ESRI Geary Lecture – Tim Besley, LSE

This year’s Geary Lecture will be delivered by Tim Besley, Professor of Economics and Political Science, LSE. He will speak on

“Making and Breaking Tax Systems: Institutional Foundations of the Fiscal State”

Date: Friday 19th October

Time: 4pm

Venue: ESRI, Sir John Rogerson’s Quay

Booking
Attendance at the event is free but must be pre-booked. There are a limited number of places available and early booking is encouraged. To book a place, please send details of attendee’s name, organisation and contact telephone number by email to geary@esri.ie

New issue of Administration

A new issue of the journal Administration is now available. Full details here. Some of the articles are available to non-subscribers:

Irish Governance in Crisis

In a piece in yesterday’s Sunday Business Post my colleague Dr Niamh Hardiman  makes a plea for better understanding of the roots of our current crisis in weaknesses in governance institutions. Such an understanding is a precondition for effective reform. She addresses weaknesses in parliamentary scrutiny, the capacity of the civil service for appropriate engagement over policy making, and the effectiveness of the public service itself. She highlights institutional explanations for tendencies for public policy to favour sectional interests, but argues that understanding the institutional weaknesses is the key to addressing them. The article is behind a paywall, but a fuller, multi-author examination of the issues is available in a book arising from a UCD project on governance, Irish Governance in Crisis, edited by Niamh Hardiman (Manchester University Press, 2012).

New issue/re-launch of journal Administration available

A new issue of the journal Administration is out today.

To mark the journal’s ‘re-launch’, this issue is available in full for free online here.

As many readers will know, Administration is published by the Institute of Public Administration, and has been a key locus for research-led debate on economic development, and of course on wider developments in the public sector and society, since 1953.

The current issue includes prefatory articles from the incoming editor Muiris MacCarthaigh, who `sets out his stall’, and from Tony McNamara, who has edited Administration since 1989. These will be of interest no doubt to a wide readership and to various contributor bases, (e.g., from academic, practitioner and civil society perspectives).

As the contents indicate, the focus of this issue is on public sector reform, with an opening piece by Brendan Howlin TD, Minister for Public Expenditure and Reform. I guess that Ministers historically have been uneven in how or whether they contribute to debate at this level; perhaps this is a good cue to them, and to politicians more generally, to get their quills out.

Contents
Notes from the Editors:

  • “Renewing public administration research and practice” by Muiris MacCarthaigh
  • “A final word” by Tony McNamara

Articles:


  • “Reform of the public service” by Brendan Howlin, TD
  • “Progress and pitfalls in public service reform and performance management in Ireland” by Mary Lee Rhodes & Richard Boyle
  • “Regulating everything: From mega- to meta-regulation” by Colin Scott
  • “Trust and public administration” by Geert Bouckaert
  • “The reform of public administration in Northern Ireland: a squandered opportunity?” by Colin Knox

Reviews:

  • Third report of the Organisational Review Programme
  • The challenge of change: Putting patients before providers

www.ipa.ie/administration

Failure to Regulate Regulation Could Prove Costly

My opinion piece in today’s Irish Times points out that the disbanding of the Better Regulation Unit in the Department of the Taoiseach risks reducing the capacity for effective oversight of regulatory institutions and strategies and for learning about and acting on regulatory successes and failures elsewhere in the OECD member states. A fuller policy brief on the topic, “W(h)ither Better Regulation?” is available here.

I hope there is no problem about my linking to the article I wrote.

Research Prioritisation Report

According to an Irish Times story by Dick Ahlstrom and Fiona Reddan the government has approved the report of the Research Prioritisation Steering Group in identifying 14 priority areas for state-funded research. The report itself is here.

One might hope (though probably in vain) that this would prompt some wider debate. For example, might at least some policy makers be even slightly concerned to question:


  • the merits or otherwise of an increasingly centralised model of state planning for innovation,
  • the continued privileging of scientific and technological knowledge which current policy advances,
  • the extent to which the relentless shift towards commercialisable state-funded research is in conflict with a core original rationale for this policy: namely the provision of public goods—those which are by definition not commercialisable (current policy can look a lot like socialising the costs, while privatising the benefits), and:
  • the further opportunities for rent-seeking, by both industry and academics, this sort of exercise creates and embeds, and relatedly, the high political value thereby assigned to demonstrating (by innovators, no less!) compliance with hierarchy, obedience to instructions and the uncritical acceptance of a consensus policy, aka ‘groupthink’?

