State Investment Bank

Michael O’Sullivan and I have an article in today’s Irish Times arguing for a state investment bank. Some links to supporting materials are below the fold.

Allocation of bank lending by sector and poor investment record is discussed here

Role of the state and the weakness of private sector in providing ‘productive investment’ from 2000-8 is documented by Rossa White of Davys here

Patrick Honohan’s QEC article on the limited role of finance in Ireland’s economic success of the 1990s is here

Research on the effectiveness of grant aid:

Manufacturing in the 1980s:
O’Malley, E., K.A. Kennedy, and R. O’Donnell. 1992. Report to the Industrial Policy Review Group on the Impact of the Industrial Development Agencies Dublin, Stationery Office (not available online)

Software in the 1990s:
Ó Riain, S. 2004. The Politics of High Tech Growth: Developmental Network States in the Global Economy (Structural Analysis in the Social Sciences 23) New York/ Cambridge: Cambridge University Press. (this link to the most relevant part via google books may work)

Manufacturing in the 1990s:
Girma, S., H. Gorg, E. Strobl, F. Walsh, 2008. “Creating jobs through public subsidies: An empirical analysis” Labour Economics 15, 6, 1179-1199

Already noted above, this piece provides data on how state funding stimulated private investment funding in the late 1990s and after the dot.com bubble.

27 thoughts on “State Investment Bank”

  1. Wouldn’t the liabilities of this bank be guaranteed by the state? This is precisely the opposite to what I want to see: the business of the Irish banks transferred entirely to non-eurozone banks, which can’t be blackmailed by the ECB.

  2. There should be absolutely no consideration of a state investment bank until there is comprehensive restructuring, sensible regulation and efficient financing of the infrastructure and utility activities under the state’s control in the public and semi-state sectors. This would reduce excessive, unnecessary burdens on consumers and the economy and boost economic activity. It would also release resources to support efficient investment and financing of investment in other sectors.

    Establishing an institution of this nature on top of the current policy and regulatory dysfunction would be a recipe for disaster.

  3. A admirable policey goal , but the state now owns chiefly bad banks & their debts rather then goverment money which should have been owned /saved by the people / depositors when it entered into the “nationalisation” process.
    (Real nationalisation means nationalisation of money rather absorbing then private banks and their private debts.)
    Therefore the leverage is now very extreme – it would be lending into a deeply dysfunctional economic ecosystem with little demand and also with deeply embedded private debt contracts that create huge inefficiencies and no wealth.
    The first thing you do with a badly injured car crash victim is stop the bleeding – more advanced therapy comes later.

  4. I thought the NPRF was supposed to be a sort of national investment bank.

    Where did all the money go ?
    It really is a great circus.

    “the business of the Irish banks transferred entirely to non-eurozone banks, which can’t be blackmailed by the ECB.”

    The banks are like the vicious foulmouthed ex spouse who has got the mobile phone number of your down to earth and very decent new partner.

  5. I believe that the only people who are likely to make poorer investment decisions than the existing staff of the Irish banking sector would be a staff recruited and employed by the state. 

    I thought that the biggest single lesson we learned from the financial crisis was that regulatory capture had led to a situation where the finance industry had grown too close to the government. Is there seriously a discussion to formalise this relationship by creating another investment bank owned by the state? Isn’t this the kind of thing all those people are protesting against on Wall Street? 

    Do we seriously believe that the same state that has brought us the banking guarantee, Terminal 2, massively overpaid workers at the ESB etc etc are going to do right by the taxpayer? I could see a future awash with Solyndras.

    Regardless if how this idea might sound on paper, this would end up as another over-staffed special interest grabfest. 

    If the state wants more green energy companies it should put more money into training engineers and physicists. If it wants to encourage investment they should reduce CGT on investments in growth companies or create other incentives (in the same way it encouraged the property boom through tax breaks and incentives). There is plenty that could be done without channeling more of taxpayers money to friends of the state.

