Thursday, April 19, 2018

Aggregate improvement in the household sector motors along

Last week the CSO published the Q4 2017 update of the Institutional Sector Accounts (ISAs) which give us a preliminary insight into the full-year outcomes by sector.  The ISAs follow from the Q4 Quarterly National Accounts (QNAs) a few weeks ago.  For a variety of reasons the QNAs get lots of coverage and the ISAs close to none.  There is far more information, and better information, in the ISAs. 

Here we will look at the household sector. The snapshot shows the nature of the general improvement.

Household Sector Income Expenditure and Net Lending

Let’s looks at some of the detail.  First the current account:

Household Sector Current Account 2013-2017

We could go through it but it is a picture of general improvement.  In the middle we see that Gross National Income, largely the sum of self-employed, employee and property income, is estimated to have increased by six per cent in 2017.  Once we account for taxes and transfers we get an annual increase in Gross Disposable Income of 5.1 per cent. 

With final consumption expenditure estimated to have risen by 3.1 per cent, the current account ends up an increase in the Gross Savings of the household sector; from 7.0 per cent of GDI in 2016 to 8.8 per cent of GDI in 2017.  This is still likely to leave Ireland towards the bottom of the EU15 ranking in 2017 as was the case in 2016.  [The legend in the chart is ranked by the 2016 outcomes.]

EU15 ISA Household Sector Gross Davings Rate

So what can we do with these Gross Savings from the current account?  Disposable income that hasn’t been used for consumption can either be lent (put into financial assets such as deposits or equity and/or used to reduce financial liabilities like loans) or used for capital formation (new houses, improvements/renovations of existing houses etc.)

Obviously, here we are looking at aggregate outcomes, so the outcome for individual households will vary. A household that has borrowed for consumption expenditure can further borrow for capital formation.  The aggregate descriptions refer to the outcome for the sector as a whole.

So what happens when we put €8.8 billion of gross savings into the capital account?

Household Sector Capital Accounts 2013-2017

For 2017, it is estimated that the household sector undertook €9.2 billion of capital formation.  So all the gross savings from the current account was spent (or at least that was the aggregate outcome – some households were borrowing while others were savings) and after capital taxes and transfers we end up with a net borrowing outcome of around €200 million. 

In 2017, between current expenditure and capital formation, the Irish household sector pretty much spent all of its disposable income – and this has been the case for every year since 2014.

All in all, the growth rates for 2017 look very positive.  All sources of income are growing rapidly, current spending is growing but not as quickly, while capital spending is growing a bit faster.  All in all it paints a very positive picture.

One concern is that the Irish household sector has been a net borrower for the past three years.  The chart below shows household sector net lending/net borrowing for the EU15 in per capita terms.

EU15 ISA Household Sector Net Lending Per Capita

It is not the crazy days of 2006/07 but after moving into the middle of the EU15 pack from 2009 to 2012, we have been drifting downwards since.

But this chart clashes with view that the Irish household sector is deleveraging.  In fact, as the last line in the previous table shows the Irish household sector has been spending more than it is earning since 2014.  Can this be true?

The Quarterly Financial Accounts of the Central Bank show that the loan liabilities of the household sector were €167.7 billion at the end of 2013.  The latest figure is for Q3 2017 which shows that loan liabilities had been reduced to €141.8 billion.

That the Irish household sector is reducing its loan liabilities is not a surprise.  But how have loan liabilities reduced by €16 billion over the past three years or so when expenditure, current and capital, has exceeded disposable income by €2 billion.  And it is also worth noting the currency and deposit assets have increased by €12 billion over the same period.

So where did the money come from to reduce loans by €16 billion and increase deposits by €12 billion if spending exceeded income by €2 billion?  That is a €30 billion gap in just three years and is something we may return to in a subsequent post.

For now we will focus on the growth rates rather than the levels.  The growth rates are motoring along nicely. 

Household Sector Income Growth

Nominal household income grew by between five and six per cent in 2017. That is pretty strong. It would be much better to focus on that than chattering about how much of the GDP growth shown in the QNAs was due to iPhones (plus I suspect the very specific claim made by the IMF is wrong).

