The recent publication by the CSO of the 2015 National Income and Expenditure Accounts generated a lot of reaction. There is no doubt that a 26.3 per cent real GDP growth is bizarre but it was not farcical, false or based on fairy tales.
Many commentators went out of their way to highlight that the figures did not characterise what was happening “on the ground” in the Irish economy. But this seems like a bit of a strawman. Instead of being told what the figures were we were been scolded over what they weren’t. No one said the economy was growing at 26 per cent. Arguments against using GDP in an Irish context have made for the past quarter of a century. Even as recently as March, when the first growth estimates for 2015 were provided, there were plenty of people who pointed that the underlying growth rate of the economy was probably around half of the 7.8 per cent growth rate in real GDP shown at that time.
But a 26.3 per cent real GDP growth rate is very very unusual. And one that deserves understanding rather than dismissal. However, the discussion of the figures has generated more heat than light. At the briefing it seems three items were identified as having oversized effects on the national accounts’ aggregates. These were:
aircraft leasing
inversions and corporate restructurings, and
asset transfers to Ireland
It would be really helpful if the CSO provided a recorded webcast of these briefings so we could know what was actually said. Anyway most of the subsequent focus was drawn to the first two but it seems likely, to me at any rate, these were provided as items which could impact the national accounts rather than specific factors which explain the 2015 growth surge.
The aircraft leasing example was particularly ubiquitous but an examination of the figures shows that investment in aircraft actually fell in 2015 (see Other Transport Equipment in Annex 4A here). There were some early references to a 70 per cent rise in aircraft investment but this may have been due to a miscommunication somewhere including this note. And even if aircraft investment did jump the GDP effect would be minimal as the positive investment effect would be offset from the negative balance of trade effect of having to import the aircraft.
The GDP impact of leasing the aircraft can be seen from the Balance of Payments and the inflow of operational leasing revenues. These rose from €9.4 billion in 2014 to €11.8 billion in 2015. Now, usually a €2.5 billion rise in any flow would be significant but in the context of a €60 billion plus rise in GDP it is not a central part of the story. Indeed, one eminent economist was issued with a note by the CSO indicating as such.
The effect of inversions also got a good airing but there are also a number of problems with this. For a start there simply wasn’t enough of them in 2015 which saw the Allergan-Actavis and Medtronic-Covidien deals completed. The balance sheets and profits involved in these were simply not large enough to explain the surge in GDP. And it must be remembered that a corporate headquarters is not the only basis for determining where a company’s assets and output are assessed. If a pharmaceutical company has a manufacturing plant in New Jersey, the plant forms part of the US capital stock and the value added the plant produces contributes to US GDP. If the company redomiciles to Ireland the location of the plant is unchanged. A company’s assets do not get added to a country’s capital stock just because it redomiciles there. The company may choose to move some assets along with the headquarters (such as intellectual property) but that is a change in addition to the actual inversion itself and may have tax implications in the originating country. And in each case one of the companies is already “Irish” so the net effect on the capital stock may be relatively small.
If inversions were a significant factor in 2015 then we would expect to see an increase in the inflow of direct investment income. The profit from the manufacturing plant in New Jersey would be a factor inflow to the company HQ in Ireland and would form part of Ireland’s GNP (unless paid out as an actual dividend in the same period). In fact, the inflow of direct investment income fell in 2015 to €15.8 billion from €19.9 billion in 2014. There is no doubt that a large part of this accrues to foreign-owned redomiciled PLCs (and the fall in 2015 could be the result of some companies generating losses) but there is little evidence that inversions alone caused the surge in GDP.
So that leaves us with the transfer of assets to Ireland and there seems little doubt that this is where all the action happened and is likely related to other forms of corporate restructuring and relocations. Here is probably the best snapshot of it from the data published to date and is taken from the International Investment Position data published the same day as the NIE.
