Dan O’Brien: ‘Day of reckoning will come as Irish economy’s links to the US get ever deeper’
Brexit is bad in many respects. One of the downsides is that following its many twists and turns takes up a great deal of time. The distraction from other issues amounts to a big opportunity cost.
This was brought home yet again recently by a presentation on the US economy by the chief economist of the National Treasury Management Agency, Rossa White. “US risks getting lost amid Brexit furore” was the title of his talk.
Before considering some of the points he raised it is worth stepping back to consider the bigger picture. The US not only remains the world’s largest economy, it also has many more strengths than weaknesses.
It is dynamic, innovative and entrepreneurial, as evidenced by its leading position in many of the newest and fastest-growing sectors of the knowledge economy. Its unemployment rate – now below 4pc and at its lowest level in decades – is further testament to American dynamism.
While the US has its challenges, as is the case for all countries, it will remain a central player in the global economy for is long as anyone reading this is alive.
In the short term – the focus of White’s presentation – things could get bumpy. There is a real risk of turbulence ahead after a very long period of asset price inflation – price-to-earnings ratios for US stocks are close to the all-time high recorded on the eve of the 1929 crash and commercial property prices are now well above their peaks before the huge property crash of more than a decade ago.
Some debt indicators are also flashing red – the stock of student loans has exploded and corporate borrowing relative to GDP is at a record high, some of which has been borrowed not to invest in plant, equipment and the like, but to buy back shares.
As both of the 21st century recessions in the US have been triggered by upheavals in financial markets, all this is cause for concern, even if there are few real economy indicators suggesting that strong growth currently being enjoyed is about to come to an end.
Moreover, the big fiscal stimulus unleashed by last December’s wide-ranging package of US tax cuts is likely to add to momentum for a while yet.
That is good news for Ireland, because the Irish and US economies are more integrated than ever. In recent years, the US has overtaken the UK to become Ireland’s largest national trading partner.
Last year Ireland earned €33.3bn from goods sold to Americans and €18.5bn from services. A large chunk of these exports is accounted for by US companies selling back into their home market (much to the chagrin of US President Donald Trump).
American companies have come to dominate the two sectors which are the most important from an export perspective. They now account for almost 80pc of gross value-added generated by the manufacturing sector and two thirds of that generated by the information technology sector.
The central role American companies play in the Irish economy is also to be seen in jobs numbers. They employ 7pc of all those working in the private sector in Ireland, the highest level in Europe.
The outsized role the Irish operations of US corporates play in the global activities is also well illustrated in other jobs figures. Google’s 7,000 workers in Ireland and Facebook’s 2,000 account for 8pc of both companies’ global head counts.
Apple’s 6,000 Irish employees make up 5pc of its worldwide workforce.
US direct investment into the Irish economy continues apace, with hardly a week passing without yet another American company announcing plans to establish a new operation in the country.
Non-direct investment has also been significant. American portfolio investors have bought into the Irish banks and property companies to a significant extent.
According to White’s presentation, the 10 largest US investors in Bank of Ireland and Cairn Homes own a quarter and 45pc of the two entities respectively.
It is also worth remembering that back at the start of the decade, when Ireland was a sell for most investors, it was now-commerce secretary Wilbur Ross who bought into ailing Bank of Ireland.
That sent a strong signal that better times were ahead and helped change international sentiment towards the Irish economy.
Yet another upside of integrating into the US economy has been the taxes that have rolled into the state’s coffers. American corporates pay tax via the Vat system and social insurance fund.
Their employees pay billions in personal tax. At least half of the almost €10bn in corporation tax revenues which will be paid this year comes from US companies.
Much of the discussion of the State’s growing, and possibly excessive, dependency on US companies’ profit taxes has focused on the possibility that companies will shift their profits out of the country as fast as they have located them here in recent years. This is indeed a concern. But less discussed than this mere possibility is the near certainty that corporation tax revenues will fall sharply whenever the next recession hits.
Everywhere, profit taxes are among the most volatile of taxes. That is because profits are volatile. They almost always fall by a lot more than personal incomes and consumer spending during a slump. As a result, profit tax revenues fall by more than income taxes and consumption taxes such as Vat.
During the last recession, for instance, Irish profit tax revenues almost halved from peak to trough. By contrast Vat fell by one third and income tax revenue by 17pc (rates of both taxes were hiked, unlike corporation tax, which does explain some of the difference).
The Government is now more dependent on corporation tax revenues than ever before. It has built no buffer into the public finances for even the standard cyclical downturn in receipts that can be expected in the event of a downturn.
The day of reckoning is probably some time away yet. But it will come eventually.
The middle of next year will mark the 10th anniversary of the ending of the last US recession.
Already the current expansion is one of the longest on record. Sooner or later all good things come to an end.
Sunday Indo Business