The Goldilocks question: Is Ireland’s economy too hot, too cold or just right?

Posted on August 25, 2016 · Posted in Accounting & Business

Ireland’s economy is out-growing the rest of the eurozone, but costs are rising.  What are Ireland’s prospects?

 

Ireland’s economy is racing ahead – and is the fastest growing in the eurozone.  This places Enda Kenny’s Fine Gael party in a strong position for the forthcoming election.  But will growing cost pressures undermine the country’s competitiveness?

 

Ireland grew at an annual rate of 7% in the third quarter of last year.  This is the fastest growth rate since 2000 and easily outstrips eurozone growth of just 1.6% in the same period.  Irish employment is rising by around 3% a year – nearly three times the EU rate.  Export growth of 12% in a year was even more impressive, but the figures may be misleading because of the impact of tax inversions and Irish headquartering of multinationals.

 

Economist Colm McCarthy – who chaired the panel advising the Irish government in 2009 on how to cut public spending –  argues that Ireland benefited from a series of factors that were not of its own control and which boosted its economy.  “We got lucky!,” he says.  “There were special reasons for this.  The weak euro was a big boost for the Irish economy.  It sells a lot of stuff in sterling and dollars, whereas other euro countries tend to sell in euro.  So the weak euro is much better news for Ireland.

 

“Secondly, the oil price – even in euros – has more than halved and Ireland imports almost all its oil.  So the fall in oil price was a big factor, too.  Thirdly, interest rates charged [to the government for the bail-out of banks] have been negotiated down.  Thanks to QE, the Government has been able to buy back almost all its debt from the IMF, so debt servicing costs are much lower than looked likely.

 

“Eventually that [good news] has to stop.  If interest rates are still zero in five years time, we are screwed.  With the exchange rate and oil prices, we just don’t know.  Oil prices will probably go up eventually.”

 

EY’s latest Economic Eye report expects GDP for 2015 to have officially grown 5.8%, once the final statistics have been collated.  But EY predicts this will fall back to 4.3% this year.  There is uneven economic performance, it reports, with urban centres showing much faster growth than rural areas.  Cities have the highest levels of high value-added employment and resulting economic benefits. While unemployment in Dublin and its travel to work area has fallen significantly in recent periods, to 8%, the same is not true in the South East and the Midlands, where it remains over 12%.

 

Mike McKerr, managing partner EY Ireland, explains: “Employees and investors alike continue to be drawn to cities, due to the lifestyle advantages, better infrastructure and the talent-cluster they offer. The future is bright for Dublin, Cork, Belfast and the island’s other large cities. That notwithstanding, the strength of the manufacturing, tourism and agriculture sectors hold potential for the rural areas that struggle to compete for professional services and ICT investments. Avoiding the costs of success, namely high prices, congestion and property shortages will be paramount to ensuring the continuation of the urban success story.”

 

These factors demonstrate, says EY, the need to respond to infrastructure pressures.  More investment is needed in housing in Dublin, while more spend on transport links, broadband, energy, water supply and waste treatment will help to stimulate economies in rural areas.

 

Challenges lie ahead, not least the impact of BEPS on Ireland’s competitive position.  But Deloitte points out that the detail of BEPS will not be known for some time.  Louise Kelly, a Deloitte Ireland tax partner, says: “There is very little in the BEPS paper which is a minimum standard, or mandatory.  So a number of actions were recommendations or best practice.  Because of that approach we can expect different countries to implement BEPS in different ways.  Some countries may choose not to implement it in domestic legislation and others not to implement it at all.

 

“The actual granular detail about what we need to do is not yet known.  So for a couple of years there is a lot of uncertainty.  Some countries will move much quicker than others.  For a period there could be quite different rules for different countries.  Ireland needs to ensure it is abreast of all these changes and that the Irish regime operates within the context of BEPS, while not losing competitiveness.  Different industries will be impacted a little bit differently.  Countries will continue to try to attract investment and Ireland is still attractive for companies to remain here and to set up here.”

 

In addition, the Knowledge Development Box (KDB) could be an important element that actually improves Ireland’s tax competitive position.  Martin Shanahan, chief executive at IDA Ireland, says: “This KDB will see a lower tax rate applied to profits from intellectual property that is generated as a result of research and development undertaken in Ireland.  This is the first Knowledge or Patent Box in the world that is compliant with the detail of the OECD’s BEPS initiative. This allows companies to make long-term plans for their activities in Ireland.

