26% GDP Growth: Where did it come from and who got it?

The reaction yesterday to the publication of the National Income and Expenditure Accounts showing 26 per cent real GDP growth was as one would expect given that such a growth rate was completely unexpected.  There was lots of talk of the numbers not reflecting the reality of the Irish economy but I didn’t come across anybody who said they did while talk of “leprechaun economics” was just derogatory.  The underlying growth rate of the Irish economy is probably somewhere around six per cent which is just fine, thank you.

Yesterday’s figures show that real GDP expanded by 26 per cent in 2015. We have known for a long time that GDP is a problematic measure for Ireland and recent developments just accentuated this. 

What change resulted in the transfer of €300 billion of assets to Ireland?  We can safely assume that much of this is related to tax but the Irish corporate tax regime has hardly changed over the past few years.  The Knowledge Development Box only applies to intellectual property that is developed here and, if it was in any way effective at all, would show up through increases R&D activity in Ireland rather than the transfer of assets to Ireland.

What has changed is the international tax environment.  The OECD’s BEPS project has an underlying goal to align profit with substance and the aim of providing more information for tax authorities through country-by-country reporting.  It is clear that one consequence of this has been for companies to move more risks, functions and assets to Ireland.  There may have been the view that Ireland was a target of the BEPS project but, for now at least, it is clear that we are a beneficiary of it.

And the benefits are massive.  Increased profits in Ireland means increased taxable income subject to our Corporation Tax.  We know the Corporation Tax receipts rose from €4.6 billion in 2014 to €6.9 billion in 2015 with a good likelihood of a further increase in 2016.  €2.3 billion is a massive amount of money.  If the cost of collecting an extra €2.3 billion in tax is a few days of headlines about bizarre growth rates sign me up.

So where did the growth come from?  Well the standard Y = C + I + G + (X – M) isn’t very helpful as the level of noise between the components makes identifying underlying trends almost impossible.  To be fair consumption is unaffected by much of this and grew by 4.5 per cent in 2015 which is a good clip.

To get a better picture we should look at the output method and the gross value added generated by the different sectors of the economy.  Here are the gross value added in nominal terms for the six sectors used by the CSO.

As can be seen gross value added increased by €61.5 billion in 2015 and when we add in the €1.1 billion increase in net product taxes we get the €62.7 billion increase in nominal GDP.

The sectoral data show that over 80 per cent of this came from the Industry sector.  We are usually provided with a further breakdown of this into sub-sectors such as chemical and pharmaceutical, computers and instruments, and medical and dental devices but this was not published by the CSO on this occasion.

There has been a lot of attention on the impact of aircraft leasing on the figures but the impact of this sector on the growth outcome seems to be overstated.  Aircraft leasing is included in the broad category of “Other services”.  This sector accounts for only ten per cent of the increase in gross value added and aircraft leasing will only be a portion of that.

Next we turn to the beneficiaries of this growth surge and look at the wage and profit gains from net value added and also the important changes to the provision for depreciation.

We can see that of the €62.6 billion increase in GDP only €30.9 billion went to households and firms in the form of wages, profits or mixed income.  Another €1.1 billion went to the government in the form of product taxes but the most notable change in the €30.7 billion rise in the provision for depreciation.

It is pretty clear that most of this applies to companies in the industry sector.  In this sector alone gross value added rose by €50.7 billion while the profits of all companies rose by €23.1 billion.  There are two ways to cut the reconcile this difference of €27.6 billion. 

The first is employee remuneration which is up but only by €4 billion or so.  The second is depreciation which is subtracted from gross value added to get net value added.  The provision for depreciation in the Industry sector must make up a large part of the overall €30 billion provision for depreciation.  And foreign companies will dominate this.  In a bit of a simplification companies are making gross profits (sales minus cost of goods sold) and a large portion of this is going to cover the reducing value of assets that they hold.

The €23 billion rise in company profits before tax is roughly in line with the €2.3 billion rise in Corporation Tax (suggests an effective rate of around 10 per cent which is before financing costs above FISIM are accounted for).  It can also be seen that the net factor income outflow roughly corresponds to the increase in company profits which is what we would expect.

Gross National Product strips out most MNC profits but it does not account for depreciation and it is now clear that most of the provision for depreciation in our national accounts accrues to foreign firms.  We should be counting this as an outflow as well which may be angle the CSO might take if looking to provide some auxiliary economic indicators.

So if we look at the €62.7 billion increase in nominal GDP we can break it down as:

• Households
  • €4.2 billion of employee remuneration
  • €1.5 billion of self-employed/mixed income
• Companies
  • €23.1 billion of company profits (mainly foreign companies)
• Government
  • €1.1 billion of product taxes
• Non-Sectorised
  • €30.7 billion for depreciation (mainly foreign companies)
  • €1.9 billion for stock adjustment/statistical discrepancy