Wednesday, April 4, 2018

Revisions (introduced and expected) to the NFC sector in the national accounts

When the 2016 Institutional Sector Accounts were published in November the CSO provided a breakdown of the non-financial corporate sector in the “top 50 foreign-owned NFCs” and “other NFCs”.  We went through the accounts for each here.  A few weeks ago the CSO made some minor revisions to the figures and it is worth giving them a little look. Click to enlarge.

NFC Sector Current Account 2013-2016 Split

The CSO have revised down the property income paid by the large, foreign-owned NFCs which has the effect of increasing the aggregates as the revisions work down the table.  The revisions summed to around €8 billion across the four years for which the split of the NFC sector is currently available.  A derived measure such as “Net Savings” which here is Gross Savings less consumption of fixed capital (i.e. depreciation) is now essentially zero.  As companies so not undertake final consumption we could equivalently say that the Net Disposable Income of the large foreign-owned companies is zero.

We would not expect foreign companies to be contributing anything to the net savings of the economy.  By the time you get down to Gross Disposable Income the only thing left to cover is depreciation.  There should be no excess as any residual should be counted as a property income outflow (such as retained earnings accruing to non-residents). 

[The numbers in the panel of the table above for the Net Savings of the large, foreign-owned NFCs are close to but not exactly zero though these values do seem to be related to the net of other transfers paid and received further up the table.  In the greater scale of things the numbers are close enough to zero to make no difference.]

Of course, the aggregate measures that get most of the attention, GDP, GNP, GNI etc., are in gross terms so the impact of depreciation is important.  Measures of national income and growth in net terms are very useful and should be more widely used but differences, inconsistencies and robustness concerns in how depreciation is estimated across countries means that the primary focus remains on the gross measures.

The changes don’t hugely affect what was said in the previous post and a fuller discussion of what the breakdown does and does not provide is available there.  Here we will just look at a couple of additional points.

Firstly, on the tax paid by foreign-owned companies.  We usually focus on Corporation Tax and the table above shows that the 50 companies in this category paid around €2.5 billion of Corporation Tax in 2015 and 2016.  A bit further up the table though we have “other taxes on production paid”.  For 2015 and 2016 these came to around €900 million for this group which is a significant contribution [it can also be seen that “subsidies on production received” were zero).

There are a number of taxes that make up this categories and for the foreign-owned companies involved it is likely that the relevant ones are:

  • Commercial Rates
  • Motor Tax
  • National Training Fund Levy

Second, when looking at the contribution of foreign-owned companies to national income we would like to know what they spent on:

  • goods and services from Irish suppliers (i.e. non-imported intermediate consumption)
  • compensation of employees to the direct staff
  • taxes, both taxes on income and taxes on production
  • capital investment, particular on tangible goods

The table above gives us the middle two of these for the top 50 foreign-owned NFCs, €4.3 billion for compensation of employees and €3.4 billion for taxes.  We don’t know how much of their intermediate consumption comes from Irish suppliers and the investment figures recently have been skewed by volatile investment in intangibles but it would not be a surprise is these two figures were around €4 billion as well. 

With a bit of juggling this could be seen to be in line with finding from the Survey of Business Impact now carried out by the Department of Business, Enterprise and Innovation though the non-imported component of intermediate consumption of one MNE could simply be the imported by an Irish supplier (or another MNE for that matter) and it will certainly be the case that a share of the investment in tangible goods will be on imported equipment.

Turning to the second panel in the table doesn’t offer much as it remains a bit of an impenetrable gloop. It obviously contains all domestic firms but also contains those foreign-owned NFCs not included in the “top 50”.  The CSO are working on a more complete foreign/domestic split which will help.

We would expect the profits of foreign-owned companies to be stripped out via property income paid so the Gross National Income and Gross Disposable Income shown in this panel should give us a good idea of the earnings of Irish companies.  That does not appear to be the case as the growth rates are much too rapid.  The nominal growth rates of GNI for other NFCs for 2014 to 2016 were 19 per cent, 11 per cent and 23 per cent.  The growth rates of the Gross Disposable Income of this group were similar.

