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Making the Jump

Frank Barry

There were few foreign-owned manufacturing operations in the Irish Free State at independence. Surprisingly, the largest was American rather than British: Ford had started tractor production in Cork in 1919. Irish biscuitmaker Jacob’s factory in Liverpool employed more than any British firm in the twenty-six counties. Foreign direct investment would increase dramatically with the growth of protectionist barriers in subsequent years. Foreign firms “jumped over” the new barriers by establishing overseas operations to allow them access to their traditional markets.

Independence saw excise duties imposed on British-Irish trade in cigarettes. By the late 1920s the Dublin factory of British firm Players-Wills was one of the largest in the state. Dundalk firm Carrolls crossed the Irish Sea in the opposite direction. One of its brands, “Sweet Afton”, was particularly popular in Scotland. (The sister of Robbie Burns, whose portrait adorned the packet, had lived in Dundalk.) Carrolls had gained market share by supplying free tobacco to the front lines in World War One. It opened a plant in Liverpool in 1923.

The trend accelerated when trade barriers were raised in the 1930s. Guinness established its Park Royal plant in London when threatened with British tariffs. Fianna Fáil, which came to power in 1932, pursued a policy of “import-substituting industrialisation”. Towards the end of the protectionist era, British firms such as Cadbury and Rowntree, Dunlop, Ranks Flour and Clarks Shoes were among the largest manufacturers in the country.

In today’s globalised world, such “tariff-jumping” foreign direct investment (FDI) has retreated to the margins. For the multinational corporations in Ireland today – the likes of Google and Intel, Apple and Pfizer – the country serves as an export platform from which to service European markets. Yet given the protectionist sentiments that have been growing in strength on both sides of the Atlantic of late, tariff-jumping FDI may be set for a return. When governments place obstacles in the way of business, business does its best to find ways around them.

A “hard Brexit” will undoubtedly create grave difficulties for Irish-owned businesses. The UK remains their most significant export market. That British businesses represent their main competitors on the Irish home market will offer only minor compensation, particularly if sterling continues to weaken.

Tariff-jumping FDI will come to seem an obvious response. Irish firms will establish operations in the UK, as Jacob’s, Guinness and Carroll’s have done in the past. (Jacob’s began production in Liverpool in 1914 partly because of uncertainty as to what Home Rule might entail). Similarly, British firms will open up in Ireland to maintain their access to EU markets. This is already in train, as reports of legal, architectural and other British firms scouting for office space in Dublin suggest.

The sense of unease in Ireland has been compounded by the recent victory of Donald Trump in the US presidential election. (While the broader global consequences are undoubtedly of greater import, my focus here is on narrowly Irish concerns). Trump’s campaign rhetoric suggests a turn towards protectionism across the Atlantic as well, though there is an important difference between the two cases. It is the EU rather than the UK that will initiate protectionist measures on this side of the Atlantic. A British exit cannot be made too easy, as this would open the door for other EU member states to follow, or threaten to follow, the its lead.

The Irish economy has benefited hugely from global trade liberalisation. The Single European market was an important trigger of the export-led boom of the 1990s that preceded the bubble economy. Anti-globalisation sentiments have been kept at bay, partly through the regional policies of the IDA. Though the phenomenon of Irish parochialism is well-attested, there is no Irish equivalent of the “rust belt” phenomenon.

Ireland will be caught in the crossfire of any global retreat into protectionism. Further concerns have been raised by the Trump campaign’s rhetoric on corporation tax. Ireland’s corporation tax regime – in place since the 1950s – has been characterised by former IDA managing director Padraic White as “the unique and essential foundation stone of Ireland’s foreign investment boom”. Media reaction to the Trump rhetoric on this issue has been excessive however. There are good reasons why a high US corporate tax rate is in America’s own interests. The US State Department too appreciates the “soft power” it derives from overseas investments by US firms. As to the other proposed change in the US corporate tax regime – the issue of “deferral” to be discussed below – it is Congressional Republicans rather than Democrats who have blocked this initiative for decades past.

