Thursday, March 5, 2015

Exaggerating the Irish-US economic relationship

Here is a link to a report published today on the Irish-US economic relationship with a particular emphasis on FDI.  The report has attracted some attention.

  • The Irish Times: “Ireland is the number one destination in the world for US foreign direct investment (FDI), according to a new report.”
  • Irish Examiner: “Ireland is now the number one destination in the world for US Foreign Direct Investment.”
  • Irish Independent: “Ireland is the number one destination for US foreign direct investment”

We’ll start with a couple of charts from the report.  First the total US FDI stock in Ireland.

Total US FDI

There are a couple of things that should cause doubt about the above chart.  The first is that the data appear to be nominal so is not comparing like with like.  The second is the extra-ordinary increases that have occurred in recent years (when inflation was low).  The FDI stock rose from $130 billion in 2009 to $240 billion in 2013.  Just what did US companies invest in in Ireland over those five years?

The most notable concern is the source of the data: the US Bureau of Economic Analysis.  The problems with this data are a well-worn path.  In their FDI data the BEA assign companies to countries on the basis of their place of registration or incorporation.  The activity can happen anywhere but is assigned to the country where the company is incorporated.  There is no restriction on the activity taking place within the assigned jurisdiction.

The above chart refers to the investment stock of Irish-incorporated subsidiaries of US MNCs.  It does not refer to the investment stock in Ireland of US MNCs. 

There are also issues when it comes to the definition of FDI.  One would assume it involves flows inwards but buried in the glossary at the end is this:

There are three components of foreign direct investment: equity capital flows, intercompany debt, and reinvested earnings.

The last part of this is crucial.  The definition of FDI includes retained earnings that are not repatriated to the US parent.  Therefore there are two reasons why the FDI flows to Ireland are unusually large in this data:

  1. It includes all the activities of Irish-incorporated subsidiaries of US MNCs, not just their activities in Ireland
  2. It includes the retained earnings of these companies, some of which are part of the most profitable companies in the world.

The tax strategies of some of the most high profile US MNCs in Ireland have attracted a lot of attention in recent years.  Schemes such as the “double-irish” and “stateless income” have achieved notoriety.  The whole purpose of these schemes is to trigger the deferral provisions in Subpart F of the US tax code for profits earned outside the US.  This deferral is maintained as long as the profits are not repatriated to the US parent, i.e. as long as they are retained in the non-US-incorporated affiliate.

We know that many US companies use Irish-incorporated companies as part of their global tax structures.  These companies have been accumulating massive retained earnings and these retained earnings are counted as FDI flows to Ireland – even though the money may never even pass through Ireland.

Apple is a case in point.  We know that Apple has Irish-incorporated companies at the centre of its global tax structure.  We don’t need to rehash it here.  Three of the key companies,  ASI, AOE and AOI, were subject to a US Senate investigation where the committee chair, Sen. Carl Levin concluded:

In short, these companies’ decision makers, board meetings, assets, asset managers, and key accounting records are all in the United States.

These companies are Irish-incorporated so are included in the BEA FDI data but almost everything about them happens in the US.  Ireland gains nothing from the accumulation of profits in these entities.  And later this year the European Commission will conclude that their worldwide profits are not subject to Irish Corporation Tax.  We should not count their retained earnings as FDI inflows to Ireland.

Apple’s most recent SEC 10K filing shows that Apple has huge sums of retained earnings in these companies with the US corporate income tax deferred until the funds are transferred to a US-incorporated entity within Apple’s structure. 

Apple has around $130 billion of profits retained offshore.  Of this they have made a tax provision to reflect the possibility that they may repatriate around half of it:

As of September 27, 2014, the Company had [.] deferred tax liabilities of $20.3 billion.

Apple reports a similar deferred tax liability for funds that it has not declared a intention to repatriate.  Apple may decide to repatriate these profits to the US but on their balance sheet have not set aside the funds to cover the payment of the (indefinitely) deferred taxation.

As of September 27, 2014, U.S. income taxes have not been provided on a cumulative total of $69.7 billion of such [foreign] earnings. The amount of unrecognized deferred tax liability related to these temporary differences is estimated to be approximately $23.3 billion.

We know that Apple is accumulating most of these funds in Irish-incorporated companies.  These funds are counted as an FDI inflow to Ireland in the BEA data. 

The massive profits that Apple has been earning recently (and it is just after reporting net earnings of $18 billion for Q4 2014) are a major driver of the increase of the “Irish” stock of FDI of US MNCs in recent years.

The report does account for some of this by stripping out the effect of holding companies (companies that own other companies) but this still gives an inaccurate picture. ASI is a trading company in Apple’s structure but does most of its trading in Cupertino, California; not Hollyhill, Cork.  The stock of FDI excluding holding companies will equally be skewed by the extent to which US MNCs retain earnings in their trading companies.

