Wednesday, July 18, 2018

When can we expect the next wave of IP onshoring?

The 2017 National Income and Expenditure Accounts will be published by the CSO on Thursday.  In a detailed information note the CSO have set out some of the updates and revisions we can expect.  Some of updates relate to the treatment of expenditure on imports of R&D services and tally with a lot of what we said here.

While these welcome updates are likely to be the most significant changes introduced by the CSO they are unlikely to be headline grabbers.  But they will significantly improve the usefulness of key measures of the economy such as the modified current account balance in the Balance of Payments, CA*, and the level and recent nominal growth rates of modified Gross National Income, GNI*. 

It is a bit of a punt but it is possible that for 2017 we will see CA* record a surplus somewhere in the range of 2-4 per cent of GNI*, while the recent nominal growth rates of GNI* may fall in the range of 5-8 per cent per annum.  These are impressive, and plausible, numbers.

But impressive and all as these might be it is likely that more attention will be directed at seeing how this pointer in section 4.1 of the CSO information note plays out:

The CSO’s Large Cases Unit (LCU) continues to work with data providers on their R&D-related activity. As part of this work, additional purchases of R&D-related IP assets have been identified in recent years and will be included as imports of services in the upcoming National Accounts and Balance of Payments results, with offsetting additions to the capital stock in the National Accounts. As a result of these new additions to the stock of intangible assets, the GNI* indicator will also include revisions to its depreciation adjustment for R&D-related IP assets in recent years.

We don’t have a GNI* depreciation adjustment for 2017 so that can’t be revised, thus it could be that these newly-identified onshoring events relate to years up to 2016.  And we do have another data source which now goes up to 2016 where these transactions are likely to make an impact – the aggregate Corporation Tax calculation published by the Revenue Commissioners.

The table below shows the national accounts depreciation adjustment for MNC imports of intellectual property products from last year’s NIE release and the capital allowances claimed for intangible assets under Section 291A of the Taxes Consolidated Act which was introduced with the Supplementary Budget of April 2009.

IP CFC and S291A CA

While these obviously are related concepts the figures do not have to match each other but they are strongly correlated which is best shown by the change in 2015 when both series rose by €25 billion ± €1 billion.  Conceptual differences aside it looks like there is some scope in most years for the national accounts version to be revised up.

This seems particularly true for 2016.  In last year’s NIE the CSO increased their depreciation measure for these IP products by €2.7 billion.  The recently-released aggregate CT calculation from the Revenue Commissioners shows a €6.9 billion increase in 2016 for the amount of capital allowances claimed for intangible assets.  There is a €4 billion difference between the changes.

It should also be noted that the time period covered by each series is different.  The CSO data covers activity that happens in a calendar year; the Revenue data reflects the details in CT returns filed for accounting periods ending during the calendar year.  So, for example, a company with a June 30th year-end will have the figures from its CT return included for one year even though the figures reflect activity that happened in the second half of the previous calendar year. 

This is only a minor wrinkle and should wash out between the series over a couple of years.  But it should be noted that changes in the Revenue data for a particular year could relate to activity that began the previous year and if a June 30th company introduced a change from July 1st 2016 it won’t appear in the Revenue data until 2017 but it could affect the revised 2016 data the CSO is set to publish this week.

So while little more than an enlightened guess we could see a couple of billion added to the national accounts depreciation measure in question here for years up to 2016. 

So what would a €4 billion increase in any year mean for the national accounts?  If we assume a 10-year lifespan then we could be looking at an increase in the capital stock of these intangible assets of around €40 billion.  Given recent developments it is likely that the upward revision to GDP (and GNP) would be around €4 billion.  This could add 1.5 to 2.0 percentage points to the growth rate of each.  GNI* will largely be unaffected as the upward movement in GDP will be offset by the increase in the depreciation adjustment that is subtracted to get this modified measure of national income.

So while the improvements to CA* and GNI* will be main source of added-value from this release they will have to fight for attention if tens of billions of intangibles are further added to the estimates of Ireland’s capital stock of intangible assets.

And, of course, we have absolutely no idea what could be introduced for 2017.  It is possible that the recent wave of IP onshoring was linked to “stateless” companies who would have been impacted by changes introduced to Ireland’s residency rules in the 2014 Finance Act that became effective from the start of 2015 and the implementation via the OECD’s BEPS process of country-by-country reporting by MNCs to the tax authorities in the countries in which they operate.  A country report for “Republic of Nowhere” would probably have raised a few eyebrows.  Maybe we have a few laggards but one would have thought that most of the impacted companies would have restructured before the end of 2016.

Of course, a second wave of onshoring is likely in response to the 2015 Finance Act changes to Ireland’s residency rules which become fully effective at the start of 2021 and, more importantly, proposed changes to Ireland’s transfer pricing rules which would see the latest OECD guidelines based on BEPS Actions 8 to 10 incorporated into Irish legislation. 

This would see royalty payments for IP disallowed as a tax deduction if the recipient of the royalties does not have sufficient DEMPE functions to warrant receipt of the royalties (DEMPE functions are the development, enhancement, maintenance, protection and exploitation of IP).

Up to now Irish legislation has been blind to the location, residence and substance of entities receiving outbound royalty payments but if BEPS Actions 8 to 10 are incorporated into Irish transfer rules (and it has been recommended that this should be done before the end of 2020) then the substance of such entities will matter.  Companies can continue to make royalty payments to them but they would only be eligible as a deduction for Irish Corporation Tax purposes if the receiving entities have sufficient DEMPE functions.  Cash-box entities in the Caribbean are unlikely to satisfy the criteria.

So either companies reroute the royalty payments to an entity that has the required DEMPE functions – such as the parent company in the US that undertakes most of these MNCs R&D activity – or restructure their operations in Ireland.  If recent events are anything to go by this restructuring will involve the onshoring of the IP licenses previously located with the cash-box entities in the Caribbean or other offshore financial centres..

Thus, the taxable income of the Irish operating company will move from being reduced by “renting” the IP and making annual royalty payments for the use of the IP to being reduced by “buying” the IP and claiming capital allowances each year based on the cost of acquiring and maintaining the IP.

Could we have seen a few early movers in 2017 even though such a change could have been delayed until 2021? Maybe, but it seems unlikely.  There was a reasonably-flagged change to S291A that became effective from midnight on the night of Budget 2018.  This saw that amount of capital allowances that could be used in any one year limited to 80 per cent of the relevant taxable income. 

This guarantees that some of the intangible-asset-related profit will be exposed to tax each year though if the cap is binding it means it takes a longer period for the capital allowances to be exhausted as the full amount is still available to be used.  It seems unlikely that a company would have moved in advance of the introduction of this change when they could continue with the royalty-based structure until the end of 2020. 