Incoherent privatisation policy a cause for concern

Eoin Reeves and Dónal Palcic write in today’s Irish Times on the issue of privatisation, and they don’t pull their punches. From the piece:

Not only is there a lack of clarity about the companies to be sold and the timing of any sales, but it has also emerged that there are significant differences between the Government and the troika on the role privatisation should play in contributing to any economic recovery. These differences do not bode well in terms of making the best decisions about the future ownership of critical infrastructure industries.

At this stage, two key points of difference between the Government and the troika can be discerned. First, the drip-feed of information provided during the latest visit indicates that the troika views privatisation as a structural reform issue that should be implemented to improve the overall competitiveness of the economy. The Government, meanwhile, appears to be focused on privatisation as a means of raising exchequer revenues.

The second point of difference concerns how the proceeds from privatisation should be used. Whereas the Government wants to direct revenues towards job creation, the troika views proceeds as a means of paying down the national debt.

The troika’s view of privatisation as a tool for reducing costs and improving competitiveness is an orthodox proposition that is traditionally associated with multilateral organisations such as the International Monetary Fund but it is one that can be readily challenged.

Palcic and Reeves finish by making an important point about the dangers of short term political thinking applied to long term strategic assets. This problem is rarely discussed, as far as I can see, in Irish public policy. Hopefully we’ll see some more discussion in the comments about this problem.

Fire sale prices versus stagnation prices

The concept of “fire sale prices” is a useful one in many contexts – some examples are the October 19th 1987 US stock market crash, the LTCM crisis of 1998, and the 2007-8 US credit-liquidity crisis. In all three of these cases, security prices crashed in a particular sub-market, policymakers stepped in providing extraordinary credit-liquidity support, and eventually (quickly in the first two cases, slowly in the last) the capital market situation normalized. Unfortunately, “fire sale prices” is a useless or even harmful analytical tool for understanding the current Irish financial predicament. A better term for current conditions in Irish asset markets is stagnation prices rather than fire sale prices. Policymakers should look to Japan circa 1991 and the following two decades, rather than the USA, for a useful historical precedent. The fire sale concept gives the wrong policy guidance in the Irish situation; it is metaphorically like trying to use a fire hose to drain a swamp.


Andrei Shleifer and Robert Vishny have a series of papers exploring the use of the fire sale concept in modelling financial markets. There has been a large outpouring of papers by other authors with similar or related models, but the Shleifer and Vishny model is clear and simple and their survey is particularly good. They provide a definition:

“A fire sale is essentially a forced sale of an asset at a dislocated price…. Assets sold in fire sales can trade at prices far below value in best use, causing severe losses to sellers.”

They discuss how fire sales can cause financial and macroeconomic instability via credit and liquidity channels. In a related paper they laud US policymakers for their prompt and correct response in 2007-9 in injecting massive credit and liquidity into the markets for mortgage-related and credit-related securities caught up in the fire sale environment of 2007-9.

Fire sale mitigation policies are unusual as economic policies in that, as a rule, they should result in a net profit for the policymaker. This follows from the theory of the limits to arbitrage. This certainly seems to apply in the US case – the Federal Reserve made a trading profit of $79.3 billion in 2010 and $76.9 billion in 2011. The Fed vastly outperformed the best-performing hedge fund both years, at U.S. civil service pay rates, and without actually trying to make a profit. TARP was also profitable or near profitable, after an adjustment for the expensive but necessary bail-out of the US automobile industry. This is the nature of fire sale mitigation policies – they are about buying securities slightly below fair value and holding them temporarily on government account while injecting liquidity and credit.

The bad news is that this has near-zero relevance for Ireland. Irish asset markets are not suffering from a fire sale problem but rather from a long-horizon stagnation problem. The appropriate comparison case is not from the USA but rather Japan circa 1990. Japanese policymakers and financial institutions worked endlessly to slow the pace of adjustment, leading to an almost twenty year period of stagnation, suppressing growth and business innovation, and leaving a massive overhang of government debt. Irish asset markets need to be forced to adjust quickly and reach their new (much lower) equilibrium values with un-frozen free trading and clear, public pricing. This applies to banks, collateralized pools of debt, commercial leases, and commercial and residential property. Preventing this from happening is not preventing a “fire sale” rather it is guaranteeing a long stagnation. It could even last twenty years, as in Japan.

Another question – what is it about the US environment that gives rise to fire-sale-induced financial crises of typically short duration? Part of the answer lies in the USA lead in financial innovation. New financial innovations were key to all three fire-sale market crashes mentioned in the first paragraph of this post (portfolio insurance, statistical arbitrage, and numerous CDO innovations, respectively). High-frequency trading (the most recent big innovation) will be the likely cause of the next fire-sale-related crash, if one comes in the USA.* Ireland seems to avoid these fire-sale crashes, but is plagued instead by long-lasting periods of stagnation. Let us hope the current one is not dragged out for a decade.