  6. @Edward
    But now that the equality between credit and state money has been formalized all bank lending is officially a crony affair.
    At least this state bank proposal is a more honest mechanism to create credit with more open chains of command rather then the murky world of the Central bank / commercial bank nexus.
    And no, ESB pay levels did not cause the collapse of the states ability to create wealth – it was bank leverage.

  7. @Ó Riain & O’Sullivan

    Yes. But which state?

    State of the present state, and serious lack of skills/capacity on ‘real economy’ within extant banking mileau polluted by the toxic property fetish suggest that this should be outsourced to an arm of a state which knows what it is doing and which has a track record …..

    Let’s outsource it to a Danish bank which knows what a globally trading,and locally employing, SME sector requires to function. In reality, we have never been industrial; a few minor exceptions excepted.

    @seafoid
    NPRF! Ouch cubed. What has been done with its resources is an unmitigated disaster … a gold medal in the annals of crass stupidity … not a bad day, so I say no more on this one.

  8. This is a timely and considered intervention. When the bank crisis broke out, we were told the purpose of the guarantee, the capitalisations and NAMA was to ensure that banks could quickly return to the business of providing credit to the productive economy. The more fundamental question was never asked – what has been the track record of the private banking system and private sector investment and does this record suggest optimism for investment in the future. The authors rightly suggest no – and Sean’s links to various studies in the post (Davy, Honohan, O’Riain) provide significant evidence to this effect.

    A state investment bank has the potential to rectify this historical failure. It is certainly not new. It is instructive to read the Dail debates when the Industrial Credit Corporation was established to get a feel for the ongoing flaw in financing for domestic firms.

    Even without the historical record, banks’ ability to boost investment into the productive economy during a period of substantial asset downsizing is questionable. And with the Government conceding that next year the economy will be mired in its 5th consecutive year of domestic demand recession suggests there is not much incentive for the private sector to commence investment.

    All the more reason to expedite the establishment of a strategic investment bank with an exclusive mission to provide credit to productive activity whether in the private or public sector.

  9. @ Michael Taft

    “It is instructive to read the Dail debates when the Industrial Credit Corporation was established to get a feel for the ongoing flaw in financing for domestic firms.”

    It is also instructive to see what happened to the ACC. The country could also do with a few well run building societies . Where did they go?

  10. Edward is under the impression that AIB & BOI are investment banks!!!

    I LOVE IT – the absurdity of it all is just too much.

    I could move to the remote region of Corkadorkery and watch the Irish banks do their Beal Bocht routine from afar but I fear there is no escape.

    Money & private loans need to be seperated boy.

  11. There is an ongoing and concerted effort by the ‘government machine’ – and all those beneficially associated with it – to promote the fiction that any policy, regulatory or governance dysfunction existed solely in the banking and property development sectors; that this has been, and is being, properly addressed and remedied; and that, apart from the requirement for some relatively minor changes, there is no evidence of any policy, regulatory or governance dysfunction in any other sectors.

    This is total and utter balderdash. Policy, regulatory and governance dysfunction is endemic in all of the sheltered sectors – public, private and semi-state. It varies in extent – and in terms of the economic damage it causes, but of its existence, and malign impact, there can be no doubt. Indeed, a certain amount exists, and will exist, in all societies and economies; the challenge always is to determine how much to prevent and how much to permit. But far too much is being permitted in Ireland.

    The interests of final consumers and the economy, including those of the tradable and exposed sectors, are being damaged by this dysfunction. Reducing this dysfunction would generate economic benefits – not least in increasing disposable incomes and business profitability. Focusing on this would be far better than this ill-thought through desire to establish a state investment bank.

    But a focus on such a bank would allow a blind eye to be turned to the endemic dysfunction and would give the impression that ‘something is being done’. I could easily see the momentum building up in favour of this economically stupid idea.

  12. The fiction being peddled by the machine is that the banks were somehow not part of the state’s apparatus. The banks were in the middle of government policy; bankers were/are just highly paid civil servants. They did what the machine told them to do. The conection between all of this and a functioning market economy is tenuous at best.

