Even before the crisis, our volatility was more in the range of emerging economies, writes ASHOKA MODY
IRELAND IS a rich country and despite the recent setback, the economy will continue to provide a high standard of living to the vast majority of Irish citizens. But unlike other countries that have reached this high level of income, the Irish economy is subject to a high degree of volatility. Even before the Great Recession exposed serious cracks in the economic structure and led to a precipitous fall in output, Ireland’s GDP volatility was more in the range of emerging economies than of advanced nations.
During the miracle years, Irish economic performance was facilitated by a relatively small, effective and entrepreneurial bureaucracy that grasped the mood of the time and Ireland’s place in the global economy. Foreign investment-driven growth required simple rules and a business-friendly environment, both delivered in a commendable manner.
But as the miracle years faded – leaving in their wake a property and credit-fuelled boom to prop up the economy – Ireland failed to maintain the pace of institutional development needed to sustain and nurture sophisticated economies. As governor of the Central Bank, Patrick Honohan has candidly documented, regulatory and supervisory oversight of the banking sector failed to respond to the emerging needs. It is time, then, for Ireland to establish a new generation of institutions to match the complexity and sophistication of its economy. These are needed to anticipate risks and, where risks do materialise, to deal with them flexibly and in the least costly manner. Such tools and checks and balances are required especially in the financial and fiscal domains. In that regard, the new and more proactive supervisory and regulatory processes are a major step in the right direction, moving to forcefully correct past deficiencies. Noteworthy is the greater attention to the governance of banks. To be successful, the regulator will, however, require enhanced resources and enforcement powers to deliver his end of the bargain. But more must be done. One regulatory enforcement tool that needs early attention is the institution of a special regime for bank resolution. At the start of this global crisis, the importance of such a regime was not well recognised. That is no longer the case. Many countries are instituting the legal basis and procedures to allow for preemptive action to arrest the slide of failing banks with due regard to the disruption arising from their systemic importance. In Ireland, the issue has not received the priority it deserves. Such special regimes require making complex choices, particularly where there are concerns about their constitutionality. The experience is that careful legal drafting should protect legitimate private property interests while providing for greater financial stability.
The other area that got out of hand, at least in retrospect, was the management of fiscal risks. In particular, the risks of temporary property-related revenues were insufficiently recognised.
Again, Ireland needs to be guided by international trends. That trend is to adopt fiscal benchmarks and supporting rules, along with a technical voice in the form of “fiscal councils” to evaluate budgetary risks. Like all institutions, these do not work perfectly. But pragmatic approaches are possible. Benchmarks act as public guideposts for fiscal discipline and the associated rules create mechanisms that give priority to longer-term economic and fiscal sustainability goals over short-term political considerations. Fiscal councils can sound the alarm bells at an early stage, and this will be taken more seriously than concerns expressed by outsiders. This is a moment of great challenge for Ireland. In the circumstances, it may be tempting to place such longer-term institutional strengthening on the back burner, while focusing on the here and now. But that would be an easy pass. Ireland can only navigate the present by retaining the credibility acquired from its firefighting actions, undertaken with speed and boldness. That credibility will be reinforced as Ireland creates checks and balances within its decision-making structure to minimise risks of future missteps. In turn, that should reduce Ireland’s growth volatility and, as the economy recovers, put it on a path to rising and steadier income and employment.
Ashoka Mody is assistant director in the European department of the International Monetary Fund