………………………………………………………………………

*A post-script on HFT and the Tobin tax. After my last blogpost, Frank Barry asked me to give more details about Tobin’s use of the term “sand in the wheels” and its application in old-fashioned engineering. I do not know that much about the engineering use of sand in the wheels – I only heard Tobin discussing it in an interview. I now know that historically the sand in the wheels technique was used in the case of a metal (steel or iron) wheel aligned on a track and needing better grip, such as an old-fashioned railway wheel on a wet track. It is used for wheel-type mechanisms and not for gears with teeth. See Wikipedia for some details for those with an interest. I remember Tobin saying he was annoyed that many commentators mistook him as suggesting sabotage, and I remembered that key idea correctly. Sand in the wheels is a technique to improve, not hinder, performance.

The fiscal compact and referendum mechanisms in Ireland

The Minister for Transport, Mr Varadkar, in commenting on whether a referendum will be necessary for Ireland to sign up to the fiscal compact is reported to have made the commonplace point that

There’s only one reason why you have a referendum and that’s where there is a requirement to change the constitution.

Em, not quite.

Apart from a political view that a referendum might be desirable in any event, there is a particular mechanism in the Constitution of Ireland for holding a referendum, even when a measure does not require constitutional amendment. This is set out in Articles 27 and 47, whereby one-third of the Dáil and a majority of the Seanad could petition the President to decline to sign and promulgate a Bill “on the ground that the Bill contains a proposal of such national importance that the will of the people thereon ought to be ascertained.”

The detailed provisions of Article 27 envisage that if such a petition were successful, the will of the people could be ascertained either by referendum (in which at least one-third of those on the register would have to vote “no” in order to veto, by virtue of Article 47) or, in effect, by a general election.

I guess the fiscal compact itself may not in fact be a Bill, but presumably the detailed fiscal provisions of the agreement will have at least that legal form. Apart from whether the required numbers of TDs and Senators would line-up for the petition which Article 27 envisages, whether or not this mechanism will be applicable seems to me, as a non-lawyer, to turn on whether the Bill in question is a “Money Bill”. Money Bills appear to me to exempt from Article 27 (reading back to Articles 23 and 22) but I may be mis-reading that, so perhaps we might get some legally informed views in comments.

Ireland’s Policy Stance on a Tobin Tax

The most recent Final Conference to Save the Euro ended in disarray when the UK refused to sign up to a proposed set of EU treaty changes. The UK’s veto was due to the inclusion of an EU-wide Tobin Tax on security transactions in the set of proposals. The justification for an international Tobin Tax is quite strong. Hypercompetitive securities markets with excessively-large trading volumes and hyper-fast price changes are a serious danger to global financial stability. A Tobin Tax would eliminate these dangerous trading excesses without impinging much on underlying market efficiency. On other hand, the UK government’s refusal to sign up to an EU-only Tobin Tax, imposed on the City of London while the US and Asian global financial centres remain outside the tax net, was an obvious and sensible policy decision for the UK.

After the proposed EU treaty changes were restricted to a coalition of the willing, the Irish government fretted that a Tobin Tax might particularly disadvantage the Irish financial services industry, given that the UK will be outside the tax net.

What should be Ireland’s policy stance toward an international Tobin Tax? Should Ireland do the right thing as a global citizen by supporting such a tax within the Eurozone, or should it protect its international financial services industry from UK (and non-EU) predation and therefore veto any such tax proposal? It would be much better for all concerned if the Tobin Tax could be imposed at a global rather than EU level.

Sometime in the future, May 6th 2010 might rank with August 9th 2007 as a “warning date” for a subsequent financial market disaster. Recall that starting on August 9th 2007, quant-trading hedge funds experienced an extremely turbulent, credit-market-related meltdown. Although the quant-trading markets calmed down after about two weeks, many analysts now recognize this as an early warning signal of the subsequent global credit crisis. In an interesting parallel, on May 6th 2010, high-frequency trading systems generated a “flash crash” of US equity markets, causing a 9% fall and 9% rise of the US stock market within a 20 minute period. Some individual stock prices went bananas; completed trades at crazy prices during this short “flash crash” period were annulled that evening by the NYSE board. Since the markets righted themselves within a day or two, many analysts have forgotten about this incident. But could this “flash crash” be an early warning sign of a subsequent “permo-crash”? High frequency trading (HFT), using entirely computerized systems to trade at hyper-second frequency, now constitutes 70% of US equity and equity-related (equity baskets, futures, options) trading volume, and 30% in the UK. If HFT generates a flash-crash at the end of the trading day, rather than mid-day as on May 6th, and something else goes wrong at the same time, it could lead to an enormous disaster.

