Ireland – The Questions Nobody Seems to be Asking
by Mike Kimel
Ireland – The Questions Nobody Seems to be Asking
Cross-posted at the the Presimetrics blog.
Talk about deja vu all over again. Here’s Tyler Cowen talking about the Ireland bailout, and linking to Megan McArdle discussing the same. Its deja vu, for me, because it seems just about everyone commenting on the issue is ignoring what should be an obvious point, namely that a bail-out is at best a possible solution to the wrong problem. Interestingly enough, this wrong problem has been around for a very long time, and the same cast of characters have been busily ignoring it (or even praising it) for a very long time.
I said this is deja vu all over again for me, because the last time I gave much thought to the issue (back in 2006), I wrote a post that linked to both Tyler Cowen and Megan McArdle (then Jane Galt). I’d like to quote myself extensively if I may:
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?
(Note – transfer pricing was a favorite topic of the early posters on Angry Bear – Angry Bear, Kash, and PGL all had a number of excellent posts on Transfer Pricing that predated mine.)
About six months after that post, I noted some, er, corroborating evidence:
According to the CBO 20% of the returns on investment abroad by US companies from 1993 – 2003 came from Ireland and Bermuda. Ireland and Bermuda. If there’s some way to explain that 20% of the returns of all American companies abroad came from Ireland and Bermuda without invoking tax fraud on a massive scale, I’d love to hear it.
Now, none of this is intended to suggest that the Irish government wasn’t amazingly stupid in agreeing to take on the debts of private banks. (Hey, the administrations of both GW and Obama did the same amazingly stupid thing, but they disguised it a bit better, and the ability to print dollars buys the US some leeway to deal with it.) However, it does raise important issues:
1. How much of the Irish growth was fictitious?
2. What is the expected rate at which fictitious growth is transformed into real growth? Presumably that rate exceeds zero (if companies set up so much as a pass-through in Ireland to reduce their tax rate, some of the money will stick to Ireland), but presumably it is well less than 100% (if you’re attributing a technology developed by 23 engineers in San Jose, CA and 14 in Frankfurt to a single technician in Dublin, you might reduce your tax rate but the knowledge base still won’t be in Dublin.) I imagine that, paradoxically, the more the American and German tax authorities enforce compliance, the more they help the beggar-thy-neighbor types by essentially forcing their companies to do something real in those jurisdictions. Eventually, some of the engineering work actually does move to Ireland.
3. Are the beggar-thy-neighbor countries (or states, natch) more susceptible to downturns than other countries? After all, when the doo-doo hits the fan, and profits are down, Siemens and Intel and the rest of ’em have less of an incentive to minimize profits in high tax jurisdictions, and more of an incentive to show losses in those same high tax jurisdictions. Activities of any sort in Ireland becomes an afterthought. Additionally, I imagine that the Irelands of this world are disproportionately dependent on financial transactions.
4. How much of a hit do places like the US and Germany (or New York and California) take as a result of beggar-thy-neighbor policies? What should these countries (and states) owe to their citizens or corporations that take advantage of the schemes made possible by the beggar-thy-neighbor policies?
5. Is the stupidity of the Irish government (in taking on the debts and obligations of private banks) something that will have a long term deleterious effect on Ireland’s ability to continue playing beggar-thy-neighbor? The collapse of the housing bubble is a separate matter altogether from the transfer-pricing-milking-operation the Irish government was running, but might it affect Ireland’s ability to keep playing the game? (I don’t know enough about the Irish economy to hazard a guess right now, especially given the baby on my lap has just starting screaming since I started writing this sentence… which I guess is a signal to end this post.)
1. Most of the growth of “wealth” and collateral for borrowing was in bubbling property value, as in the US, is fictional, bubble pushed by Euro investors’ looking for returns with no concern for the fictions’ risk.
2. In short term about plus 10%, in longer term, minus 25%. All phony gains lost then some. Disinflation, nice word for deflation. But deflated bubbles are actually good. No I am not going Schumpeter depressions are not good.
3. The risk takers are getting bailed out, but yes the lenders are at great risk, the problem is the politicians are sharing that risk which is 1929 all over again.
4. Don’t know of this in terms of rates, but politicians ignore price stability and unemployment at their own great peril. Ireland has no control same as a US state. But the US congress has not gone to “beggar the states mode” yet.
5. I do not think the government will be around after the spring election, if not sooner. They deserve a no confidence and the parliament disolved. Parliamentary systems are not so easily bought by bankers.
I think the Euro needs a bit of Quantitative easing.
The ECB needs to buys 1T in euros of Euro notes to provide liquidity for the bail out.
Then maybe the Euro will stand. The lenders take a hair cut in inflation. The people take a hit in price stability going bad.
But the Euro could survive flaoting along like the US D.
