ESRI research has called into question the way growth is measured in Ireland

By Economics Correspondent Sean Whelan

Few in Ireland have really taken GDP to be a serious measure of the Irish economy, because of the very large impact that the activities of foreign owned multinationals have on the numbers.  GNP has always been regarded as a more relevant measure.

But now it seems we can’t rely on that either.

Or – for that matter – the balance of payments current account figure, which had been seen as a lead indicator of growing strength in the Irish economy over the past four years.

Earlier this week the ESRI published important new research by John Fitzgerald on the impact of re-domiciled PLCs on GNP and the balance of payments.

For more than a year the Central Statistics Office has been highlighting the distorting effect that these companies – which have moved their registered head office to Ireland for tax reasons, but which conduct little or no real activity here – have had on the GNP figure.

The CSO knew there was something not quite right, but couldn’t put their finger on it.

Prof Fitzgerald has drilled into the CSO data to shed light on the issue, and the findings aren’t at all pleasant.

The money held by these re-domiciled companies – around €7.4 billion last year, or 5.5% of GNP – is enough to distort the figures.

Prof Fitzgerald’s analysis says these inflows had the effect of reducing the recorded amount of profit outflows by multinationals based in Ireland, which had the effect of raising both the GNP figure and the balance of payments current account surplus.

Working back to 2009, when these inflows started – apparently prompted by concerns over the possible direction of the UK tax regime – Prof Fitzgerald finds the economic contraction in 2009 was deeper than officially recorded, and that GNP contracted in 2010, rather than the 1% expansion recorded in the official statistics.

It also impacted last year’s figures, which officially show GNP expanded by 3.5%, but the ESRI analysis says the real expansion was just over 2%.

The impact on the balance of payments surplus is more dramatic.

A surplus on the balance of payments indicates that a country is saving more than it is spending or investing. Usually large surpluses are not sustained, and eventually lead to increased domestic demand as these savings are reduced and spent in the domestic economy.

However Prof Fitzgerald’s research suggests that rather than running a current account surplus of 6% of GNP / 5% of GDP -the real number is less than 1%.  This implies there will be less of a bounce for the domestic economy, as there is not as high a level of savings to be released as future domestic spending as previously thought.

If GNP is smaller than thought, and GNP is a truer measure of the tax base of the economy that is available to support the national debt, then the debt/GNP ratio is worse than thought too.

And as an extra kicker, GNP’s close relative Gross National Income (GNP plus the inflow of profits from multinationals) is the one used to calculate a member states contribution to the EU budget.  And the effect of the re-domiciled PLCs is to inflate GNI – so we have been paying more to the EU than we should have.

But it’s the balance of payments figure that is really depressing.

Professor Philip Lane at Trinity College is quoted in the Financial Times responding to the report by saying “The reality is that the Irish economy’s competitiveness and its ability to pay down its debt is vastly exaggerated in the official figures.”

Writing on, Prof Lane says:

“…. the Irish national accounts now features two unusual elements:

(a) the large-scale operations of the affiliates of foreign multinationals mean that there is a large gap between GDP and GNI due to the high recorded profits of these firms. Moreover, the high import content of the exports of these firms means that there are analytical issues in understanding the dynamics of valued added in Ireland. To the extent that transfer pricing means that true imports are understated as a means to boost recorded profits, it also means that the trade surplus is overstated (but one-for-one net factor income is understated, so the current account is unchanged)

 (b) the more recent feature is the impact of re-domiciled firms which are counted as Irish firms, since the headquarters are here and even though these have virtually zero domestic activities and the ownership is entirely foreign. As shown in John’s note, this sharply alters the interpretation of the GNI data – but has no impact on the GDP data (which relates to domestic production). It also sharply alters the interpretation of the current account data, which is a key variable in the European Commission’s “macroeconomic imbalances” scorecard.

 So – both GDP and GNI data need to be handled with care. In particular, the traditional short cut of interpreting GNI as a better measure of true domestic activity is not wise – it is an income measure, not an activity measure.”

