Wednesday, October 24, 2018

Similar economic structures fuel Ireland’s high Brexit risk

Despite the gulf in the sizes of the economies of the Republic of Ireland and the United Kingdom, they have similar economic structures — in particular, a high reliance on foreign direct investment (FDI) — which raises the Brexit risk for the Irish economy.

The departure of Britain from the European Union presents both countries with significant challenges and this week the news that Sir James  Dyson, the most successful British inventor and innovator of recent decades, has chosen Singapore as the location to build a Dyson electric car, highlights the rocky road ahead for post-Brexit Britain — Sir James is a Brexit supporter.  

In 2016, Ireland's indigenous tradeable exports to the other 18 member countries of the Euro Area were valued at only €3bn and improving on that dismal performance would take many years while Britain is likely to become a more intense competitor for FDI. 

Foreign-controlled British firms are about twice as productive as domestically owned firms, according to Bank of England staff Sandra Batten and Dena Jacobs, who examined data from around 40,000 companies. There is evidence that this situation is replicated in Ireland and the Organisation for Economic Cooperation and Development (OECD) noted this year, "Most Irish firms have experienced declining productivity over the past decade. This has largely reflected the poor performance of local firms, with the large productivity gap between foreign-owned and local enterprises having widened. The resilience of the Irish economy hinges on unblocking the productivity potential of these local businesses" — raw multinational data show ridiculous rates of productivity because of massive profits shifting.

Exports and FDI

OECD data show that foreign-controlled firms account for over 60% of the UK’s annual export value compared with 30% for Germany and about 35% for France. Official Irish export data in 2017 show that foreign firms accounted for 90% of total Irish export value of €356bn — the indigenous exports (including international transport + inward tourism) ratio rises if my estimate of the €152bn worth of fake overseas contracting and services exports (think of firms such as Google and Facebook booking a third of global revenues in Ireland and Microsoft about a quarter) are eliminated while the foreign ratio would fall to 83%.

Denmark, with a population that is a fifth higher than Ireland’s and which like Ireland was reliant on agricultural export in the 1950s, relies on foreign firms for only a third of its exports.

Services accounted for 45% of both the UK and Ireland’s official exports values in 2017 (the Irish ratio is exaggerated) compared with 27% for OECD member countries in 2016 and 17% for Germany.

The majority of business research and development (R&D) spending in the UK and Ireland is by foreign-controlled firms and the UK/Irish rates related to economic output are low compared with countries that have significant indigenous exporters.

UK goods trade has been in deficit every year since the early 1980s while services exports have been in surplus persistently since the 1960s.  The UK combined goods and services total has been in deficit every year since 1999 while trade with Ireland has been in surplus every year in the same period.

In 2017 there was a net deficit of £26bn comprising a goods deficit of £137bn and a services surplus of £111bn.

In 2017 UK exports accounted for 30.5% of GDP; France and Italy were at 31% and Germany was at 47%.

The UK in the world economy

Irish commentators focus on the chaos of the UK’s Brexit negotiations but even though the UK has already been damaged by the decision to leave the European Union, it will remain a significant economy.

Economists at the Swiss Bank UBS put the foregone GDP at 2.1% while Oxford Economics estimates that output would get an additional 2% hit if a deal with the EU doesn’t materialise. Non-tariff barriers account for more than half the costs, it estimates.

EY, the Big 4 accountancy firm, says the UK attracted 6% more foreign direct investment (FDI) projects in 2017 compared to 2016, but in a European market growing at 10%, the UK’s market share fell for the second successive year.

When 450 global investors were asked by EY ‘where is the most attractive place to invest in the future’, they favoured Germany (1st), with France (2nd) overtaking the UK placed 3rd. France has seen a surge in FDI projects by 31% in 2017, supported by the so-called “Macron effect”.

In 2018 the United States has a GDP value of $20.4tn, according to data from the International Monetary Fund (IMF), which show the US economy grew from around $19.4tn last year.