Tobin originally proposed his tax for the foreign exchange market, which was the first financial market to have hyper-competitive trading costs. He saw that most of the trading volume in forex markets provided very little economic value. A small tax would have a big influence on trading volume, rendering purely speculative and potentially destabilizing trading strategies unprofitable, while having little or no impact on the real economic value of these markets. Tobin called it “throwing sand in the wheels” of securities market trading. Nowadays, Tobin’s “sand in the wheels” metaphor is widely misunderstood. Tobin was a World War Two naval officer and throwing sand in the wheels was an accepted way to improve machine performance in his day. For mid-twentieth century machinery a little sand in the wheels would slow down the mechanism (think of something like a navy ship’s water pumps) and make for more reliable performance with less chance of overheating. With modern precision engineering the notion of “sand in the wheels” as a repair method seems ridiculous, so commentators assume Tobin is advocating sabotage of securities markets. That was not what he meant – “sand in the wheels” is an old-fashioned procedure to slow down machinery so that performance improves, not a means of sabotage. Oddly, the tax is designed to generate minimum revenue – it relies on the elasticity of trading volume to net costs, and tries to drive out destabilizing short-term trading strategies while collecting minimal tax revenue.

Now, after decades of hard-fought liberalization, US and UK equity markets have the same hyper-competitive trading costs as forex markets. HFT has hijacked this and feeds off this market cost improvement (and by earning net profits from “normal” market traders) with trading systems that add little real efficiency improvement for markets. Eliminating their net profits with a small tax would do little harm, and make markets safer. The very bright computer scientists who run these HFT firms could go back to socially useful activities like designing better software.

There is another interesting parallel to the global credit crisis. US housing regulators worked for thirty years to increase access to owner-occupied housing for lower and middle income households and this was a big success. Then, they took that policy too far, and the policy was hijacked by self-interested actors in the US property lending and securities trading sectors. There was too much of a good thing in terms of the too-low-credit-quality US residential property lending market. The same applies now with securities market trading costs and trading access. Regulators have succeeded in driving out bad securities trading practices and greatly lowering trading costs, but this process has gone too far. It has been hijacked by HFT. I call this the Too Much of a Good Thing (TMGT) theory of regulatory capture.

During the credit bubble, Ireland enthusiastically joined the dumb-down contest to impose the minimal possible regulation on the financial services sector. Perhaps now Irish policy leaders could make amends by joining the push for a Tobin Tax.

How would a Tobin tax impact the competitive draw of Dublin for its brand of “off shore” financial services? Perhaps it would be the death knell for the Irish stock exchange since all trading volume might migrate to London. Ireland policymakers should encourage a global solution, bringing the US and UK in particular into the plan. Asian markets (which are not yet competitive for HFT) might be willing to cooperate as well, since there is no great cost for them.

Economic Foundations of Irish Foreign Policy

I was asked to write this chapter for a forthcoming RIA volume on Irish foreign policy. A summary:

A country’s foreign policy is largely driven by what it perceives to be in its economic interests. That this does not provide a complete picture is evidenced by the fact that Irish development assistance has never taken the form of tied aid. Nor can the influence of powerful vested interests be discounted. A case can be made that Ireland turned protectionist again once membership of the European Union had been achieved. Agricultural and sheltered-sector interests have sought to stymie the liberalisation efforts of the WTO and the European Commission respectively. A further complicating factor is that a society’s own economic interests can occasionally be miscalculated. Joseph Lee has noted that “while the ‘political’ skills of Irish representatives in negotiating positions are widely acknowledged… there seems to be no comparable criterion for assessing the calibre of conceptualisation of the Irish case.” Irish foreign policy through the years has nevertheless recorded many successes in defending the economic interests of the citizens of the state.

The paper considers the political and economic determinants of Irish trade policy, the evolution of its inward foreign direct investment strategy, and the country’s position on international migration and on the broadening and deepening of European integration. A separate case study focuses on how successive governments have sought to defend and exploit the advantages of Ireland’s low corporation-tax regime in international negotiations.

Constitutional changes

Karl is quoted here as saying that the Franco-German proposal that we insert borrowing limits into the Irish constitution will not solve our current debt problems. This is obviously correct, as is the point that such an amendment would not have made a blind bit of difference during the bubble years.