And it seems even more unlikely when the alternative is a capital-allowances-based structure that is essentially limited by the amount that can be claimed arising from the initial acquisition cost versus the open-ended and virtually unlimited amounts that can be used in the royalty-based structure.

But maybe it would be a consideration with a particular profit outlook and risk appetite. Such risk assessments could include the possibility of an EU State-aid investigation (and maybe the risk appetite of national tax authorities for the same could also be a factor).  If you were a typical US MNC availing of the “double-irish” to defer your US tax liability you might get the heebie-jeebies when reading the full version of the Amazon-Luxembourg state-aid case.

Even with that it is more probable than not that the second wave of IP onshoring to Ireland will not be seen until nearer to 2020.  Although the analysis is preliminary it does not appear that the Tax Cuts and Jobs Act passed by the US Congress last December will significantly change the incentives involved for existing IP that companies have moved offshore.  

And with over €70 billion of outbound royalty payments currently being made from Ireland the potential scale involved is huge. However, section 5.1 of the CSO information note indicates that this will be revised down by some amount but it should be remembered that this is on the basis of a national accounting interpretation of what is going on not a tax interpretation. 

This issue aside it could be that the total value of the assets involved is of the order of something approaching a trillion euro while the associated gross profits / capital allowances could be double the levels seen by the end of 2016 bringing the annual amounts to something around €100 billion. 

Could any of this have arrived in 2017? Maybe.  Just as it’s a possibility that there were some late first-wave movers that only got around to getting their affairs in order in 2017.  As flagged by the CSO there will be changes to the national accounts with revisions to the data relating to onshoring that took place up to 2016. 

At this stage the rest of us really are blind as to what could have happened in 2017.  Maybe the NIE release on Thursday will see us stunned like startled earwigs again, and then again maybe it won’t, but IP onshoring is something we should be expecting to see much more of as we move towards the end of the decade.  Buckle up!

Tuesday, July 17, 2018

Capital Allowances and companies with Net Trading Income that is negative or nil

The previous post went through the overall outturns from the 2016 aggregate Corporation Tax calculation which was recently published by the Revenue Commissioners.  As detailed there the figures for capital allowances are worthy of attention.  The amounts of capital allowances used against gross trading income for the last four years for which we have data are:

  • 2013:  €15,955m
  • 2014:  €18,621m
  • 2015:  €46,153m
  • 2016:  €59,254m

Additional research from staff of the Revenue Commissioners tells us that a large part the increased claims for capital allowances are linked to intangible assets.  Here are the amount of capital allowances claimed for expenditure on intangible assets from 2014 to 2016.

  • 2013:    €2,522m
  • 2014:    €2,652m
  • 2015:  €28,871m
  • 2016:  €35,737m

It is worth noting that capital allowances claimed as shown in above figures is not the same as capital allowances used which were shown in the first set of numbers.  A company may claim capital allowances but unless it has income against which to offset those capital allowances the capital allowances remain unused and can be carried forward as a loss for use in subsequent period when there may be income to use them against.  There is a story here but it doesn’t relate to intangibles which is the focus here and is something we may land on in future.

The CSO host a databank from the Revenue which provides some distributional details of income, deductions and allowances used for Corporation Tax purposes.  The next table shows claims of capital allowances for plant and machinery (which includes intangible assets) by range of net income since 2013.

Plant and Machinery Capital Allowances by Range of Net Income

It can be seen that two income ranges are responsible for almost all the capital allowances claimed: companies with net incomes greater than €10 million and companies with negative or nil net income.  And of these, most of the action is within companies with negative or nil net income.  Since 2014, the amount of capital allowances claimed by such companies has gone from €12.6 billion to €47.5 billion.

The distributional data has been made available much quicker by the Revenue this year and we can put together a rough CT calculation for companies with negative or nil net trading income.  There are some missing items but there enough to allow us to see what is going on.

Corporation Tax Computation for Companies with No Trading Income

The fifth row gives the duck eggs for Net Trading Income (0 0 0 0) but above that we can see that these companies had significant amounts of Gross Trading Profits.  These profits went from €13.5 billion in 2014 to €40.0 billion in 2015 to €49.9 billion in 2016.  These gross profits are included in GDP but it is Taxable Income that matters for CT payments. 

And we see that after the application of losses, and most importantly, capital allowances, the resulting net trading income of these companies with almost €50 billion of Gross Trading Profits in 2016 was zero.  It doesn’t matter what the tax rate is, the tax due on trading incomes of zero is zero.   Some companies in this category do pay Corporation Tax but that is due to Other Income such as rental, foreign or capital gains rather than Trading Income.

The Gross Trading Profits shown in the above table are responsible for a large part of the recent surge in GDP.  But they have no role in explaining the recent rise in Corporation Tax.

The 2016 Aggregate Corporation Tax Calculation

Ireland’s national accounts cannot be accused of being dull and the latest update to the National Income and Expenditure Accounts due this Thursday looks like it will offer plenty to chew over.  Of course, all the CSO are doing is reporting on what is going on.  The main reason for the lack of dullness in the accounts is the corporate sector, and in particular, the impact of foreign-owned MNCs.

We know tax is a factor behind a lot of what goes on so the tax data provided by the Revenue Commissioners is a useful complement to the national accounting data published by the CSO. 

The Revenue have now published the 2016 update of the aggregate Corporation Tax calculation.  This might seem a bit sluggish but the deadline for CT returns is nine months after the end of the financial year to which they apply to CT returns for tax years ending in December 2016 would have been filed up to September 2017 and the process of compiling the aggregate figures means we get the data about half way through the following year.

So, now that we have the aggregate CT calculation for 2016 what does it tell us?  Essentially, we can divided the calculation into two parts:

  1. The determination of Taxable Income from Gross Trading Profits, and
  2. The determination of Tax Due from Gross Tax Due

We’ll start with the determination of Taxable Income.

Aggregate CT Calculation for Taxable Income 2012-2016

In relative terms (i.e. compared to 2015!) the changes in 2016 were relatively modest.  The starting point of the table, Gross Trading Profits, had a massive surge of almost €50 billion (and 50 per cent) in 2015.  The 2016 increase was €15 billion or “just” 10 per cent.

From 2014 to 2016, Gross Trading Profits increased from just over €95 billion to almost €160 billion.  Over the same period the bottom line here, Taxable Income, increased from €50 billion to €71 billion.  This suggests there is a lot going on in between when a €65 billion rise in Gross Trading Profits translates into an increase in Taxable Income of around one-third of that amount.

It also suggests that caution should be exercised when drawing a link between the 2015 surge in GDP and the 2015 surge in Exchequer Corporation Tax receipts.

There is a lot going on and it is almost all due to just one item: Capital Allowances, i.e. the tax treatment of expenditure linked to the acquisition or maintenance and development of fixed assets.  The fourth row of numbers in the table shows what happened.

