Contract Manufacturing in the QNAs

There is a lot going on in Ireland’s national accounts.  Here we will just try to isolate a few trends that allow us to see the impact “contract manufacturing” is having on the figures.  As before the conclusion is that the impact on some individual series in the accounts is large but that the growth effect is probably small.

First up, here’s the trade components of GDP which are threatening to go off the chart.

The first indication that this is having a limited growth effect is that it is both exports and imports that are rocketing so the balance of trade is largely unaffected.

But let’s go through it in a bit more detail. First if we divide the trade figures into goods and services.  With exports we can clearly see that the recent surge has occurred in goods.

And we know that these goods do not physically leave Ireland in the state recorded in the national accounts because of the massive gap that has emerged between the goods exports figures in the Quarterly National Accounts and the Trade Statistics datasets. 

The Trade Statistics do show goods exports increasing but such has been the increase over the past 18 months in goods exports using national accounts methodology that the gap between the two series was €8.5 billion in Q2 2015.

The goods may have left Ireland in an unprocessed state but there was additional processing done in another country that added to the value of the goods.  Much of this added value is booked in Ireland as some elements of the risks, functions and assets behind that added value are located here.  The party that does the manufacturing gets paid a fee for undertaking the activity (so their national accounts show a service export) but the sale of the goods is recorded in Ireland’s national accounts.

There might be lots of money coming into Ireland from these sales (even though the goods don’t originate from here) but we can also see money flowing out.  Here is the breakdown of imports.

If goods exports have been shooting up in the national accounts we can see that services imports have been showing a similar rise on the other side.  A small amount of this is probably the fees the companies are paying to the entities carrying out the contract manufacturing.  Far more of it is likely to be patent royalties associated with the goods being made – the huge increase in this ‘contract manufacturing’ activity has happened in the pharmaceutical sector.  This can be seen in the Industrial Production statistics published by the CSO which includes contracted manufacturing.

Anyway what we have is large inflows to Ireland from the sale of these goods and large outflows from Ireland to where ever the patents of these products are held.  This means that the balance of trade in goods is showing remarkable growth while there is an offsetting decline in the balance of trade in services.

What is the net impact after accounting for this offsetting effects? Difficult to say.  In an earlier note the CSO did say that ‘contract manufacturing’ was “not particularly significant in explaining the recent growth in Irish GDP” when discussing the 2014 figures.

It might not be driving growth but it must be having some effect.  And as we noted before someone is paying a lot of Corporation Tax.  For the first eight months of the year Corporation Tax revenues are 40 per cent ahead of where they were profiled to be with some €900 million extra collected in the year to date.  The information note from the Department of Finance released with the August Exchequer Statement says that this “over-performance in the year to date primarily relates to improved trading.”  I don’t know whether trading has improved but it certainly has increased – an mainly intra-company trading at that.

It could also be that we are the beneficiaries of some pre-BEPS jitters.  Companies could be amending their structures in advance of BEPS measures such as country-by-country reporting.  This will require companies to provide revenue authorities that they owe corporate income tax to with the positions in the other countries in which they operate.  It could be that companies are moving to report more of their activities/profits in Ireland rather than in some other jurisdictions (actual tax havens perhaps) to try and avoid drawing the ire of other tax authorities that they report to.  Just some supposition mind!