There might be something going on with depreciation.  From 2013 to 2016 the depreciation associated with aircraft for leasing increased from €2.6 billion to €5.1 billion. However, even the derived “Net Savings” measure shown at the bottom of the table has average annual growth rates of 20 per cent over the three years.  This measure excludes all depreciation and should exclude  the profits of foreign-owned companies.  That does not appear to be the case.

It is likely that the odd outcomes here are, at least in part, linked to the treatment of imported R&D services expenditure (which was raised in this recent post on the Balance of Payments).  It is likely that a large share of the imported R&D services relates to “cost-sharing payments” made by the Irish subsidiaries of US MNCs are part of the licensing arrangement for the use of intellectual property outside the US. The Irish subsidiary contributes a share of the company’s overall R&D expense relative to the size of the market it covers.

One outcome of a more consistent treatment of this R&D services imports as capital formation could be an upward revision to property income paid by foreign-owned companies in this group.  It also seems likely that the full impact of any changes will be seen in the “other NFCs” group given the consistency that now appears in the revised figures for the “top 50” group (i.e. the near zero figures for “Net Savings").

The stability in the figures from 2013 to 2016 for property income paid for the other NFC group would suggest that the profitability of foreign-owned firms in this group was also relatively stable as dividends paid and retained earnings accruing to non-residents will make a large part of this figure. 

This does not seem likely.  The Corporation Tax paid by this group rose 75 per cent between 2013 and 2016 and if the bulk of that came from Irish firms it would imply a remarkable rise in profits.  For example, if Irish firms paid half the Corporation Tax of this group in 2013 then the resultant rise in Corporation Tax would imply the profits of the Irish firms rose 150 per cent (as the amount of tax would need to rise from €1 billion to €2.5 billion).

[And it is also worth noting that the figures for property income received in the right-panel will contain the retained earnings of redomiciled PLCs which is another wrinkle to be ironed out.]

There is a recovery but a 150 per cent rise in the profits of Irish firms is highly implausible.  This suggests the figures in the right-hand panel above are, like the Balance of Payments, subject to revision.  The revision will likely see the property income paid (outbound profits) revised up.  This in turn will see Gross National Income, Gross Disposable Income and “Net Savings” revised down.  The scale of such revisions are difficult to assess but imports of R&D services are significant and have been growing as the table here shows.

Imports of Rand D Services

At present in the accounts investment spending on R&D services carried out elsewhere, i.e. imported, is counted as coming from “Irish” income.  This is because the Balance of Payments are not yet fully aligned with BPM6 and such spending is still treated as intermediate consumption for Balance of Payments purposes rather than capital formation.  When the updated approach is applied by EU countries then the money spent on R&D services by foreign-owned firms will be first counted as a profit outflow in the current account and then re-introduced as an investment inflow in the capital account.  As discussed previously this increase in the outflows of profits should reduced the Balance of Payments current account and will also likely reduce Gross National Income.

There will be a few moving parts.  It will depend on how much of the imports of R&D services shown above was undertaken by foreign-owned firms (likely a lot) and the depreciation of any assets that arise from the investment will have an impact as it is profit after depreciation that is counted as an outflow.  Still, given the numbers above, we are probably looking a some significant changes.

These changes will probably work their way through to economy-wide measures such as the new GNI*.  When this was first published the recent growth rates were queried by some as being “too hot”.  If the changes mooted here work through as expected those growth rates could be revised down – with a downward revisions of the levels also possible which would impact ratios which use GNI* as a denominator.  Given the nature of Ireland’s national accounts there could be revisions across a number of areas (the consumption conundrum?) so it’s best to wait to see what the outcome is first but it does give something to look out for.

Tuesday, April 3, 2018

The 2017 Balance of Payments

A few weeks ago the CSO published the 2017 estimates for the Current Account of Ireland’s Balance of Payments.  It got no attention – deservedly so.

Balance of Payments Current Account Annual

Up to recent years most of the impact of MNCs on Ireland’s Current Account largely netted out.  This wasn’t the case for redomiciled PLCs and their retained earning have been flattering the current account since these corporate relocations first had an impact in it around a decade ago.  The impact of aircraft leasing has been growing over the same period and since 2015 the acquisition and depreciation of intangible assets has been source of the recent major volatility in the data.

