Ireland puts all its chips on multinationals, but the EU house wants its cut

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By Cormac Lucey

The Organisation for Economic Co-operation and Development (OECD) is an intergovernmental economic think tank headquartered in Paris. The organisation published a detailed report on the Irish economy recently. Its conclusions regarding our recent performance were understandably positive, but it warned that the country’s economic prospects “are clouded in uncertainty”.

The good news is that the robust economic recovery has now spread to domestic demand. Irish export performance has displayed a sustained improvement and business investment by local firms is recovering strongly, especially in construction. Household consumption has also revived, propelled by tax reductions and employment growth. The unemployment rate has declined rapidly, and this is now leading to increased wage growth in some sectors.

Additional good news is that economic expansion is projected to continue, even if at a reduced pace. A fall in unemployment towards 5.5% will place further upward pressure on wages and cost inflation. Consumer prices are expected to rise by more than 2% in 2019. Private construction activity will continue to be spurred by rising property prices, though equipment and machinery investment are likely to be held back by increasing uncertainty in the business sector. The OECD projects growth of about 2.5% for 2019.

Looking out beyond that period, the picture darkens. For starters, Brexit is a serious risk to our economic outlook. OECD estimates show that a World Trade Organisation trade arrangement between the UK and EU could reduce total Irish exports by 20% in some sectors such as agriculture and food. Given the large share of multinational firms in the Irish economy, the OECD also warns that rising international tax competition presents an additional risk.

It is interesting that the organisation doesn’t pass comment on the threat posed by the EU’s sustained assault on our low corporation tax model. Seamus Coffey, the chairman of our Fiscal Advisory Council, has previously warned that the attack poses a greater economic risk to Ireland than Brexit.

The OECD makes the entirely logical point that heightened economic uncertainty increases the importance of Ireland further improving its fiscal position. Since 2010 our public finances have improved noticeably, but government debt remains high: in absolute terms, public debt per head in Ireland is the second highest in the world. More aggressive debt reduction would create greater scope for budgetary policy to support the economy in the event of a negative, external economic shock. This could be done, according to the OECD, by re-examining preferential VAT rates and exemptions and more regular revaluations of the property tax base.

The report warns that vulnerabilities in the financial sector also need to be further addressed. While non-performing loans (NPLs) on bank balance sheets have declined by about 60% from their peak, the level remains high. According to the OECD, this reflects “judicial inefficiencies relating to the repossession of collateral and limited progress in improving the regulatory framework for writing off NPLs”. Over to you, Chief Justice Frank Clarke.

The OECD report then arrives at its most worrying statement: the majority of Irish firms have experienced declining productivity over the past decade. This has largely reflected the poor performance of indigenous firms, with an already large productivity gap between foreign-owned and local enterprises having widened over the period. This is alarming, as is the extent of the productivity gap revealed by the detailed figures.

Locally owned manufacturing improved its productivity by 25% between 2006 and 2016, but the foreign-owned sector boosted its productivity by 66% over the same period and, at its end, was six times as productive as its native rivals. Locally owned services saw their productivity decline by 4% between 2006 and 2016, whereas the foreign-owned sector boosted its productivity by 17% over the same period and, at its end, was 3.5 times as productive as its native rivals.

 

What lies behind these disparities? Multinationals’ transfer-pricing practices — which may be used to shift much of the companies’ global profits into Ireland, where they will be taxed at a low corporate tax rate — may be playing a role. They would have the effect of boosting apparent productivity among multinational employees.

Differences in sectoral focus may also play a role: the performance of the foreign-owned sector will be boosted by its concentration in high-innovation, hi-tech sectors. By contrast, indigenous Irish industry is concentrated in relatively low-tech sectors such as agribusiness. These are factors that largely lie outside our control. The areas of largest productivity divergence are “scientific R&D” and “other services” — which may include firms such as Facebook and Google.

Yet there are important factors within our control that also contribute to the feeble productivity performance of our indigenous sector. According to the OECD, there are “high regulatory barriers to entrepreneurship”. This reduces competitive pressures on incumbents and the growth of new firms with new ideas. The report warns there are costly regulations relating to commercial property and legal services, and the costs of business failure are high.

The OECD also warns that access to finance for young firms needs to improve and would benefit from further efforts to mend the health of the banking sector and raise the efficacy of state- supported lending initiatives.

The main factor within our control is the emphasis of government policy. Here, leading politicians find the short-term sugar hit of a steady flow of high-profile new IDA Ireland job announcements more enticing than the hard political choices required to develop the indigenous sector.

On budget day last November, the government announced it would reform the taxation of share options with a new scheme to be known as the key employee engagement programme. The optimism evaporated quickly when the Finance Bill appeared, and it emerged that the scheme was riddled with restrictions that vitiated its effectiveness. This is precisely the problem posed by a parasitical political class: it wants press coverage that it is helping entrepreneurs, but doesn’t really want to offer simple and predictable schemes that would actually help.

The strategic danger facing Ireland is that our economic dependence on the foreign-owned sector is getting ever greater, even as EU attacks mounts on the tax model that is its foundation.


Published in The Sunday Times (Ireland edition)
March 25th 2018