Back in 2012, firms used €8.5 billion of capital allowances against their gross trading profits (though this could have been affected by lower profits) and by 2016 the amount of capital allowances used had risen to almost €60 billion. Most of this increase has happened in the latest two years for which data is available, 2015 (+€27.5 billion) and 2016 (+€13.1 billion).

The only other notable change in 2016 was the €6 billion or so reduction in Trade Losses Carried Forward used though all this has done is brought this item back to its 2014 level.  There is lots to be learned in the table but when it comes to recent changes, and finding links to developments in the national accounts, it really is all about capital allowances.  The next post will look at these in more detail.  For now we will looks at the second part of the aggregate CT calculation which shows how Tax Due is reached from the starting point of Gross Tax Due.

Aggregate CT Calculation for Tax Due 2012-2016

Applying Ireland’s two Corporation Tax rates shows that the Taxable Income reported by companies for tax years ending in 2016 resulted in a Gross Tax Due amount of almost €9.5 billion. Ireland does have a third tax rate paid by companies, that on capital gains, but these amounts are regrossed based on the difference between the CGT rate on the CT rate of 12.5 per cent and the 12.5 per cent rate is applied to these regrossed amounts to give the amount of tax due.

We can see that the €9.5 billion of Gross Tax Due results on a Tax Due amount of €7.2 billion once we reach the bottom line.  The reduction is due to credits and reliefs available under Irish CT legislation.  These are actually pretty limited in number and we can see that the bulk of the reduction is due to two sets of items:

  1. Double Taxation Relief and the Additional Foreign Tax Credit
  2. The R&D Tax Credit used against tax this year and the Payment of the Excess R&D tax credit.

Between them these factors account for €2.0 billion of the €2.3 billion difference between Gross Tax Due and Tax Due.  Earlier posts considered the impact of these features of Ireland’s CT codes on effective tax rates here and here.  Without them the effective tax rate on Taxable Income would essentially be 12.5 per cent.

Finally, it is worth comparing the figures for Tax Due shown here and the cash receipts for Corporation Tax recorded by the Exchequer.

CT Tax Due and Exchequer CT Receipts

For the five years shown the two series roughly sum to the same aggregate amount (c.€27 billion) but reach the 2016 amount of c.€7.25 billion by difference routes.  As is well known Exchequer CT receipts spiked by almost 50 per cent in 2015.  On the other hand the increase is Tax Due as shown in the aggregate CT calculation is more evenly spread across 2014, 2015 and 2016. 

This suggests there may have been a timing issue at play when it comes to the surge in cash receipts in 2015 with some receipts due on activity that occurred in 2014 delayed until the final CT return was filed nine months after the end of the companies’ accounting periods. 

And, again it highlights, that although the surge in CT receipts may have happened in the same year as the jump in GDP, they are not necessarily directly related.  As with lots of things lately, capital allowances play a central role in this and it is to them that we will turn next.

Monday, June 18, 2018

Who shifts profits to Ireland?

Eurostat’s structural business statistics give a range of measures of the business economy broken down by the controlling country of the enterprises.  Here is the Gross Operating Surplus generated in Ireland in 2015 for the countries with figures reported by Eurostat.

Ireland Business Economy by Controlling Country - Profits 2

In total companies reported around €125 billion of Gross Operating Surplus in Ireland in 2015.  Of this 90 per cent arose in companies controlled from just two countries.  These were companies “controlled by the reporting country” (i.e. Ireland) and companies controlled from the United States.  Much smaller amounts of profits are reported for companies controlled from all other countries.

Although there are problems with it we can get some insight into the profitability of companies by comparing their gross operating surplus to their personnel costs.

Ireland Business Economy by Controlling Country - Profitability 2

Again, there is one stand-out figure – that for the United States.  There are other countries which do seem to have companies in Ireland with “excess” profits (Australia, Japan, Italy and Belgium) but as shown in the first chart the amounts in question are relatively small and some of the high rates are one-offs rather than showing up consistently in the data.

Do these charts show:

  1. Profits being shifted out of large market countries such as France and Germany, etc. or
  2. Profits being shifted out of their source in the United States?

And if it is #1 why is it only US companies that seem to be able to do it?  Why don’t French or German companies shift their profits to Ireland?  Of course, the answer is that the charts actually show #2 to be key issue but that seems unlikely to get a foothold in the debate anytime soon.

Wednesday, May 9, 2018

Why is the Irish “average wage” in the OECD Taxing Wages so low?

A few weeks ago the OECD published the 2018 update of their Taxing Wages publication.  There is plenty in the report worth chewing over but one minor issue that arises is the level of the “average wage” benchmark used for Ireland.

OECD Taxing Wages Average Wage Ireland 2000-2017

It doesn’t really appear to be anything too noteworthy.  It rises fairly rapidly up to 2008 (the figures are nominal so no account is taken of inflation), drops in 2009, has been edging upwards for the past three or four years or so, and is put at €36,800 for 2017.

But what about when we look at it in a comparative context?  OK, an international comparison  isn’t as straightforward as looking at a single country through time but we can overcome some issues if we look at countries that share a common currency. 

Here are the nominal average wages used for 2016 for a group of euro-area countries.

  • Netherlands €50,120
  • Germany €48,300
  • Belgium €46,528
  • Austria €45,073
  • Finland €43,716
  • France €37,906
  • Ireland €35,430

So, we still haven’t adjusted for prices but some of the gaps here are very large.  Is the nominal average wage in Ireland 27 per cent lower than Germany and 29 per cent lower than The Netherlands?

The OECD also has an Annual Wages publication which uses aggregate data from the national accounts to work out an average wage.  As the notes say:

Average annual wages per full-time equivalent dependent employee are obtained by dividing the national-accounts-based total wage bill by the average number of employees in the total economy, which is then multiplied by the ratio of average usual weekly hours per full-time employee to average usually weekly hours for all employees.

So what does this tell us?  Here are the 2016 averages from this dataset.

  • Ireland €51,336
  • Netherlands €46,709
  • Belgium €43,097
  • Austria €41,421
  • Finland €41,209
  • Germany €38,302
  • France €36,809

Of the selected group Ireland has gone from last to first with a 44 per cent rise in the estimated annual average wage as measured using the national accounts versus that used in Taxing Wages.  For most of the other countries the difference is only a few per cent – bar Germany where the national accounts show an average that is over 20 per cent lower.  Still by far the greatest absolute difference is for Ireland.

So,what explains it?  Perhaps it is coverage.  The national accounts cover the entire economy where the Taxes Wages figure is derived from NACE sectors B to N, i.e. the business economy which excludes state-dominated sectors such as education and health. But this coverage is the same for all countries.

The answer lies in the annex of the Taxing Wages report

Table A4 shows the method used to calculate the average wage.  One piece is the type of workers covered.  There are columns which show whether supervisory or managerial workers are included.  There are 36 countries covered in Taxing Wages and 34 of them include both of these types of workers, many of which we can assume would be in the top half of the earnings distribution. 

