According to The Economist\'s \"The Irish economy: Fitter yet fragile Ireland’s

Question

According to The Economist's "The Irish economy: Fitter yet fragile Ireland’s success in attracting foreign investment has its drawbacks" (January 3, 2013), foreign presence in Ireland is now a "towering one": "[h]elped by a low corporate-tax rate of 12.5%, Ireland continues to attract foreign direct investment (FDI), especially from American firms and particularly in pharmaceuticals, information technology and financial services. The number of new FDI projects in 2012 has been similar to that in 2011, itself the highest for a decade, says Barry O’Leary, the boss of Ireland’s inward-investment agency". But Ireland's reliance on foreign firms may have undesirable effects, e.g., "Irish GNP is lower than GDP because of the big profits made by foreign firms [and t]he gap between the two has been widening, from 14% in 2007 to 20% in 2011". Why is this a problem? Explain using your own words

Explanation / Answer

To provide some viewpoint on this reality its worth reading Simon Johnson’s statement presented before the US Senate Committee on Foreign Relations Subcommittee on European Affairs hearing on “The Future of the Eurozone: Outlook and Lessons” (dated 1st of August 2012).

“Ireland’s GNP is substantially smaller than its GDP. Due to its role as a tax haven, many foreign companies have set up operations in Ireland, with a controlling shell company located in a tax-free nation, in order to take advantage of Ireland’s regulations that specify that the controlling owner, rather than the resident company, is subject to tax. For this reason companies such as Google, Yahoo, Microsoft, Forest Labs, and many others channel license revenues and royalties through Irish subsidiaries. These royalties and revenues are in large part excluded from the tax base in Ireland. These companies would move if Ireland changed rules and made such revenues taxable. Since the relevant concept for fiscal sustainability is the taxable base, it makes sense that this should be used to measure Ireland’s indicators. No other nation in Europe has a large difference between GNP and GDP. The IMF regularly reported Irish GNP in its staff reports but recently removed all reference to GNP. This raises concerns that the IMF is attempting to mask fiscal sustainability problems by not reporting these data.”

The difference between GDP and GNP is made up of net factor flows, which in reality includes net profit repatriation by multinationals and interest on the foreign component of the national debt. In Ireland’s case, GDP is significantly larger than GNP because of the large US multinational presence here.”

Stiglitz says that around 1990, GDP supplanted GNP as the primary measure of economic progress. He says that GNP measures the income of the people within the country whereas GDP measures economic activity in the country. If economic activity occurs in the country but the income from this activity accrues to foreigners, it will still be counted in GDP but not in GNP.

Thus the problem is that none of the economic activity benefits the natives of Ireland. If GDP is taken as a measure for economic progress then it will give a false impression as this increase doesnot help the people of Ireland significantly. They are adversely affected by profit repratiation and decrease in government revenue and hence fiscal sustainability.

Thus it can act as a threat as FDI is present in core areas like pharmaceuticals, information technology and financial services. If the tax structure changes, these companies will leave and hence will affect a country to a large extent as the country itself fails to have the capability to develop in these areas. The reliance on foreign firms should be reduced for sustainibility and thus GNP should increase along with GDP. The nationals should be capable of sustaining themselves.

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