As we have been tracking there also seems to be an issue about the treatment of expenditure on R&D services in the Balance of Payments.  Although changes in both national accounting methodology (ESA2010) and balance of payments methodology (BPM6) now mean that R&D spending is considered investment rather than intermediate consumption, implementation delays across the EU mean the spending on R&D services is still treated as intermediate consumption for balance of payments purposes.  This means that the amount of outbound profit is lower than it otherwise might be if such expenditure was treated as investment (i.e. the use of reinvested profits) rather than a cost (i.e. something that reduces profits).

The CSO publish a modified Current Account, CA*, that now takes account of all of these issues except that relating to R&D services.  This has yet to be updated for 2017 so the available figures only go as far as 2016.

Balance of Payments Modified Current Account Annual

This is better but the improvements in recent years seem a little hot with a surplus of €13 billion reported for 2016.  Some of the heat may be taken out of this if the treatment of spending on R&D spending is updated.  This isn’t a Irish-specific modification per se but will see the Irish estimates move more in line with the approach set out in the updated methodology. 

We can try to assess the possible impact this will have by using the figures for R&D services imports that can be derived from the various categories of investment now provided by the CSO in the quarterly national accounts.  At present the spending on imported R&D services of MNCs is treated as coming from “Irish” income. 

It would be better if this were regarded as “foreign” income and thus treated as an outflow of retained earnings in the current account and counted as inflow of direct investment in the capital account.  The net effect of this on the overall accounts will be zero but the changed treatment will better reflect the ownership of the income used to fund the R&D services investment spending.  Thus there will be higher profit outflows in the current account and higher investment inflows in the capital account. 

Balance of Payments Underlying Current Account Annual

This is possibly what the modified current account, CA*, will look like in due course and seems to provide a narrative that fits with the overall story of the Irish economy over the past 15 years or so.  It still doesn’t go to 2017 as we have details on very few of the adjustments that are necessary but it would not be a surprise if the improvements shown for recent years continued.

Although there are a huge number of moving parts with large offsetting flows here are some factors which may have helped achieve that improvement.

1) The amount of interest payable on public debt to non-residents has been falling since 2014.  Figures for 2017 haven’t been released yet but that downward trend is likely to have continued.

GG Debt Interest Payable Outside the State Nominal

2) Corporation Tax receipts have surged in recent years and around 80 per cent of Irish Corporation Tax paid by foreign-owned companies.  This increases the amount MNCs are contributing to Ireland’s national income and boosts the current account.

Corporation Tax Receipts 2003-2017

3) On the domestic side food exports have performed well though a large part of this is due to price effects rather than volume increases.  Ireland’s balance of trade in food reached €4 billion in 2017

Balance of Trade in Food

And a large part of the improvement in 2017 was driven by developments in dairy with the higher price of milk seen in 2017 adding significantly to incomes.

Balance of Trade in Dairy Products

4) Revenues from international transport are counted as an export for the country the operator is resident in.  Unsurprisingly, Ireland runs a large surplus for transport services with most of this being international air transport around the EU (though imports in other categories will obviously reduce the overall impact on the current account).

Balance of Trade in Transport Services

5) And finally here’s one that had been helping up to 2015 (or at least making a less negative contribution) but since then spending by Irish residents on tourism services abroad (mainly accommodation and food services) has been growing at much the same rate as such spending by non-residents in Ireland.

Balance of Trade in Tourism Services

Tuesday, March 27, 2018

What is going on with GNP?

The issues with Ireland’s national accounts have gotten a good airing over the past two years or so.  Since the publication of the 26 per cent growth rate in July 2016 one that has been surprising is where some of the well-known (and not so well-known) distortions show up. 

A lot of attention has focused on GDP but apart from an extraordinary quarterly growth rate in Q1 2015 the following chart isn’t that noteworthy.  There has been a bit of volatility since late 2016 but it doesn’t seem that much different to what is showing for 1998/99.