Which countries do not have them included when the average is calculated? Turkey and Ireland.

Part-time workers are another category that get varying treatment across countries.  Some countries leave them out altogether and only include full-time employees when working out the average.  Other countries include them but do so on a full-time equivalent basis such that their earnings are included but are scaled up as if they were a full-time employee.  There are six countries who include part-time employees in the calculation but do so on the basis of their actual annual earnings as part-time workers.

In their notes the OECD say:

The worker is assumed to be full-time employed during the entire year without breaks for sickness or unemployment.  However, several countries are unable to separate and exclude part-time workers form the earnings figures (see Table A.4). Most of them report full-time equivalent wages in these cases.  In four countries (Chile, Ireland, Slovak Republic and Turkey), the wages of part-time workers can neither be excluded nor converted into full-time workers (for example, an OECD Secretariat analysis of available Eurostat earnings data for selected European countries has show that include part-time workers reduces average earnings by around 10%).

So, the Irish figures used in Taxing Wages exclude supervisory and managerial staff, and include part-time workers on an unadjusted basis. 

What would the Irish figure be if it was estimated in line with the practice for most other countries?  Figures on that basis are available from Eurostat’s Structure of Earnings Survey though it is only available every four years.  The averages (with part-time employees given on a full-time equivalent basis) for sectors B to N are given as:

  • 2002: €33,320
  • 2006: €40,761
  • 2010 : €42,111
  • 2014: €44,700

This would put Ireland pretty much in the middle of the set of countries used above. 

Would it make a difference if the 2017 average wage used for Ireland was €45,000 rather than €36,400?  It probably would.

The OECD show that a single person on the average wage in Ireland has taxes and social insurance deductions of just under 20 per cent of their gross wage.  If this calculation was done using an average of €45,000 then the deductions would be 25 per cent of gross wage. 

This is part of an infographic the OECD used to promote the publication of Taxing Wages

OECD Taxing Wages Infographic

The OECD average is given as 25.5 per cent for 2017 and Ireland is included in the group of “low-tax” countries with tax rates for a single worker on the average wage of less than 20 per cent.  If an average wage was used that better reflected the actual outcomes in Ireland, in line with the methods used for other countries, then Ireland would be pretty much bang on the OECD average and would not be flagged (literally) on such infographics. 

Such a change would probably have limited impact on the estimated progressiveness of the Irish income tax system but it would change the range of values that are currently included in the analysis.  The OECD analysis extends up to earners on 167 per cent of the average wage.  This is around €60,000 with the average currently used but would be €75,000 if that was increased to the value proposed here.

If €45,000 was used for the Irish average wage (which the available data would support) then Ireland would not be down towards the bottom of charts like this.  This calculator puts the tax rate on a single person earning €45,000 in 2017 at 25 per cent.

OECD Taxing Wages Tax Rate on Average Wage

If a more realistic average wage was used, Ireland would pretty much be the same as the OECD average (and rise maybe ten places higher) in the above chart.  So why is such an unrepresentative average wage used for Ireland in this important report?

Why don’t the household sector accounts make sense?

Ireland’s national accounts have their foibles but they don’t seem to be limited to the corporate (MNCs) or financial (IFSC) sectors.  Their are some quirks in the household sector as well though maybe the heading above is a bit of an exaggeration.  The household accounts do make sense just maybe not in the way that we would expect.

The issue can be seen by looking at two outcomes:

  1. The flow of net lending or borrowing of the household sector.  This is essentially the outcome after all current and capital flows (income, expenditure, taxes and transfers) have been accounted for and gives a surplus available for use (net lending) or a deficit to be financed (net borrowing).
  2. The stock of loan liabilities of the household sector.  This is simply the sum of all loans (mortgages, car loans, short-term loans etc.) of the household sector taken at a point in time usually the year-end.

First the annual flow of net lending/net borrowing of the household sector:

Household Sector Net Lending

And the stock of loan liabilities:

Household Sector Loan Liabilities

OK, at first glance both of these are pretty much what would expect.  The household sector went deep into net borrowing by 2007 with loan liabilities rising steeply. The borrowing stopped abruptly in 2009 and the household sector became a net lender and this deleveraging is evident in the drop in the amount of loan liabilities from just north of €200 billion at the end of 2008 to around €140 billion at the of 2016.

So what’s the problem?

This issue is the difference between the amount of resources that the current and capital accounts tell us is available for net lending (such as repaying loans) and the drop in loan liabilities.  Here are the sum of the flows (net lending) versus the change in the stocks (loan liabilities) since 2008:

Household Sector Net Lending v Loan Liabilities

These don’t have to be the same but we would like to be able to explain the difference between them.  From 2009 to 2016 the loan liabilities of the household sector were reduced by around €60 billion.  Over the same period the household sector had cumulative net lending of around €15 billion.  The household sector has significantly reduced its loan liabilities but the resources to do so does not seem to have come from income.

And, as the first chart above shows, for the past few years we can see that the household sector has had a net lending outcome of close to zero (and even been a small net borrower) while at the same time continuing to reduce its stock of loan liabilities by around €8 billion a year. 

Where is the money coming from?

There are a number of ways the loan liabilities of the household sector can be reduced.  These include:

  • making repayments from income
  • selling assets (real or financial) to finance repayments
  • revaluations, write-offs or other stock adjustments.

Can these three factors explain the €60 billion reduction in loan liabilities that has occurred since 2008?  Even if all the available net lending generated from the first was devoted to repaying loans that would still leave €45 billion to be explained by the latter two.

We can get some insight into the contribution of revaluations and write-offs is we compare the flow of loan transactions (net drawdowns versus repayments) to the stock of liabilities.   Again we will take the end of 2008 as the starting point.

Household Sector Loan Transactions v Loan Liabilities

In the five years to the end of 2013 the €34 billion reduction in loan liabilities is closely matched by the minus €33 billion sum of loan transaction, i.e. the reduction was almost entirely achieved through repayments.  Since 2013 though, the reduction in the stock of household loan liabilities has exceeded the amount that can be attributed to loan transactions.  The gap reflects revaluations and write-offs with a €12 billion difference showing in the chart above by 2016.

But we still don’t know where the money came for the loan transactions shown above.  All told they are responsible for €47 billion of the €60 billion reduction in household loan liabilities since 2008.  If every cent of net lending the households generated from their income this could only provide €15 billion over the same period.  Where did the other €32 billion come from?

Maybe it came from deposits. This could be borrowers themselves using deposits. It would also show if an asset (such as a house) was sold with the seller using the proceeds to repay a loan while the purchaser funded all or a large part of the transaction with deposits.  For the household sector in aggregate give rise to a reduction in loans and a reduction in deposits. 

