Ireland, Argentina, and Transfer Pricing

There seems to be some discussion about why Ireland is growing as quickly as it is.

I am completely ignorant about this, and haven’t even been to Ireland. But I do have a question… Is it possible that part, even a large part, of the Irish boom, is fictional?

By fictional, I don’t mean lacking in physical manifestations such as massive improvements in infrastructure, etc. Consider the effects of something else I’m mostly ignorant about, namely the Menem-and-Cavallo-dollarize-privatize-and-steal plan (as I recall it had a different name, but to me this one captures its essence a little better) in Argentina. For a number of years after it was launched, it looked like Argentina was doing really well. There was all kinds of new investment in infrastructure, the mood in Argentina was upbeat, and many economists (especially the conservative ones) and financial publications such as the Wall Street Journal were breathlessly pointing to Argentina as a country that other developing nations should imitate.

The problem in Argentina was that much of the funding for the short-term but much-hyped prosperity that followed came from the proceeds of the sale of government-owned assets (airline, railroads, etc.), or rather, the portion of the proceeds of the sale of government-owned assets that wasn’t stolen outright. Instead of assuming the proceeds from those sales were a one-time windfall, the Argentine government, foreign economists and the Wall Street Journal acted as if they were recurring sources of funding, leading gullible foreign investors to come running with their money. With so many experts patting them on the back, eventually even the skeptical Argentine public came to believe Argentina had miraculously fixed all its problems. When the windfall ended, the dwindling foreign reserves were not enough to maintain the dollar peg for long, and the whole house of cards came down.

Now… some of the growth in Argentina was real, and both dollarization and privatization may well have created more amenable economic conditions. But not enough to justify all the enthusiasm, or to ignore the very real problems the plan also brought.

So… where does that leave Ireland? Well, the worst year of my life was spent at a Big X (at the time, X was equal to 6) accounting firm, doing transfer pricing. Transfer pricing often amounts to little more than highballing the amount of a company’s activity taking place in low tax jurisdictions and lowballing the amount that takes place in a high tax jurisdiction in order to reduce one’s overall tax burden. It is often done creatively. Say company X transfers ownership of a logo to the subsidiary of company X in the Caymans. Then, every time company X sells a tennis shoe with that logo, it pays a royalty to its subsidiary in the Caymans. If taxes in the Caymans are lower in the US, X hires E&Y or PWC or whoever to argue that most of the value in the shoe sits in the logo (and therefore is income received by the Cayman subsidiary and thus taxable in the Caymans), and not in the shoe itself (which is income received by the parent company and taxable in the US).

So back to Ireland…. Say you’re a pharmaceutical company. You have hundreds of highly paid researchers scattered throughout the globe – in places like the US, Switzerland, Germany, etc. Because taxes are lower in Ireland than in the rest of these locations, when a blockbuster drug is discovered, it is advantageous to play up the contribution of the researchers in Ireland and play down the part of the researchers made elsewhere.

This has at least two obvious effects. The first is the direct artificial boost to Irish GDP (and an artificial reduction elsewhere). Since Ireland is relatively small, if a crumb is taken from the US, another crumb is taken from Switzerland, etc., the effect can be very large in Ireland. The second effect is indirect – in order to pull this stunt off, it is necessary to have at least some facilities in Ireland, leading to more hiring and building in Ireland as more companies get more heavily invested in playing the game. But its in nobody’s interest to say this is being as a tax dodge, so a mythology springs up (as it did in Argentina), and part of that mythology, at least, is self-sustaining.

I would imagine the situation is not quite as artificial as in Argentina – Ireland does have a young, fairly educated population, and a convenient location, whereas the change from hyperinflation to rapid growth in Argentina truly looked like a miracle to those who didn’t look too closely (i.e., almost everyone). The Irish miracle has gone on for at least two decades, and there may well be enough of a solid underpinning for it to continue indefinitely. But, I have no idea how much of the Irish growth is due to these effects, nor a clue how to measure them. Any ideas? Any other thoughts as to why Ireland is growing so rapidly?

update: Some grammatical errors corrected. Sorry about that.

update 2: In comments, PGL reminds me that the topic of transfer pricing has come up many times before on this blog. Even with respect to Ireland .