You could call it a €75 billion mystery. Or a €300 billion conundrum. But either way trying to interpret the official economic figures for 2015 is next to near impossible.
Everybody knows that the 26 per cent plus growth rate recorded for 2015 may be a statistical fact, but in terms of reflecting what is actually going on it is clearly a fiction. But trying to pull apart the various different bits of the puzzle is very difficult, because for confidentiality reasons the amount of information the Central Statistics Office felt able to provide was very limited.
But let’s stand back and look at two big numbers. The first, the €75 billion is the recorded rise in exports last year, from €220 billion to €295 billion, an extraordinary €75 billion jump. Imports also rose, by about €40 billion. This still left a big net contribution from the trading sector to our overall growth economic figures.
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Overall GDP, again adjusting for inflation, rose by around €50 billion last year, so the rise in net exports is a key part of the puzzle. We are used to multinational trade leading to swings in our export figures from year to year, but the scale of this is something else entirely.
So why did this happen? Why has the measured level of exports risen so dramatically?
Let’s look at our second mystery figure: the €300 billion, which refers to the increase in Ireland’s stock of productive assets. As pointed out by economist John FitzGerald in his column today, this figure rose from some €700 billion in 2014 to over €1,000 billion last year, again an extraordinary jump in a number which normally just edges up from year to year.
We now enter into the world of speculation about why exactly this happened – and the CSO’s reticence to tell us suggests that a small number of companies are involved. What must have happened is that a few companies moved productive assets to Ireland from abroad, leading to a jump in our capital stock. We know, for example, that aircraft leasing company AerCap moved the domicile of its fleet of aircraft into Ireland, which has a total value of over €35 billion.
There have also been reports that Apple moved some of its valuable intellectual property assets to Ireland – essentially the copyrights and patents on the design and technology behind the products it sells, relating to sales outside the US economy. This is a hugely valuable asset and – potentially – could account for a significant part of the jump in value of Ireland's capital stock.
The real value to our economy of having this intellectual property housed here is limited, but the impact on the different components of our economic data is explosive.
In terms of measuring our actual growth rate, the immediate impact of these massive asset relocations inflate both our investment and import data – and as one is a plus for GDP growth and the other a minus, the net impact on growth is limited.
However as John FitzGerald points out, there is an impact. The annual depreciation on these assets, which adds to the measured level of investment – and thus growth – in Ireland.
There is a link between our the two key figures – the €75 billion and the €300 billion – even if it is impossible to be precise. Because more productive assets are located in Ireland, more exports are also showing up in our national accounts. How his happens and how it is counted will depend on the structure of the companies concerned and as we don’t know this we can’t be precise.
To solve the question of why exports jumped so dramatically, we have to look elsewhere, too, particularly as the main rise was in exports of goods, rather then services.
Here we move even further into the realm of speculation, albeit that the CSO has given us some pointers in its statement. It referred to two other factors: contract manufacturing and company restructuring.
It appears that some changes in contract manufacturing arrangements by multinationals based here – under which goods are manufactured abroad on behalf of an Irish-based subsidiary – have added to measured exports.
Given the scale of the jump, this appears likely to have resulted from one or two so-called corporate inversions. This is where Irish-based companies buy larger foreign firms – typically US companies – and the resulting merged entity is headquartered in Ireland.
This appears to have led to a higher level of exports being booked to Irish official figures. Because these exports have not shown up in our monthly trade figures, this indicates that we are talking about contract manufacturing conducted abroad. And a big one-off jump in this would only make sense in the context of a corporate inversion, where goods already being manufactured on behalf of a company newly headquartered in Ireland are moved into our GDP data.
The deal which saw Irish-based medtech firm Covidien merge with former competitor Medtronic, for example, could have been a key factor.
So we seem to have had two big distortions in our GDP growth figures. The first was the deprecation of assets moved to Ireland. And the second was the jump in exports from contract manufacturing and tax inversions.
Should we just shrug our shoulders and say that this is the inevitable result of big globalised multinationals operating in a small open economy? That would not appear wise, for two reasons.
The first is that we need reliable economic figures to judge our own economic performance and guide policy. We can't construct an annual Budget based on GDP growth of 26 per cent, for sure. But given the once-off boost to GDP, can we trust the debt to GDP ratio – a key measure of our debt burden – which we are now told has fallen from 96 per cent to 80 per cent. Probably not, as former Central Bank governor Patrick Honohan said in a blog written on the irisheconomy.ie website.
And how are we to judge whether the economy is now operating near full capacity, a key factor in deciding the appropriate stance of Budget policy? Soaraway figures will only encourage demands to spend extra State money, and cut taxes. But economists will argue that if they indicate that the economy is getting close to full capacity, this is the opposite of what should happen. One of the key mistakes made during the run-up to the crash was adding fuel to an already growing economy via massive spending hikes and tax cuts.