But household deposits have actually increased over the period, from €120 billion at the end of 2008 to €135 billion at the end of 2016.  Of course, this only adds to the mystery.  If, as we would expect, some of the household net lending went to increase deposits then even less would have been available for loan reductions so the gap to be explained is even larger than €32 billion.

How do the accounts explain the gap?

The financial accounts do make sense, i.e. add up, so we can see where it is implied the money came from. And this is the sale of assets – the second of the three possibilities listed above. shares.  What did the household sector sell? The answer apparently is unlisted shares, that is shares in private or family companies. 

However looking at the balance sheet doesn’t reveal that this is the place to look.  Here is the stock of unlisted shares held by the household sector.

Household Sector Unlisted Shares

There has been some reduction since 2009 but only in the order of a couple of a billion.  The stock position was €39.5 billion at the start of 2009 and had declined to €32.75 billion at the end of 2016.  It is not clear from this that the household sector has generated substantial resources from the sale of unlisted shares to fund the level of debt reduction we have seen.  But if we look at the transactions and revaluations behind these end-of-year positions this is what we see since 2009.

Household Sector Unlisted Shares Transactions Table

The stock position might have declined by only €7 billion or so between 2009 and 2016 but the cumulative impact of transactions was almost minus €53 billion, i.e. the household sector had net sales of unlisted shares of €53 billion!  The reason this had such a small impact on the stock position is that there were offsetting positive revaluations and other adjustments of plus €46 billion.  These are big numbers.

But wouldn’t we see some evidence of these transactions elsewhere. For example, selling tens of billions of assets would probably have some Capital Gains Tax implications but CGT receipts for the past few years have been in the order of hundreds of millions and, of course, reflect realised gains on a broad range of assets not just shares in private companies.  There is no evidence of tens of billions worth of transactions in unlisted shares. 

And it is interesting to note when they were added to the accounts.  This table shows the figures as published in different vintages of the Financial Accounts going back to 2012.

Household Sector Vintages of Unlisted Shares Transactions Table

In the 2013 release, the reported transactions for the years 2009 to 2012 summed to –€7.4 billion.  The latest estimates for those years sum to –€26.3 billion.  And it can be seen that the changes have been made in relatively neat amounts.  The 2009 figure has been revised by €5,000 million compared to what was in the accounts originally.  Similarly even figures can be seen for the other changes.

The absurdity of the reported Irish outcomes can be seen if we look at transactions in unlisted shares by the household sectors across the EU15.

EU15 Household Sector Unlisted Shares Transactions Table

No country comes close to having the scale of household sector transactions in unlisted shares to that of Ireland.  The median sum for the period 2009 to 2016 across the EU15 is +0.3 percentage points of GDP.  As can be see the outcome for Ireland is –26.6 percentage points of GDP (and that’s even with an inappropriately large denominator).

So Ireland’s household sector accounts do make sense. The net lending/borrowing shown in the Capital Account is a close match for the net financial transactions shown in the Financial Account. 

Household Sector Net Outcomes CSO 2002-2016

The discrepancy between net financial transactions (B.9F) and net lending/net borrowing (B.9)this is included by Eurostat (as variable B.9FX9) in their sector accounts.  But the relative consistency shown in the chart above, particularly since 2010, is only achieved through the inclusion of massive transactions in unlisted shares which do not make sense. 

As we went through before the CSO and Central Bank views of the financial transactions that are very different.  The Central Bank do not have have tens of billions of net sales transactions in unlisted shares.

So, where do we stand?

Here are the net lending/net borrowing outcomes for the household sectors of the EU15 in nominal per capita terms since 1995.

EU15 ISA Household Sector Net Lending Per Capita

There isn’t much of a surprise in seeing Ireland as the stand-out series up to 2006 and 2007.  But after getting back into the middle of the pack by 2009 we have dropped down through the ranks again in recent years.

And if we go back to the Current Account we can get the gross savings rate which is the share of gross disposable income (with an adjustment for pension funds) that is not used for consumption expenditure.

EU15 ISA Household Sector Gross Davings Rate

Just as with the outcome for net lending/net borrowing which comes after capital spending has been accounted for the gross savings rates show the recent outturns for Ireland to be “low”.

Is any of this important?

It is if trying to gauge the impact on the economy of future changes in the household sector is important.  A "deleveraging hypothesis" would suggest that the household sector has been repaying significant amounts of debt built up during the credit boom and that as these debts are repaid the household sector will have more resources available for consumption and investment as elevated savings to make debt repayments will no longer be required. 

This hypothesis is in line with the huge reduction in debt liabilities we have seen on the household sector's financial balance sheet since 2009.  However, the capital account shows that the household sector is already a net borrower and that there is limited scope to increase consumption and capital formation from existing resources.  This would suggest a stable path for the gross savings ratio over the next few years and forecasts of consumption growth in line with income growth would probably be appropriate. 

But what if household consumption expenditure and/or capital formation grows faster than household income? Should we be concerned particularly if the national accounts indicate that this could only be possible through increased borrowing? 

All this feeds through to expected changes in the current account of the Balance of Payments and informs one's view of whether the level of economic activity is sustainable or not. If activity is dependent on being financed by deficits that activity requires the lending and/or borrowing behavior to continue which, history tells us, is something that can change very quickly.

If the increased activity is being funded through a reduction in gross savings, net lending and/or current account surpluses then reasons for concern should be limited but if it is being funded by increased borrowing and/or current account deficits then at a minimum it should at least trigger an amber warning which may lead to concern being warranted. 

We don't have visible sight of the underlying current account (because of an issue with R&D services imports) and until we do the household gross savings rate and the outcome for net lending/net borrowing take up increased significance.  These would suggest that the financial capacity of the household sector is “tight” and that any rapid expansion should be a cause for concern.

So what to do?

Taking the gross saving rate and net borrowing numbers at face value offers some support for an “overheating hypothesis” and whatever policy prescriptions would follow from that diagnosis.  As the net lending/borrowing chart (the first chart above) shows it is a long way from the dizzying days of 2004 to 2007 but the Irish economy is one in which conditions can change rapidly.  Housing can be a driver of such swings.

But should we take the numbers at face value?  We think there is an underlying current account surplus in the Balance of Payments and that this possibly increased in 2017.   We know that the underlying net international investment position of the economy has been rapidly improving.  We know that the financial position of the household sector has improved and that debt reduction has made a significant contribution to that.  These sit counter to an “overheating hypothesis”.

So maybe just have contradictory signals and none can be taken as evidence of anything. But shouldn’t the pieces of the jigsaw fit together? Shouldn’t we have a coherent story?  In this instance the contradictory signals are in the current, capital and financial accounts of the household sector.

Putting together the national accounts requires a certain amount of estimation and interpolation. Hard evidence will only get you so far and jumps that join the dots are sometimes required.  But putting in tens of billions of sales transactions does not seem credible.

