Two reports clearly show this Government's economic policies for the shambles they were, writes GARRET FITZGERALD
THE TERMS of reference for the “scoping” banking enquiry undertaken by Central Bank governor Patrick Honohan concentrated upon the “conduct of the sector” whilst leaving it open to him to include any matter that he felt should be brought to the Minister’s attention.
For their part, Messrs Regling and Watson had a wider brief: “to thoroughly examine how events in the banking sector, the regulatory system, and the wider Government sphere of responsibility contributed to the crisis”.
In his report, Patrick Honohan has critical comment on the Financial Stability Reports published as part of the Department of Finance’s annual budget documentation, as well as on the way in which “deference and diffidence” on the part of the institution that he now heads led to “insufficient decisive action or even clear and pointed warnings” from that source.
He also says that there should have been more consultation with authorities abroad, and he questions the Government’s subsequent decision to leave senior management of the banks in place. But for the most part he rightly concentrates his attention on banking and regulatory issues.
More than one-third of the Regling-Watson report is devoted to what its authors describe as the “macro-economic setting”, involving government actions earlier in this decade affecting the competitiveness of our economy – well before the housing bubble and banking crisis.
It points out that from the late 1990s wage settlements accelerated markedly, with compensation per employee increasing at a rate two to three times the euro zone average. Competitiveness deteriorated significantly, and the growth rate of public expenditures also accelerated to the highest pace among the developed world. Ireland also lost market share in international trade.
The report confirms that Ireland was right to adopt the single currency by joining the EMU. Had we not done so, the funding problems of the banks would, it says, have become much worse. Euro-zone participation has been highly beneficial for Ireland. For, without European Monetary Union, European currency markets would have been in turmoil in 2008/2009. Funding problems for the banking sector would have been much bigger, and households and firms would have borrowed more in foreign currencies – leaving the latter exposed to balance sheet risks.
For Ireland, EMU membership has been highly beneficial, but unfortunately, after the EMU was established, available policy instruments such as budgetary policy, bank regulation and income policy were not used by the government to offset the expansionary effects of membership of a low-interest rate zone, but instead were used in a way that, the report says, “actually fuelled the fire”.
This was the result of both public expenditure and revenue developments. Expenditure increases were particularly marked in 2006 and 2007, (when Taoiseach Brian Cowen was minister for finance).
The report goes on to point out that during this period, public sector pay and the growing size of the civil service contributed particularly strongly to the increase in current expenditure. The number of staff in the Irish public sector grew by 15.5 per cent from 2001 to 2008.
But, add the authors, developments on the revenue side were even more worrying. The composition of tax revenue had changed dramatically from the 1990s, shifting from stable sources of taxation such as personal income tax and VAT/excise taxes, to taxes such as corporation tax, stamp duty and capital gains tax.
Why did that happen?
First and most importantly, says the report, although beneficial in its early stages, the linking of tax cuts with wage restraint eventually narrowed the tax base and made it more fragile, owing to the fact that the “booming” part of the revenue turned out to be a transitional phenomenon.
Next, Ireland is one of very few countries where there is no property tax, and where at the same time payments on mortgages can be deducted from income taxation. Finally, our tax system includes a large number of tax allowances, exemptions and reliefs.
The authors say this proved to be “an Achilles heel of policy analysis” which made it very difficult to estimate the state of the economy. In the face of this, they say, “the economic analysis resources of the Department of Finance deserve to be strengthened”.
They add that the introduction of independent institutional sources for economic and fiscal projections would appear useful, and it would be helpful to explore the use of a domestic fiscal rule, such as a medium-term expenditure ceiling, to supplement the EU Stability and Growth Pact.
Although this analysis may be carefully worded, it is in fact a quite devastating indictment of almost every aspect of the government’s economic and fiscal policy between 1999 and 2007.
True, little in it will be unfamiliar to the readers of this less-elegantly written column since 2002. But, until now, the crucial government policy issues raised in this report were almost totally ignored by the media.
It is important that the record of a decade of policy failure and mismanagement that left us hugely vulnerable to the banking crisis, ruined our competitiveness and lost us one-fifth of our exports has finally been exposed in the most authoritative way.