QNA GDP Quarterly Growth Rate 1997-2017

The Q1 2015 spike clearly points to concerns about the level but that one quarterly growth rate apart most of the other outturns are within the realm of plausibility.  But what about the quarterly growth rates of GNP? GNP is what is supposed to be left after the profits of MNCs have been counted as an outflow.

QNA GNP Quarterly Growth Rate 1997-2017

This obviously shows a good deal of volatility but up the middle of 2016 it is not that outlandish.  Since then though the quarterly growth rates of GNP have been all over the place.  The last five observations are:

  • Q4 2016: +10.3%
  • Q1 2017: –6.4%
  • Q2 2017: –3.7%
  • Q3 2017: +12.3%
  • Q4 2017: +6.3%

As we commented here we have had the highest and lowest quarterly GNP growth rates in quick succession.

We might expect the relative volatility in growth rates to be the other way around: that if MNCs are causing GDP to jump around these would wash out through net factor payments and that GNP would be the relatively stable one.  The fact that MNC profits generated in Ireland are counted as a factor outflow in the period in which they are earned.  So an MNC-driven spike in GDP should be matched by an offsetting increase in factor outflows.

This is what we get if we look at the quarterly change in nominal GDP from the national accounts and the quarterly change in direct investment income on equity from the balance of payments.

Changes in GDP versus Profit Outflows

The surprising thing is how string the relationship is in 2015 and how weak it is recently.  The spike in GDP in Q1 2015 was accompanied by a spike in profit outflows. This is a bit surprising given the expected relationship between the 2015 GDP increase and depreciation.  The changes in GDP are “gross”,  i.e. before depreciation, whereas the profit outflows are “net”, i.e. after depreciation (and tax of course!).  Anyway, as GDP oscillated through 2015 the change in profit outflows tracked the changed in nominal GDP.  This continued through to the middle of 2016.

Since the middle of 2016 the changes to profit outflows have been relatively modest. The quarterly outflow was €13.1 billion in Q3 2016 and had reason fairly steadily and was put at €16.2 billion in Q4 2017. 

Over the same period GDP has been much more volatile, either rising by more (as was the case for most quarters) or falling by more (as was the case for Q1 2017).  It is the gaps between the lines in the chart above (and the changes in their signs) that have contributed to the recent volatility of GNP.

Value added has bounced around a bit over the past year and a half.  The relative stability of profit outflows means these changes in value added are being reflected in Ireland’s national income (or least are not been attributed to non-residents).

But why is this? What factors are there that can cause value added to bounce around yet not have this reflected in net profit outflows?  It could be that depreciation (of aircraft or intangibles) is playing a role but depreciation itself should be relatively stable (unless assets enter or leave the capital stock). 

If we had quarterly GNI* data we might be able to throw some light on this as,among other things, that measure is adjusted for the depreciation of aircraft and intangibles.  But until we get that we are left with the question, “what is going on with GNP?”, and even then we mightn’t be able to answer it.

Finally, just to show that outflows of direct investment income on equity in the balance of payments are the key constituent of net factor outflows in the national accounts this shows the two of them since the start of 2012:

Net Factor Income Outflows

Thursday, March 22, 2018

The Consumption Conundrum

Ireland’s national accounts get a bad rap but amidst all the distortions one would think that personal consumption expenditure on goods and services (the “C” of C + I + G + (X – M)) would be a distortion-free zone.  Of course, in relative terms, the consumption component of aggregate demand is as oasis of calm but there are a few wrinkles worth exploring.

By almost all metrics the Irish economy is motoring along nicely.  Employment is growing rapidly (+3.1% in Q4 2017), full-time employment is growing even faster (+5.4%) average weekly employees earnings are rising (+2.5% in Q4), agricultural incomes boomed (+35.2% in 2017) and though we have seen some modest income tax changes the PAYE and total USC component of Income Tax was up 8.6% in 2017.  And the population is growing (+1.1% in the year to April 2017).

But is this being translated into consumption growth?  Here are the year-on-year growth rates of personal consumption expenditure from the Quarterly National Accounts with the Q4 2017 update provided last week.