There is also the point that a constitutional amendment is a much bigger deal in Ireland than in some other countries, since it can only be changed by means of a new referendum.

Here are two questions:

As per Derek Scally in the Irish Times, is this a taste of things to come, or much ado about nothing?

What are the chances of the Irish government winning such a referendum?

Democracy, the euro, and the nation state

This report from the Guardian is consistent with Thomas Klau’s argument that current eurozone governance arrangements are pushing “democratic debate and voters’ choices to the margins”. It also suggests that in the long run the present way of doing things will prove politically unsustainable, in a union of democratic states. Whether Klau’s preferred solution is likely to come about is another question entirely.

Coup d’état?

Shamefully, it has taken me several weeks to realise the full import of the attached Irish Times piece by Garret FitzGerald.  He has for many years sought to draw the attention of the Irish public to the role of the European Commission as defender of smaller states’ interests.  Here he warns, in much more modest language than that with which I have entitled this entry, that the current German-French proposal for euro zone reform “represents a new attempt to bypass the union’s tried and tested decision-making system… There is a new danger that the decision-making system that for over half a century has sustained and kept in balance an inherently cumbersome union… may lose its hitherto carefully preserved cohesion, and for the first time become dominated by some larger states.”

What do you mean “we”, white man?

Via the indispensable Eurointelligence, here is yet another astonishing statement by a senior German policymaker (in this case, Axel Weber):

“We have to put into the constitutions of member states a balanced budget rule of (sic) a deficit reduction rule, some way or another.”

Never were Tonto’s words so politically to the point.

Historical Origins of Ireland’s Low Corporation Tax Regime

Readers might be interested in this analysis of the (bureaucratic and electoral) politics of the introduction of export profits tax relief in 1956, available here. The abstract is as follows:

T. K. Whitaker and Seán Lemass are generally credited with effecting the policy shift from protectionism to outward orientation. Ireland’s low corporation tax regime, however, has its origins in the export profits tax relief (EPTR) measures introduced by the second inter-party government in 1956. EPTR was introduced at the behest of the Department of Industry and Commerce in the face of long-standing opposition from Revenue and the Department of Finance. Industry and Commerce at the same time successfully thwarted the desires of the Taoiseach, the Department of Finance and other state agencies to have restrictions on foreign ownership of industry repealed. These apparently contradictory positions were rooted in the historical legacy of protectionism. The inter-party Taoiseach, John A. Costello, downplayed the connection between EPTR and foreign investment in an apparent attempt to deprive Fianna Fáil of an opportunity for controversy. Its introduction hastened the end of Fianna Fáil prevarication on the issue of foreign ownership.

The importance of the intense electoral competition of the period is also frequently ignored in accounts of the policy shift towards outward orientation. Following sixteen years of unbroken Fianna Fáil rule, the next four general elections brought four changes of government. Along with the depth of the 1950s recession, this forced Fianna Fáil into a comprehensive reexamination of its industrial strategy. The economic thinking of the major political parties co-evolved, and many of the institutional innovations of the period, including the Capital Investment Advisory Committee, the Industrial Development Authority, the early Córas Tráchtála, and, of course, EPTR, were the result of inter-party government initiatives.

The defeat inflicted on Finance by the Department of Industry and Commerce partly motivated Finance’s work on Economic Development, the 1958 publication of which was important in providing political cover for Fianna Fáil’s U-turn on overall economic strategy.

“Can Europe Be Saved?” by Paul Krugman

Paul Krugman has a thoughtful survey of the Euro crisis in this week’s New York Times Magazine (forthcoming on Sunday but available on-line now).  This is not stockbroker-economist-type research, which tends to be long on buzzwords and hyperbole.  It is a well-reasoned feature-length review with some policy suggestions.  It has a central focus on Ireland and the other troubled peripheral states.

Reputation

Some blog readers have bristled at invoking reputational damage as an argument against policies such as defaulting on bank liability guarantees. I have sympathy with this reaction given the elasticity of the concept, and because it is often thrown out as a sort of argument stopper. But there is still no getting away from the fact that Irelands reputation for institutional soundness matters for both domestic and international investment. It is hard not to worry that this reputation is being damaged by some recent crisis management policies. Continue reading “Reputation”

The Red C opinion poll

We are into political economy territory bigtime now, and I don’t think economists can ignore the constraints that this may impose going forward.

So it would be wrong not to have a thread on the latest opinion poll, which shows Sinn Féin leap-frogging Fianna Fáil into third place. Pretty predictable really. Presumably the boffins from Brussels and Frankfurt have factored this sort of thing into their calculations?