Leprechaun Economics and the Danger of the Narrow View

This month, Paul Krugman took to Twitter to lambast the most recent Irish GDP figures as “leprechaun economics.”Looking past the slightly insensitive language of the tweet, we see that the country’s most recent economic output registered a staggering 26% growth in GDP, which on the face of it, is patently absurd. This absurdity is only numerical though, as no one actually believes that a 26% expansion is a reasonable representation of the performance of the Irish economy. By all accounts, considering unemployment decreases, increases in tax revenue, and retail and durable goods sales, a figure of 5 – 7.8% is more accurate. The two linking factors that led to this farcical figure are the statistical practices of Irish Central Statistics Office (CSO) and more importantly, several recent cases of corporate inversions with large groups being redomiciled in Ireland. While cases like this involving tax dodging corporations and number crunching Eurocrats can easily get lost in the weeds, there is an important lesson to be gleaned from this uncanny spurt of Irish growth. With a little digging, it becomes clear that the figure itself is a poignant example of a dangerous habit; giving too much credence to a single indicator, economic or otherwise.

Your initial reaction to the 26% figure might be to have a laugh at the CSO’s expense or to assume that the employees of the organisation are less than competent, but anything more than a cursory glance reveals this to be untrue. The Central Statistics Office is a highly respected organisation that has consistently reported accurate information in accordance with the rules of EuroStat, the EU’s statistical regulatory organisation. They follow the Code of Practise and are generally considered a reputable agency. The problem they have in this unique case is that they are required by EU law and the expectations of the European Statistical System to release the results of formulaically calculated economic figures, including GDP. Even though the CSO likely realised that releasing 26% growth figures would seem ridiculous, they are ultimately required to do so, as outlined in the European System of Accounts (ESA), published in 2010.  In other words, by sticking to the rules and releasing their diligently compiled numbers, the Irish have been ridiculed. It should be said that this roasting is not necessarily deserved or fair. As Colm McCarthy puts it, “the leprechauns are in Luxembourg, not [in Ireland].”

So if the CSO was doing its job accurately and responsibly, how did such a ridiculous number get released? The answer lies in a clever bit of tax avoidance called a corporate inversion. In its most basic form, a corporate inversion is when a large company acquires a foreign based firm, typically a much smaller one, and then shifts their headquarters to the address of this new foreign acquisition. The primary reason that companies do this is to avoid tax bills; normally the newly acquired company is based in a country where the corporate tax rate is incredibly low. In Ireland, for example, the corporate tax rate is veritable steal at 12.5% compared to the 38.9% (statutory) rate in the United States. The primary benefit for companies is that these inversions help them avoid paying the IRS for their sales overseas. The United States collects taxes on international profits, but exempts profits that are not brought back to the US, which allows companies like Pfizer and Burger King to keep a bit of their extra change. The problem is that that change sometimes amounts to billions of dollars. According to the White House, these corporate inversions could cost the Treasury up to $40 billion over the next ten years.

But what does all of this mean? All of this talk of European statistical analysis, tax avoidance, corporate restructuring and unrealistic GDP growth? Although incredibly convoluted, the one strain that runs through the whole debacle is a rhetorical crutch; outsize reliance on a single indicator. Since its modern incarnation under Simon Kuznets and its adoption under the Bretton Woods system, GDP has been used as a shorthand for economic health. It was used during the Second World War to calculate how best to allocate resources and was an essential dataset for the Truman Administration’s execution of the Marshall Plan. If you get on Google and search for “richest countries,” you’ll be presented with a list of the nations with the highest GDP per capita. GDP is highly ingrained in our system of analysis for the wealth of nations.

The centrality of this single indicator is important, as it has a large impact on national governments. For example, as a result of the newest figures, the Irish government may be on the hook for an additional €400 million bill to the EU. That’s €400 million the State could have spent elsewhere, on housing, on foreign aid, or even to help avoid the protests over Irish Water charges. The point is that this is money the country could have used, but now must pay elsewhere because of a massive jump in GDP that has no relation to reality. According to James Woolery, these corporate inversions add significantly to GDP, but give “little of the job creation, substantive investment, economic growth or other tangible benefits typically afforded by traditional foreign direct investment.”

From bean counting Eurostaticians to address changes for massive corporations, the point of all this is that international bodies are far too concerned with GDP as an indicator of economic health and wellbeing to the exclusion of others. Even though all reasonable actors realise the Irish economy did not grow by 26% in practical terms of employment, retail sales, or real wages, the EU could still legally hold their feet to the fire for a larger budget contribution. Due to this reality, the EU should alter the formula it uses to calculate its GNI-based contribution expectations for member states.

Nigeria and Ghana’s massive economic increases, while not altering reality on the ground, could be used as a populist cudgel in the parliaments of western countries to reduce aid contributions, adversely affecting the poorest citisens of these nations. Reliance on GDP to a fault is a dangerous habit we have in policy analysis circles and as democratic societies that we would be wise to temper with more even handed usage of a wider range of statistics. Opinion makers, elites of the commentariat, and even Nobel Laureates must be careful not to deal damage by forgoing rigorous analysis of a broad range of indicators for the panacea of GDP.

 

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