The second reason is our international reputation. What are bodies such as the EU Commission and the IMF to make of it when they try to assess what is going on? What about investors in our Irish Government bonds? Moody's, the rating agency, said in a report this week that the volatility was a concern and suggested that the Government needed to keep more in reserve in relation to its budget in case the swings went the wrong way. Elsewhere the reaction was more pointed, most famously with US economist Paul Krugman referring to " leprechaun economics".
There is now a push to come up with some more accurate indicators. Even if the CSO has to keep producing GDP figures using international guidelines – and it will – there is no reason why we couldn’t develop other indicators which try to net out the impact of these huge distortions. Looking at a range of figures from last year, suggests that real underlying growth last year might have been around 5 per cent. Maybe a bit lower. Maybe a bit higher. But certainly not 26 per cent.
Growth figures distorted by activity in four key areas
Contract manufacturing
The term refers to a form of outsourcing whereby companies, usually big multinationals, engage other entities abroad to manufacture components or products on their behalf.
The fragmentation of the production chains across multiple jurisdictions has become an increasingly common feature of globalisation and makes national accounting very complicated.
Irish export volumes have been artificially inflated by contract manufacturing for several years. The Central Statistics Office does not disclose anything about the organisations involved, but the assumption is that we are dealing with a handful of firms in the pharma and tech sectors.
The Government’s own fiscal advisory council first raised concerns it was distorting our headline GDP metric back in 2014.
The International Monetary Fund also queried the strength of Ireland’s economic growth in 2015, which was 5 per cent at the time, noting it is being exaggerated by two pharma firms involved in contract manufacturing.
Back then, it was suggested it was flattering growth to the tune of about 2.5 per cent. Last year, it appears to have been an even bigger factor.
In the past, offshore product or component was returned to Ireland to be packaged, meaning it would turn up as imports, effectively neutralising the effect on trade numbers.
However, more recently the product doesn’t appear to entering the domestic economy at all.
It was described as a significant component of the 102 per cent jump in net exports in 2015, significantly augmenting the value of economic growth but perhaps not representing a true picture of activity.
Tax inversions
These deals typically involve US companies acquiring a foreign-based firm and relocating their headquarters to where these firms are incorporated.
The “inversion” term is used because the company outside the US is typically smaller but often the deal is dressed up to make it look like the smaller entity is acquiring the bigger one when the reverse is the case.
The US company thus moves its domicile outsider the US, although typically its operations and management remain there, albeit there is a ripple on the national accounts here.
Companies undertaking this strategy are likely to select a country that has lower tax rates, hence the popularity of Ireland.
One deal thought to be a factor behind the bounce in Ireland’s GDP involved US medical device firm Medtronic, which moved to Ireland through a merger with rival Covidien in a deal worth $48 billion.
US botox maker Allergan also transferred its headquarters to Ireland via a reverse takeover of Irish-based drug maker Actavis in a deal worth $66 billion.
A spate of such deals since 2014, roughly in tandem with international efforts to tackle multinational tax avoidance, eventually led to a clamp down by the US treasury. The US action derailed the “superinversion” Pfizer-Allergan deal, keeping the US company’s headquarters in New York instead of Dublin.
The inversion deals may overlap with the contract manufacturing element of our accounts as some of the firms involved appear to have large offshore manufacturing operations.
Relocating patents
The transfer of international patents or intellectual property assets from one jurisdiction – typically a tax haven – to another appears to be a direct response to the OECD-led clampdown on multinational tax avoidance.
Apple and a handful of other tech companies recently transferred IP assets to Ireland, effectively booking a much greater share of profits through the State.
This may go some way to explaining the bumper level of corporate tax receipts currently coursing through the exchequer’s accounts.
A common way to shift profits offshore is through transfer pricing, which was central to the now discontinued double Irish arrangement. This involves multinational subsidiaries in different countries charging each other for goods or services sold within the group.
It is most associated with tech and pharma companies where the businesses are underpinned by intellectual property, the value of which is subjective.
Royalty payments between subsidiaries are priced in a way to minimise profits in high-tax countries and maximise them in low-tax ones.
The international outcry over this, however, has led several big multinationals to quietly rearrange their tax affairs, effectively moving their IP out of more obvious tax havens and into low-tax jurisdictions such as Ireland, massively boosting the State’s capital assets.
Aircraft leasing
Investment in aircraft for leasing can result in large additions to the domestic capital stock. One deal suspected of contributing to the bubble in Irish GDP involved leasing firm Aercap, which last year redomiciled the bulk of its €39 billion in assets in the Republic as part of its takeover of rival firm International Lease Finance Corporation.
The inclusion of aircraft leasing activities in the national accounts only began last year and it seems already to have had a seriously distorting effect on the breakdown of the national accounts and some impact on the bottom-line growth figures.
Ireland is a global hub for aircraft leasing, with approximately 4,000 commercial aircraft leased through companies here, representing a total value of $115 billion. Changes to accounting conventions will now see the purchases of aircraft included as imports.
“As well as making the data on exports and imports difficult to interpret, this will also make the policy implications of changes in the current account of the balance of payments more obscure,” economist John FitzGerald says.
