes with a series of recommendations on how the cluster itself can play a leading role in Ireland’s transition to an innovation-driven economy. B. Ireland – Country Analysis Ireland is the third largest island in Europe with a population of approximately 6 million people. In 1801 Ireland became part of the United Kingdom (UK), but a war for independence in the 20th century led to the partition of the island into two: The Republic of Ireland (from here on Ireland) and Northern Ireland, still part of the UK. Independence was followed by a period of low economic growth and political unrest. In 1988, The Economist described Ireland as “The poorest from the rich”. Ten years later, the same magazine coined Ireland: “The Celtic Tiger: Europe's shining light". B1.1 Development of Ireland’s Economy 2 Ireland’s economy underwent a radical transformation in the last two decades. It went from being one of the least developed countries in Europe to having one of the most prosperous economies by leveraging export- oriented manufacturing and trade (See Figure 1 for a breakdown of Irish development focus). Figure 1: Industrial Development in Ireland by Decade Source: McSweeney, 2010. Foreign direct investment (FDI) led the transformation of Ireland by providing capital and skills to move the country into more sophisticated sectors. Multinational corporations (MNCs) became attracted to Ireland because of the country’s favorable tax structure, the availability of a well-educated young population, the presence of relatively low wages, and the proximity to the European market. Today, Ireland is one of the most open economies in the world with an unusually large manufacturing sector. Exports and imports represented almost 157% of GDP in 2009, almost 3 times as high as the average for OECD countries1. A significant portion of the economic activity in Ireland consists of importing goods from abroad, adding value to them through high technology infrastructure, and exporting those high-value goods in sectors like chemicals and pharmaceuticals, both of which represented half of the 2008 total export of goods 1 Country Data – Annual Time Series. Economist Intelligence Unit. countryanalysis.eiu.com/countrydata 3 Although scaling and upgrading of the manufacturing industry has bolstered the development of indigenous firms, Ireland’s economy still relies heavily on MNCs. Today, Ireland’s GDP is approximately15% larger than its GNP, the largest gap among OECD countries2. Foreign capital dependency forces Ireland to constantly nurture an attractive business environment and to compete with the newly admitted EU members who are also seeking FDI. B1.2. Growth and Well-being Ireland’s structural transformation promoted GDP growth and created new employment opportunities. GDP per capita grew around 6% per year over the last decade, placing Ireland as one of the countries with highest income per capita within the OECD (Figure 1). In 2008, despite a 2.3% decrease due to the financial crisis, GDP per capita (at PPP, 2005 constant prices) stood at $39,253, above the OECD average of $34,9633. Figure 2: Real GDP per Capita and Growth $50,000 15% $40,000 10% $30,000 5% $20,000 $10,000 0% $0 ‐5% 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 Ireland GDP per capita, PPP (constant 2005 international $) OECD GDP per capita, PPP (constant 2005 international $) GDP growth (annual %) Source: EIU B1.3. Growth and Productivity FDI in high-tech sectors was the main driver of improvement in productivity and economic growth. However, in recent years productivity growth has decelerated as a result of the exhaustion of the investment 2 Country Data – Annual Time Series. Economist Intelligence Unit. countryanalysis.eiu.com/countrydata 3 Country Data – Annual Time Series. Economist Intelligence Unit. countryanalysis.eiu.com/countrydata 4 driven model. (Figure 3). Since 2004 the increase in labor force participation, due to inward migration and the entrance of a young population into the work force, has compensated for the low productivity growth. Nevertheless it is worth noting that, in the long-run, economic growth cannot be sustained by changes in the labor force participation alone. Figure 3: Contribution to GDP per Capita Growth 10% 8% 6% 4% 2% 0% ‐2% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 ‐4% ‐6% ‐8% Productivity Growth Labor Force Participation Source: EIU In addition to low productivity growth, the labor market has tightened as a result of Ireland’s fast economic growth and inability to supply enough workers with the right skills for all its industries. The increase in wages has outpaced improvements in productivity (Figure 4), thus affecting Ireland’s competitiveness. Today, Ireland’s priority in its economic agenda is to attract high-skilled and highly productive workers rather than combating unemployment, which on average has been below 5% since 20014. 4 Country Data – Annual Time Series. Economist Intelligence Unit. countryanalysis.eiu.com/countrydata 5 Figure 4: Labor Costs per Hour (US$) and Productivity $35 30% $30 20% $25 $20 10% $15 $10 0% $5 $0 ‐10% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Labor costs growth (%) Labor productivity growth (%) Source: EIU B1.4. Macroeconomic Stability Macroeconomic stability gives Ireland an advantage vis-à-vis other manufacturing and technology exporting countries in Eastern Europe and Asia. Ireland´s entrance in the European Monetary System in 1979 allowed the country to achieve price stability, and helped it to attract more long term investments. Despite the pressure from skyrocketing property as well services prices in 2006 and 2007, inflation was kept below 5% (Figure 5). Figure 5: Consumer Price Index (% change p.a.) 8% 6% 4% 2% 0% ‐2% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 ‐4% ‐6% Source: EIU 6 In addition, the 10-year government bond yield, which to some degree reflects expectations of inflation and confidence on Ireland’s future performance, has been stable at around 4%. In 2009, the bond yield peaked at 4.88% as a result of the recent economic crisis. However, rather than having a permanent impact on the structure of the economy, the crisis simply led to pricing readjustments in the real estate and financial services sectors. Figure 6: 10-year Government Bond Yield 6% 5% 4% 3% 2% 1% 0% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Source: EIU Historically, Ireland has had enormous fiscal deficits. However, Ireland has enjoyed a budget surplus in the last few years. The public debt, as shown in Figure 6, has fluctuated around a third of the GDP, except for the last two years when the crisis increased the debt ratio to up to 62% in 2009. Ireland’s government needs to tighten its expenditures as low economic growth rates are expected in the near future. Figure 7: Public Debt (% of GDP) 70% 60% 50% 40% 30% 20% 10% 0% Source: EIU 7 The revaluation of the Euro in real terms has hurt Ireland’s capacity to compete in world markets. Rising prices of domestic goods combined with the nominal revaluation of the Euro against the Dollar and the Pound, have made Ireland’s goods more expensive in its two main markets: the U.S. and the U.K. This has exacerbated the need to move to the high end of the value chain. Figure 8: Public Debt (% of GDP) Figure 9: Exports/Imports (%of GDP) 120 100% 100 80% 80 60% 60 40% 40 20 20% 0 0% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Source: EIU Source: EIU B2. Assessment of the National Business Environment B2.1. Macroeconomic, Political, Legal, and Social Context Ireland is a Republic, with a parliamentary system of government. It has a well-managed economy, an independent judiciary, a strong Intellectual Property (IP) reputation, and low levels of bureaucratic red tape. Ireland joined the European Community in 1973. EU membership has enabled Ireland to have access to structural funds, which have been used to upgrade infrastructure, and prompted the Government to foster policies that keep inflation and interest rates low (Maastricht Treaty).5 In 2006, Ireland had the sixth highest GDP per capita and the fifth highest Human Development Index in the world.6 Ireland’s political and economic stability coupled with its highly educated workforce make the country an attractive destination for FDI. This enabled Ireland to have an impressive economic growth from the 1990’s until 2007, a phenomenon known as the “Celtic Tiger.” 5 Boland et al.