  13. We have a State investment bank in all but name and the expereince there should be looked at before embarking on a venture that would be built on good intentions, vacuous superlatives and the spin that permeates most aspects of enterprise policy.

    I recall Micheál Martin once using the terms ‘cutting edge’ and ‘state of the art’ in the same sentence.

    Policymakers led by starry-eyed ministers in both past and the current administrations, have provided billions of euros for research; there is plenty blather produced on inputs, colloborations, patents (whether comercially redundant or not) etc but information on outputs is very vague — the results are longterm we are told and crucially, there is little said about market demand.

    There is a ‘consensus’ that even more should be spent even though there is ZERO accountability.

    Who could not be for investing in ‘green’ projects and what does it matter that any firm with potential would be acquired by bigger overseas fish and the promoters would make a bit of a killling but the taxpaper would get very little?

    Why not more investment in biotech where only a small number of firms ever made a profit, in over 40 years?

    Just a silly question as to what useful information policymakers and experts at the bank would have on the process of the birth and death of startups in Ireland and the ones that survive?

    I was once a director of a fish farm where an agency called the National Development Corporation, had an investment.

    There is a case for diverting some of the welfare spent on the thousands of researchers on the public payroll.

    It’s easy to see why a minister would find this type of proposal compelling; it could show vision in the short-term and would be a substitute for the real challenge of where jobs could come from when the indigenous tradebale sector has been basically stagnant since the early 1990s.

    Bruton plans to issue a wish list next Jan on creating 200,000 new jobs. The ancien regime added in indirect jobs in their targets to jazz things up – – order up a consultants’ report to give the bs a bit of heft.

    An ESRI conference on productivity would cost little but this type of project would require a lot of bobs and who would want to rain on the parade of aspirations when there are many in need of a job.

  14. Forget about a State investment bank. We’re saved by AIB…today worth 54b, so less the 20 b we put in, we are up 34b.

    Now for the hard part…how do we unload 550 billion shares over the next week while all the banks in Europe are taking a hammering.

    Amazing how our Pillar has advanced 8% to day while BNP, Soc Gen and others are off about 10%

  15. Paul Hunt nails it. The abiding myth in the state sector (where the author is overpaid) is that this sector has nothing to do with the misallocation of capital in the Irish economy. Funny thing is – the state managed to expropriate and misallocate more capital than the construction sector. A lot of this money was creamed off from the construction sector. The rationalisation of the government sector of the truth about the bust is heroically self-serving and entirely misleading. In fact the one part of the bubble that hasn’t deflated is the state sector.

  16. An excellent article highlighting that before private investment was dangerous it was merely useless.

    @Paul MacDonnell

    Funny thing is – the state managed to expropriate and misallocate more capital than the construction sector.

    I would be interested to see some of the figures you base your analysis on.

    The rationalisation of the government sector of the truth about the bust is heroically self-serving and entirely misleading.

    How odd.

    I would have thought that majority of rationalization going on after this latest crisis of capitalism was about how exactly market liberalism was not the main culprit. The Croke Park agreement weakened the moral fibre of the country so it was unprepared for the rigors of market discipline and all that.

  17. @Paul MacDonnell
    The state was operating in a envoirment of extreme credit money – sure it misallocated capital , what else could it do ?
    It was just one fish in a pond suffering from Eutrophication – it had no real control over the farmer dumping slurry all over the fields.

    Look at goverment central funds in the early 80s which went from 12%+ GNP ratio to 2.5% /3% during the last half decade of the boom.
    This is the mark of extreme leverage , when the equilivent American version went into surplus during 1999 even Greenspan said he could not operate monetory policey.
    2.5% is a incredible 40 to 1 leverage.
    Any loss in investments is devastating at that extreme level.

  18. @Shay,

    I’m sure Paul McDonnell is well able to defend himself, but your assertions and queries should not go unchallenged.

    I suspect that validating Paul’s assertion about the extent of state expropriation and misallocation of capital would require a huge and detailed forensic accounting exercise trawling through data that the government sector prefers to conceal. I can speak only about the sectors where I have done some detailed analysis.

