That 26% growth rate: two weeks on

The recent publication by the CSO of the 2015 National Income and Expenditure Accounts generated a lot of reaction.  There is no doubt that a 26.3 per cent real GDP growth is bizarre but it was not farcical, false or based on fairy tales.

Many commentators went out of their way to highlight that the figures did not characterise what was happening “on the ground” in the Irish economy.  But this seems like a bit of a strawman.  Instead of being told what the figures were we were been scolded over what they weren’t.  No one said the economy was growing at 26 per cent.  Arguments against using GDP in an Irish context have made for the past quarter of a century.  Even as recently as March, when the first growth estimates for 2015 were provided, there were plenty of people who pointed that the underlying growth rate of the economy was probably around half of the 7.8 per cent growth rate in real GDP shown at that time.

But a 26.3 per cent real GDP growth rate is very very unusual.  And one that deserves understanding rather than dismissal.  However, the discussion of the figures has generated more heat than light.  At the briefing it seems three items were identified as having oversized effects on the national accounts’ aggregates. These were:

  • aircraft leasing
  • inversions and corporate restructurings, and
  • asset transfers to Ireland

The leprechauns are in Luxembourg, not in Ireland

Colm makes an important point on those Irish GDP statistics here.

Economy expands by 26.3%

Or at least that is what the national accounts tell us.  The CSO have published the National Income and Expenditure Accounts for 2015.  These show that real GDP expanded by 26.3 per cent in 2015 and real GNP grew by 18.7 per cent.  Do these numbers mean anything?  It is hard to know.

Looking at the expenditure approach the big real changes were in investment (+26.7%), exports (+34.4%) and imports (+21.7%).

In nominal terms, exports in 2015 were put at €317.2 billion, up from €219.8 billion in 2014. Exports minus imports was €81.2 billion compared to €34.6 billion in 2014.  We would usually expect most of this to feed through to the outflow of factor payments but net factor income from abroad only went from –€29.7 billion in 2014 to –€53.2 billion in 2015.  That means most of the improvement in net exports also contributed to GNP but the “gross” part of this seems to be important.

The reason is that there seems to be an awful lot happening on the asset side of the national accounts.  The nominal provision for depreciation rose from €30.9 billion in 2014 to €61.6 billion in 2015.  It looks like a large part of the increase in gross value added in 2015 of €60 billion went to cover the depreciation of assets.

The biggest source of the additional value added was in the Industry sector which rose 97.8 per cent in real terms over in the year (and in nominal terms rose €50 billion).  The CSO don’t provide a sectoral breakdown for this (they usually do) but it is probably a safe guess that a large part of it is related to the chemical and pharmaceutical sector.

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.  There is also a once-off increase in investment when the asset moves here (but the growth effect of this is offset by the import of the asset).

It is also worth noting that the increase in value added isn’t necessarily related to goods manufactured in Ireland.  The CSO’s External Trade data, which only include goods that physically leave Ireland, shows €111 billion of goods exports from Ireland in 2015.  Goods exports in the national accounts are done on a different basis (where ownership rather than location matters) and show exports of €195 billion.  A large part of the value added from these exports is accounted for in Ireland.

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 in 2014 to €71.5 billion in 2015.

The domestic trading profits of companies rose from €52.3 billion in 2014 to €74.4 billion in 2015.  This €22 billion increase roughly corresponds the increased outflow of net factor income.  Profits before depreciation would be up by even more but a lot of that went against the fall in the value of the assets.

But even then the value on onshored assets can’t account for all of this.  Most of the increase in investment can be attributed to research and development which in nominal terms rose from €9.6 billion in 2014 to €21.3 billion in 2015.  It is likely that most of this increase is due to once-off purchases of intangible assets rather than ongoing expenditure on R&D.

There may also be impacts from the aircraft leasing sector.  Although the investment figures show a small decrease in investment in transport equipment in 2015, a balance-sheet effect may have resulted in increased aircraft assets being accounted for in Ireland.  Gross value added in aircraft leasing may be high but depreciation of the asset would again consume a lot of this.

The CSO highlighted this and slide 6 of their presentation on the figures shows that Ireland’s gross capital stock rose by about €300 billion in 2015, from €750 billion to €1,050 billion.  Even with today’s inflated figures this corresponds to an increase in the gross capital stock equivalent to 120 per cent of GDP in just one year. Investment in 2015 was equivalent to just over 20 per cent of GDP so these balance-sheet effects impacted the capital stock to the tune of almost 100 per cent of GDP.

