The behaviour of foreign investors has masked a worrying fall of 1.5 per cent in GDP for the first quarter, writes PAUL TANSEY
THE IRISH economy is retreating and advancing at the same time, according to the national accounts for the first three months of the year, published yesterday by the Central Statistics Office (CSO).
Using the volume of Gross Domestic Product (GDP) as the measure of economic performance, the economy was 1.5 per cent smaller in the first three months of this year than it had been in the first quarter of 2007.
However, where the volume of Gross National Product (GNP) is taken as the indicator of performance, the economy was 0.8 per cent bigger in the first quarter of 2008 compared to the first quarter of 2007.
This has all the makings of a terrible Irish joke. Did you hear the one about the economy that was moving in opposite directions at the one time? Fortunately, there is a convincing, though complex, explanation. It centres on the behaviour of foreign investors. Effectively, they took €1 billion less income out of the Irish economy in the first quarter of 2008 than in the first three months of 2007. This more than compensated for the 1.5 per cent fall in real GDP, translating it into a 0.8 per cent advance in real GNP.
For most advanced countries, GDP and GNP are interchangeable but Ireland is a special case because of the scale and importance of foreign direct investment in the Irish economy. Foreign industrial investment provided the platform for the Irish boom and foreign-owned enterprises continue to dominate production and exports in Irish manufacturing industry. They contribute substantially to the amount of output produced and income generated in Ireland. That contribution is reflected fully in the GDP statistics.
However, foreign companies did not invest in Ireland for the good of their health. They came to Ireland because it was a highly profitable location that allowed free profit repatriation. A major slice of the profits, dividends, interest and other income earned by foreign-owned enterprises operating in Ireland is exported abroad.
Such repatriations comprise a substantial element of the outflow of net factor income from the country. This net outflow of factor income is a large number. In 2007, it exceeded €29 billion, equivalent to more than 15 per cent of GDP. Since this income leaves the country, it must be deducted from GDP to arrive at GNP.
In very broad terms, GDP measures the value of what is produced in the Irish economy, by indigenous and foreign enterprises alike. It represents the net output or added value generated in the economy during any given period. GNP, on the other hand, identifies that portion of the income generated in Ireland that is retained in this country in any time period.
In sum, where GDP measures the value of output produced, GNP represents what Ireland gets to keep from what is produced here.
The derivation of GNP from GDP is illustrated in the table. It shows changes in value added by sector of origin for each of the principal components of GDP between the first quarters of 2007 and 2008.
As can be seen, the output of the building and construction sector in the first quarter of 2008 was one-sixth lower than a year earlier. The output of new housing fell 30 per cent over this period, while other building also registered a small volume decline. This clearly indicates that the economic downturn has been construction-led.
It was left to "other services" to save the economic ship from capsizing altogether in the first quarter of the year. "Other services" registered a growth rate of 4.5 per cent, due principally, it is understood, to the expansion of education and health services.
When value added in all sectors is totted up for the first quarter of this year, it comes to €46.8 billion, a volume fall of 1.5 per cent on the €47.5 billion worth of net output generated in the first quarter of 2007.
However, the outflow of net factor income from the country in the first quarter of the year amounted to €6.7 billion, some €1 billion less in constant price terms than the €7.7 billion outflow in the corresponding period of 2007.
Subtracting the outflows from the GDP data leaves GNP rising from €39.8 billion in the first quarter of 2007 to €40.1 billion in the first three months of this year, an increase of 0.8 per cent.
The sensitivity of the GNP data to outflows of net factor income can be seen from the following example. If the net factor outflow in the first quarter of this year had replicated the 2007 performance, then real GNP in the first quarter of 2008 would have been 1.8 per cent lower than a year earlier.
Thus, the behaviour of foreign investors saved GNP from slipping into negative territory in the first three months of the year while also resolving the contradiction between Ireland's simultaneously rising and falling growth rates.
Paul Tansey is Economics Editor of The Irish Times