Friday, November 15, 2019

The Domestic Non-Financial Corporate Sector in the Institutional Sector Accounts

The release by the Central Statistics Office of the 2018 Institutional Sector Accounts saw their work in helping using overcome the impact of globalisation in Ireland’s national accounts.  In this year’s release, the non-financial corporate sector was subdivided into “foreign-owned” and “domestic” sub-sectors with figures provided back to 2013.

In general terms, sub-dividing the NFC sector is something that is set out in the European System of Accounts (ESA2010) as the CSO say:

Non-financial corporations are sub-divided into foreign-owned (S.11a), domestic (S.11b) and redomiciled (S.11c) in these accounts. [.]  The sub-sector S.11a corresponds to the ESA 2010 definition of sub-sector S.11003, foreign controlled non-financial corporations.

The ESA2010 manual gives the definition of foreign NFCs as:

Foreign controlled non-financial corporations (S.11003)

2.54 Definition: the foreign controlled non-financial corporations subsector consists of all non-financial corporations and quasi-corporations that are controlled by non-resident institutional units.

This subsector includes:

(a) all subsidiaries of non-resident corporations;

(b) all corporations controlled by a non-resident institutional unit that is not itself a corporation; for example, a corporation which is controlled by a foreign government. It includes corporations controlled by a group of non-resident units acting in concert;

(c) all branches or other unincorporated agencies of non-resident corporations or unincorporated producers which are notional resident units.

However, deviations from ESA2010 arise with the domestic sector due to the treatment of government-owned NFCs and the presence of the ‘headquarters’ of re-domiciled PLCs in Ireland:

Redomiciled PLCs and domestic NFCs are a part of sub-sector S.11002, national private non-financial corporations, however, following the treatment in the definition of modified GNI, Redomiciled PLCs are separated out in these accounts as S.11c. Government controlled non-financial corporations (S.11001) are included as part of S.11b.

Here we will focus on new domestic NFC sector.  First, the current account (click to enlarge):

Domestic NFC ISA Current Account 2013-2018

The current account takes us through production, generation of income, allocation and distribution and income and the use of disposable income (which for companies is just saving as they don’t engage in final consumption – they have intermediate consumption). So what do we see.

In the past five years, the output produced by the domestic NFC sector has increased by €26 billion (27 per cent).  Intermediate consumption (goods and services used in the production process excluding labour) has not increased in line with output so that the Gross Domestic Product (Gross Value Added) of the sector by €23.5 billion (54 per cent).

What we have seen though, is an increase in the pay bill of companies in the domestic NFC sector.  This has risen in line with output.  In 2013, these companies spent €28.0 billion compensating their employees; by 2018 this had risen to €40.4 billion, a rise of 44 per cent, with 2018 showing an increase of 6.4 per cent.

Labour costs did not consume all the additional value added and the Gross Operating Surplus for the sector rising €11 billion (76 per cent) in the past five years.  Over the five years, the labour share of value added fell by 64.8 per cent in 2013 to 60.5 per cent in 2018.

After Gross Operating Surplus, we get different allocations due to property income such as interest, dividends and retained earnings.  In line with the increased profits the dividends distributed by these firms has increased.  They distributed €1.5 billion in 2013 with this increasing to €2.7 billion by 2018.  These distributions are relatively small compared to the overall Gross Operating Surplus generated meaning most profits are not distributed to other sectors.  The use of the non-distributed profits will be shown in the capital account.

However, in the allocation of income account the most significant change is the increase, on the resource side, in the retained earnings of direct foreign investment.  This is the profit earned by foreign-subsidiaries of companies in Ireland’s domestic NFC sector that are retained in the country in which they are earned rather than being transferred as a dividend to the parent in Ireland.  Such retained earnings have increased from €0.9 billion in 2013 to €3.4 billion in 2018, a near 300 per cent increase.  Whoever these companies are their foreign subsidiaries seem to be doing pretty well. [There are likely to be genuine reasons underpinning some part of this success but one might wonder whether there is a tax story related to it as well.]

Adding and subtracting the above property income from Gross Operating Surplus gets us to Gross National Income. This has increased from €11.6 billion to €25.4 billion in the past five years, with the increase (€13.7 billion) slightly outstripping the increase in Gross Operating Surplus.