Protectionism was a cornerstone of postcolonial economic strategy, from Ireland in the 1930s to India and most of sub-Saharan Africa at independence. Poorer, less-developed states felt they had little chance of prospering in the face of competition from more advanced economies. It is ironic that the US now apparently believes itself unable to compete against poorer low-wage countries.

Protectionism advantages import-substituting industries to the detriment of exporters. Agriculture was the main Irish export industry in the 1930s. As James Meenan wrote of the period, “farmers could be prosperous only if they were able to export. But precisely because the British market was open to the world, the Irish farmer could compete only if his products were of good quality and capable of being sold at a competitive price. Tariffs, rates and taxes had to be kept as low as possible.”

Protectionism is costly because it imposes a constraint on economic growth. Growth in Ireland required imports of sophisticated capital goods and raw materials that could not be produced at home. The resulting Irish balance of payments crisis of the 1950s forced policymakers to turn outwards. Huge economies like the Soviet Union, India and China were able to develop their own “heavy industries” while remaining aloof from the international trading system – each had launched satellites and developed atomic weapons – but at huge cost to the general welfare of the population. They too have all since turned outwards.

If the new Trump administration turns protectionist, the high-tech export industries of the east and west coasts will suffer. These are not of course the areas from which Donald Trump garnered his electoral support. Tariffs are a very blunt instrument with which to address regional income and employment inequalities however, which is what at least a segment of his electorate seems to desire him to address. Regional policies and educational and reskilling initiatives do not create the kind of collateral damage that protectionism can.

Protectionism provokes retaliation, as happened during the Great Depression of the 1930s, and trade wars can easily spiral out of control. If the US were to raise trade barriers against China and Mexico the vacuum would simply be filled by imports from other low-cost economies. Tariffs would have to be extended much more broadly for traditional industries to be repatriated to the US. And even if they could be brought back, think of the consequences for prices at Walmart, where poorer Trump supporters shop.

Might it not be easy enough, though, to repatriate the jobs that have been “lost to Europe”? Leave to one side the fact that US subsidiaries’ sales would not necessarily be replaced by US exports. Many of these markets would be captured by non-US firms. The Trump strategy to “bring these jobs home” – based on the rhetoric of the campaign trail – is to slash the US corporate tax rate and abolish the tax deferral concession. “Deferral” refers to the fact that outstanding US tax liabilities on overseas profits can be deferred as long as they are reinvested (or remain available for reinvestment) abroad.

US corporations would obviously be delighted to see the US corporate tax rate slashed. This is why we might not necessarily take at face value one soundbite currently doing the rounds in the media: that of former Hewlett-Packard CEO Carly Fiorina, who said, while campaigning for Senator John McCain in the US presidential election of 2008, that “we sent jobs to Ireland because the tax rate in Ireland was lower”.

Most US MNC (multinational company) investments in Europe are undertaken for market access reasons or to diversify across geographies. To the extent that the operations are based in Ireland, an important factor is undoubtedly tax – specifically that the Irish tax rate is low relative to other EU countries. Germany will not follow the US down to a putative new low rate of 15 pe cent. It doesn’t need to. US MNCs are not of sufficient significance to Germany.

Large, rich economies have innate advantages that allow them to levy higher rates of corporation tax than smaller, peripheral economies. Corporation tax revenues comprise around the same share of the total tax take in the US as in Ireland. Britain has had to cut its rate to compensate for the disadvantages of exiting the EU. Slashing the US rate would benefit US corporations to the detriment of the US exchequer.

The “deferral” issue is more complicated. Abolition of the deferral privilege has been a consistent plank in Democratic Party platforms since the days of JFK. It was in John Kerry’s manifesto in 2004 and Barack Obama’s in 2008. (Does anyone now recall the media frenzy in Ireland when Obama announced that this was on his agenda?) The Kennedy administration sought to abolish deferral in 1962. Kennedy noted that it had led to the “unjustifiable use of tax havens” for practices that included “artificial arrangements between parent and subsidiary regarding intercompany pricing, the transfer of patent licensing rights and the shifting of management fees”. These are exactly the same issues that surfaced in recent investigations by the US Senate, the UK House of Commons and the EU Commission into the tax affairs of large multinationals. They lie at the heart of the Apple controversy. If the problems were identified more than fifty years ago, how is that little action has been taken in the interim? The answer lies in the US Congress. The Kennedy initiative was blocked by Congressional Republicans, who argued that it would damage the international competitiveness of US corporations.