Davy Stockbrokers’ chief economist Conall Mac Coille has the following take on the ESRI research:

“The 5% current account surplus has been often used as a critical summary statistic of Ireland’s success in rebalancing the economy. The news that the balance, stripping out accounting distortions, is close to 0.5% of GDP will take some of the gloss off Ireland’s export-led recovery story. However, even excluding these distortions, there has been a sharp improvement in the deficit since 2009, up 3% from -2.5% in 2009. And the measurement problem has no bearing on the pace of household saving and debt reduction. So the underlying trends in the Irish economy have not changed. Nonetheless, the revelation that Ireland’s current account surplus may be overstated by 4.5% of nominal GDP illustrates a worrying trend, with volatility in the national accounts  and balance of payments driven by tax accounting strategies.

While point (b) of Philip’s piece has been highlighted by John Fitzgerald, it was the re-appearance of a Google executive before a British Parliamentary committee this week that shone the spotlight once again on the matters raised in point (a): the €30 billion outflow to foreign owned multinationals from their Irish operations that accounts for the gap between GDP (€163 billion) and GNP (€133 billion) last year.

Matt Brittin, Google’s vice president for sales and operations for Northern Europe, got beaten up by the British Commons’ Public Accounts Committee, with much talk of “smoke and mirrors accounting” and “doing evil” over the way it sells advertising in the UK, but books all the transactions from its EMEA headquarters in Dublin.

The company has faced similar, though less colourful, scrutiny in Germany and France (which even contemplated a Google Law to capture some of the revenue raised in France that is declared in Ireland).

And lurking in the background is the big one – the United States – where the Obama administration seems committed to a reform of Corporation Taxes to encourage companies to bring their earnings (and the jobs they generate) back to America.

Remember, the Americans are only beginning their fiscal consolidation process to deal with a debt and deficit situation that’s considerably worse than Europe’s.

But the row over where Google pays its taxes has highlighted another problem with Irish economic statistics – the export figures.

Since 2008 we have been hearing that exports will be the engine of Irish recovery in the Great Recession, and on the surface that has been the case – helped by the recession-proof nature of pharmaceutical exports.

But now, as predicted, the impact of the “patent cliff” – the expiry of patent protection for some high profile “blockbuster” drugs means a reduction in the volume and value of merchandise exports.

This has been offset by the rise of services exports, particularly computer services.  Indeed last year the value of services exports surpassed the value of physical goods exports for the first time.

This trend continued in the first quarter of this year, according to the Irish Exporters Association, with merchandise exports down almost 10%, and services exports up 8%.

It is certainly bad news to see the decline in exports of physical goods – both from the patent cliff and from the effects of the recession in the euro zone (and this is happening despite our supposed gains in productivity – though the Central Bank has long ago cast doubt on those statistics – it attributes most of the gain in productivity to the mass redundancies in the “low productivity” construction sector, which makes the rest of the economy look better).

However should we not also be concerned that the major part of our exports are now reliant on activity that appears to be driven primarily by tax laws here and internationally?

Michael Hennigan of the Finfacts website – a longstanding critic of the distorting effect of tax planning by multinationals on official Irish economic statistics – puts it more trenchantly in this comment on Prof Lane’s post:

“Google’s global web revenues grew by 29% and 21% in 2011 and 2012 respectively and in 2011, 45% of the total was booked in Ireland. Google Ireland reported revenues of €12.4 billion in 2011; payroll costs were €218 million; corporate tax in Ireland on trading activities was €3 million; total tax charged at €22.2 million including foreign withholding tax. When the Google Ireland’s 2012 accounts will be published this year, they will show revenues of at least €15 billion or 41% of Irish computer services in 2012.

Google, Microsoft, Apple, and commercial aviation leasing, employing about 6,500, account for 52% of Irish services exports.

Up to half of the services exports total of €90 billion in 2012 may be effectively fake i.e. unrelated to Irish economic activity.”

So if GNP, GNI, GDP, productivity and service export figures can’t be relied on to accurately describe the Irish economy, what can?