The estimates vary, but they can be significant, reaching 8-12% of GDP in the long term in some scenarios.7
The size of the impact critically depends on the extent to which these policies reduce productivity, including through reduced knowledge transfer or reduced competition facing domestic companies.
Of course, in addition to the steady-state costs, there are also transitional costs, as it takes time and effort to reconfigure supply chains.
And any such changes would also imply increased policy uncertainty, which – as we have seen in the past – can also dampen economic activity and investment.8
Fragmentation could also affect prices and inflation dynamics.
In the decades before the pandemic, global economic integration in its various dimensions acted as a positive and persistent supply shock.
The rise in global production capacity through the integration of many emerging market economies into global value chains weighed on inflation.
Reduced trade integration could impact inflation in the opposite direction.
This could happen directly, through lower shares of imports from lower-wage countries. And it could also happen indirectly, through higher costs for multinationals participating in global value chains.
Geo-economic fragmentation could also increase the volatility of inflation, if it resulted in abrupt shifts in trade patterns that led to imbalances between supply and demand.
What are the potential implications of global fragmentation for the Irish economy?
As a general principle, given the small, open nature of the Irish economy, such global shocks would be expected to have an amplified effect on Ireland.
As always in economics, though, it depends.
So let me illustrate the potential effects with an example, focusing on the semiconductor industry, which has been at the heart of the policy debate around de-globalisation.
In a more benign scenario, Ireland could be a beneficiary of ‘friend-shoring’ policies in some respects, reflecting our strong links with both Europe and the US.
For example, imagine if ‘friend-shoring’ resulted in some of the production of state-of-the-art semiconductor designs that might have otherwise taken place in Asia shifting to Ireland.
This would further boost domestic technological knowledge, potentially making Ireland a more attractive location for future investment in this industry.
Even in such a benign scenario, however, there would – of course – be costs.
The new chip production would take time to come on stream, potentially leading to higher prices during the transition.
Given the Irish economy is operating close to capacity, new production could further exacerbate capacity constraints in the labour and housing markets.
This could increase costs in Ireland, reducing our external competitiveness.
Finally, any relocation of production to Ireland could also lead to a retaliation on Irish products from disaffecting countries.
There are also more adverse scenarios of potential increased fragmentation.
For example, foreign companies currently based in Ireland may seek to limit the extent of new investment taking place here.
This could be either due to a desire to reallocate production to their home markets, or due to increased competition globally for manufacturing of critical products.
Indeed, recently, we have seen increased use of government subsidies to attract investment in strategic assets, such as semiconductors, to reduce geopolitical dependence.
In that context, smaller countries – such as Ireland – may find it more difficult to attract new investment than larger economies with greater fiscal capacity.
Finally, in a tail scenario, foreign companies already operating here could seek to re-shore some of the production that currently takes place in Ireland.
Given the importance of foreign MNEs in Ireland, this would have a significantly adverse impact on Irish output and employment, with an associated risk of loss of high value-added jobs.
It would also have an adverse effect on the public finances, not least given the particular reliance of corporate tax receipts on foreign MNEs operating here.
Overall, depending on the precise nature and depth of fragmentation, it could have large economic ramifications for the global and Irish economies in the years and decades ahead.
Policies to build resilience in a small open economy
Of course, many of the forces that are shaping these trends are global in nature.
So what are the implications of this shifting external landscape for domestic economic policy?
Let me cover three areas.
The first is around the importance of policies that safeguard macro-economic resilience.
A stable macro-economic environment is a key precondition for sustained prosperity of people.
It is also a key precondition for remaining an attractive destination for foreign investment, including in a world of heightened uncertainty.
As a small, highly-interconnected economy, Ireland faces greater downside macro-financial risks compared to larger, more diversified economies.
Being part of a monetary union also means that monetary policy is not a lever that can be used to respond to domestic shocks, with monetary policy set for the euro area as a whole.
Our domestic macro-economic management framework needs to recognise these characteristics and be set accordingly.
Fiscal policy needs to guard against pro-cyclical dynamics and avoid the risk of overheating in good times, which can damage competitiveness.
The experience of the 1980s and the early 2000s provide salutatory lessons of the costs of pro-cyclical fiscal policy for a small open economy.