We can try to look at data from the CSO which use the source of the investment rather than the jurisdiction of incorporation in their approach.  But that is equally problematic.  At the end of 2013 the CSO but the end-year position of US FDI in Ireland at €18.3 billion.  For investment from Luxembourg is was €66.9 billion.  The CSO data does not break through to the beneficial owner of the investment; it merely gets to the next location in the chain.  FDI from “offshore centres” of Central America (aka Caribbean tax havens) was €20.7 billion.

Trying to establish economic relationships on the basis of official FDI data is close to impossible given the hugely complex operating structure of MNCs.  Collating the data on the basis of place of incorporation (as in the BEA data) does not reflect activities that happen outside of the country of incorporation.  While collating the data on the basis of place of origination (as in the CSO data) does not pierce through to the beneficial owner of the investment.

The claim that Ireland is the top destination of US FDI is bogus.

Top US FDI Destinations

This chart reflects little more than the fact that some of the most profitable US MNCs accumulate their non-US earnings in Irish-incorporated companies.  The impact of Apple has already been noted.  Google Ireland Holdings will be in the above chart but that’s little more than a brass-plate operation in Hamilton Bermuda, though crucially is Irish-incorporated.  The above chart reflects tax optimisation strategies to retain earnings outside the US rather than any substantive investment activity in Ireland.

There are other issues that should raise doubts in the report.  Here is a chart of the sales of “Irish” affiliates in the BEA data.

Sales of US Affiliates

For 2013, sales of around $340 billion are shown.  For 2013, the dollar/euro rate averaged 0.783.  This means the sales shown above correspond to something around €266 billion.  According to the CSO total exports from Ireland were €184 billion in 2013 (national accounting methodology).  Therefore US companies account for 145 per cent of Irish exports. Or something.

The something is that most of these sales are not made in Ireland.

Next, the report estimates that the gross value added of US MNC affiliates in Ireland was $85.5 billion in 2013.  Using the above exchange rate gives a figure of €67.0 billion.

The CSO tell us that gross value added for the entire Irish economy in 2013 was €159 billion (add in net product taxes of €16 billion to get GDP of €175 billion).  Anyway today’s report purports to tell us that 42 per cent of the added value in the Irish economy was generated by US companies.  Maybe Bono was right but this report isn’t.

There is one chart in the report that hints that all is not as it seems with the headline FDI, sales and value added data.  And this one really is the bottom line for us in Ireland: jobs.

Manufacturing Employment of US affiliates

Since 2009 the stock of US FDI is reported to have gone from $125 billion to $240 billion.  Unfortunately the trend for manufacturing employment has been somewhat different.

There are lots of claims in the report that do not stack up to scrutiny.  Many of these are usefully collected under ‘Chapter 1 highlights’.  They include:

  • Total U.S. investment to Europe in the first nine months of 2014 fell 19% from the same period in 2013, to $115 billion, while U.S. flows to Ireland surged nearly 42%, to roughly $37 billion.
  • U.S. direct investment stock in Ireland totalled a record $240 billion in 2013, a greater investment stake than Germany and France combined ($196 billion).
  • U.S. companies have invested roughly $277 billion in Ireland since 1990; the comparable figure for Brazil: $92 billion; for Russia: $10 billion; for India: $32 billion; and China: $51 billion.
  • US affiliate output in Ireland totalled nearly $82 billion in 2012, a five-fold increase from the start of the century. For the year, US affiliates produced more output in Ireland than in China ($46.4 billion) and India ($21 billion) combined.

In the report the section that looks at FDI excluding holding companies includes the following claims:

  • In 2013, the last year of complete data, Ireland ranked as the number one destination in the world for U.S. foreign direct investment. U.S. FDI to the nation totalled nearly $19 billion, a record high. The figure was just over 12.2% of the global total.
  • Ireland accounted for 36.4% of total US FDI to the European Union in 2013, a record high.
  • In the post-crisis era (the 2008-13 period), U.S. firms have invested more capital in Ireland ($81.1 billion) than the BRICs combined ($52 billion). Corporate America’s investment in Ireland since 2008 is five times larger than comparable investment levels in China and 16 times greater than U.S. FDI in India

None of the above seven claims are true if one is interested in the economic impact of US MNCs in Ireland.  This is not to discount the impact of US MNCs in Ireland.  The ‘Chapter 1 highlights’ concludes with he following:

  • For decades, US firms in Ireland have been instrumental in creating jobs and income for Irish workers, profits for indigenous firms, and tax revenues for local and national governments. Due in part to the large presence of US affiliates, Ireland has been transformed from one of the more underdeveloped nations of Europe into one of the most prosperous over the past 50 years.

