Opening statement by Governor Philip R. Lane at the Committee on Budgetary Oversight

28 February 2017 Speech



Chairman, Committee members, thank you for inviting me to give an overview of the report of the Economic Statistics Review Group (ESRG), which I chaired.


The ESRG was mandated to provide guidance to the CSO on how best to meet user needs for greater insight into Irish economic activity, taking account of the challenges inherent in providing a comprehensive picture of the highly-globalised Irish economy. The members of the ESRG comprised policymakers, analysts, regulators, business and trade union representatives, academics and the international statistics community. In carrying out its work, the ESRG benefitted from written contributions and presentations by both members and others, which have been released along with the report.


Background and Challenges


The CSO compiles national accounts and balance of payments statistics in accordance with established global standards, which ensures that the results can be compared across countries and across time. The accuracy of the National Income and Expenditure (NIE) accounts and their compliance with these international standards has been affirmed by Eurostat.


However, it has become increasingly difficult to interpret the complexities of activity in highly globalised economies in headline national accounts indicators such as Gross Domestic Product (GDP) and Gross National Income (GNI). Reflecting the increasingly interconnected nature of business and its growing fragmentation across national borders, it has become much more challenging to fully understand the impact of globalisation on national economic statistics.  Particular challenges relate to the increasing role of intangible assets, such as intellectual property, in the world economy, the globalisation of production processes and the residential location of the corporate structures of global firms.


It is critically important to generate reliable measures of the aggregate size of the economy. This is necessary for a wide range of private-sector decisions. It is also essential for fiscal planning and assessing the sustainability of private and public debt stocks.  For macroprudential policy, the size of the economy is a necessary scaling factor in assessing the level of credit issued by the financial system.


EU legislation requires the production of statistics that meet the agreed international standards and the CSO will continue to produce GDP, GNI and related measures.  Nevertheless, it is the view of the ESRG that supplementary statistics that are more appropriate to the measurement of domestic economic activity are needed that will be comprehensible and stable over time. Such supplementary variables will need to be accessible and publishable, in that the confidentiality of data from individual firms is not compromised, and sufficiently robust in that possible future globalisation-related changes affecting companies will not reduce the relevance of the series.


An Adjusted-Level Indicator: GNI*


One basic principle of a stable measure of economic performance is that it should be robust to alternative accounting approaches. A second basic principle is that a measure of the level of economic activity should be robust to alternative mechanisms by which the foreign investor is paid out. These principles informed the work and recommendations of the ESRG.


It has long been recognised that GDP is an inadequate indicator of the level of economic activity for Ireland, given the size of measured factor income accruing to the foreign owners of Multinational Enterprises (MNEs) operating in Ireland.  For this reason, GNI has been widely employed as an alternative indicator, since GNI strips out net international factor income flows.


However, several factors suggest that GNI is no longer a sufficiently reliable indicator. In particular, there are two significant measurement issues. The first, a more recent challenge, relates to the treatment in the National Accounts of depreciation on the foreign-owned portion of the domestic capital stock, while the second, a pre-existing issue, relates to the treatment of the retained earnings of re-domiciled firms. In both instances, measures of Irish economic activity calculated on a gross basis now include sizeable elements which, ultimately, are borne by or accrue to non-residents.


With regard to the first issue, Ireland has experienced significant growth in the foreign-owned portion of the domestic capital stock, largely as the result of the relocation of foreign-owned IP capital into Ireland. In the National Accounts, depreciation on the domestic capital stock, regardless of ownership, is treated as being absorbed within the economy. However, it is important to appreciate that there is a fundamental distinction between the depreciation of domestic capital held by foreign-owned firms and depreciation of domestic capital held by domestic residents. Whereas the latter is absorbed by domestic residents, the former is borne by the foreign investors.


Since the depreciation on the foreign-owned capital stock is absorbed by foreign investors, it should not affect a measure that is intended to capture the resources accruing to domestic residents.   This is especially the case if the relocated capital is not deployed in combination with domestic labour but in combination with overseas workers through contract manufacturing arrangements.


Accordingly, the ESRG proposed that an adjusted GNI measure (GNI*) should exclude the depreciation of foreign-owned domestic capital.  This would prevent corporate re-organisations that have no impact on actual economic activity having an outsized impact on the national accounts simply by shifting the geographical address of capital assets that remain under the control of the same set of ultimate owners that receive the revenues associated with the capital assets and bear the depreciation costs incurred on these capital assets.  