The increased profits has led to an increase in the Corporation Tax paid by these companies from €0.7 billion in 2013 to €1.7 billion in 2018 which shows that some of the recent surge in Corporation Tax has come from companies in the domestic NFC sector.

We can get a measure of the effective tax rate on these companies by looking at Net Operating Surplus.  This is Gross Operating Surplus less the consumption of fixed capital (i.e. depreciation, which is shown in the capital account below).  The national accounts measure of Net Operating Surplus is akin to the accounting concept of EBITDA (earnings before interest tax depreciation and amortisation).

Over the five years, the effective rate on NOS averaged 8.2 per cent and exhibited a slight upward trend over the period going from 7.2 per cent in 2013 to 8.7 per cent in 2018. This could be linked to the exhaustion of losses generated during the crash for use against future profits.

After current transfers (mainly linked to insurance premiums and claims) we get to Gross Disposable Income and as firms don’t have final consumption this is equivalent to Gross Savings.  As shown, this increased from €10.2 billion in 2013 to €23.5 billion last year. 

We now turn to the capital account to see how those gross savings were used. Again click to enlarge.

Domestic NFC ISA Capital Account 2013-2018

The main use of the Gross Savings (arising from the increased Gross Operating Surplus) shown in the current account is capital formation.  The Gross Fixed Capital Formation of companies in the domestic NFC sector has increased from €7.8 billion in 2013 to €15.4 billion in 2018.  In five years, the sector has essentially doubled its level of fixed capital investment. 

The companies have also been increasing their inventories.  In 2013, inventories in the sector reduced by €350 million while in the four years since inventories were increased by an average of €1.4 billion per annum.

The investment rate (capital formation as a share of gross operating surplus) averaged 60 per cent across the five years and has shown a generally rising trend from 50 per cent in 2013 to 63 per cent in 2018.

After consumption of existing fixed capital (i.e. depreciation) is accounted for from this investment, Net Capital Formation increased from €3.9 billion in 2013 to €8.5 billion in 2018.  In aggregate terms, the domestic NFC sector is reinvesting a large share of the additional profits being made and this is replacing existing capital, adding new capital and increasing inventories.  Of course, we cannot know that the individual companies undertaking the investment are the ones generating the profits but this is what we see in am aggregate sense.

However, it should also be noted that the additional investment is less than the surpluses being generated and the bottom line shows that the domestic NFC sector is a net lender, and this is increasing.  Per the OECD:

Net lending/borrowing reflects the amount of financial assets that are available for lending or needed for borrowing to finance all expenditures – consumption expenditure, gross capital formation and capital transfers – in excess of disposable income.  If it is positive it is described as net lending and if negative, as net borrowing.

So, the disposable income of the domestic NFC sector exceeds all expenditures.  In 2013, this was €3.6 billion and this had risen to €7.9 billion.  In part, this could be linked to the ongoing deleveraging of the Irish economy – with companies possibly using surpluses to pay down debts.  In due course, we might look at the financial accounts of the sector to see what insights that might through up.

For our purposes here the bottom line of the capital account, net lending, is far enough. And this links to the discussion in the previous post about the large surplus on the modified current account of the balance of payments recorded in 2018. In that post we said:

One reason to pause before we get excited with highfalutin plans to spend the surplus is that, in the latest figures at any rate, almost half of it arises from the non-financial corporate sector and we really don’t know what is going on there.  Given the scale of the gross amounts in this sector revisions to the figure could be significant.

Before the sector accounts it wasn’t clear where the NFC surplus was arising – with some concerns that maybe it was a residual from the adjustments necessary to go from the headline to the modified current account.  Now we know that this is not the case – a large source of the increase in the modified current account in recent years has been the domestic NFC sector, from which companies involved in the so-called “star” adjustments (GNI*, CA* etc.) are excluded.

And we also know one reason why the domestic NFC sector might be running an increasing net lending balance – the increase in the retained earnings of their foreign subsidiaries.  It may that the companies are investing these earnings abroad so they would not be available for investment or other spending in Ireland.  Or they could simply be held as a financial asset by the foreign subsidiaries and would be available for use if they were transferred as a dividend back to the parent companies here.

This retained earnings strand might be something for another day.  All-in-all these new figures on the domestic NFC sector paint a very positive story: all of output, value added, employee compensation, operating surplus, corporation tax, and investment have risen strongly in the last five years.  The domestic NFC sector has been a major contributor to Ireland’s recent growth.

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