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Assessing Ireland’s economic performance

Jul 01, 2019
The performance of the Irish economy is of interest to us all. Whether we’re assessing a new job that might be on the horizon, what an end of year bonus might look like, or the accuracy of a profit forecast — growth matters. You might, therefore, think we would have one simple and clear measure of growth. Unfortunately, economics is rarely that simple. Annette Hughes, Director in EY-DKM Economy Advisory, explains.

When it comes to reporting on the economy, a range of measures exist, all of which are relevant, but each of which tells us something different about the economy. The differences between the measures can be difficult to understand, and the use of the wrong measure can lead to mistakes.

The inaccuracy of GDP

Gross Domestic Product (GDP) is the most commonly quoted measure and the one you would normally read about in the media. GDP represents the total economic output of Ireland and its citizens. It is an internationally-comparable measure, allowing comparisons across countries.

At this point, you may be wondering why we need any other measures. The complicating factor is foreign direct investment (FDI). If an Irish investor bought a factory in France, the initial investment would reduce GDP, as money would flow out of Ireland. However, profits being repatriated leads to an increase in GDP. Therefore, increasing economic activity in France could both have a negative impact (making the factory more expensive) or a positive impact (making the return on investment higher) on GDP. 

The reverse is true when a foreign company invests in Ireland. This is normally known as net factor income (NFI) from abroad. As a result, GDP reflects Ireland’s performance against other economies but does not give a true sense of how the ‘real’ economy is performing. 

Things get complicated

To get an accurate reading on the economy, you need to remove NFI. This gives you gross national income (GNI), the economic activity generated inside the Irish economy. For many years, GNI was the go-to measure for most economists seeking to understand the health of the Irish economy.

Then, in 2015, things got complicated. According to the CSO, GDP growth jumped from 8.5% in 2014 to 34.4% (in current prices). GNI growth went from 8.6% to 22.3%. Now, while we all like to see the Irish economy do well, this would have been unparalleled for any major developed economy; Nobel Prize-winning economist Paul Krugman termed it ‘leprechaun economics’. So what happened to cause that major upward shift in the growth figures?

This remarkable upward shift was due to the treatment of the balance sheets in major international companies. In 2015, the government changed the rules on intellectual property (IP) rights. Before that point, companies could write off capital allowances in investments in IP against a maximum of 80% of the related profits in any one year. In 2015, the 80% limit was removed. This lead to balance sheets dominated by IP products being relocated to Ireland. As these balance sheets were considered to be intangible assets, they were included in GDP. It is estimated that this change led to roughly €30 billion of additional GDP in 2015. 

The introduction of GNI*

The additional GDP in 2015 meant that a change was needed. GNI needed to be ‘modified’ and modified GNI, otherwise known as GNI*, was created, eliminating the impact of all redomiciled company balance sheets, and giving a more accurate measure of real economic performance. Using GNI*, economic growth in 2015 went from 22.3% to 8.6%; still an impressive performance and somewhat more believable than the original GNI figure. 

In 2017, the total modifications came to €53 billion, of which €43 billion was associated with trade in IP (other differences reflect the treatment of depreciation on aircraft leasing). While GNI may be of interest to those looking at the trade in IP rights, for most of us, GNI* would be considered the most reliable measure to gauge real economic activity.

A more relevant method

Soon after GNI* was introduced, a second, new measure was also developed. This was modified domestic demand (MDD) and was first published in 2017. MDD is defined as total domestic demand, personal and government spending on goods and services, plus capital stock additions and valuation changes, minus the same modifications discussed above. MDD, therefore, gives total spending in the economy and provides a good measure of the health of the domestic economy — arguably the economy that will be more visible or relevant to citizens and businesses. 

What’s next?

So what’s next for the Irish economy? As GNI* is only available on an annual basis (with the most recent year being 2017), most forecasts focus on GDP and MDD. The latest EY Economic Eye report forecasts growth in GDP of 4.1% in 2019. This is down from the 2018 level of 6.7% but still reflects a robust economic performance.

Welcome to the ‘real’ world of economics.