When ranking the hard evidence used for the household sector it is likely that the financial balance sheet would be towards the top of the reliability stakes.  Getting a handle on the loan and deposit positions of the household sector is possible using data from a fairly small number of financial institutions and while there might be some uncertainty around the levels, the direction and magnitude of changes should have greater confidence associated with them. 

These changes point to a €60 billion reduction in household loan liabilities since 2009 and a €15 billion increase in household deposits over the same period.  These figures might be wrong but to be out by tens of billions seems unlikely.

If these balance-sheet changes are considered reliable shouldn’t the rest of the accounts be consistent with them – and in a manner that makes more sense than using absurd transactions in unlisted shares?  It is possible the inconsistency is due to unreported income, in the informal or black economy, not showing up in the current account but one would imagine there is plenty of consumption spending that is not picked up either.

If the accounts are to be more consistent it would require income to be higher, spending to the lower, or some combination of the two.  However it was achieved, the outcome would be a higher gross savings rate and an outcome for net lending more in line with the observed deleveraging.

Of course we actually had that this time last year but such coherence was revised away. Can we have it back please?

Thursday, April 19, 2018

Aggregate improvement in the household sector motors along

Last week the CSO published the Q4 2017 update of the Institutional Sector Accounts (ISAs) which give us a preliminary insight into the full-year outcomes by sector.  The ISAs follow from the Q4 Quarterly National Accounts (QNAs) a few weeks ago.  For a variety of reasons the QNAs get lots of coverage and the ISAs close to none.  There is far more information, and better information, in the ISAs. 

Here we will look at the household sector. The snapshot shows the nature of the general improvement.

Household Sector Income Expenditure and Net Lending

Let’s looks at some of the detail.  First the current account:

Household Sector Current Account 2013-2017

We could go through it but it is a picture of general improvement.  In the middle we see that Gross National Income, largely the sum of self-employed, employee and property income, is estimated to have increased by six per cent in 2017.  Once we account for taxes and transfers we get an annual increase in Gross Disposable Income of 5.1 per cent. 

With final consumption expenditure estimated to have risen by 3.1 per cent, the current account ends up an increase in the Gross Savings of the household sector; from 7.0 per cent of GDI in 2016 to 8.8 per cent of GDI in 2017.  This is still likely to leave Ireland towards the bottom of the EU15 ranking in 2017 as was the case in 2016.  [The legend in the chart is ranked by the 2016 outcomes.]

EU15 ISA Household Sector Gross Davings Rate

So what can we do with these Gross Savings from the current account?  Disposable income that hasn’t been used for consumption can either be lent (put into financial assets such as deposits or equity and/or used to reduce financial liabilities like loans) or used for capital formation (new houses, improvements/renovations of existing houses etc.)

Obviously, here we are looking at aggregate outcomes, so the outcome for individual households will vary. A household that has borrowed for consumption expenditure can further borrow for capital formation.  The aggregate descriptions refer to the outcome for the sector as a whole.

So what happens when we put €8.8 billion of gross savings into the capital account?

Household Sector Capital Accounts 2013-2017

For 2017, it is estimated that the household sector undertook €9.2 billion of capital formation.  So all the gross savings from the current account was spent (or at least that was the aggregate outcome – some households were borrowing while others were savings) and after capital taxes and transfers we end up with a net borrowing outcome of around €200 million. 

In 2017, between current expenditure and capital formation, the Irish household sector pretty much spent all of its disposable income – and this has been the case for every year since 2014.

All in all, the growth rates for 2017 look very positive.  All sources of income are growing rapidly, current spending is growing but not as quickly, while capital spending is growing a bit faster.  All in all it paints a very positive picture.

One concern is that the Irish household sector has been a net borrower for the past three years.  The chart below shows household sector net lending/net borrowing for the EU15 in per capita terms.

EU15 ISA Household Sector Net Lending Per Capita

It is not the crazy days of 2006/07 but after moving into the middle of the EU15 pack from 2009 to 2012, we have been drifting downwards since.

But this chart clashes with view that the Irish household sector is deleveraging.  In fact, as the last line in the previous table shows the Irish household sector has been spending more than it is earning since 2014.  Can this be true?

The Quarterly Financial Accounts of the Central Bank show that the loan liabilities of the household sector were €167.7 billion at the end of 2013.  The latest figure is for Q3 2017 which shows that loan liabilities had been reduced to €141.8 billion.

That the Irish household sector is reducing its loan liabilities is not a surprise.  But how have loan liabilities reduced by €16 billion over the past three years or so when expenditure, current and capital, has exceeded disposable income by €2 billion.  And it is also worth noting the currency and deposit assets have increased by €12 billion over the same period.

So where did the money come from to reduce loans by €16 billion and increase deposits by €12 billion if spending exceeded income by €2 billion?  That is a €30 billion gap in just three years and is something we may return to in a subsequent post.

For now we will focus on the growth rates rather than the levels.  The growth rates are motoring along nicely. 

Household Sector Income Growth

Nominal household income grew by between five and six per cent in 2017. That is pretty strong. It would be much better to focus on that than chattering about how much of the GDP growth shown in the QNAs was due to iPhones (plus I suspect the very specific claim made by the IMF is wrong).

Wednesday, April 4, 2018

Revisions (introduced and expected) to the NFC sector in the national accounts

When the 2016 Institutional Sector Accounts were published in November the CSO provided a breakdown of the non-financial corporate sector in the “top 50 foreign-owned NFCs” and “other NFCs”.  We went through the accounts for each here.  A few weeks ago the CSO made some minor revisions to the figures and it is worth giving them a little look. Click to enlarge.

NFC Sector Current Account 2013-2016 Split

The CSO have revised down the property income paid by the large, foreign-owned NFCs which has the effect of increasing the aggregates as the revisions work down the table.  The revisions summed to around €8 billion across the four years for which the split of the NFC sector is currently available.  A derived measure such as “Net Savings” which here is Gross Savings less consumption of fixed capital (i.e. depreciation) is now essentially zero.  As companies so not undertake final consumption we could equivalently say that the Net Disposable Income of the large foreign-owned companies is zero.

We would not expect foreign companies to be contributing anything to the net savings of the economy.  By the time you get down to Gross Disposable Income the only thing left to cover is depreciation.  There should be no excess as any residual should be counted as a property income outflow (such as retained earnings accruing to non-residents). 

[The numbers in the panel of the table above for the Net Savings of the large, foreign-owned NFCs are close to but not exactly zero though these values do seem to be related to the net of other transfers paid and received further up the table.  In the greater scale of things the numbers are close enough to zero to make no difference.]

Of course, the aggregate measures that get most of the attention, GDP, GNP, GNI etc., are in gross terms so the impact of depreciation is important.  Measures of national income and growth in net terms are very useful and should be more widely used but differences, inconsistencies and robustness concerns in how depreciation is estimated across countries means that the primary focus remains on the gross measures.

