'Leprechaun economics' set to change EU GDP calculations

When the economist Paul Krugman referred to the latest Irish national accounts figures as "Leprechaun economics" he was missing the real story. The new framework for measuring output worldwide was developed by the United Nations down the road from him in Manhattan and these new rules affect not only the official measure of Irish gross domestic product (GDP) but also how overall European Union GDP is calculated.

As Eurostat has implemented the new UN framework, Ireland's Central Statistics Office was obliged to apply it. However, the revised statistical framework has not yet been implemented by the United States and many other leading economies, though they may do so in future.

The revised methodology means activity redomiciled to Ireland by one or two very large firms has increased measured Irish GDP by about 20 per cent in 2015, and euro-area GDP by 0.4 per cent. The underlying economic activity behind the apparent shift in GDP takes place in China or other low-cost manufacturing countries – neither Ireland nor Europe has seen a real change in output, just a change in where the legal ownership of the output is located.

Euro-area fiscal policy

The consequences of the headline rise in EU GDP is probably the more interesting aspect of the story. If these numbers were to be taken at face value, that would suggest the euro-area economy was performing better than expected and, therefore, the European Central Bank should consider tightening its monetary policy stance. It would also suggest euro-area fiscal policy does not need to be relaxed, as the EU economy is now operating closer to capacity.

However, we know that this addition to euro-area GDP does not signify higher real growth. As a result, I am sure the ECB will ignore this change and will not be diverted from implementing its current policies. For the European Commission, charged with implementing EU fiscal rules, the situation is more complex. It too now knows that this addition to EU growth is an illusion and that it should not require an alteration in the fiscal stance for the euro area. However, because the commission is governed by rules based on the latest version of the national accounts, it will be more difficult for it to apply common sense. In the case of Ireland, it will face a particularly acute choice between the rules, strictly applied, and sensible economics.

While the effects of this change in the national accounts for the EU are clear, the effects on global output are more uncertain. The relocation of activity to Ireland (and the EU), probably by US firms, was equivalent to 0.25 per cent of US GDP. Such a change in US GDP could also have had implications for US fiscal and monetary policy.

However, as the US has, so far, not implemented the new UN rules its accounts have not been affected to date.

In fact, the firms concerned may have relocated from a tax haven where they paid little or no tax and where the relevant country’s national accounts did not record their activity at all. In that case the relocation resulted in an increase in measured world GDP of about 0.1 per cent in 2015.

While, as is now well known, the decision to revise the national accounting treatment of key global firms has given rise to very strange results, there was a certain logic to the new framework. It was designed to ensure that all activity by such firms is recorded somewhere in the world. If applied consistently across the world it would achieve this objective. However, a cost of such consistency is that the results may not provide sensible time-series information for individual economies.

Corporate tax increase

However, if we were still using the old statistical approach then the national accounts for 2015 would have shown a big increase in corporate taxation with a limited change in the relevant tax base – profits – which would also have looked very strange. Because of the new approach to measuring GDP, profits in Ireland, as shown in the national accounts, are now very close to the actual tax base used in determining corporate taxation, which is at least one advantage of the new statistical treatment.

What all this highlights is that the latest problem with the Irish national accounts affects the EU and, potentially, other major economies such as the US. It also shows that, because of globalisation, finding a better set of accounting rules that will provide sensible and robust measures of economic activity in Ireland, the EU and the rest of the world will not be an easy task.