How fast is the economy really growing and does it matter for fiscal space?
Posted on September 15, 2017 by Tom Healy
It all depends. The last annual set of national accounts were published in July by the CSO. As expected, these show a significant divergence between GDP and what the CSO now term GNI*. GNI* excludes globalisation effects that are disproportionately impacting the measurement of the size of the Irish economy. The CSO reported GDP at €276 billion in 2016 while GNI* came to €189 billion. The gap is €87 billion or 32% of GDP including net factor income and other elements. The gap between Gross National Income and Modified Gross National Income (GNI*) is almost 17% of GNI and is accounted for by the following three components:
- Depreciation on R & D related intellectual property imports (€28 bn)
- Factor income of redomiciled companies (€6 bn)
- Depreciation on aircraft leasing (€ 5 bn)
(See Chart, below, for details).
What the CSO term ‘Domestic trading profits of companies (including corporate bodies) before tax’ has increased from €56.7 billion in 2014 to €89.7 billion in 2016 (reflecting in part the distorting effect of the 2015 surge in GDP).
The most recently published CSO Quarterly National Accounts, last week, illustrate a mixed set of signals. On the positive side, output across virtually all sectors of the economy is rising in the first half of 2017. However, personal consumption declined by just over 1% in the second quarter (compared to the first quarter). This is the first such decline since early 2013. GDP increased in the second quarter although GNP (which excludes net profits repatriated abroad) fell in two successive quarters. The high degree of volatility from quarter to quarter in key aggregates as well as particular components shows the need for caution in basing an economic outlook on a limited number of measures which are prone to distortion or short-term fluctuation. A more telling indicator is what the CSO term Modified Total Domestic Demand (MTDD). The value of this measure increased by 4.5% in the second quarter of this year, whereas it fell by 5.6% in the first quarter (compared to the previous quarter). Overall, MTDD grew by 2.6% between the first half of 2017 and the first half of 2016.
Ironically, the fact that recorded GNP declined for two successive quarters in 2017 did not even merit notice in the limited public commentary about last Friday's release is interesting (though, technically this might be close to a declaration of a technical recession). Only two years ago, GNP was a popularly used measure and viewed as more telling than GDP. The Fiscal Council, among others, were given to using a 'hybrid' measure of GDP and GNP to better estimate meaningful economic activity. Judging by recent trends, GNP is possibly even less reliable than GDP given the intrusion of tax-avoiding PLC redomiciling here as well as the rise of contract manufacturing in the Far East for technically Irish-owned enterprises. The introduction of GNI* (modified GNI) provides a temporary solution. However, the fiscal rules only recognise the concept and measure of GDP. By ignoring GDP growth in 2015, the Government, the EU Commission and others have, effectively, consigned the fiscal rules to the sidelines. Once bent and suspended the door has been opened to other exceptions and derogations on whatever grounds. It is a case of making up new rules and conventions and creating whatever fiscal space you want at a given point in time.
The matter of fiscal space has been actively raised by IBEC, among others. The case has been made for greater flexibility around the fiscal rules especially in regards to the continuing under-spend on public capital projects. IBEC has argued that the exceptional jump of 26% in GDP recorded for 2015 should be factored into the estimation of available ‘fiscal space’. They state that the various activities incorporated into GDP but not included in GNI* belong to long-term sustainable national income available for public spending via taxation. However, the European Commission and the Government along with the Irish Fiscal Advisory Council regard the increase in GDP as an unreliable basis for future tax flows. The Commission and Government, here, have averaged growth in 2014 and in 2016 and imputed same to 2015 instead of the recorded increase in GDP (even though the fiscal rules are based on GDP, only).
My sense of the matter is that fiscal space is probably larger than the figures quoted in recent Government statements and documents for the following reasons:
- The calculation of the ‘structural deficit’ is distorted by the use of inappropriate methodology by the European Commission (who regard the Irish economy as currently ‘over-heating’).
- The complete ignoring of the jump in GDP in 2016 is not justified since it remains part of national income and expenditure and is very likely to be available for coming years.
That said, it appears that official estimates of fiscal space do not sufficiently account for the impact of demographic change. Moreover, the surge in national income from extraordinary and one-off increases in measurable GDP is not a stable or reliable basis in the very long-run. A middle course is justified in a way that allows for more flexibility and, therefore, for higher net fiscal space taking account of the some of the increase in GDP with a margin for downsized risks arising from Brexit or reverse shocks to GDP as a result of corporate behaviour. Clearly, government capital spending plans need to be revised up significantly especially in areas such as social housing, education, health and childcare. However, the increased spending should be funded from a combination of borrowing at low long-term interest rates (and taking advantage of greater leeway arising from the 2015 surge in GDP) as well as higher revenue given the systematically low level of taxation in Ireland compared to comparator countries in Europe. It may be possible to devise a progressive wealth tax at local level (based on residential and commercial property) to pay for specific local public services including social housing.
In a wider EU context it is clear that a number of Member States have availed of fiscal rule flexibility either ‘ex-ante’ ‘ex-post’. A concise overview and listing of countries is provided in this table which is part of a study done by researchers at the German IFO here .