Usually when an incongruous chart like this is returned the cause would be a coding error or a data entry problem but neither seems to be the culprit in this instance. Net external debt is the balance between gross external debt and external assets in debt instruments. For our purposes here there is only one line that interests us: direct investment debt.
From the middle of 2013 the net external debt associated with direct investment became more negative (external debt assets exceeding external debt instruments). This is likely related to inversions and redomicilced PLCs. But there is no doubting the most significant change which was the once-off level shift in the net external debt associated with direct investment of about almost €300 billion in Q1 2015. Here are the components of the net position shown for direct investment in the first chart.
The level shift in external debt in Q1 2015 is readily seen. So what has happened?
It seems some MNCs have transferred huge amounts of assets to Ireland and achieved this by having the entities holding the assets become Irish resident. The stepped nature of the change suggests that the number of companies involved is small (unless there were reasons for several companies to act simultaneously).
If the assets were purchased they would show up in investment. In a short note on the revision Eurostat state that the GDP surge in 2015 “was primarily due to the relocation to Ireland of a limited number of big economic operators.” Anyone know what the technical definition of an economic operator is?
Anyway these economic operators have brought a huge amount of assets to Ireland with them. These assets have been added to Ireland’s capital stock and the newly-resident companies owe liabilities to other entities within the MNC structure for the benefit of having these assets.
We can safely deduce that these are intangible assets. We might usually expect the impact of increased intangible assets to show up in royalty flows either through increased inbound royalty payments if others wish to use the IP or reduced outbound royalty payments if the IP is already being used in Ireland. Neither of these happened, in fact outbound royalty payments increased by around €20 billion in 2015.
What has happened is that these intangible assets have been used for contract manufacturing where the owner of the intangible asset contracts with an external party in another country to manufacture some product based on using that intellectual property. The manufacturer is paid a fee for undertaking the production but the profit arising from the difference between the costs of production and sales revenue accrues to the owner of the IP, who has now become Irish resident. Because of rules on ownership in ESA2010 the exports and imports associated with the product are counted as Irish with the country of the external manufacturer showing an inbound service fee for undertaking the production. Even if not included in Irish trade data (and also our industrial production) the GDP effect of a different statistical approach may not be that significant as the added value would still be counted here under the heading of goods for processing, merchanting, outsourcing or factoryless goods producers.
The current rules mean that it is in the Irish “industry” sector that the impact is seen. Gross value added in the Irish industry sector more than doubled in 2015. Nominal GVA for Industry went from €41 billion in 2014 to €92 billion in 2015. There is your surge in GDP. Most of the production took place somewhere else but the IP behind the production is now located here. And this is a level-shift in GDP not a once-off jump that will quickly be reversed.
Why are companies doing this? There were some references to the ending of the “double irish” but this does not seem plausible for a number of reasons not least that the provision was grandfathered until 2020. An alternative explanation is that it related to changes in the international tax environment brought about by the OECD’s BEPS project such as country-by-country reporting or that the companies are looking to avoid bad PR down the line. This is not to discount past strategies used by these companies utilising, for example, Irish-registered non-resident companies which may have aided in the decision to transfer the assets to Ireland and, of course, moving companies out of no-tax jurisdictions is probably relatively straightforward.
Making a few heroic assumptions this contract manufacturing is likely an activity that the companies have undertaken for a while but with the intangible assets held in no-tax jurisdiction. Country-by-country reporting would require the companies to report the destination of the profits to the tax authorities in the country where the manufacturing facilities are located. And alarm bells may sound if the tax authorities see the profits accumulating in no-tax jurisdictions (even if ultimately a 35 per cent share is due to Uncle Sam). So the companies have moved the assets to Ireland and report that the profits are subject to our Corporation Tax. All just supposition of course but the €2.3 billion rise in Corporation Tax was real. Now if we could only figure out what the real growth rate of the Irish economy is it would be win/win. But the benefits of the MNC sector in Ireland outweigh the costs of some distorted national accounts figures and some cheap disparaging remarks by many many multiples.