The changes don’t hugely affect what was said in the previous post and a fuller discussion of what the breakdown does and does not provide is available there.  Here we will just look at a couple of additional points.

Firstly, on the tax paid by foreign-owned companies.  We usually focus on Corporation Tax and the table above shows that the 50 companies in this category paid around €2.5 billion of Corporation Tax in 2015 and 2016.  A bit further up the table though we have “other taxes on production paid”.  For 2015 and 2016 these came to around €900 million for this group which is a significant contribution [it can also be seen that “subsidies on production received” were zero).

There are a number of taxes that make up this categories and for the foreign-owned companies involved it is likely that the relevant ones are:

  • Commercial Rates
  • Motor Tax
  • National Training Fund Levy

Second, when looking at the contribution of foreign-owned companies to national income we would like to know what they spent on:

  • goods and services from Irish suppliers (i.e. non-imported intermediate consumption)
  • compensation of employees to the direct staff
  • taxes, both taxes on income and taxes on production
  • capital investment, particular on tangible goods

The table above gives us the middle two of these for the top 50 foreign-owned NFCs, €4.3 billion for compensation of employees and €3.4 billion for taxes.  We don’t know how much of their intermediate consumption comes from Irish suppliers and the investment figures recently have been skewed by volatile investment in intangibles but it would not be a surprise is these two figures were around €4 billion as well. 

With a bit of juggling this could be seen to be in line with finding from the Survey of Business Impact now carried out by the Department of Business, Enterprise and Innovation though the non-imported component of intermediate consumption of one MNE could simply be the imported by an Irish supplier (or another MNE for that matter) and it will certainly be the case that a share of the investment in tangible goods will be on imported equipment.

Turning to the second panel in the table doesn’t offer much as it remains a bit of an impenetrable gloop. It obviously contains all domestic firms but also contains those foreign-owned NFCs not included in the “top 50”.  The CSO are working on a more complete foreign/domestic split which will help.

We would expect the profits of foreign-owned companies to be stripped out via property income paid so the Gross National Income and Gross Disposable Income shown in this panel should give us a good idea of the earnings of Irish companies.  That does not appear to be the case as the growth rates are much too rapid.  The nominal growth rates of GNI for other NFCs for 2014 to 2016 were 19 per cent, 11 per cent and 23 per cent.  The growth rates of the Gross Disposable Income of this group were similar.

There might be something going on with depreciation.  From 2013 to 2016 the depreciation associated with aircraft for leasing increased from €2.6 billion to €5.1 billion. However, even the derived “Net Savings” measure shown at the bottom of the table has average annual growth rates of 20 per cent over the three years.  This measure excludes all depreciation and should exclude  the profits of foreign-owned companies.  That does not appear to be the case.

It is likely that the odd outcomes here are, at least in part, linked to the treatment of imported R&D services expenditure (which was raised in this recent post on the Balance of Payments).  It is likely that a large share of the imported R&D services relates to “cost-sharing payments” made by the Irish subsidiaries of US MNCs are part of the licensing arrangement for the use of intellectual property outside the US. The Irish subsidiary contributes a share of the company’s overall R&D expense relative to the size of the market it covers.

One outcome of a more consistent treatment of this R&D services imports as capital formation could be an upward revision to property income paid by foreign-owned companies in this group.  It also seems likely that the full impact of any changes will be seen in the “other NFCs” group given the consistency that now appears in the revised figures for the “top 50” group (i.e. the near zero figures for “Net Savings").

The stability in the figures from 2013 to 2016 for property income paid for the other NFC group would suggest that the profitability of foreign-owned firms in this group was also relatively stable as dividends paid and retained earnings accruing to non-residents will make a large part of this figure. 

This does not seem likely.  The Corporation Tax paid by this group rose 75 per cent between 2013 and 2016 and if the bulk of that came from Irish firms it would imply a remarkable rise in profits.  For example, if Irish firms paid half the Corporation Tax of this group in 2013 then the resultant rise in Corporation Tax would imply the profits of the Irish firms rose 150 per cent (as the amount of tax would need to rise from €1 billion to €2.5 billion).

[And it is also worth noting that the figures for property income received in the right-panel will contain the retained earnings of redomiciled PLCs which is another wrinkle to be ironed out.]

There is a recovery but a 150 per cent rise in the profits of Irish firms is highly implausible.  This suggests the figures in the right-hand panel above are, like the Balance of Payments, subject to revision.  The revision will likely see the property income paid (outbound profits) revised up.  This in turn will see Gross National Income, Gross Disposable Income and “Net Savings” revised down.  The scale of such revisions are difficult to assess but imports of R&D services are significant and have been growing as the table here shows.

Imports of Rand D Services

At present in the accounts investment spending on R&D services carried out elsewhere, i.e. imported, is counted as coming from “Irish” income.  This is because the Balance of Payments are not yet fully aligned with BPM6 and such spending is still treated as intermediate consumption for Balance of Payments purposes rather than capital formation.  When the updated approach is applied by EU countries then the money spent on R&D services by foreign-owned firms will be first counted as a profit outflow in the current account and then re-introduced as an investment inflow in the capital account.  As discussed previously this increase in the outflows of profits should reduced the Balance of Payments current account and will also likely reduce Gross National Income.

There will be a few moving parts.  It will depend on how much of the imports of R&D services shown above was undertaken by foreign-owned firms (likely a lot) and the depreciation of any assets that arise from the investment will have an impact as it is profit after depreciation that is counted as an outflow.  Still, given the numbers above, we are probably looking a some significant changes.

These changes will probably work their way through to economy-wide measures such as the new GNI*.  When this was first published the recent growth rates were queried by some as being “too hot”.  If the changes mooted here work through as expected those growth rates could be revised down – with a downward revisions of the levels also possible which would impact ratios which use GNI* as a denominator.  Given the nature of Ireland’s national accounts there could be revisions across a number of areas (the consumption conundrum?) so it’s best to wait to see what the outcome is first but it does give something to look out for.

Tuesday, April 3, 2018

The 2017 Balance of Payments

A few weeks ago the CSO published the 2017 estimates for the Current Account of Ireland’s Balance of Payments.  It got no attention – deservedly so.

Balance of Payments Current Account Annual

Up to recent years most of the impact of MNCs on Ireland’s Current Account largely netted out.  This wasn’t the case for redomiciled PLCs and their retained earning have been flattering the current account since these corporate relocations first had an impact in it around a decade ago.  The impact of aircraft leasing has been growing over the same period and since 2015 the acquisition and depreciation of intangible assets has been source of the recent major volatility in the data.

