Analysis

Thursday 21 August 2014

Colm McCarthy: Economic growth is being held back by headwind of eurozone constraints

Initiatives to shore up our corporate tax rate and in the area of education are key to an export-led recovery

Colm McCarthy

Published 30/12/2012 | 05:00

  • Share

The different countries making up the eurozone have divergent interests and will not be equally well served by a common policy. This problem has been present from the beginning but has become acute over the last few years.

  • Share
  • Go To

Countries with heavy debts and high unemployment often opt, when free to do so, for a policy mix of temporarily higher inflation and a softer currency. Inflation helps debtors at the expense of creditors since it erodes the real debt burden. A softer exchange rate gives a short-term boost to competitiveness. Stuck in a currency union committed to low inflation and a strong exchange rate is not the best place to be for struggling countries.

The expectation of both the Government and the EU Commission is that the Irish economy will grow its way out of the current difficulties through an export-led recovery but there are serious headwinds which inhibit better export performance. The main barrier is the policy stance of the eurozone.

Several international currencies have weakened since the onset of the current crisis. The most important from an Irish standpoint is sterling, the currency of our largest trading partner. The more labour-intensive Irish firms are particularly exposed to the sterling exchange rate, both through direct export dependence as well as import and third-market competition from UK firms.

Since 2007, sterling has fallen almost 20 per cent against the euro. The inflation target of the Bank of England, currently two per cent (same as in Euroland) may be relaxed next year, which would eventually mean yet further sterling depreciation. Most eurozone countries have limited exposure to the common currency's exchange rate, since they do relatively less trade outside the zone, so Irish concerns about a high euro are not widely shared.

Countries experiencing high unemployment would benefit from more relaxed budgetary policies on the part of those economies with discretion in the matter. The zone now consists of countries that are bust and hence unable to relax fiscal policy, and countries which are not bust but unwilling to do so.

The result is a eurozone macroeconomic stance of low inflation, a strong currency and tight fiscal policy. There is precisely nothing that small countries like Ireland can do about this, but it does not provide a friendly environment for an export boom.

The long-established Irish model of economic development has centred on attracting multinationals. During the period of genuine and broadly-based growth up to about 2002, Ireland was a desirable destination for foreign direct investment, due to three strong selling points. These were the low corporate tax rate, the advantages of an English-speaking population and the availability of suitably trained employees. All three are no longer as effective as they once were.

While it is well understood by now that domestic policy went seriously off the rails about 10 years ago, with huge bubbles in bank credit and in public spending, it is not at all clear that the successful growth model of the Nineties will revive automatically once the crisis is passed, or that any alternative model is being constructed.

Ireland's corporate tax rate has been set at the relatively low figure of 12.5 per cent for almost 20 years, and has been low in manufacturing for much longer. This position is now under threat, both from reducing rates elsewhere and from European and US dissatisfaction with tax mitigation practices of multinationals in Ireland and other alleged tax havens.

The UK has been cutting its corporation tax rate and the plan is to reduce it further, to 21 per cent, by 2014. This erodes Ireland's competitive edge. In several European countries and in the USA, there is a growing realisation that countries like Ireland are being used for corporate profit-laundering at the expense of their national treasuries, and the pressure is on to make changes.

Ireland's position could until recently be defended on the basis that, although the rate of tax was low, companies actually had to pay up at the stated rate.

The much higher headline rates set in many European countries can readily be avoided through various loopholes. This line of defence has been considerably weakened as it has emerged that many companies with Irish operations are routing profits through Irish units without paying very much tax, even at the low Irish rate. This is achieved through exploitation of double-taxation treaties and assorted cunning (but perfectly legal) manoeuvres by the tax advisers. Profits earned on business in mainland Europe wend a merry dance through Dublin to some spit of sand in the Caribbean, with a jolly weekend in Amsterdam along the way.

It would be nice if Irish ministers could argue that 'we say 12.5 per cent, and we collect 12.5 per cent', knowing that several European countries collect no more than this, despite the pretence of higher rates. That argument has been undermined these last few years and the prospects of retaining the 12.5 per cent rate would be enhanced if the profit-laundering could be restrained. While there is more hypocrisy about corporate taxes than in any other area of international economic diplomacy, it is time to consider what policy changes are open to the Government to contain the fallout from recent revelations.

The advantage, particularly in attracting US companies, of an English-speaking environment is eroding steadily as the world adopts English as its favoured second language. The extent to which European countries have promoted English as the main business language is remarkable. It is now unusual to encounter a business or professional person anywhere in Europe who does not have decent English. Outside Europe, English has won decisively the race to become the world's business vernacular. English is compulsory in many school systems, including at primary level, and many universities have converted teaching programmes to the English medium.

A pub-quiz question for media buffs: which is the world's largest-selling English language daily newspaper? The answer is the Times of India. In Ireland the lazy presumption that our English language skills still provide a competitive edge has been overtaken by events. In Ireland there has been no response in terms of better provision of modern language teaching in schools. Only three per cent of primary school students study a modern European language. The figure is up to 90 per cent in several European countries.

The third traditional selling point for Ireland, namely the availability of a well-educated workforce, is the constant mantra of industrial promotion agencies and the education industry. Last February PayPal announced 1,000 new jobs over the next few years. But the company's chief executive here noted that she was recruiting people with modern continental languages for the Irish operations from 19 different countries. Google and other companies report the same problem.

Specialists in information technology, despite the emphasis supposedly placed on the sector in the education system, are being imported. Multinational companies are receiving taxpayer support for creating jobs which they must fill with foreign workers.

Domestic demand in Ireland is likely to remain weak for many years. The Government will be in budget-tightening mode while the business and household sectors must repair damaged balance sheets through restraining expenditure. The banks continue to de-leverage and credit availability will stay constrained. So it makes perfect sense to focus on the export of goods and services as the most likely engine of recovery.

With the hostile policy environment in Europe unlikely to alter, and in the absence of fiscal or exchange rate options, it is time to consider what domestic policy initiatives are actually available to make the export-led recovery more than a pious aspiration. Evasive action is required to deflect criticism of the low corporate tax regime. Ireland is perfectly entitled to choose its own rates of tax but the loopholes need to be plugged.

If the 12.5 per cent rate is to be defended, it needs to be collected. Compulsory study of a modern language in primary school needs to be introduced, as well as measures to involve business and industry directly in the design of the curriculum and the allocation of places in third-level colleges.

A Happy New Year for 2013, and hopefully a prosperous one before too long.

Sunday Independent

Read More

Don't Miss

Editor's Choice