Ignoring the slight hyperbole there is truth here.  Unfortunately the report offers very little to actually verify it.  Can we do it here?  Well we actually have done it before.  See here and also elsewhere here.  Eurostat have added an 2012 update to the data previously used and here is the updated table.

Contribution of US companies to Ireland

The “business economy” is NACE Rev. 2 categories B to N excluding K (financial and insurance activities).  The contribution of US-owned companies to the Irish economy is immense.  The direct effects for 2012 are:

  • Compensation of Employees: €6.2 billion
  • Capital Expenditure: €5.3 billion (average €3 billion)
  • Corporation Tax:  €2 billion (estimate)

Some of the capital expenditure will go on imported plant, machinery and equipment but a large part of will be spent on Irish-sourced materials and, of course, labour. 

The Gross Value Added of US-owned companies in 2012 was €35.9 billion.  This is a much more reasonable, but still hugely significant, 22.8 per cent of total GVA for the entire Irish economy.  Of this, €6.2 billion went on the compensation of employees giving a labour share of value added of just 17 per cent for US-owned companies.

Gross Operating Surplus was €29.7 billon in 2012.  This is akin to EBITDA (earnings before interest, tax, depreciation and amortisation).  We would need to subtract interest and depreciation (capital allowances) to get taxable income.  This would probably come in at around €20 billion and with an effective corporation tax rate of around 11 per cent this would result in Corporation Tax revenues of around €2 billion, give or take.

There will also be indirect effects.  US companies in Ireland bought €90 billion of goods and services in 2012 for intermediate consumption.  Most of this will be imported (raw materials for pharmaceuticals, patent royalties and the like) but they also will buy a lot of goods and services in Ireland.  It is estimated that for every three direct jobs from US MNCs a further two indirect jobs are created from their expenditure in Ireland.

This will include expenditure on security, logistics, catering, cleaning and other services, as well as thousands of agency workers used by the companies.  There are also other largely unseen things like the outsourcing of manufacturing,  quality control and research activities, and, of course, expenditure on professional services from legal, accountancy and tax firms in Ireland. 

It is difficult to pinpoint the contribution these expenditures from US companies make to the Irish economy but it is a significant amount.  It is a finger in the wind but I would estimate the figure is in the ball park of €4-5 billion. 

The now-discontinued Annual Business Survey of Economic Impact from the now-defunct Forfás indicated that agency-supported foreign-owned firms bought €3.3 billion of Irish-sourced materials in 2012 (14 per cent of total materials purchased) and, excluding computer programming, €4.1 billion of Irish-sourced services (8 per cent of total services purchased).

As stated above the bottom line for Ireland is jobs.  The Eurostat data show that this was around 100,000 in 2012.  And this is for “the business economy” which excludes financial and insurance services (the IFSC and related sectors).  This would add to the employment total from US MNCs and bring the annual compensation of employee payments to close to €8 billion and add maybe another couple of hundred million to Corporation Tax receipts.  Around half of the Corporation Tax paid in Ireland comes from US-owned companies.

All told the contribution of US-owned companies to the Irish economy is probably between €17 billion and €20 billion a year, every year.  Under conservative estimates it can be put as:

  • Compensation of Employees: €8 billion
  • Capital Expenditure: €3 billion
  • Corporation Tax: €2 billion
  • Expenditure on Goods and Services: €4 billion

As well as direct Corporation Tax from their profits, the government will also collect Income Tax and PRSI from their compensation of employees and a range of taxes from the indirect expenditure by the US-owned companies.  Government revenue probably benefits to the tune of €6 billion a year, every year, from the presence of US MNCs in Ireland.

The impact US MNCs make in Ireland is immense.  We have a class of high-performing rent-seekers who seek gain from the investments by US shareholders instead of looking for preferential treatment to gain from allocations by government.  We are all the better for it.  It is high risk but we are gaining from it (as are US shareholders).

There is no need for headline-grabbing efforts to exaggerate the impact US MNCs have on Ireland.  FDI data, and BEA data in particular, tell us little about what is happening in Ireland.  If they don’t tell us anything about effective tax rates in Ireland (and they don’t!) it’s a bit disingenuous to use them to say something about foreign investment in Ireland.  Maybe Finance will drop Foreign Affairs a note discouraging them from writing forwards (see page 7) to such reports.

1 comment:

  1. While these money matters are already discussed in the business plan, VCs would want to hear you stating the same facts and figures in your ten minute business pitch. Boris Goldstein Expect drill-down questions like "Why three years for that ROI, why not two?" or be ready to give your best explanation when they tell you "What you're asking is too much (or too little)." If you want to receive that venture capital, you have to be bold on your financial bets.

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