China is second with $14tn; Japan is in third place at $5.1tn, followed by Germany at $4.2tn; the United Kingdom is fifth at $2.94tn and France is sixth with $2.93tn. India is 7th; Italy 8th; Brazil is 9th and Canada at $1.8tn is 10th.

The United States’ economy is larger than the combined economies of numbers four to 10 on the list and accounts for 25% of the global economy, which has been estimated by the IMF to be worth $79.98tn this year.

This month the World Economic Forum published its Global Competitiveness Index 4.0 report with the US at first ranking, the UK is at 8th and Ireland’s rank is 23rd.

Best countries in the world to start or run a business in 2018

Brexit risks to Ireland and the UK

We have already covered specific Brexit risks both to the Irish economy — for example, the reliance of the indigenous food sector on the British market — and the long-term vulnerabilities of the British economy that could be exacerbated by Brexit.

Brexit and rickety foundations of the Irish economy

Brexit, the lost empire, and dodgy modern UK economy 

By 2030, a study on the impact of Brexit found that the size of the Irish economy could fall between 2.8 and 7% depending on the Brexit deal that emerges. The study was presented to the Government in early 2018.

Research by Copenhagen Economics modelled the effect on the Irish economy of the different types of possible Brexit and while the Irish economy will continue to produce strong growth over the coming period despite the effects of Brexit, by 2030 the economy could be as much as 7% smaller than its likely size had Brexit never occurred, the study finds.

This reduction compares to the impact of the bursting of the property bubble when economic output contracted by 8%.

IBM's Global FDI Location Trends 2018 Report

In 2020 the UK corporation tax rate will decline to 17% and a tax of 10% applies to patent-related profits. The comparable Irish rates are 12.5% and 6.25% while Northern Ireland will have a 12.5% corporation tax rate if a local Executive can be restored.

While many UK businesses are more concerned with non-profit charges such as national insurance on wages and business rates, it’s likely post-Brexit that a British government will be under pressure to improve incentives for FDI (foreign direct investment).

The Financial Times reported last July that US banks are calling on the British government to cut taxes and red tape that they say could lead to financial assets and jobs pouring out of the UK after Brexit.

The FT said senior Wall Street executives have warned UK government ministers that the City of London is losing its competitive edge against New York, especially since US president Donald Trump slashed corporation tax and pushed for looser regulations.

Oliver Wyman, a consultancy, estimated in 2015 that almost 50% of financial services revenues were generated by work for UK clients, about a fifth were from EU-related business, and almost a third related to business from the “rest of the world.”

Compared with Ireland's very small local market, the UK's large domestic market and the role of the City of London will continue to attract foreign interest.

No-deal scenario would hurt both UK and EU

While the European Union has the upper hand in the negotiations, both sides risk significant losses. 

1) The majority of UK goods exports to the EU are intermediate goods delivered into multinational supply chains. Disruption of this trade would be very damaging for the  UK; 

2) The UK’s trade surplus with Ireland was £12.2bn in 2017, which was the UK’s second highest trade surplus (goods + services), after the surplus with the United States. Ireland was one of only FOUR EU states the UK had a trade surplus with, in 2017 – the other three were with Luxembourg, Sweden and Denmark. The largest deficit was with Germany (£21bn); 

3) The EU was the UK’s largest trading partner in 2017, accounting for 46% of UK exports of goods and services and 53% of UK imports; 

4) Besides, the EU recovery is softening as China’s growth is slowing and one of the top executives of Bridgewater, the world’s largest hedge fund with more than $160bn in assets under management, says the US economy is “at a potential inflection point where the economy is moving from hot to mediocre"; 

5) The Northeast of England which supported Leave relies on the EU for 59% of its exports (topped by Japanese cars) compared with 42% for Remain supporting London; 

6) While the UK faces the biggest highest risks, a fragile Europe cannot afford risks also.