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Ireland's Misleading Growth Spurt

Leonid Bershidsky is a Bloomberg View columnist. He was the founding editor of the Russian business daily Vedomosti and founded the opinion website Slon.ru.
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Who said euro-area economies aren’t growing fast enough? Ireland has reported a 26.3 percent increase in its real gross domestic product for 2015. No Western country has posted such a rate of expansion in this century, though small but oil-rich Azerbaijan grew 34.5 percent in 2006, when oil prices rocketed. Unfortunately, Ireland’s freak growth has less tangible causes. It is a result of tax shenanigans and a clear indication that GDP increases shouldn’t be considered the ultimate measure of policy success.

“When statistics go bad,” the Nobel laureate economist Paul Krugman commented on the release by Ireland’s Central Statistics Office. Indeed, Ireland is going to jump in the per-capita GDP rankings -- the measure of nations’ relative wealth -- but few people in Ireland would have noticed that last year made them wealthier by more than a quarter. And yet the growth number -- calculated in accordance with the European standard -- is going to have some real consequences, as Finance Minister Michael Noonan said in a glowing statement on Tuesday. 

According to Noonan, Ireland’s debt to GDP ratio should now improve to 79 percent of GDP, compared with 93.8 percent at the end of last year. This means Ireland will be able to borrow more, and on better terms. 

Noonan has no qualms about the numbers. “I think the figures released by the Central Statistics Office show that Ireland’s economy continues to grow,” he said in the statement. “Peoples’ lives are improving with more at work than at any time since the onset of the downturn.”

That, however, is not what’s going on. Bloomberg has suggested that inversions -- the relocation of U.S. companies’ head offices to Ireland for tax reasons -- could have inflated the growth because “inverted” multinationals’ profits could be counted as part of Ireland’s GDP. Indeed, the Central Statistics Office’s methodology indicates that the overseas profits of Irish investors are considered as distributed to them, meaning that when a company relocates to Ireland, a share of its profits accruing to the Irish holding company counts as part of the Irish economy. 

There is an alternative explanation, however, and it may make more sense.

At the end of 2014, the Irish government moved to close the tax loophole long used by U.S. tech and pharmaceutical companies. It was known as the Double Irish and allowed a company to set up a subsidiary in Ireland and another one domiciled for tax purposes in a tax haven such as the British Virgin Islands. The BVI company held patents to important technology -- or, say, prescription drugs. The Irish subsidiary collected the multinational’s profit and sent most of it to the BVI as royalties for the use of intellectual property. The small remainder was taxed at Ireland’s low rate -- 12.5 percent, the lowest in the European Union -- and some companies, such as Apple, negotiated even better deals, which the EU is now investigating, suspecting illegal state aid. 

As the Double Irish became illegal beginning in 2015, companies moved to bring the patents “onshore” -- meaning, to Ireland: Its tax rate remains unbeatable if a company wants to use a developed country as its domicile.

In a blog post, the Irish economist Seamus Coffey explained how these moves by multinational companies affected Ireland’s GDP statistics:

One explanation is that a number of sectors saw MNCs move intangible assets onshore.  This increases gross value added in Ireland as there are no longer outbound royalty payments.

For example, Coffey wrote, the industry sector in the national accounts received 97.8 percent, or 50 billion euros ($55.3 billion) more value added than in 2014. Coffey suggested that most of the increase probably came from the pharmaceutical sector.

The Irish government, however, hasn’t collected a lot of tax on all that value added. As Coffey points out, a large part of the increase -- more than 30 billion euros -- was used to cover the depreciation of assets, possibly the same patents that multinationals moved to Ireland.

The same happens in another industry that has increasingly used Ireland as a base -- aircraft leasing. Companies lease their fleets in Ireland for tax purposes, but the revenue from the leasing is used to cover depreciation. Coffey noted:

So we have a large increase in gross value added but this doesn’t fully feed through to increases in wages and/or profits.  Non-agricultural wages and salaries rose from 67.7 billion euros in 2014 to 71.5 billion euros in 2015.

In other words, the Irish aren’t really much richer and the government isn’t awash in tax money. Its ability to borrow gets a boost, though, so Noonan, who only moved against the Double Irish under pressure from the EU and the U.S., is happy. It’s also a relief to the Irish government that the multinationals haven't taken flight.

Ireland is a relatively small economy, so a single tax change can turn it into a growth leader overnight. It’s utterly meaningless to turn it into a poster child for austerity or export-led growth because its data -- including those on exports and imports -- can be distorted by the tax planning of a few foreign corporate behemoths. Sure, it had some underlying growth -- probably high for the euro area, at more than 5 percent in 2015 -- but that wouldn’t be easy to calculate without knowing the exact effect of intangible assets being moved to the country.

The Irish case is a cautionary tale for economists who like to discuss economic growth as a measure of policy makers’ success. Even in bigger countries, the methods used to assess the economy’s size are imperfect. They don’t always reflect increases or drops in a nation’s actual wealth or in its bona fide economic activities. The economies of many countries are grossly underestimated because of their large shadow sectors. Others -- such as Ireland’s in 2015 -- can be unintentionally inflated. Numbers lie, even when compiled with the best of intentions. Measures such as happiness may better describe the effect of economic policies than traditional GDP numbers. 

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Leonid Bershidsky at lbershidsky@bloomberg.net

To contact the editor responsible for this story:
Max Berley at mberley@bloomberg.net