The Political Economy of the Current Crisis

There is widespread agreement as to the policy errors that have compounded the current crisis. These include a pro-cyclical and politically driven fiscal stance, the failure to reform the tax system and tackle the house-price bubble, the first round of public-sector benchmarking and the weakness of financial sector regulation. There has been less analysis of the institutional and political economy factors that led us into these errors. I think a number of them can be seen to be interconnected. Thinking about these dimensions is necessary if we are to be saved from future crises.

Philip Lane (1998) and Colin Hunt (2005) have shown that some components of Irish fiscal policy at least have been pro-cyclical since at least the 1960s, and we stand out in this in comparison with much of the rest of Europe. I don’t think the political economy reasons have been fully identified, but McCreevy’s dismissal of ECOFIN’s 2001 criticism of Ireland’s fiscal stance represented a tragically missed opportunity to exploit external fiscal commitments to help overcome the political pressures that drive pro-cyclicality. McCreevy famously announced that “when I have the money, I spend it; when I don’t, I don’t.” He even used the occasion of the 1999 launch of “Understanding Ireland’s Economic Growth” to jeer at the economic perspective!

Instead of retrenchment, 2001 saw the introduction of the profligate SSIA scheme and continued income tax reductions. While such reductions had expanded the supply side in the earlier years of partnership by helping keep the lid on wage demands, their impact fell increasingly on the demand side as labour supply became increasingly inelastic (Barry and Fitzgerald, 2001).

Partnership, as Patrick Honohan has pointed out, contributed to a shifting of the tax burden away from income tax. We ended up excessively reliant on transactions-sensitive and property-sensitive forms of taxation (stamp duty, capital gains tax and VAT). Instead of tax reform we got further tax breaks for property investment, even as house price inflation soared. Areas like Achill and Clifden now look like Dublin suburbs.

The Bacon reports, which were supposed to take the steam out of the housing market, were conservative in the extreme. (One insider suggests they were ghost-written by the Department of Finance, which, if true, is shockingly indicative of the extent of regulatory and insider capture). I have previously cited research suggesting that the proportion of the price of a house that is accounted for by the site cost rose from around 15 per cent – which is apparently the norm by international standards – to some 40-50 per cent at the height of the property boom. The Kenny report of the early 1970s was asked to consider ways in which increases in the value of development land attributable to the decisions or operations of public bodies could be secured for the benefit of the community rather than of the property developers concerned. Nothing has been done about this over the last three decades. The rezoning decisions of public officials can still create massive overnight profits for private individuals. (I suggested this as a perfect example of what our penny catechisms used to call “an occasion of sin”!).

The problem lies, of course, in Fianna Fáil’s continuing entanglement with property developer interests. The only way I can see out of this is through wholesale reform of how political parties are funded, though Blair, Mitterrand, Kohl and many others all found ways of sidestepping such legislation. It remains a crucial area of policy design.

The housing boom was compounded by the failure of the Financial Regulator to hold bank lending to traditional standards of 2.5 times income and so forth. Many of us have long felt that the regulator’s office should not have been staffed from within the same institution (the Central Bank) that had purposely turned a blind eye to the Ansbacher and DIRT scandals.

The final connection I want to draw between the various policy errors concerns the excessively generous awards made under public-sector benchmarking Mark 1. This was arguably driven by the fact that traditional house-owning groups like the Gardaí, teachers and nurses found themselves increasingly excluded from the housing market. Under tighter credit conditions, the generosity of public-sector pension provisions and the permanency of public-sector employment would have ensured their housing market status. This was no longer the case. Hence the house-price boom can be seen as directly responsible for the generosity of these much-criticised awards.

The most recent research shows that public service salaries are some 20 percent higher than private sector salaries when comparing like-with-like in terms of education, experience etc. The real benefits or otherwise of social partnership will become apparent in the near future when this issue comes to be addressed. Supporters such as Paddy Teahon, secretary general of the Department of the Taoiseach when the process was established, argue that partnership has promoted a shared understanding among unions, employers and the government of the key mechanisms and relationships that drive the economy. (This was not apparent, though, in the debate preceding the devaluation of 1993). Other analysts viewed it as successful – in the early stages at least – by providing a mechanism to deliver wage moderation in exchange for income tax cuts. The Teahon view will be seen to be of validity if some agreement can be reached to reduce public-sector pay until the current crisis is overcome. The only politically viable option that could deliver this, many of us feel, would require that other more advantaged groups such as hospital consultants and the legal profession that receive much of their remuneration from the public purse are also faced with similar or larger reductions.

