Author: Kevin O’Rourke

The last couple of days have seen several commentators raise fundamental questions about the role and optimal size of the financial sector. Free Exchange very helpfully links to three pieces, including one discussing the extraordinary statements (given their provenance) by Lord Turner, chairman of the British FSA. Turner suggests that a lot of what the City does is socially useless, and that finance has gotten too large.

There are lots of issues to be discussed here, so let me just pick up on one for now. That is the argument that the UK (and arguably other Anglo-Saxon economies) is suffering from a form of Dutch Disease, with an expanding financial sector sucking in too many resources, and depriving other sectors of much-needed inputs.

A standard thing to say about the Dutch Disease is that it isn’t a disease at all. If workers flock into the booming sector (say natural gas) because of higher wages, that is efficient, since those higher wages reflect higher productivity in the booming sector. (The higher productivity is due not just to the physical productivity of the workers in that sector, but to the price of the sector’s output.)

The term ‘Dutch Disease’ is thus a misnomer.

On the other hand, you can clearly argue that high wages and bonuses in the City have reflected bubble conditions, and the relative prices guiding resource allocation have thus been ‘wrong’. There is therefore a much better case for regarding financial services expansion as a ‘disease’, and for government intervention of some sort to reduce the consequent misallocation of resources.

So: can anyone think of a nice alliterative label to replace ‘Dutch Disease’?

Michael Hennigan continues the debate on research funding in today’s Irish Times.

Research funding is good, but so are decent primary schools, a decent health service, and many other things. From what we read in the papers, it seems likely that the state is going to cut social welfare payments this winter. Against that background, vested interests seeking state money need to carefully justify their demands for public funding. If the argument people are making in favour of university research funding is economic, then we are entitled to expect rigourous cost-benefit analysis of some sort from them, rather than the faith-based appeals we generally get.

(My own view, for what it is worth, is that academics are very foolish if they allow the argument in favour of university research to become an economic one. If that argument becomes generally accepted, then the most important research funding which any of us receives — that is, the portion of our salaries not related to teaching, which allows us to study whatever we want, including such arcana as economic history — will presumably come under scrutiny, in which case it will be time to pack it in.)

More generally, Ireland is a small open economy, and we are only ever going to make a vanishingly small contribution to pushing back the world technological frontier. Does it not follow that the priority here should be on innovation policy — helping companies apply best-practice technology — rather than on invention policy — creating the best-practice technology ourselves? In order to evaluate such a proposition, I guess you would need empirical evidence on inter alia the extent to which new technologies are geographically mobile.

As a final note, I am pleased that Michael picks up on the utterly embarrassing references to Stanford we heard earlier in the summer.

Pages 9-13 of the report contain an impressive array of data showing indications of Ireland’s falling competitiveness. They also indicate that the IMF team and the Irish authorities disagreed about the extent of the competitiveness problem, with the Irish being more optimistic (due to our falling wages). We all agree, I presume, (and the IMF agrees) that to the extent that our nominal wages fall, we will become more competitive. But, it would be nice to have more data on the extent to which this is happening, in Ireland and elsewhere. As the IMF points out, you can’t just assume that wages are not falling in any of our competitors (and that is even leaving aside the issue of nominal exchange rate changes). Good comparative quantitative evidence (as opposed to anecdotes) would be nice: does anyone know of any?

From today’s Irish Independent

The Government is putting the finishing touches to a new bill establishing the National Asset Management Agency, but there are concerns a raft of liquidations before it is introduced could undermine the agency.

However, sources said it was seen as “highly unlikely” that other banks would take court actions because the resulting losses would land on their books, rather than the loans being transferred to NAMA.