Dan O'Brien: How one Irish industry flew to success

The rich ecosystem of Irish companies in the sector has evolved thanks to a favourable tax and regulatory environment at home that has facilitated the exploiting of opportunities afforded by huge changes in the size and structure of the airline business across the world (Stock picture)

Dan O'Brien

The outstanding indigenous entrepreneurial achievement of this country is not to be found in the food or the hospitality or the still nascent tech sectors.

It is instead to be found in an industry that has a limited public profile - aircraft leasing. For a small country that played no role in the history of getting man airborne to become a global player in a competitive and highly capital intensive industry is really quite remarkable.

But that is exactly what has happened over the past four decades.

The economics profession hasn't paid much attention to the sector - until now.

A recent paper by economists at the Central Bank has done quite a bit to add to our understanding of the industry and its impact on the wider economy. The paper, which provides a basis for future study, is a welcome contribution to explaining and understanding the phenomenon of aircraft leasing in Ireland.

What is well known, at least to readers of these pages, is that the industry has come a very long way since Tony Ryan founded Guinness Peat Aviation 40 years ago. Back then the leasing of planes could hardly even have been described as a cottage industry - in 1970 only 17 civilian airliners were leased worldwide; today 40pc of the (massively increased) global fleet is leased, amounting to thousands of planes (see chart below).

What is far more phenomenal is that about half of the world's leased commercial aircraft, according to a variety of sources, are managed out of Dublin and Shannon. A factoid that those in and around the industry are wont to cite is that an Irish-registered plane takes off somewhere around the world every two seconds.

The rich ecosystem of Irish companies in the sector has evolved thanks to a favourable tax and regulatory environment at home that has facilitated the exploiting of opportunities afforded by huge changes in the size and structure of the airline business across the world.

One such change is how carriers view their most important assets - planes. Many have concluded that it makes more sense for their bottom line to lease these assets rather than own them outright. And even when they have not made this decision it has often been made for them - consistently poor and volatile profitability in the airline industry has made banks and other lenders more reluctant to finance carriers' aircraft purchases.

But the ultimate tailwind has been the increase in demand for air travel. Passenger numbers have soared in recent decades, as the sharp and continued decline in global poverty has pushed hundreds of millions of people into middle-class status. As this trend is expected to continue, the bourgeois travel bug is forecast to go on spreading. The International Air Transport Association (IATA) predicts that passenger numbers will double over the next 20 years, reaching seven billion by 2035. Expansion is forecast to take place everywhere, but, as with many economic trends, much of the growth will take place in Asia.

Over the same time period, the global duopoly of plane makers, Airbus and Boeing, expect to build a mind-boggling $5-6 trillion worth of new aircraft. Plane makers think that about half of these new aircraft will be purchased by leasing companies, suggesting that the trend towards leasing over ownership by carriers will continue. That is view is supported by the utterances of industry insiders. Willie Walsh, the boss of IAG, has recently spoken of moving to a 50/50 split in leasing versus ownership of his group's fleet, compared to the current 30/70 ratio. There is, of course, always reason for caution, especially given ongoing political events. The by now multi-headed spectre of protectionism-inspired deglobalisation can only be a threat to globalised firms of all kinds, and few are more globalised than Irish plane leasers.

Another threat is how tax rules might change. The Central Bank paper highlights that depreciation on plane purchases can be done over a mere eight years under Irish law, despite the lengthening average working life of aircraft, which now stands at 25 years or more. Although there is no sign, that I am aware of, that such an accelerated, and very generous, depreciation schedule is being looked at askance by any relevant non-Irish authority, in the current climate around tax avoidance one never knows if it might become an issue in the future.

Many of the opportunities and threats to the industry were discussed at the Annual Airfinance Conference in Dublin in January. Potential headwinds specific to leasing included stricter bank lending rules and a possible bubble in aircraft prices. Another reported talking point was competition from hubs such as Hong Kong and Singapore, which are offering better tax packages, particularly when it comes to personal tax.

All that said, the opportunities for the industry in Ireland would appear to be considerably greater than the threats. That augurs well for continued success.

With that upbeat observation, let us return to those drier matters raised in the recent paper by Central Bank economists Jenny Osborne-Kinch, Dermot Coates and Luke Nolan.

Measurement issues are looked at in some detail. Changes to international and European national accounting rules in 2010 meant that leased aircraft are now included in the capital stock of the country in which they are registered, regardless of where they are actually deployed. That means that an Irish-registered plane that flies around Asia for 30 years and never touches down in Ireland is counted as an investment when it is purchased, thus inflating GDP. It inflates other important metrics, including imports, although increased exports from operating leases offsets this effect over time.

In order to determine the significance of leasing, the Central Bank economists prepared a database of all Ireland-based firms. They were able to look at 848 entities linked to the industry, most of which lease planes in Europe and the Asia/Pacific region.

Many of these companies are long-established, but there has also been an increase in firms who are Irish-based for tax purposes. One in seven entities in the industry are configured as special purpose vehicles, structures that have at times been mired in controversies of various kinds in recent times.

The economists estimate that the book value of the aircraft owned by Irish lessors to have stood at €81 billion in 2014, which amounted to 40pc of the economy's then GDP. But the Central Bank economists reject the charge made in some quarters that the sector was the main cause of the 26pc spike in GDP growth in 2015.

That said, changes to how national accounts are compiled do mean that the purchase of lots of pricey planes by Ireland-based companies has a bigger impact on the level of GDP than in the past. And they will have an even bigger impact if the industry continues to grow.

That points to further turbulence in the numbers, something that discombobulates nerdy economists but is, in the grander scheme of things, a small price to pay for reaping the rewards of Irish companies leading the way in a high-growth global industry.