 

“The rate of 6.25% that was announced is competitive – I believe it will help in attracting new R&D to Ireland.  In addition to IDA Ireland’s direct R&D support, the KDB adds a further dimension to our best in class corporation tax offering, which includes the 12.5% headline rate, the R&D tax credit and the intangible asset regime.”

 

Neil Gibson – professor of economics at Ulster University and economic advisor to the EY Economic Eye – predicts that the Irish economy will begin to rebalance, with stronger consumer growth providing more of a boost in the immediate future.  “Consumers are feeling better off and there have been tax reductions,” he explains.  “After six or seven years of maybe not replacing the washing machine or car [consumers are ready to spend again].  Export markets can’t perhaps do in 2016 what they did in 2015 and there are difficulties in China and US interest rates are rising.

 

“The problems and risks are with cost pressures: wages, particularly in Dublin, the property market and rental costs.  You can see the IDA and the Irish government working very hard, ahead of the curve, and with the commitment to see opportunities elsewhere than Dublin – in Cork and Galway – and I think that is important.  They are already well aware of the risk that cost pressures will erode Ireland’s cost advantage.  If growth stayed at 5% or 6% it would create difficulty.  It might be nice for a year or two, but it would lead to overheating as before.  But these are nice problems to have.

 

“BEPS could possibly cause problems, but you have to think that Ireland’s position is advantageous for a whole lot of reasons, not just tax.  Ireland is already in a strong position with skills.  Once a firm is here it is very difficult, very expensive, to retrench from that.  One thing that Ireland is good at is compliance legislation.  There will be changes, but I don’t think anyone will be able to play the tax position as Ireland has done.  And BEPS is all about making tax more connected to where the activity is taking place – and so much of the activity is in Ireland.

 

“The knowledge box could be an important opportunity for Ireland, as many of the firms in Ireland are firms that can avail of those opportunities.  In a new type of tax system Ireland is again at the forefront and it is sending out a really good message that Ireland is ahead of the curve.”

 

A more cautious view is taken in the study Squeezing the Irish Corporation Tax Base from University College Cork economist Seamus Coffey (published by CAI), which warns that BEPS could have a negative impact on the Irish tax take.  Coffey reports that 80% of the €4bn of corporation tax collected in Ireland each year is paid by US and other foreign-owned companies and that one sixth of that tax comes from the pharmaceutical sector.  He says that as only 1% of EU pharmaceuticals sales takes place in Ireland, the Irish government stands to lose annual revenues of €575m to €650m from the impact of BEPS, along with the possible introduction of a Common Consolidated Corporation Tax Base.

 

In short, while the outlook for the Irish economy remains positive, the rate of growth is likely to fall and there are risks.  While we have yet to understand the full impact of BEPS, Ireland has demonstrated a world class capacity to play the tax competitiveness game better than most countries – and is well placed to continue to do so.

 

Box – Northern Ireland

 

EY’s Economic Eye believes Northern Ireland’s economy will have grown by 1.7% in 2015.  Growth in 2016 will be hampered by public sector austerity and the small size of the North’s private sector.  The intended devolution of corporation tax – to be cut to match Ireland’s rate of 12.5% in 2018 – will “alter [the] competitive landscape”, predicts EY.

 

It is likely, says EY, that this will support the development of different sectoral clusters north and south.  An EY survey of business leaders predicted that the cut in the North’s corporation tax is most likely to attract additional investment in the life sciences and pharmaceuticals, technology and manufacturing.

 

Michael Hall, managing partner for EY Northern Ireland, says: “Austerity is dampening domestic demand in Northern Ireland now in the same way it did in the Republic in recent years, and there have already been considerable job losses in the public sector as a result. We must offset this constraint by attracting more FDI in the private sector. This will be key to ensuring continued growth and uplift in employment in the coming years.”

 

Like the Republic, economic performance in the North is much stronger in large urban centres, particularly Belfast, than in rural areas.  But employment rates are improving, with 24,000 jobs created in 2015.  Wage rates reflect regional differences in appeal, with median wages a third higher in Belfast than in weaker areas.  As with the Republic, suggests EY, greater investment in infrastructure is needed to drive economic performance outside of Belfast.

 

PwC chief economist, Dr Esmond Birnie, warns that while recent employment data is positive, “there are no grounds for euphoria”.   He says: “The gap between the Northern Ireland and UK employment rates remains about 5% points – that means that Northern Ireland’s employment rate is essentially the same as it was four years ago.  The rate of long term unemployment remains at 54%, almost double the UK average.  Whilst jobs growth is still being recorded, this is not being reflected by growth in real wages, household disposable incomes, while manufacturing output has actually fallen.”