I think Italy is closer to California vis a vis the Euro than Ireland.
thanks for the cheery essay to start my day. just when i was concluding that everything i know about a related issue tends to prove that we are governed by criminals and fools.
ah… you didn’t really mention the criminals. i would expect that the irish government is not “stupid,” but that irish politicians are paid to look favorably on policies that enable the scam. and no one cares about long (ish) term consequences when the short term is so lucrative.
well, the irish have a tradition of enduring bad times by sitting around in a pub telling funny stories about the people screwing them. see you there.
Or occupying the central post office!
Or, ya know, we could all get on the boat to America! Oh…wait a minute. Guess not, huh? NancyO
I look forward to many of my cousins, many times removing immigrating………………….
US Irish won’t pay the Germans, we will take the kids who come over in.
Been doing it since the English landlords starved us in 1843.
Interesting post, especially by someone caring for a baby.
I don’t actually know this, but it seems that MNCs would scam the deduction side of the equation as well. A soft drink company for example could buy its vending machines in its home country where taxes are high, thereby maximizing deductions, but then distrubute those machines globally so as to ‘offshore’ profits. Same could apply to research costs, fleet purchases, components, and etc.
IIRC, 28% of US corporations paid zero taxes in the US in 2006(?).
and just to hold the thought in our minds
a recent effort to tax soft drinks was defeated in the local legislature. horrible burden on the poor, don’t you see.
and god knows we don’t need no new taxes.
I did inform an Irishman on another blog whom was considering emigrating somewhere, that the City of Detroit is embarking on a plan to transform itself into an agricultural based economy and may have demand for potato farming skills.
His background was in the Irish financial sector however, and he was a little cool towards the suggestion.
Seems like everyone is getting deja vu:
Coorection to ECB quantitative easing:
The ECB needs to buys 1T in euros of PIIGS’ exchequer notes to provide liquidity for their bail out.
Cedric, for shame. The poor fella may need to start over and what can else he do? Quite a few people in this country are thinking about it from one blog I read. Problem is I can’t think of a country that would have us. Nancy O
Starving makes your feet itch, don’t you know. Or, that’s what happened in my family–all from the less prosperous areas of the UK. If you leave, however, don’t expect to be invited back when the itch goes away. We haven’t heard from any of the Celts for 200 years and the English side were last heard from 100 years ago. NancyO
Well, something besides finance like potato farming maybe? Doesn’t pay as well, but at least people like french fries.
We did sell a large number of our Lehman crooks to Barclays of Britain. But then Barclays left them here as a way to enter the US market.
This is like when you get a sticky thing on your finger, and no matter how hard you shake it, you can’t get rid of the sticky thing.
As for this: “The Questions Nobody Seems to be Asking”
There is another interesting aspect of the PIIGS considerations that is receiving too little attention. It would be inaccurate say that ‘nobody’ has discussed this, but it is ignored somewhat by the MSM.
There is a common denominator that connects all of the global economic problems, going back at least to the Dot Com crash. That being an element of excess liquidity and a subtle re-pricing of risk to find ways to invest that excess liquidity (think of Greece being allowed EU membership on false pretenses as a form of re-pricing risk, much the same as ‘LIAR loans’ and etc.) .
The sub-prime loans in the US for example are little different than the PIIGS shortfalls in respect to how in each case there are foreign creditors involved and nations at risk on the creditor end, as well as on the debtor end. The foreign inflows that fed the bubbles in the US make this correlation a little complicated because those inflows were recycled and re-invested by US citizens but… the common denominator can easily be established as there being a group of economies that have become too dependent on lending. Those being the US, the UK, Switzerland, Belgium, Germany, France, Netherlands, and some others to lessor degrees (I may have missed some too, and my effort to list them in order by exposure is half-baked, this gets complicated because nations such as Belgium and Switzerland have more exposure as a percentage of GDP).
Of course none of what I have explained so far would qualify as ‘questions not being asked’ but there are some related ‘questions’ being ignored: Just how much demand for ‘skilled labor’ actually exists that is sustainable, for example. Tens of trillions of dollars have been spent globally to protect ‘skilled labor’ while ‘unskilled labor’ has been mostly allowed to rely on unemployment benefits. In the US for example 2 sectors of the workforce have been bailed-out, the financial services sector, and the Public sector, while the rest of the workforce has had far less support by comparison. Consequently, we have misleading unemployment statistics when they are divided by income groups.
But the demand for loans continues to wane as it has for many years. And with cross-border capital being ever more dubious in terms of value, (any nation with a bank can simply create capital with exactly the same constraints as what applies to exogenous capital), the very concept of nations being dependent on financial services is very questionable. Moreover, the entire usurious side of capitalism has seemingly run its course yet the applicable clues are mostly avoided.
My great grandfather went back to Ireland with a US pension in the 20’s. However, my great grandmother missed the kids and the indoor plumbing. So they came back to the USA.