As we have been tracking there also seems to be an issue about the treatment of expenditure on R&D services in the Balance of Payments.  Although changes in both national accounting methodology (ESA2010) and balance of payments methodology (BPM6) now mean that R&D spending is considered investment rather than intermediate consumption, implementation delays across the EU mean the spending on R&D services is still treated as intermediate consumption for balance of payments purposes.  This means that the amount of outbound profit is lower than it otherwise might be if such expenditure was treated as investment (i.e. the use of reinvested profits) rather than a cost (i.e. something that reduces profits).

The CSO publish a modified Current Account, CA*, that now takes account of all of these issues except that relating to R&D services.  This has yet to be updated for 2017 so the available figures only go as far as 2016.

Balance of Payments Modified Current Account Annual

This is better but the improvements in recent years seem a little hot with a surplus of €13 billion reported for 2016.  Some of the heat may be taken out of this if the treatment of spending on R&D spending is updated.  This isn’t a Irish-specific modification per se but will see the Irish estimates move more in line with the approach set out in the updated methodology. 

We can try to assess the possible impact this will have by using the figures for R&D services imports that can be derived from the various categories of investment now provided by the CSO in the quarterly national accounts.  At present the spending on imported R&D services of MNCs is treated as coming from “Irish” income. 

It would be better if this were regarded as “foreign” income and thus treated as an outflow of retained earnings in the current account and counted as inflow of direct investment in the capital account.  The net effect of this on the overall accounts will be zero but the changed treatment will better reflect the ownership of the income used to fund the R&D services investment spending.  Thus there will be higher profit outflows in the current account and higher investment inflows in the capital account. 

Balance of Payments Underlying Current Account Annual

This is possibly what the modified current account, CA*, will look like in due course and seems to provide a narrative that fits with the overall story of the Irish economy over the past 15 years or so.  It still doesn’t go to 2017 as we have details on very few of the adjustments that are necessary but it would not be a surprise if the improvements shown for recent years continued.

Although there are a huge number of moving parts with large offsetting flows here are some factors which may have helped achieve that improvement.

1) The amount of interest payable on public debt to non-residents has been falling since 2014.  Figures for 2017 haven’t been released yet but that downward trend is likely to have continued.

GG Debt Interest Payable Outside the State Nominal

2) Corporation Tax receipts have surged in recent years and around 80 per cent of Irish Corporation Tax paid by foreign-owned companies.  This increases the amount MNCs are contributing to Ireland’s national income and boosts the current account.

Corporation Tax Receipts 2003-2017

3) On the domestic side food exports have performed well though a large part of this is due to price effects rather than volume increases.  Ireland’s balance of trade in food reached €4 billion in 2017

Balance of Trade in Food

And a large part of the improvement in 2017 was driven by developments in dairy with the higher price of milk seen in 2017 adding significantly to incomes.

Balance of Trade in Dairy Products

4) Revenues from international transport are counted as an export for the country the operator is resident in.  Unsurprisingly, Ireland runs a large surplus for transport services with most of this being international air transport around the EU (though imports in other categories will obviously reduce the overall impact on the current account).

Balance of Trade in Transport Services

5) And finally here’s one that had been helping up to 2015 (or at least making a less negative contribution) but since then spending by Irish residents on tourism services abroad (mainly accommodation and food services) has been growing at much the same rate as such spending by non-residents in Ireland.

Balance of Trade in Tourism Services

Tuesday, March 27, 2018

What is going on with GNP?

The issues with Ireland’s national accounts have gotten a good airing over the past two years or so.  Since the publication of the 26 per cent growth rate in July 2016 one that has been surprising is where some of the well-known (and not so well-known) distortions show up. 

A lot of attention has focused on GDP but apart from an extraordinary quarterly growth rate in Q1 2015 the following chart isn’t that noteworthy.  There has been a bit of volatility since late 2016 but it doesn’t seem that much different to what is showing for 1998/99.

QNA GDP Quarterly Growth Rate 1997-2017

The Q1 2015 spike clearly points to concerns about the level but that one quarterly growth rate apart most of the other outturns are within the realm of plausibility.  But what about the quarterly growth rates of GNP? GNP is what is supposed to be left after the profits of MNCs have been counted as an outflow.

QNA GNP Quarterly Growth Rate 1997-2017

This obviously shows a good deal of volatility but up the middle of 2016 it is not that outlandish.  Since then though the quarterly growth rates of GNP have been all over the place.  The last five observations are:

  • Q4 2016: +10.3%
  • Q1 2017: –6.4%
  • Q2 2017: –3.7%
  • Q3 2017: +12.3%
  • Q4 2017: +6.3%

As we commented here we have had the highest and lowest quarterly GNP growth rates in quick succession.

We might expect the relative volatility in growth rates to be the other way around: that if MNCs are causing GDP to jump around these would wash out through net factor payments and that GNP would be the relatively stable one.  The fact that MNC profits generated in Ireland are counted as a factor outflow in the period in which they are earned.  So an MNC-driven spike in GDP should be matched by an offsetting increase in factor outflows.

This is what we get if we look at the quarterly change in nominal GDP from the national accounts and the quarterly change in direct investment income on equity from the balance of payments.

Changes in GDP versus Profit Outflows

The surprising thing is how string the relationship is in 2015 and how weak it is recently.  The spike in GDP in Q1 2015 was accompanied by a spike in profit outflows. This is a bit surprising given the expected relationship between the 2015 GDP increase and depreciation.  The changes in GDP are “gross”,  i.e. before depreciation, whereas the profit outflows are “net”, i.e. after depreciation (and tax of course!).  Anyway, as GDP oscillated through 2015 the change in profit outflows tracked the changed in nominal GDP.  This continued through to the middle of 2016.

Since the middle of 2016 the changes to profit outflows have been relatively modest. The quarterly outflow was €13.1 billion in Q3 2016 and had reason fairly steadily and was put at €16.2 billion in Q4 2017. 

Over the same period GDP has been much more volatile, either rising by more (as was the case for most quarters) or falling by more (as was the case for Q1 2017).  It is the gaps between the lines in the chart above (and the changes in their signs) that have contributed to the recent volatility of GNP.

Value added has bounced around a bit over the past year and a half.  The relative stability of profit outflows means these changes in value added are being reflected in Ireland’s national income (or least are not been attributed to non-residents).

But why is this? What factors are there that can cause value added to bounce around yet not have this reflected in net profit outflows?  It could be that depreciation (of aircraft or intangibles) is playing a role but depreciation itself should be relatively stable (unless assets enter or leave the capital stock). 

If we had quarterly GNI* data we might be able to throw some light on this as,among other things, that measure is adjusted for the depreciation of aircraft and intangibles.  But until we get that we are left with the question, “what is going on with GNP?”, and even then we mightn’t be able to answer it.

Finally, just to show that outflows of direct investment income on equity in the balance of payments are the key constituent of net factor outflows in the national accounts this shows the two of them since the start of 2012:

Net Factor Income Outflows