Author: Philip Lane

The Fiscal Cost of the Irish Banking Crisis in Comparative Perspective

It is useful to place the current Irish crisis into a comparative context.   In “Risk Management and the Costs of the Banking Crisis” [IIIS Discussion Paper No. 262 (published in National Institute Economic Review)], Patrick Honohan estimated that the mean fiscal cost of systemic banking crises to be 17.1% of GDP [narrow sample of 45 countries] or 19.1% of GDP [broader sample of 78 countries].  The respective median values are 13.2% and 15.5% and the upper quartile values are 16.7% and 27.7%.

It is notoriously difficult to calculate the total fiscal cost of a banking crisis  – as Reinhart and Rogoff have emphasised, there are substantial indirect costs since a banking crisis typically also amplifies recessionary forces, leading to a generalised decline in tax revenues.

In addition, the final fiscal cost may differ from the upfront fiscal cost, to the extent that there is ultimately a positive investment return on the fiscal injections.

The current projection is that the State injection into the banking system will soon stand at €33 billion or so. This is made up of €3.5bn preference shares in BOI (some of which will probably be converted into ordinary equity); €3.5bn preference shares in AIB (some or all of which will probably be converted into ordinary equity); €22bn in Anglo (€4 already put in + €8.3bn + an expected further €10bn); €2.7bn into INBS; and about €1bn into EBS.

€33 billion is about 22 percent of GDP (26 percent approx of GNP).  The injections into AIB and Bank of Ireland could ultimately deliver some level of payoff to the taxpayer, such that final cost could approach the mean value for a systemic banking crisis.  In the other direction, additional fiscal injections in the future would raise the total bailout cost.

I note also that the gross fiscal cost is not all paid out up front, in view of the strategy of using promissory notes.

[Clearly, it matters for this ratio whether it is measured vis-a-vis pre-crisis GDP or current GDP.]

Finally, the fiscal cost of the banking crisis is a narrow measure  –  many households and firms will also suffer private losses of various types.

The Future of the Irish Banking System

It is timely to open a thread on all the announcements.  This Irish Times article carries links to the various files.

This Department of Finance file carries a lot of the details and explanatory text.

Request for Indicators: Annual Competitiveness Report, Benchmarking Ireland’s Performance 2010

The National Competitiveness Council reports on key competitiveness issues facing the Irish economy together with recommendations on policy actions required to enhance Ireland’s competitive position.

One of the NCC’s annual publications is Benchmarking Ireland’s Performance. In 2009, this analysis of Ireland’s competitiveness performance used approximately 140 indicators to see how Ireland compares internationally on, for instance, living standards, export performance, prices and costs, productivity, innovation and infrastructure. Now, in preparation for the 2010 report, the NCC would welcome suggestions for additional/alternative internationally comparable indicators that could further our understanding of Ireland’s relative competitiveness.

If you are aware of such indicators and would like to suggest them for inclusion, please email ncc@forfas.ie .

Previously used indicators can be seen in the Annual Competitiveness Report 2009, Volume One: Benchmarking Ireland’s Performance.

Macroeconomics of Public Sector Reform

Without knowing the details of today’s deal, it is still worth thinking about the macroeconomics of public sector reform.  I will take it that the deal delivers widespread productivity growth in the public sector.

All else equal, an improvement in the quality or output of public services should be valued by the population. It is desirable that this be reflected in the measurement of GDP and various countries are attempting to capture quality and output measures for public services to this end. (The alternative is to measure public sector output by the volume of inputs – but this cannot capture productivity growth.)  The value to the population of extended opening hours, for example, should be considerable.  It would be helpful if Ireland made efforts to improve the measurement of the public sector contribution to GDP.

Next, for given levels of output and quality, an improvement in productivity means that the public sector requires fewer workers.  This expands the supply of labour to the private sector.  This will benefit private-sector enterprises, including via the attendant downward pressure on wage levels.  A cautionary note:  the initial impact of technological progress can be contractionary, since rigidities in the labour market may mean that it takes time for private-sector employment to expand to absorb the extra supply of workers.

Next, the financial savings from the reduction in public sector numbers [and/or the elimination/reduction of premium payments for some types of overtime] can be allocated in several ways:  (a) reduce the deficit; (b) increase the provision of public services [equivalently, avoid service reductions] ; (c) reduce taxes [equivalently, avoid tax increases beyond what is inevitable]; or (d) increase public sector pay levels [equivalently, partial or full restoration of previous pay cuts].

It is currently unclear about the intended allocation of savings across (a) through (d).

I further note that uncertainty in the provision of public services is damaging for the population, such that the commitment to avoid strike action and other types of service interruption is very welcome.

Finally, as part of the overall package, a commitment to no further pay reductions is also welcome by providing certainty to public sector workers  – this should reduce the level of excess precautionary savings. (I made this point back in January 2009 in my paper “A New Fiscal Strategy for Ireland”  –  the ideal time profile for pay cuts is to make a significant initial cut but not to pursue a sequential process of gradual pay cuts.) Since there are likely still significant pay premia for many public sector occupations, it will be important to closely monitor future public pay dynamics by reference to labour market conditions across the economy.

Public Sector Deal

The main points are summarised in this IT article.