    So I will repeat what I have highlighted many times – even if most economists prefer to ignore it. The ESB’s networks have more than trebled in book value in the last decade. These contribute the lion’s share of the ESB’s total book value. More than three-quarters of this investment has been financed by consumers – either directly via capital contributions or indirectly via final electricity prices – with a quarter coming from borrowings. The state has not contibuted one red cent of new equity investment. Instead, it has extracted dividends (mostly provided by the networks business) to the tune of more than €700 million in the last 6 years.

    A responsible majority shareholder of a rapidly growing, extremely profitable business with a guaranteed stream of revenue and minimal risk would have recycled dividends, injected new equity and secured additional debt financing to secure the most efficient financing at the lowest possible cost of capital. But we don’t have a responsible shareholder to do these things. Instead, final consumers have been required to pay up-front to finance a share of this investment and they are then required to pay to fully recover all this investment plus the return required – all determined and sanctioned by the CER.

    The story is the same, but at a lesser scale, for BGE. I estimate that up to €5 billion has been extracted unnecessarily from final consumers over the last decade. This takes no account of other glorious inefficiencies in the financing of the businesses, thier operations or in the functioning of the so-called ‘competitive’ market. And it takes no account of similar financing inefficiencies in other sectors. Nor does it take account of the rent capture in the private sheltered sectors often directly or indirectly sanctioned by the state.

    But, as usual, there are none so blind as those who will not see. Too many powerful, embedded vested interests benefit from these arrangements.

    And as for this belief that markets are evil and the state is pure and virtuous, it’s probably futile to advance any rational exposition. But, what the heck…

    The word ‘market’ is used to describe all sorts of exchanges of good and services, so therefore there are all types of ‘markets’. They exist across a broad spectrum from situations where markets do not exist (monopoly), through situations where market power is being abused to situations where property rights and contracts are clearly defined, there are no barriers to entry or exit and there is transparent price discovery. They also vary along another dimension in response to the nature of state intervention and state governance.

    Only those where property rights and contracts are clearly defined, where there are no barriers to entry or exit, there is transparent price discovery and where market power and political meddling have been banished should properly be called markets.

    The irony is that those who advance free markets absolutiely loathes, hate and detest markets of this nature and will do everything in their power to rig, subvert and distort them – and will secure the support of governments in these efforts. So when those of the progressive-left rail against market liberalism they are actually railing against rigged, distorted and subverted markets. But, rather than focusing on what would be required to subject these markets to effective governance and to make them work properly, the knee-jerk reaction is to throw the baby out with the bathwater and to advance the state in their place.

    So, once again, there are none so blind as those who will not see. And, of course, it suits those who will benefit from an expansion of the state’s apparatus.

  19. @Paul
    The state had to buy private assets ( the pension fund) to prevent itself going into surplus ,what does that tell you about the envoirment back then ?
    During the Gold standard years no country needed FX reserves or surplus pension funds as the system was self regulating.
    Post gold standard sovergin countries such as the UK & US ( euro countries are not sovergin) always needed a high defecit to prevent malinvestment.
    The US going into surplus in 1999 forced citizens into massive private debt and malinvestment.
    In the worlds monetory system post 71 goverments must spend much more i.e. produce goverment paper for others to save.
    If they do not the private sector banks gets out of control through leverage.
    The one area even many conservatives agree on is the state must control the money supply – otherwise it is not a state.

  20. The state has taken on life-time commitments to employees in terms of pay and pensions that are, in effect, bubble prices.

    Worse a huge number of these careers should not – at any price – exist.

    Irish income tax rates for median to higher earners is now at EU continental ‘social democratic’ levels but without the services (including Defence expenditure) that would account for it. So what’s happening? Confiscation to underwrite the bubble era and bubble-sized state sector.

    One thing is true though. Since Reagan and Thatcher governments have pretended to be ‘free market’ by cutting taxes whilst borrowing to make up the short-fall so that they would not have to reform government. Politicians – even Reagan and Thatcher – lied to everyone on ‘right’ and ‘left’.