With regard to re-domiciled firms, issues arise from the difference in the accounting treatment of net income depending on whether an entity is classified as a directly-owned foreign firm or as a domestic firm owned by foreign portfolio equity investors (shareholders). In relation to direct ownership (as captured by the definition of foreign direct investment), the net income earned by these firms is recorded upon accrual as a factor income outflow to the parent company.  In relation to portfolio-type ownership, the net income earned is only recorded as a factor income outflow if a dividend is actually declared.  If the entity opts to retain the earnings, then no factor income outflow is recorded in the current period. Accordingly, an adjusted measure of GNI should also subtract the retained earnings of firms that are predominantly owned by foreign portfolio investors. 


Combining these proposals, the ESRG recommends the publication of an adjusted indicator of the size of the economy, GNI*, which would subtract from GNI both the retained earnings of re-domiciled firms and adjust for the depreciation of foreign-owned domestic capital assets (such as IP capital assets).


Requirement for supplementary data detail


A framework of accounts more appropriate to the measurement of domestic economic activity, which is both more informative and stable over time, requires greater detail on the impact of foreign direct investment (FDI) on Irish economic data and the breakdown between domestic and foreign sectors.


Of course, any proposed analytical presentation must also ensure the confidentiality of the firms that supply data to the CSO, which has implications for the level of detail that can be presented.  Another key requirement for any new presentation or analysis of the macroeconomic data is to be forward looking and framed in a way that does not rule out the publication of possible future globalisation-related analysis of changes affecting companies.


To meet these accessibility and robustness requirements, it is accepted that requests for as much detail as possible will need to be met with a certain level of aggregation. In this regard, the ESRG has discussed a number of extensions to the accounting presentations at both annual and quarterly intervals to complement and enhance existing outputs that are published by the CSO. 


From the perspective of Ireland’s external financial position, the balance of payments (BOP) and the international investment position (IIP) have also been affected by the international transfer of capital assets owned by foreign MNEs and the international income flows associated with re-domiciled firms.  In line with the recommendations indicated earlier in relation to a more detailed treatment of the role of foreign-owned firms in the economy, supplementary presentations of the BOP/IIP data are required that show the impact of re-domiciled firms and relocated capital assets on the stock-flow dynamics of the international balance sheet.


Development of additional cyclical indicators


From an analytical perspective, policy makers require indicators of the cyclical macroeconomic situation, since appropriate fiscal and macroprudential policies require assessments of whether the economy is growing above or below potential.


The most commonly used macroeconomic aggregates for policy purposes are those that appear on the expenditure side of the National Accounts. The problem, which has emerged in recent years, is that the trade and investment data aggregates have become distorted by massive gross flows related to the activity of MNEs and aircraft leasing companies operating in Ireland.


This has given rise to a growing practice among domestic policy institutions and economic commentators to modify the published data on expenditure to improve its domestic macroeconomic relevance.  In the main, this has involved constructing an adjusted measure of investment. Practitioners then use modified investment to construct a measure of underlying domestic demand, which has been more closely aligned with growth in employment. In addition, the adjusted investment measure is a more relevant guide to the capital available to produce domestic output.


Reflecting this, the ESRG recommends the publication of underlying investment and underlying domestic demand measures as supplementary indicators to be published quarterly alongside the ESA2010-consistent national accounts data. Similarly, adjusted exports and imports data, netting out the effects of contract manufacturing and any related royalty and other import flows, should also be published routinely, to provide a more accurate indicator of domestic trade in both current and constant prices.


In terms of output-side data, more detail on its sectoral composition and an amended industrial production time series is sought.


Communication policies


On the CSO’s communication policy in relation to the release of macro-financial statistics, the ESRG has identified a number of initiatives that it believes would enhance user understanding of Ireland’s major statistical releases and largely relate to potential enhancements to presentations, briefing and explanatory materials provided at the time of data releases.


Cooperation between institutions


Finally, the ESRG report noted the high degree of ongoing co-operation between the CSO and other agencies, both domestic and international. At the domestic level, the ESRG supports the joint commitment of the CSO and the Central Bank to improving the collaborative mechanisms between the two organisations. At the international level, it strongly encourages the continuation and strengthening of the CSO’s contributions to the several important initiatives currently in progress to meet the measurement challenges posed by globalisation.


Concluding remarks


In summary, the report and recommendations of the ESRG map out a path ahead to address the measurement challenges in providing greater insight into Irish economic activity. The new analytical presentations recommended by the ESRG will supplement, and not substitute for, the existing statistics compiled in accordance with global standards. The key is to have supplementary statistics that provide a measure of underlying economic performance and of domestic resources, which are accurate, accessible, publishable and robust. Progress will necessarily be incremental and is likely to be evident in annual data initially, with the adaptation of the quarterly data likely to follow later.