Equally, the fiscal response to the pandemic and the energy crisis triggered by Russia’s war in Ukraine demonstrate the value of ensuring fiscal policy has the capacity to operate counter-cyclically.
In the current environment, with the economy operating at capacity and inflation remaining elevated, it is important that the fiscal policy stance does not add further stimulus to the economy.
In addition, the public finances need to be resilient to any shocks to windfall tax revenues from MNE activity in Ireland, which are highly concentrated in a very small number of companies and sectors.
It is, therefore, welcome that the government is considering channelling windfall corporation tax receipts into a longer-term savings vehicle.
The domestic policy framework also needs to guard against risks stemming from financial imbalances, and the potential that vulnerabilities build in lenders’ and borrowers’ balance sheets.
Again, our own history offers important lessons of the severe consequences of financial imbalances and insufficient resilience of lenders and borrowers.
In the run-up to the financial crisis, there was no policy lever to build resilience against such macro-financial imbalances. Macroprudential policy has filled that gap.
Learning the lessons from the crisis, Ireland has been very active in deploying macroprudential tools to safeguard resilience.
The Central Bank’s strategy for deploying macroprudential capital buffers, for example, reflects the higher exposure of the Irish economy to the global environment, including to the risk of structural shifts in international trading arrangements.9
The second is around structural economic policies to maintain competitiveness.
Ireland already has a number of characteristics that make it a competitive economy.
It is part of the single market; English-speaking; has a competitive corporate tax regime; a common law system; and high levels of educational attainment.
One area where Ireland often lags behind other countries in cross-country measures of competitiveness is around infrastructure.
High-quality infrastructure is a key ingredient for ensuring a country has the capacity to achieve long-term, sustainable growth and plays a key role in determining quality of life.
It is a critical element of ensuring that the gains of global integration are shared across the population.
And it can also enhance the attractiveness of a place to live, a key factor in terms of retaining and attracting internationally-mobile workers.
Government policies to support infrastructure development – including in housing, the transition to net zero, digitisation and transport – are therefore key to maintaining competitiveness.
This also relates to the composition of government spending and ensuring an appropriate balance between current and capital spending.
Prioritising capital expenditure – within the context of the government’s spending rule – will be key to addressing infrastructure needs.
Another important dimension in maintaining competitiveness relates to human capital and skills.
Looking back, the rise in educational attainment following Ireland’s education reforms in the 1960s were key in raising living standards, including through higher productivity.10
Education also played a part in ensuring that Ireland was an attractive destination for inward foreign direct investment.11
The skills our economy needs are likely to continue to evolve amid the rapid technological changes taking place globally, underlining the importance of continuing to nurture human capital for the future.
The third is around playing an active role towards strengthening European integration.
Some of the world’s most complex problems will be very difficult, if not impossible, to address absent multilateral co-ordination.
Tackling climate change, preparing for future global pandemics or safeguarding global financial stability are key examples of challenges that can only be met with cross-border cooperation.
Of course, we cannot be blind to the evolving reality of an increasingly multi-polar world.
That underpins the importance of strengthening integration within Europe, to be better able to meet future global challenges.
From an economic perspective, completing the banking union and making concrete progress towards a true capital markets union remain essential to strengthen the euro area’s shock-absorption capacity and to support growth.
Meaningful progress in these areas would also help to reduce fiscal tail risks in Europe.
Still, as the ECB’s Governing Council has noted, the need for a permanent central fiscal capacity remains.12
The response to the pandemic, including the creation of the Next Generation EU fund, was a key moment for Europe, demonstrating the benefits of a central fiscal capacity when large adverse shocks hit.
A permanent central fiscal capacity, if appropriately designed, could play a key role in enhancing macroeconomic stabilisation and convergence in the euro area in the longer run.
Conclusion
Let me conclude.
Signs of fragmentation at a global level have been growing.
It is not yet clear whether this will be confined to a change in the shape of global integration or the level of integration. But the implications of these developments for the global economy could be significant.
Ireland is particularly exposed to the risk of global fragmentation, given the highly globalised nature of our economy.
Of course, these are global forces, largely beyond the control of policymakers in these shores.
But Ireland can navigate the choppy waters that increased geo-economic fragmentation would bring through careful macro-economic management; structural economic policies to maintain competitiveness; and by playing an active role in further strengthening European integration.
Thank you very much for your attention.