John FitzGerald: A fair legal framework is crucial for business

While factors like productivity and cost competitiveness are important for a country’s economic success, the quality of its institutions, though less easy to quantify, is also essential. Strong governance and stable well-functioning institutions underpin the world’s most successful economies.

Institutional failures such as political instability, arbitrary behaviour by governments and corruption characterise some of the world’s poorest economies.

Stability, predictability and the fairness of the legal framework are crucial for business. For Ireland, the predictability of the corporate tax regime is probably even more important than the low rate. Strong independent legal institutions are essential, not just to protect individual citizens' rights but also to protect companies from arbitrary decisions by governments.

Firms setting up in Ireland know under what laws they will operate. They are written down, and the courts interpret them consistently. In case of dispute, the legal system will treat all parties fairly whatever their nationality. The EU’s Single Market legislation ensures that firms based in Ireland can compete on equal terms for business across the EU.

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However, recent decisions by the Competition Directorate – subject to whatever final rulings emerge from the European Court – have introduced some degree of unpredictability into the EU’s business climate.

There are areas where Irish law makes for unnecessary cost and uncertainty for business

Up to now much of the operation of the EU financial system has been underpinned by contracts written under UK law. Thus a contract between French and German financial institutions for the sale of a financial instrument is often written under UK law. In such cases, any disputes are decided by UK courts, whose decisions are enforceable, at present, across the EU.

Uncertain

As the UK prepares to exit the EU, acceptance of UK jurisdiction for such disputes becomes much more uncertain.

The reason that UK law has been favoured for financial services is partly tradition. However, because UK judges have been deciding these cases for decades, their judgments are predictable, minimising uncertainty for all concerned. If these arrangements change, a new team of judges may take time to build up experience and, even if the laws are unchanged, interpretations of the law may alter.

The extra uncertainty this would bring will likely raise the cost of doing business across the EU, albeit by a small amount.

While Ireland has an independent judiciary and a legal system that generally works well, there are areas where the law makes for unnecessary cost and uncertainty for business.

Though it is important to have a planning appeals process to safeguard the public good and individuals’ rights, the possibility of long drawn-out additional appeals via the courts can lead to exceptional delays in getting a final decision on important projects. This is unhelpful to investment.

Subsidiary

The perceived quality of a particular state’s legal system can affect whether multinational firms choose to produce goods in that country via a legal subsidiary or via contract manufacturing. This in turn affects the measured impact of the multinational’s activity on the GDP of the country concerned.

Thus when Volkswagen produces cars in Brazil, it establishes a local subsidiary which handles all aspects of the production and all local contracts. The subsidiary is wholly owned by the parent company. It pays the parent for use of intellectual property, such as patents, and it pays its profits to the parent. However, as the activity in Brazil is undertaken by a Brazil-resident company, the subsidiary’s output is included in Brazil’s GDP.

Legal reforms in China have the potential to raise Chinese GDP and lower Ireland's significantly

Where multinationals perceive the local legal system to be weak, or to offer poor protection for intellectual property, the practice is to contract with a local firm to make the products rather than to establish subsidiaries. Multinationals producing goods in China tend to favour this form of arrangement. The risks of dealing with the local administration are managed by the Chinese firm, and ownership of the IP is held abroad.

Legal entity

The goods, such as smartphones, produced by contract manufacturers are owned by the foreign multinational from the outset. This means much of the output concerned is recorded as being in the GDP of the country, like Ireland, which hosts the legal entity that had entered into the contract with the Chinese company to make the phones.

If multinationals were to perceive an improvement in the Chinese legal environment, they could switch from contract manufacturing to the establishment of subsidiaries as their norm. So legal reforms in China have the potential to raise Chinese GDP and lower Ireland’s significantly given the different forms of business organisation are treated so differently in the national accounts.