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Profit-led in effect or in appearance alone? Estimating the Irish demand regime given the influence of multinational enterprises

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Abstract

Most studies on the demand regime of Ireland tend to find it is profit-led. However, these studies use conventional national accounts statistics, which are grossly distorted in Ireland. Since the activities of multinational enterprises (MNEs) drive real demand on one level and severely distort conventional macroeconomic data on another, the possibility of bias due to omitted variables and measurement error arises. This paper summarizes the real and distortionary effects of MNEs in Ireland, and then adjusts and controls for these effects in an econometric estimation of the underlying Irish demand regime. It also addresses the threat of simultaneity bias by employing a three-stage least-squares approach. Ireland is found to be wage-led once the influence of MNEs is taken into account. Moreover, the average effective corporate tax rate (AECTR) on foreign affiliates in Ireland is found to be statistically significant in explaining investment. These results, alongside indicative foreign affiliate statistics, support the view that the underlying Irish economy is both wage-led and “tax competition-led” (Woodgate, Rev Keynes Econ 8:512–535, 2020), where a lower AECTR has a net positive effect on aggregate demand. It is contended that this beggar-thy-neighbor, tax competition-led regime helps explain why Ireland is profit-led in appearance rather than in effect.

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Data availability

All data used in this study are derived from the public domain resources described in the text and reference list and are also available from the author upon request.

Code availability

All econometric analysis was completed in R. It is available from the author upon request.

Notes

  1. The trade-off between higher MNE investment and higher corporate tax revenues is weakened or non-existent if, as Woodgate (2020, p. 532) details with reference to Ireland, the government manages to differentiate between domestic and foreign firms when setting AECTRs.

  2. However, the model in Woodgate (2020) does not account for profit shifting. Given that shifted profits may be taxed and spent, tax competition-led demand may be achieved in ways not fully captured by these conditions.

  3. In fact, the national gross fixed capital formation was used as the denominator in Figs. 1 and 3, which includes some of these inflating distortions, meaning that, if anything, the contribution of foreign MNEs to Irish investment has been underestimated in these figures, especially in recent years.

  4. For more on the nature and classification of conduit and sink tax havens, see Garcia-Bernardo et al. (2017).

  5. If Ireland is wage-led and tax competition-led but not profit-led, increases in Irish demand are associated with increases in Irish labor costs and the profits of foreign-owned MNEs, but not increases in profits accruing to Irish capitalists. Of course, changes in the AECTR may affect demand indirectly through effects on the distribution between Irish workers and capitalists, but such complications are omitted here for the sake of simplicity.

  6. Note that the conventional and modified series (such as GNI and GNI*) are at very similar levels in 1995, when the globalization effects were still relatively insignificant. Hence, the conventional and modified series may combine in a straightforward manner.

  7. In order to view the demand regime in terms of the wage/profit share, a common practice in the literature is to define \({\Delta NX}/\Delta \omega\) as the change in net exports caused by a change in unit labor costs, where the change in unit labor costs also causes a one percentage point change in the wage share. In essence, this approach is equivalent to dividing Eq. (2) by \(\partial \omega /\partial \mathrm{ULC}\). ULC drive net exports and total private demand in such an approach as well, albeit implicitly. As such, here it is deemed simply clearer to define the demand regime explicitly in terms of ULC since the direction of causation is immediately understood, as are the underlying drivers of functional income distribution, trade and total aggregate demand (ULC and expressly not, for example, mark-ups).

  8. This z-ratio was used in preliminary versions of this paper, but ultimately decided against due to the sensitivity of the variable and the results to the definition of the numerator (\(E*{P}^{f}\)).

  9. The approach taken here is not without precedent, however. For example, Bowles and Boyer (1995) employ a similar setup, though with the average propensity to save rather than the average propensity to consume.

  10. Indeed, Zellner and Theil (1962), the originators of the 3SLS method, use the approach to estimate a similar simultaneous system of consumption, investment, and output in their seminal paper (see pp. 71–77).

  11. Modified national income, wage share, and unit labor costs are all treated as endogenous in the 3SLS analysis, and are instrumented by the preceding four lags of these variables. The first lag of some of these endogenous variables was deemed necessary in the desired, second stage regressions. For example, the first lag of the wage share was necessary for the investment function, but not the average propensity to consume. Hence, it could serve as an instrument in the latter but not in the former, and therefore the list of instruments needed to vary on an equation-by-equation basis.

  12. To rule out an alternative explanation suggested by an anonymous referee that the results may be influenced by collinearity between ULC* and PWFA, an additional robustness check was run, where PWFA in the export and import regressions was replaced by the share of worldwide profits of US MNEs booked in Ireland. The results are very similar. In particular, unit labor costs were still found to be insignificant in driving Irish exports and imports in specifications three and four at even the 10 percent level.

  13. Further analysis not reported in full here show that replacing ULC with the price level does not qualitatively change the result that price competitiveness appears as an insignificant predictor in the third and fourth specifications of the export and import regressions.

  14. See IDA (n.d.) for an extensive list that includes information and communication technology companies such as Amazon, Apple, Facebook, Google, and Microsoft, and pharmaceutical companies such as Pfizer, Roche, Novartis, and GlaxoSmithKlein, as well as many more of the largest MNEs.

  15. At the time of writing (July 2021), this appears to be a real possibility, with the G20 and more than 100 other countries set to agree on a global minimum corporate tax rate and some kind of tax apportionment mechanism. While details are vague and a lot remains to be seen, in principle such a reform could threaten Ireland’s growth strategy whether or not Ireland agrees to commit to tax reforms (see Saez and Zucman 2019, ch. 6).

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Acknowledgements

I am grateful to Eckhard Hein, Leonardo Quero Virla, Valeria Jimenez, Franz Prante, and two anonymous referees for their valuable comments on earlier versions. Of course, any remaining errors are mined alone.

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  1. Berlin School of Economics and Law, Institute for International Political Economy, Badensche Str. 52, 10825, Berlin, Germany

    Ryan Woodgate

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  1. Ryan Woodgate
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Correspondence to Ryan Woodgate.

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Woodgate, R. Profit-led in effect or in appearance alone? Estimating the Irish demand regime given the influence of multinational enterprises. Rev Evol Polit Econ 3, 319–350 (2022). https://doi.org/10.1007/s43253-021-00056-1

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