The best we can do to strip out all of this madness is probably to look at net national income which excludes the provision for depreciation from all assets and accounts for net factor income from abroad.

Net National Income at Market Prices grew by 6.5 per cent in 2015 which is probably somewhere around where “the Irish economy” grew at in 2015 rather than the 26.3 per cent that “the economy in Ireland” grew by.

Managing the Budget with High Debt and No Currency

A sovereign state with low debt can access liquidity through the markets. There are limits and they will be reached when the debt ratio begins to send out distress calls. Until that (unknown) point, there are, in effect, un-borrowed foreign exchange reserves. With an independent currency liquidity can be created for government or banks without external conditionality. There are limits here too and creating excess liquidity brings inflation risk and exchange rate pressure.
With high debt and hence uncertain access to bond markets a short-term expansion cannot safely be financed through debt sales without constraining capacity to repeat the procedure. Without a currency either, the creation of liquidity is conditional on the cooperation of the foreign central bank. If its conditions include constraints on fiscal action there can be no stabilisation policy – no exchange rate, no monetary or fiscal discretion.
Most Eurozone governments can borrow in the markets at low rates, courtesy of QE, despite historically high debt ratios. In the absence of QE the perception of capacity to borrow could diminish rapidly. Availability of QE is in any event not automatic – there is none for Greece, for example. There are also unclear conditions on ELA creation by national CBs. Consent from the ECB can be withdrawn arbitrarily or may be permitted only on penal conditions, such as pay-offs to unguaranteed creditors of bust banks.
The Eurozone governments with high debt face an illusion of policy space in current circumstances, with apparently easy access to debt markets. The constraint appears to be the EU rules about budgetary limits, as long as QE lasts.
But QE will end at some stage and the constraint becomes the market demand for sovereign debt. The design problem for fiscal policy (the only stabilisation tool available) is to manage the trade-off between using it now and having less to use later. Since the election Irish politicians have found agreement on two policies: (i) that the European Commission should be lobbied to relax the budget rules and (ii) that government should borrow ‘off balance sheet’.
Policy (i), lobbying the Commission, sacrifices future budget flexibility explicitly. The inverse demand curve for sovereign debt is r = f(D) where D is the debt ratio. Unless f(D) is flat the sacrifice is real. Moreover f(D) is unknown, although known not to be flat. Unless sovereign bond buyers are unable to count (ii), hiding sovereign liabilities, is just gaming the Eurostat debt definition. This definition (gross general government debt to gross output) is not a serious measure of debt servicing capability and, after QE, a sovereign could easily be inside some EU limit and unable to borrow. Eurostat does not lend money.
There are arguments for battling to borrow: interest costs are low and it is an article of faith that high-value public investment projects are plentiful. The trade-off (looser policy now versus the risk of ill-timed tightening later) would look better if the economy was becalmed, multipliers high, debt ratios modest, macro-volatility historically low and the foreign central bank known to be benign. None of these conditions applies currently in Ireland.
There is a case for using the QE respite to borrow reserves, accepting the negative carry, as NTMA appears to be doing. The case for deferring the attainment of budget balance is harder to see.

“No recovery here”

One of the really interesting outcomes of the last election was the rejection by voters of the Fine Gael strap line: let’s keep the recovery going. As measured by GDP growth, Ireland was rebounding from its period of austerity very strongly, with the fastest GDP growth in Europe.

A household sector which had just received an income tax cut, child benefit increases, pension increases, social welfare increases, public sector pay increases (or restorations, whatever), threw the main party’s ‘recovery’ line back in its face at the doorsteps–what recovery, they asked. No recovery here.

This was taken to mean that there was no recovery outside of Dublin. Dan O’Brien’s series of columns have dispelled that myth. There is a recovery in rural Ireland, it’s just not happening as quickly as in the capital, where employment levels are now 96% of their 2008 peak. In the Mid-West employment levels are at 88% of their peak.


Then a long and rambling discussion on the corporate tax element of Ireland’s apparent rebound took place, largely on twitter. The volatility of the corporate tax take in Ireland is exceptional.

Yet another strand of the argument is given by thinking about Ireland in relation to Europe. Philip Connolly of the times in Ireland showed me these data of GDP per capita in purchasing power parity adjusted euros compare it with an actual income for consumption measure. The graph below is from Eurostat and shows the difference in the two measures  with Ireland and Luxemburg showing a very large difference between these two measures of household welfare. Using the AIC measure, Irish households are closer to Italian than Danish levels of welfare.

Source: Eurostat
Source: Eurostat

This may give a clue as to why we see such large differences between official rhetoric and the popular reaction to that rhetoric.