The Kennedy-era compromise was inadvertently undermined by new US tax regulations adopted in 1997. We might recall the controversy that erupted three years ago when a committee of the US Senate criticised Ireland as a tax haven. A memo from this same committee explicitly recognised that these new US regulations “further facilitated the increase in offshore profit shifting, which has gained significant momentum over the last 15 years”. The Treasury Department, upon realising its error, immediately tried to have the regulations withdrawn. They were instead enacted into legislation by Congress. They remain in force to this day. Is it likely that a new Republican-controlled Congress could be persuaded to reverse its fifty-four-year resistance to the Kennedy initiative?

This raises one further scenario. Let’s say that slashing the US corporate tax rate to 15 per cent could be a sufficient sweetener to persuade Congress to abolish deferral. How then might Ireland fare? Here the complexity of the US tax credit system kicks in. A US company paying the Irish rate of 12.5 per cent would owe the US exchequer the difference of 2.5 per cent between the Irish and US rates. If the company were instead to locate in Germany it would pay the effective German rate of close to 30 per cent. It would be unable to recoup the difference between the lower US rate and the higher German rate from either exchequer. The advantages of locating its European operations in Ireland would increase.

Tax systems, and the interactions between them, are complex. The Irish media have been quick to declare a crisis, just as they did when Barack Obama secured the Democratic Party nomination in 2008. A return to protectionism carries graver dangers. Missteps can lead to events spiralling out of control. Let us hope that policymakers know their history.

1/12/2016

Frank Barry is professor of international business and economic development at the School of Business, Trinity College Dublin.

Space to Think, an anthology bringing together more than fifty of the best pieces to have appeared in the Dublin Review of Books since its foundation ten years ago, was published in October. Selling in the shops at €25, it is also available to order online at a special price of €20 (to collect in Dublin) or €20 + post and packing charges as appropriate for shipping to addresses in Ireland and internationally. To buy online, follow the steps from the home page of our website.

One piece featured in Space to Think is Tom Hennigan’s 2016 assessment of Fintan O’Toole as an economic commentator. Here is an extract:

O’Toole’s narrow gaze also allows him to portray the cockups and conspiracies and now “cockspiracies” of Irish public life as a reflection of something deeply amiss, one could almost say uniquely so, in our society. His closely cropped view allows him to denounce Ireland’s public services as “squalid”. But squalid compared to what or to where and at what cost in the places where they are not squalid? Such language feeds a persistent belief among many Irish people that their country is little more than a banana republic, a term O’Toole largely avoids using, though the rest of his language lends significant ammunition to those who do. Suffice it to say that anyone who thinks Ireland is a banana republic should visit a real one to properly understand how the state they live in is not unduly burdened with intractable political disputes among corrupt elites governing masses bereft of hope.

Here is where O’Toole’s reluctance to widen his gaze is limiting. Which country would he have Ireland be more like? One might assume from his writings one of the Scandinavian monarchies (though without that region’s increasingly influential xenophobes). But such a forthright declaration would have to acknowledge the progress the Irish state has made to have such an ambition in sight and to accommodate the admission that there are fewer countries left to emulate thanks to that progress.

When he does venture a comparison in his columns it is usually to highlight some statistic that proves the country’s failings. Low wages, lack of social spending, lack of investment. But statistics are adaptable. If O’Toole wanted to understand the enduring power of the country’s conservative parties he might consider that, according to the United Nations, Ireland is the sixth best country in the world to live in, tied with Germany. Or that according to Eurostat, Irish inequality is close to the mean on what remains, even after the recent crisis, the most socially just continent on earth (again tied with Germany).

It is of course within a columnist’s remit to highlight what is wrong and what could be done better. And in Ireland there is much that could be done better, but this is a view that is shared by utopians and realists alike. For all the failures, the modern Irish state has also delivered successes. A sense of realism ‑ and proportion – are thus the most likely means to prove effective in driving forward debate and winning adherents to one’s side.

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