For faithful members of the 46-ers*, the new government budget proposal creates cognitive dissonance. How could a government so wasteful in its bank-bailout policies produce a general government budget proposal that seems so carefully and sensibly crafted to address current fiscal and competitiveness problems? In contrast to bank-bailout policies, the new general budget seems reasonable, balanced and fair, but as stringent in difficult circumstances as could possibly be asked. Does the Department of Finance (DoF) suffer from bipolar syndrome? How can we understand its behaviour?
For left-wing analysts, there is no conflict. They can invoke the theatrical model: the DoF is engaged in class war on behalf of its friends (the rich and powerful) against its enemies (the poor and powerless). Fintan O’Toole is an eloquent, thoughtful, and nuanced proponent of the theatrical model. In the right hands, this model has some merit, and certainly carries emotional appeal. It provides a satisfying explanation for many people, but for mainstream economists it lacks veracity. I hope that we can avoid discussion of all the variants of the theatrical model in this particular thread. It will just clog up this particular discussion and is not relevant to this thread. In this thread I want to focus entirely on something else: explaining DoF behaviour from a “mainstream” perspective.
Do we have any consistent, mainstream-economics explanation for an excellent budget and an appalling bank bailout strategy emanating from the same government department? Here is my simple, ex-post theory of DoF behaviour.
1. Insider generosity vs. outsider stringency.
A basic feature of human nature and social organizations is a strong bias toward insiders and against outsiders. Each government department and its ministers, is “captured” by insider special interests. Each department and attached ministers argues strenuously for more public resources for their department. In normal circumstances, the Department of Finance acts as a central control. It can balance all these competing demands, and is “captured” by none of them. That is why in most parliamentary democracies the DoF is empowered with strong central control of the entire budget. The problem for Ireland at the moment is that the DoF budget, usually a negligible sum in the overall government budget, is currently, including all direct and contingent bank bailout costs, by far the largest component of government actual-plus-contingent expenditures. While stringent and sensible toward all the other departments, the DoF has been extravagantly generous toward its own insider interest groups (the financial services industry and that industry’s clients). If Mary Hannafin, or some other “outside” minister, could control the DoF budget, and Brian Lenihan control all the others, perhaps we would not have this problem.
2. Ireland’s insolvent large property developers are Fianna Fail’s long-term, generous benefactors.
The Irish financial services industry has benefitted from recent DoF policies, but Ireland’s large property developers have benefitted spectacularly. Many of the large developers have been insolvent for over a year, but government policy has worked to prevent any bank cash calls upon them. The banks have been promised a big subsidy on fair value if they cooperate by rolling over the loans until NAMA purchases them. The NAMA plan, bank guarantee, and Anglo takeover have worked with a common purpose (unintentional?) to avoid any cash calls against Ireland’s large, troubled property developers. The NAMA business plan builds in another three-year hiatus on pursuing large property developer debts, pushing any asset liquidations beyond the next election. By the time NAMA moves to collect on these debts, all personal funds of the largest property developers will be located out of NAMA’s reach. The government bank bailout policies have effectively cancelled the bank debts of the large developers. One might cynically treat this, rather than stabilizing the banking system or increasing bank lending, as the government’s key policy goal. It certainly can be justified by the theory of political economy. Large political donors tilt government policies in their favour. Reading The Builders by Frank MacDonald and Kathy Sherian, one is struck by the long-term, very close, and financially very generous relationships between nearly all the large property developers and the Fianna Fail party. This sounds uncomfortably like a conspiracy theory, but in fact it is entirely consistent with modern political economic theory.
Where does this leave Brian Lenihan as finance minister, spearheading both the government’s excellent budget policies and its terrible bank bailout policies? Will he be remembered in coming years as the finance minister who deftly shepherded through a tough but necessary budget in Ireland’s moment of need? Or the finance minister who wasted 15 billion euro of Irish taxpayer wealth to subsidize bankers and large property developers?
* This refers to the 46 economists, led by Brian Lucey, who signed a letter to the Irish Times arguing against the government’s expensive guarantee-and-subsidize approach to Irish bank bailouts, advocating instead a cheaper nationalize-and-restructure approach.