After a deep recession, after years of stagnation, the Irish economy is growing in leaps in bounds. The ESRI is projecting by 10 percent growth over this year and next. These are almost boom-time growth rates. Should we be a bit wary?
It’s hard to disagree with the ESRI’s Dr. John Fitzgerald when he wrote:
‘ . . . the standard EU harmonised national accounts are not a satisfactory framework for understanding what is happening in the Irish economy.’
This is primarily due to the impact of multi-nationals and the IFSC which can give a false reading of headline. Let’s go through some of these categories and then come back to the question: how satisfactory or reliable are the national accounts and growth projections based on those accounts. This is a bit long and may be a tad technical in parts but hopefully you can stay with it: it tells a story about how a story is being told – and it is the telling we should be wary of.
Multi-nationals and the GDP
Everyone knows that GDP is not the best measurement of the Irish economy. But it’s not just because multi-nationals make profits here and then repatriate them (that is, take out of the country). The reality is that the profits are not made here but are counted here. Let’s look at two key sectors where multinationals dominate: manufacturing and information & communication (the latter is where the Apples and Googles would be located). Note: this is data supplied by the Irish Government to the EU.
Profits in Irish manufacturing nearly 8 times that of other EU-15 countries; in the Information & communication sector, it is over 3 times. Clearly, these are not profits generated by employees in Ireland; they are generated in other economies and ‘imported’ here to take advantage of our low tax rate and our position in the global tax-avoidance chain.
The point here is that our GDP is distorted by multi-national profit-shifting – and that’s before you start taking account profit-repatriation.
Well, Then, We Can Use GNP
Well, no, that isn’t a satisfactory measurement either. GNP is just the GDP after you take account of money flowing in and out of the country (and more money leaves Ireland than comes in). Therefore, GNP is still distorted by the multi-nationals’ profit shifting that we saw above.
We can’t be certain if the ‘fake profits’ that appear in our GDP are automatically taken out by multi-nationals. They may be retained or swim around the IFSC pool (don’t forget that US companies avoid US tax by keeping their money abroad). And not all money flowing out of the country are repatriated profits – they can be interest payments, indigenous multi-nationals investing abroad and households sending money out of the country.
There’s another issue: if multinationals retain their money here, this artificially inflates GNP (because it isn’t flowing outwards). However, if they export their profits GNP falls. Our GNP can fluctuate, depending on what multi-nationals decide to do with their money – but whatever they do, it has almost no impact on the domestic economy unless they actually invest it here (and little of it gets invested).
The ESRI uncovered a real problem in all this: they found that re-domiciled multi-national profits are artificially boosting GNP but have no impact on the real economy. This can count in billions (in 2012, it was €7.5 billion or 5 percent of GNP). Therefore, when you see a GNP figure you have to ask yourself – how much of this is real, temporary and just plain illusory.
And Then There’s the IFSC
Activity in the IFSC can also boost growth numbers – but these are just so many empty calories. Here’s what the Central Bank had to say about this in their first quarterly report this year:
‘Financial sector developments, which are for the most part unrelated to the domestic economy, account for a significant portion of the rise in GNP . . .they would further support GNP growth unrelated to domestic consumption, investment or export activity.’
Here, again, we see the profit flows and profit retentions impacting on the GNP but with little impact on the real economy.
And Now For Something Very Strange
Again, the Central Bank directs us to another, even stranger, anomaly As a result of methodological changes in compiling the National Accounts (the GDP and GNP figures):
‘ . . . goods owned by an Irish entity that are manufactured in and shipped from a foreign country are now recorded as Irish exports.’
Take that in for a moment. Goods that are manufactured in a foreign country and exported from that country, are now counted as ‘Irish exports’ if the goods are owned by an ‘Irish entity’. While this might include some domestic companies, it is no doubt dominated by foreign multi-nationals which are registered as a company here.
To show how this strange calculation can affect the numbers, let’s compare the CSO’s Balance of Payments figure for goods exports – which takes into account this new method – with the CSO’s Merchandise (or manufactured goods) Exports figures which don’t.
While we should expect differences between the two CSO series given different methodologies, what’s noteworthy here is the sizeable difference in growth in the first half of this year. The Balance of Payments’ net exports figures, which includes that little quirk of counting exports that are not exported from here, saw a rise of 59 percent; the Merchandise Trade figure, which doesn’t include this quirk, increased by only 19 percent. The difference in money terms is nearly €3 billion. This is more than the entire GDP growth in that period, in nominal terms.