As things stand, the problem has its origins in the shift to fiat currencies. This does not mean however that fiat currencies are not the best choice going forward. Fiat currencies are instead unavoidable for too many reasons to go into here… so, I hope it is enough just to say that the problem of excessive liquidity is solvable with a fiat currency.
First though, it is maybe easier to start with the solutions being proposed by the 2 opposing groups in power. Each is flawed, ironically, by a shared unwillingness to confront the fact that the problem is primarily that investment capital has far less value than what it has always been believed to have. Whether this is seen as some feudal holdover that provided the wealthy with the advantage of using their wealth to create more wealth at a time before fiat currencies, or for whatever reason, it doesn’t really matter; the simple truth is that usury has become an unsustainable burden to the global community, simple as that. And the financial system itself is making that revelation inescapable.
The Austerians on one side have no other solution than to allow creative destruction to bring back a poorer version of the status quo; while the Stimulators have no better idea than trying to borrow their way out of a crisis caused by too much borrowing. Neither of these options though will solve the problem.
What will solve the problem is happening is spite of the misguided efforts of the Austerians and the Stimulators. The ‘spillover’ effect caused by QE/ZIRP is putting capital where the demand for investment is the highest, and this will stimulate the global economy, and… curtail usury as the next step in phasing it out.
Just how stimulative this will be, and in which countries, will be determined by FX shifts in the coming months and years. If the Fin Mins of the emerging nations act boldly, which is what they have threatened to do, by purchasing dollars directly, their currencies will fall and carry trades will lose on the way out via conversions back to dollars. This will, in essence, mean that Wall St. will be providing gains to emerging nations along with what could turn out to be interest-free investment capital. Whether this is Bernanke & Co’s intent is hard to say but this part of QE strategy is a no lose scenario because the gains end up in the global economy either way. The important thing is, the global economy gets stimulated and the nations with unprecedented growth, China, Brazil, Malaysia, Indonesia, S. Korea, and a few other smaller nations, are bringing along some of their neighbors through trade arrangements.
Just as importantly, an increasing amount of this growth, will occur with less and less exogenous capital because QEII also essentially justified capital controls etc. Naturally, capital controls have not been all that effective in the past, but that was in part because they were only used in limited ways, this partly because the IMF and the WTO, and other efforts by the US through unilateral trade agreements, have had a dampening effect on how capital controls were used. Now though, with the exception of those nations being bound by direct trade treaties with the US, capital controls are being devised in new and innovative ways, and, direct interventions into the currency markets are being accepted as a necessity and this in itself, as a kind of bluff or threat, is making carry trades riskier, and that risk has the effect of abating the short-term flows. Traders can basically no longer depend on predictions based on the reliability of bully tactics.
So, the system marches on. Things could improve at a faster rate if much more were being done in the way of developing better banking systems and agricultural […]
I’ve lately thought of the bailouts as a game of musical chairs where the bailouts are intended to preserve the institutions in the financial system and shift the fallout elsewhere.
The real economy stopped functioning as a growth mechanism for aggregate capital , in the developed nations, a couple decades ago. We’ve played various financial (numerical) games since then, with the institutions happy to get a few percent of $Trillions of flows pumping the various games. You could say the games were a bet against deflation; and the whole US economy relative to the world became that – we were supposed to be doing great because, though we were borrowing hand over fist, our external equity investments were yielding more than enough to support the borrowing. In that sense, slippery slope of deflation simply wipes developed nation capital off the map, so perhaps we can all take a slice of the bailout (we being the developed).
Still, though, I think the further bailouts ought to be more democratically distributed – helicopter drops probably being better than the existing ways money is funnelled. To eliminate moral hazard, if nothing else; institutions now know where bailouts are likely to send funds and why, not a good plan for forcing real economic use of future funds.
yes, think about that for a while.
domestically we had a combination of de facto zero reserve ratios through the use of sweep accounts, the expansion in size and number of non=bank banks, e.g., money market funds, and importantly, growth in weight, methods and political importance of the GSEs like fannie and freddie — all of which began interacting during the early-mid 1990s and by 95 had achieved ‘take- off” – combined with carry trades and hot money flows into and out of asia, latin america, russia
what larry lindsey
correctly termed ‘nuclear
credit fision’ was underway
a global credit bubble that doug
noland has detailed week by week
since the early 1990s and, in concert with
‘the reverse plaza accord’ of 1996, helped create
what robert brenner termed ‘stock market keynsianism’
a rapidly growing mass of fictitious capital outstripped the labor value
it laid claim to and became progressively more difficult to valorize other than
through further credit inflation — gaps between underlying and claims began blowing
out == way evident in run up to asian crisis partic as econ profit dropped in s korea and china’s
[devaluation induced?] inflation masked weakness as SOEs were privatized……..
the most dynamic corner of the world real economy was in trouble and few seemed to notice
though, as much as i hate to admit, the imf had been issuing advisories to thailand well in advance.