Ireland needs new economic development plan for next 20 years
In December 1956 the Oireachtas (Irish Parliament) approved a 50% tax credit on profits from increased export sales, which within months would be raised to 100%. Low or no corporate tax would become a keystone of Ireland's successful drive for foreign investment. However, sixty years after the first moves on tax, Brexit including a low UK corporation tax rate, and expected tax reform in the US, are unmasking Ireland's economic vulnerabilities.
The dramatic policy changes that were put in place in the decade from the mid 1950s have been tweaked in the interval but largely remain intact. Today policy makers again face big challenges to balance Ireland's reliance on foreign direct investment (FDI) with a stronger home-grown exporting sector while addressing enduring structural economic issues.
Two weeks after the publication of the seminal 'Economic Development' report in November 1958, an article in the Irish Times stated that the publication "was a unique event, because for the first time, an Irish Government has revealed in full detail the view put to it on the whole range of economic policies by its principal adviser, the Secretary of the Department of Finance."
Ireland's subsequent success in embracing globalisation is reflected in World Bank data showing that of 101 middle-income economies in 1960, only 13 became high income by 2008. Ireland and Japan were among the thirteen.
A new long-term plan is needed that would acknowledge persistent structural problems in the economy and present an honest assessment of the challenges. Thomas Kenneth Whitaker, the principal author of the 1958 plan who will be 100 years old this Thursday, said in a 1987 interview that in "the new world, the civil servant is all the time trying to please the minister, over-conscious of what might be politically acceptable, arranging the options so that they will appeal, rather than in strict order of eligibility”— since 1987 government spin in Ireland appears to have become more pervasive and public reports which acknowledge weaknesses are very rare.
It is time for change again.
Confronting twin challenges
On Monday the Economic and Social Research Institute (ESRI) published its 2017-2025 medium-term outlook for the economy and using a new model, the economists forecast "sustainable long-term real growth rate of the Irish economy is approximately 3%, driven mainly by growth in the traded sector."
The labour force is expected to grow by close to 2% per annum.
People can't eat GDP (gross domestic product) and with about two-thirds of the private workforce in non-exporting mainly low-paid jobs which typically provide no occupational pensions, this scenario provides little optimism for the outsiders of the economy.
The researchers examined the potential macroeconomic implications of opportunities and threats to FDI flows from Brexit while a second scenario examines the impact of the proposed Common Consolidated Corporate Tax Base.
The report says:
Over the projection horizon, net exports are expected to make an increasingly larger contribution to GDP with respect to the other components.
However, the ESRI ignores the impact of tax avoidance on the opening trade data — in 2015 the inclusion of tax-avoidance related overseas contracting manufacturing with custom-tracked goods trade, boosted the merchandise trade surplus from €42bn to €110bn. Meanwhile half the value of annual services exports of about €120bn relate to Double Irish tax transactions (e.g. Google, Microsoft, Facebook, Oracle etc. booking overseas sales transactions in Ireland) and this avoidance facility will cease from 2021. There are some offsetting transactions on the import side but still unadjusted distorted data should not be used as a base for forecasting.
The ESRI's outlook is a forecast whereas our focus here is on addressing important structural problems. In May 2008 the institute forecast that the economy had "the potential to grow at around 3.75% a year over the coming decade, despite significant short-term problems."
Today Ireland has a high level of low skills among the workforce; a low level of exporting firms; one of Europe's lowest business startup rates; low innovation because of limited technology transfer linkages between the Irish-owned and FDI sectors; a food sector that is reliant on farmers dependent on public welfare while agricultural land is among the most expensive in the world; at 25% of the full-time workforce, the highest level of low pay among advanced countries, and a per capita standard of living below Italy's after the latter's almost two decades of stagnation.
In 2015 Prof Alan Matthews, professor emeritus of European agricultural policy at Trinity College, said most beef farms in Ireland are not financially viable without EU subsidies. Ireland would be financially better off getting out of beef farming and transferring large tracts of land over to forestry, he added.
On another native resource, Ireland has a fisheries zone/area that is ten times the land mass, and the Irish fleet accounts for 20% of the annual catch. Both Ireland and Denmark have a similar profile to Ireland in terms of vessels but Denmark in 2014 had a fish trade value (imports and exports) of $6.7bn compared with Ireland's $1.1bn, resulting in a net export value three times the Irish level and of course a higher indirect value-added.
Despite low business taxes, the indigenous international trading sector has persistently underperformed while remaining dependent on the UK market for about 40% of exports.
The Irish Free State on independence in 1922 began with one-third of industrial output on the island and the latest Eurostat data on the number of manufacturing firms show Ireland at 4,000 and second-last to Luxembourg, compared with Denmark's 15,000 — manufacturing is responsible for about 70% of business research and development expenditure in the EU
While local firm exports are as low as 10% of headline tradeable exports, direct employment by these firms is at a similar level to the FDI exporting sector and official data show that total spending in Ireland on wages, and purchases of materials and services in 2014 was at €21bn by both Irish-owned firms and FDI firms.
The contribution of both sectors as a ratio of GNP (gross national product) has fallen from 2000: down from 17.3% to 12.7% for Irish firms and down from 16.9% to 12.5% for FDI firms.
Low export firm and startup numbers
Ireland has a very low ratio of exporting firms, at about 4,200 exporters (3,000 indigenous and 1,200 FDI firms) or 2% of enterprises in 2014. In contrast, 10% of about 300,000 Danish business firms export.
