The debate on bank nationalisation on this site and elsewhere has been taking place at an impressively high level. Owing to the efforts of Karl and others, we stand a much better chance of having a rational banking policy. Yet I can’t help being puzzled at the depth and breadth of the support for nationalisation from so many leading economists. I have no doubt that this support for the state ownership of such a critical sector of the economy is not a position easily come to. What has led so many liberal-leaning economists to support nationalisation?
As best I can read it, there is a huge fear of government failure at one level, and a relatively relaxed attitude to failure at another. The driving fear – indeed prediction – is NAMA will significantly overpay for bank assets, imposing a potentially huge cost on taxpayers. On the other hand, while advocates of nationalisation are well aware of the dangers of politicised credit allocation, I think it is fair to say they believe we can devise institutions that would allow arms-length control and speedy re-privatisation.
I weigh the risks of these two forms of potential government failure differently. On the overpayment risk, a critical achievement of the debate so far is to shine a searchlight on the danger. With this danger firmly in mind, it should be possible to devise effective and transparent mechanisms for determining and paying expected value. Innovative mechanisms – such as Patrick Honohan’s idea to combine lower direct payments with shares in NAMA – can help attenuate overpayment bias and reduce risk to the taxpayer. Bottom line: I think this risk is manageable with due attention.
I am more worried about the danger of a politicised credit system – even with politicians having the best of intentions going into their new roles. On my reading, the international evidence on bank ownership and performance raises a huge cautionary flag. (A good survey is: William Megginson (2005), “The Economics of Bank Privatization,” Journal of Banking and Finance, 29, 1931-80; working paper version here). While recognising that selective quotations do not prove a point, I think the following from another paper by Andrei Shleifer and co-authors gives a good sense of the danger:
A government can participate in the financing of firms in a variety of ways: it can provide subsidies directly, it can encourage private banks through regulation and suasion to lend to politically desirable projects, or it can own financial institutions, completely or partially, itself. The advantage of owning banks–as opposed to regulating or owning all projects outright–is that ownership allows the government extensive control over the choice of projects bieng financed while leaving the implementation of these projects to the private sector. Ownership of banks thus promotes the government’s goals in both the “development” and “political” theories.
. . .
We find that higher government ownership of banks is associated with slower subsequent development of the finanical system, lower economic growth, and, in particular, lower growth of productivity. These results, and particularly the finding of low productivity growth in countries with high government ownership of banks, are broadly supportive of the political view of the effects of government interference in markets (LaPorta, Rafael, Florencio Lopez-de-Silanes, and Andrei Shleifer (2002), “Government Ownership of Banks,” Journal of Finance, 57(1), 265-301).
Perhaps paradoxically, the danger of politically directed lending is increased by the compelling rationale for a co-ordinated expansion in credit that nationalisation could facilitate. Lucien Bebchuck and Itay Goldstein do a good job outlining the basic co-ordination failure and rationale for intervention. The basic idea is that the creditworthiness of firms increases with a broad expansion in credit given interdependencies in the profitability of investment projects. A coordinated credit expansion can then shift the economy from a bad (low creditworthiness, low credit) equilibrium to a good (high creditworthiness, high credit) equilibrium. Nationalised banks would certainly be in a good position to solve the coordination problem. But such directed lending is likely to be the thin end of the wedge to a more pervasive politician-directed credit allocation system. I think the long-run costs would be lower with a coordinated expansion achieved through transparent fiscal instruments.
The ease with which the government has come to direct the investment strategy of the National Pension Reserve Fund provides a useful warning. As reported recently by the National Treasury Management Agency, investments “under the direction of the Minister for Finance” now account for 23.4 percent of the total fund (and that only includes investments in the preference shares of Bank of Ireland). Here again there is a rationale for the government’s direction (though I believe it is a weak one given that international bond markets are still very much open for Irish debt). But any semblance of arms-length governance is thoroughly shot – with as far as I can tell barely a whimper from economists.
Two final brief points relating to majority government ownership (the most likely alternative to full nationalisation):
First, in their Irish Times piece the proponents of nationalisation worry that the government would leave the banks undercapitalised under majority government ownership. Under nationalisation, they see the government having a strong incentive to recapitalise the bank to maximise divestiture value. However, given the government will eventually want to divest itself under both majority share ownership and nationalisation, I do not see why the incentive to recapitalise is weaker under the majority ownership option.
Finally, it is reasonable to question whether the risk of politicisation is any less under majority government ownership than under full nationalisation. However, a key focus of work on politicisation has been on cost to politicians in exercising control. The transparency and governance institutions of a publicly traded company should make it more costly for politicians to direct the banks’ credit allocation for political ends.