That’s why the Central Bank warned that our net export numbers could be extremely volatile and, therefore, put a big caveat on their growth projections. The Irish Fiscal Advisory Council made similar warnings. So we should be warned.
And While We’re on the Topic of Exports
The above relates to manufacturing exports. What about service exports. Michael Hennigan over at Finfacts has claimed (and he is not the only one) that much of what passes for service exports are actually accounting distortions arising from the activities of a handful of companies. Hennigan notes that Google books over 40 percent of its global revenues in Ireland; Facebook 50 percent; Microsoft about a quarter and Oracle 27 percent in its fiscal 2013. He goes on:
‘In 2013, we estimate that Google, Microsoft, Oracle and Facebook combined, were responsible for about €41bn of services exports and adding €6bn for other firms in excess company charging would give a total estimate of 50 percent of services exports being tax-related or effectively fake.’
I can’t verify Hennigan’s estimate here. But I do know there are some strange numbers in the service export sector.
- Let’s recall the graph above – that valued-added and profits per employee in the Irish information and communication sector (where most service exports originate) are over two and three times the average of other EU-15 countries respectively.
- While EU service exports have doubled since 2000, Irish service exports have more than quadrupled over that same period.
- The amount of exports per employee in the computer s services sector is through the roof. These are the numbers from Forfas and relate to companies operating in the export sector.
Multi-national exports in the computer services sector – as measured per employee – are 12 times higher than our indigenous sector. Are multi-national companies 12 times more ‘productive’ than indigenous companies who are also competing in world markets? These multi-national exports are over five times more’ productive’ than multi-national exports in other service sectors (finance, businesses, etc.). The gap between the multi-national and indigenous sector in information & communication is far more than the gap in other services.
This indicates that the export numbers in the multi-national services sector should come with an economic health warning.
The One Measurement That is More Reliable: But it Still Comes with a But
Is there one measurement that better reflects what’s going on in the real economy? Yes – domestic demand. This is made up of consumer spending, government spending on public services and investment. This makes up over 75 percent of the economy (the remainder is net exports). There is one small caveat.
Investment can be boosted by aircraft purchases. Many of these purchases are made by aircraft leasing firms and the planes they buy are, in many instances, neither warehoused nor maintained here. They might drop in once for tax purposes but otherwise such purchases have little impact on the domestic economy (though they boost the profits of a handful of firms). However, these purchases even out over time – this is just to warn about a sudden spike in one quarter.
So how has domestic demand been doing in the first half of the year?
When the Government entered office, domestic demand stood at €34.6 billion. Three years later it stood at €34.9 billion. We’re back to where we started.
In the first six months of this year domestic demand increased by 3.3 percent – a strong half-year performance. So what accounts for this rise in the last two quarters?
The main driver was the change in inventories – the value of goods that have not been sold yet or have been purchased by businesses but not yet used in production. This is usually a tiny category in the overall economy but in quarterly statistics it can have an impact. The one bright spot about this is that business may be stocking up in anticipation of future sales; if you don’t have confidence in the future you don’t increase your inventory. But businesses are not necessarily the best seers.
The next biggest contributor was investment. This is a little more hopeful. The Central Bank believes this investment will grow substantially over the next two years, with construction making up nearly half of this growth – understandable after years of depressed building activity.
We may be seeing a burst of business investment after years of postponed demand. Now that the future looks a little bit better, there is a flurry of activity. We’ll have to see if this activity continues over the long term – though the Central Bank estimates that investment growth will start to ease in 2015.
And this is not good news: we are in an investment crisis. In 2015 – even after these large growth numbers in investment, we’d still have to increase investment by about 40 percent just to reach the EU-15 average. And this doesn’t count the massive deficits that have grown up over the recession years.
So where are we?
- Hard to tell, given that our headline numbers in GDP, GNP and exports are being compromised by multi-national activities and new accounting methods. The Central Bank has warned about many of these potential distortions.
- Domestic demand – a reasonably reliable measurement – has increased in the first half of the year but this was largely driven by changes in inventories.
- And despite a flurry of investment activities – which may be relatively short-lived – we are still far behind our EU partners. We are still awaiting a long-term investment strategy.
Is this clear as mud? Yes – because so many of our measurements are mud. What an open and honest Government would do is strip out all these quirks and anomalies to give a real read of the economy.
But if they did that we might find we are standing on a choppy sea of numbers.