A Eurobarometer survey published in October 2015 found that 16% of Irish SMEs (small and medium size firms) including FDI firms, exported in the previous 3 years compared with 54% in Denmark; 48% in Sweden: 38% in Greece; 46% in Portugal and among big countries: 51% in Germany; 46% in Spain; 19% in the UK; 15% in France and 12% in Italy.
In 2014 the population ratio per exporting firm was 187 in Denmark; 236 in Germany; 550 in France and 1,150 in Ireland.
Apart from the low number of Irish exporting firms, developing new markets and holding them is very difficult. French research has shown that 30% of new SME exporters fail to hold onto a market for more than a year while "German SMEs, which are larger and more innovative, are also bigger exporters, with exports accounting for a larger share of their total revenue, and they also export more regularly," (the European Commission defines micro, small and medium size firms here).
OECD data show that about 50% of Canadian exporters who started exporting in 2000 were no longer doing so in 2002. After six years, only a quarter were still exporting.
Eurostat data show that the new Irish enterprise birth rate in 2014 was below 7% — one of the lowest in the EU, and that has been a pattern for several years. The UK rate was at 14% while Denmark's was at 11%.
On workforce skills, the OECD think-tank for the governments of 35 mainly advanced countries, said in 2015:
Ireland faces the challenge of having a very high share of its population being unemployed or inactive, and thus receiving no labour earnings. The unemployment rate among the poorly educated is significantly higher than the rate for those with tertiary education. This situation prevailed before the crisis, suggesting that it is a long-standing structural problem.
Impact of Brexit
Even before Brexit begins to have a significant impact, the governor of the Bank of England in a speech delivered on Monday, painted a bleak picture. He warned that in respect of falling real incomes for many Britons, "measures of aggregate progress bear little relation to their own experience. Rather than a new golden era, globalisation is associated with low wages, insecure employment, stateless corporations and striking inequalities."
The UK has suffered its “first lost decade since the 1860s” when “Karl Marx was scribbling in the British Library, warning of a spectre haunting Europe, the spectre of communism,” Mark Carney said in Liverpool.
The governor added that it was “incredible” that real incomes had not risen in the past 10 years — a decade which included the financial crisis and a faltering recovery ever since.
While the UK in 2015 was the biggest market for Irish food and drink exports with a 41% share, Ireland was the biggest market for the UK food and non-alcoholic beverage sectors at 24%.
Including alcohol, there was slight Irish trade surplus in 2015 which means that a low sterling rate is bad for Irish exporters while increased UK imports also affect the domestic sales of indigenous exporters firms, which according to official data was at a 50% average for all indigenous exporters in 2014.
The UK headline corporation tax is due to fall from its current 20% rate to 17% by 2020 (Northern Ireland will have a 12.5% rate matching Ireland's rate) and Theresa May, the British prime minister, has said that her "aim is not simply for the UK to have the lowest corporate tax rate in the G20, but also one that is profoundly pro-innovation — the Group of Twenty nations comprise the 19 biggest advanced and emerging economies.
The UK, Russia, Saudi Arabia and Turkey currently have the lowest 20% tax rate.
US corporate tax reform
US data for 2015 show that the value of American direct investment in Ireland was $343bn compared with $108bn in Germany; $139bn in China/Hong Kong, and $593bn in the UK. The Irish data is flattered by tax avoidance and employment in majority-owned US affiliates in 2013 was 108,000 in Ireland; 612,000 in Germany; 1.5m in China and 1.2m in the UK.
President-elect Trump has proposed cutting the headline corporate tax rate from 35 to 15% and an amnesty is likely to incentivise companies to repatriate the $2.6tn cash that is technically held overseas.
The biggest risk for Ireland is that the US would adopt a territorial tax system where companies would only pay on profits originating in the US. However to forestall shifting profits to no/low-tax jurisdictions, advocates of this approach also see the need for a global minimum tax. A rate above the Irish rate of 12.5% would be bad news.
In November 2015, Catherine Mann, chief economist of the OECD, said in Dublin that Ireland will have to sell itself as more than just a low-tax destination in the new era of global tax transparency. She also highlighted the poor links between the FDI sector and the rest of the economy, with Ireland having one of the lowest EU spends on R&D, despite housing some of the most innovative firms in the world.
“Global capital has come into Ireland...but somehow it hasn’t translated into Irish-owned firms,” Dr Mann said. “The patents are here, but they’re not being linked into the domestic economy, not being levered up by domestic firms or married to domestic workers.”
A long-term plan for next 20 years
An open economy is always at risk of change and there is no moat to prevent other countries from cutting corporate tax rates.
A long-term plan should focus on the next 20 years, and be both free of political spin and the type of delusion that UK Brexit ministers have exhibited about developing new export markets.
The mindset in the Irish establishment that ready-made jobs can always be delivered from elsewhere with some more tax incentives, must change.
Aspirations are easy but successfully developing new export markets that would generate jobs at home would be very hard.
Raising the internationalisation of firms, the rate of startups and innovation intensity, the skills levels of the workforce and putting Ireland at the top of global competitiveness along with Switzerland and Singapore, would be challenging but feasible, if there is a vision and determination to cull sacred cows, similar to the Whitaker era.
The incidence of low pay refers to the share of full-time workers earning less than two-thirds of median earnings (the mid point where half are above and half below). The incidence of high pay refers to the share of full-time workers earning more than one-and-a-half times median earnings.