    One mistake I made was not to have spotted this lie sooner.

    Besides the best response to leftie Civil Servants who talk about ‘rampant neo-liberalism’ is to simply say ‘Well yes but whatever about the circumstances and venality surrounding misbehaviour by banks and property developers – that doesn’t explain why your career isn’t a vast drain on the tax-payer for no real return. So let’s discuss government reform.’

    Afterall what was the banking crisis except just another example of government failure. Governments print money. They make it too cheap. They ignite a credit boom. They get lots of taxes. They get fatter. They get re-elected.

    I mean, really – Are McCreevy, Cowen and Bertie (all government people not private sector people and all making government departments complicit in their recklessness and dishonesty) any less to blame than any banker you can name?

  21. @Paul Mac
    First of all the US & the UK do not borrow to spend – the present crisis has made that clear – they just use money with a time component expressed as a interest rate.
    Second they could cut taxes because the M3 money supply increased without inflation of consumer goods because of a gigantic slave arbitrage regime using cheap oil to transport the goods to western consumers – this inflation of the money supply was chiefly credit & not goverment money.
    The ratio of goverment money to credit has declined rapidly which is a much more important metric.

    Most of yee guys are analysing indivdual creatures in a pond without asking the more important question – why it is so polluted ?

  22. @Paul MacDonnell,

    I’m surprised that it’s taken you this long to figure out the difference between Neo-conservatives and the unfortunately-named Neo-liberals 🙂

    Neo-conservatives like big government, big spending and low taxes for the vested interests and corporations that support them and hidden, stealth charges on everyone else (plus a huge deterioration in public services). The so-called ‘progressive-left’ likes big government and high spending for the vested interests that support them with higher taxes and financial repression for the higher income percentiles.

    Neo-liberals either choose, disingenuously, to ignore the real agenda of the Neocons or seek to escape the reactionary tag explicit in neo-conservative; but they’re not liberals. Genuine liberals advocate limited, but efficient and effective, government coupled with genuinely competitive markets as they maximise liberty and the use of all relevant information. This may be contrasted with the neocons restrictions on liberty, abuse of markets and projection of economic and military power; and with the ‘progressive-left’s’ reliance on a multitude of omniscient bureaucrats deciding who, what, how and how much.

    We’ve had an unholy alliance of neo-cons and the progressive-left over the last 20 years. And we’ve had various combinations in all developed economies depending on evolving political configurations. This explains why the current crisis is proving so intractable to resolve.

    Neco-cons point at governments demanding a mountain of riskless credit to finance their policy objectives and to satisfy their voters’ desires. The progressive-left points at the greed and recklessness of banks, wage repression and increasing inequality.

    No resolution will be found until both sides concede that ” it was both of us”.

  23. The type of bank used by governments to promote industry is usually a 100% state owned, non deposit taking institution. The thrust of the business is usually confined to export promotion. Insuring currency fluctuation risk, insuring default risk, lending for purchase of production machinery to promote competitiveness. Funding trade personnel in embassies, having embassies promote Irish-foreign trade associations, organising trade shows. Many of the banks are self supporting which helps with WTO and other trade treaty challenges.

    Germany differs in that it uses development banks to revitalise distressed areas. The depth and breadth of Germany’s support for business abroad is impressive. It starts with German language classes for 3 year olds conducted by German educated teachers. These are available to the foreign natives as well as Germans residing in that country. It goes on to include University for foreigners in English in Germany all subsidised.

    As for Ireland, the cost of funds is crucial if the bank is to confer an advantage. Germany can get funds for 1-3% which it can pass on to the Development bank. Ireland can get funds for xx-xx% which would bankrupt any bank borrowing to compete internationally.

    We have borrowed and continue to borrow ourselves into a hole from which it will be difficult to escape.

  24. Many Investment Banking firms offer professionals whose perspective on any engagement is limited to their background and experience primarily as bankers – a financial perspective singularly focused on a specific transaction.

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