QNA Consumption Year on Year Real Growth 2011-2017

The improvement from 2011 to the middle of 2016 is probably close to what one would expect.  Growth rates returned to positive territory and then continued to edge upwards.  But the growth rate slumps from the middle of 2016 and has hovered around two per cent for the past 18 months or so.  Such sluggish growth does seem to fit with the strength seen across other indicators (a point made recently here).

We do have indicators that point to more rapid growth in consumption. At the end of 2017 the Retail Sales Index was showing volume growth of more than six per cent (excluding the volatile motor trades).

Retail Sales Index Dec 17 Growth

The index does show a slowdown in growth (but from mid-2015) rather then (mid-2016) but only briefly fell to three per cent and has been moving upwards for the past 18 months or so.

So why isn’t this being reflected in the growth of consumption in the national accounts?  One reason why the rates are different is because the measures are different.  Retail sales are only one element of consumption and exclude almost all services consumption.

The largest item in consumption is housing services.  Housing accommodation makes up one-fifth of the national accounts measure of consumption for Ireland (in nominal terms it was €17 billion out of €87 billion in 2017). 

For tenants, the amount of money paid on rent represents their spending on housing (or at least on the accommodation part).  But about 70 per cent of Irish households don’t make a regular payment for their housing – they are owner-occupiers.  They may make mortgage payments but that is a combination of a loan repayment (saving) and an interest payment for a different service – credit. For these households an “imputed” rent is calculated as if the owner was renting from themselves. 

This “imputed rent” is also counted as household income but as it is matched by imputed expenditure the net effect is zero.   Of the €17 billion of rent in consumption in 2017, €4 billion was actual rent paid by tenants and €13 billion was the imputed rent of owner-occupiers.

Regardless of the ins and outs and it should be little surprise to see that our consumption of housing has been pretty static recently. 

Housing Consumption 2004-2016

It is hard for the consumption of housing to increase when the stock of housing available for consumption is barely increasing.  So, even if other the other components of consumption are growing strongly (as the retail sales index suggests) the overall growth rate of consumption will be dragged down because the largest component (housing) is not growing at all.

But that doesn’t explain the fall off in growth seen in 2016.  We don’t get a quarterly breakdown of the components of consumption so we can only look at annual data.  In annual terms the real growth of real consumption has gone from 4.4 per cent in 2015 to 3.3 per cent in 2016 to 1.9 per cent in 2017.  Housing may be dragging the overall rates down but it is not causing them to fall.

One culprit might be insurance.

Insurance Consumption 2004-2016

Whoa!  This shows a 80 per cent fall from 2005 to 2012 and then a 200 per cent rebound up to 2014 and declines since.  Insurance isn’t a huge component of consumption (the nominal amounts are fairly close to the constant (2010) price amounts shown in the chart) but it has been volatile in recent years.

The volatility may be down to how insurance is included in consumption.  There are a number of moving parts but in rough terms it is net cost to households, i.e. Premium + Supplements – Claims.  Part of the reason for the rapid increase since 2012 shown above was a fall in claims.  They were €9.7 billion in 20112 and had fallen to €8.7 billion by 2015.

So the consumption of insurance rose rapidly from 2012 but not necessarily because households were spending more on insurance premiums but because they were getting less back in claims.  And this may have reversed in recent years so higher claims reducing the consumption of insurance. 

As stated insurance is a relatively small component of consumption but it may be partially to blame when it comes to the growth of consumption not matching our expectations based on other indicators.  And the detailed data only yet go up to the 2016.  We will learn more when we see the 2017 figures later in the year. 

The growth rates of consumption for items such as food, clothing and furniture did slow markedly in 2016 compared to what they were in 2015 but we’ll wait until the updated (and possibly revised) figures up to 2017 are published before establishing whether this is a pattern.  There is something funny going on with the volume figures for hospital services in personal consumption expenditure but it probably doesn’t add much to our narrative here though it may be a reason for some revisions.

The growth of consumption is lower than we might expect but, in looking at housing and insurance at least, this seems likely to be due to how consumption is measured for national accounts purposes rather than anything untoward in household spending patterns.  The retail sales index is probably better aligned with the money coming out of people’s pockets and the growth of that continues to tick up.