The issue of public sector reform has also come up for discussion. An underlying problem that is reflected in Irish unions’ choice of tax cuts in contrast to economic historian Barry Eichengreen’s (1996) characterisation of the Continental post-war “social contract” (which purchased wage moderation by guaranteeing construction of an efficient welfare state and maintaining high private-sector investment) is that the Irish electorate and Irish workers do not trust the state to be able to deliver on such a deal. Kingston (2007) argues (pretty convincingly, to my mind) that a Whistleblowers’ Charter could have prevented some of the major public-service failures of recent times, such as the lethal blood transfusions, illegal charges for long-stay institutional care, police criminality in Donegal, the PPARS health-service payroll system, the electronic voting machine fiasco, the failure of the Revenue Service to stand up to then-Taoiseach C.J. Haughey, and the corruption of the system by Justice Minister Sean Doherty. A more effective public service and a shift away from the crony capitalism that has characterised Irish politics would leave us on a much stronger institutional footing.

References

Barry, F., and J. FitzGerald (2001) “Irish Fiscal Policy in EMU and the Brussels-Dublin Controversy”, in Fiscal Policy in EMU: Report of the Swedish Committee on Stabilization Policy in EMU, Stockholm: Statens Offentliga Utredningar, 2001

Hunt, C. (2005) “Discretion and Cyclicality in Irish Budgetary Management 1969-2003”, Economic and Social Review, 36, 3, pp. 295-321

Eichengreen, B. (1996) “Institutions and Economic Growth: Europe after World War II”, in N. Crafts and G. Toniolo (eds.) European Economic Growth, Cambridge: Cambridge University Press.

Kingston, W. (2007) Interrogating Irish Policies, Dublin University Press (reviewed in the current issue of Economic and Social Review).

Lane, P. (1998) “On the Cyclicality of Irish Fiscal Policy”, Economic and Social Review, 29, 1, 1-16.

6 thoughts on “The Political Economy of the Current Crisis”

  1. It seems the Government is stuck in a pro-cyclical trap. Because it didn’t spend money in the late 1980s and early 1990s, our infrastructure fell back and then it felt it had to spend with gay abandon in the late 1990s and particularly this decade.

    Now of course we have no capacity for economic stimulus – indeed cutbacks will be necessary, meaning that when we eventually get back to the good times, the pressure will still be there to spend to ‘catch up’ on the missed years of 2009-201x. McCreevy probably does have an awful lot to answer for.

    One glimmer of hope, perhaps from the naive, is that, for all it got wrong and has cost us since, benchmarking established a hugely important principle – public sector pay should mirror trends in the private sector. If private sector gross earnings fall between mid-2007 and mid-2009, then we have a case for another round of benchmarking. -10% anyone?

  2. I don’t like extinguishing glimmers of hope, Ronan, but I don’t share your sanguine assessment of benchmarking. Sure, the principle of mirroring trends in private sector pay was an important one in the terms of reference of the Benchmarking Body, but it had precious little to do with the outcome of the exercise. Had it shaped the outcome in any meaningful way, many grades would have had their pay cut under the first round in 2002 and many more (if not most) would have suffered a similar fate last time around. Besides, we cannot afford to wait for the elaborate and slow-acting machinery of benchmarking to be cranked up in order to effect public sector pay cuts, even if it was realistic to suppose that the process could produce such a result; the cuts are needed now.
    While on the subject, I would suggest that benchmarking, the first round in particular, is responsible for much of the anti-public sector comment that has featured in recent public discourse about the economic/financial crisis. My feeling is that private sector workers have been nursing a deep sense of injustice/outrage on this score for the past few years. So, in my estimation, public sector pay cuts are required at this stage, not just for reasons to do with fiscal sustainability and competitiveness, but also to rebuild solidarity between employees in the two sectors and replenish the reservoir of goodwill towards the public sector that is essential to the proper functioning of a modern economy/society. (See my piece in today’s Irish Times http://www.irishtimes.com/newspaper/finance/2009/0116/1231974457298.html )

  3. In terms of solutions to our political economy problems, I have to say that outsourcing as much regulation as possible to Brussels seems a good idea to me, and it is probably going to happen now even if it is a bad idea.

  4. this sums up what so many people have felt for so long, long before the credit crisis we had a credibility crisis and the worst part of it all is that this will take far longer to remedy than the markets.

  5. I think the key political economy moment was the 1997 General Election when there was a narrow but decisive victory for a centre right response to the large budget surpluses that had begun to appear. McCreevey’s first budget in January 1998 horrified many of the social democratic commentariat but was entirely consistent with the FF-PD manifesto. In retrospect it seems that it would have been much more sensible for more of the increases in tax revenues in the second half of the 1990’s to have been spent on better public services. Instead many of the significant improvements in public services in recent years have been due to increases in tax revenues that are mainly related to the sale of assets.

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