Looking back on a unique absence of foresight

 

ANALYSIS:Even without a review of the Department of Finance, we already know that we are near bottom of the EU class in terms of best practice in national financial management, writes DAN O'BRIEN

‘ALL SOCIOLOGY is comparative sociology,” said the father of that discipline, Emile Durkheim. Much the same could be said for economics and economic policy-making.

In assessing the culpability (or otherwise) of the Department of Finance in the economy‘s violent crash landing, comparing it with its peer ministries elsewhere gives invaluable insight.

Finance ministries are at the heart of economic governance in all countries. They have, at the very least, a finger in most departmental pies, they work with central banks and they oversee quasi-autonomous agencies which regulate industries where market failure is commonplace.

But finance ministries’ most important role is budgetary: the state is by far the largest economic agent in any economy, spending vast sum on services, salaries and procurement. Its influence over the management of the public finances ranges from dominant to total (in Ireland, the Department of Finance is located at the latter end of that narrow spectrum).

Broadly speaking, two factors determine the soundness of a country’s public finances: political will and focus of governments in general, and finance ministers in particular; and robust systems and procedures on raising taxes and resource allocation.

The mix of the two differs from country to country. Germany’s political class abhors fiscal mismanagement, but its budgetary rules are mediocre. In recent times Britain has been a near mirror image. In the 1990s it put in place state of the art budget rules, but after 2001 restraint on spending was abandoned and the rules were bent when they became politically inconvenient.

Finland – the euro area economy most similar to Ireland in terms of size, structure and trade exposure to non-euro countries – has a political class which learned the lessons of its severe crisis almost 20 years ago and fully internalised the policy-making consequences of joining the euro.

Now, and despite continuing to suffer one of the deepest recessions in the EU, its budget deficit remains among the smallest of the bloc’s 27 members.

Depressingly, the behaviour of Ireland’s political class has been chalk to Finnish cheese. Here, almost without exception, politicians quickly forgot the fiscal fiasco of the 1977-87 period and embarked (or went along with) the “if-I-have-it-I’ll-spend-it” recklessness of the past decade.

This sorry history and the experiences of other countries suggest that political will is the most important factor in sound management of the public finances.

But budgetary frameworks and procedures matter too – those countries with such structures have a much better record on deficits and public debt. In this regard, how does Ireland compare with its peers, and who is culpable – politicians or officials – if systems are inadequate?

There is a vast and growing literature on how best to manage public finances so that policy objectives are met, taxpayers’ money is used efficiently and fiscal crises are avoided.

In a pre-crisis report* drawing on this literature, the European Commission came up with a detailed methodology to measure member countries’ proximity to accepted best practice. Usefully, the study ranked participating countries.

The result: Ireland’s overall arrangements were found to be the most deficient of the 19 countries which participated in the study. Second from bottom came Greece. That was in 2007. The study turned out to have considerable predictive power. In 2009, Ireland had the largest budget deficit among the EU 27 and Greece the second largest.

Most damningly, the report found a total lack of foresight capacity. One of the seven sections of the study covered prudence. There were five metrics to judge whether finance ministries had in place measures that would insulate the public finances from crisis or set warning lights flashing if one approached. Ireland not only came last among the 19 in this sub-section, uniquely, it was found not to have a single safeguard in place.

While the commission’s 2007 study was the most comparative, it was not a one-off. In 2003 the OECD devoted most of its Country Report** to needed reforms and modernisation and in 2005 the Department of Finance openly rejected an IMF*** suggestion that greater outside involvement was needed in its work.

While all of these international organisations can be accused of failing to foresee the size of the property bubble, none is guilty of missing the institutional inadequacies of the department in relation to its core function.

Who is to blame? Ultimately, and again, it is political leaders. But that does not exonerate officials, and all the more so in a political system where top-down pressure for change is unusually lacking.

Among the central questions for any investigation into the department‘s functioning must be why officials, who were all too aware of their political masters’ shortcomings, did not do more to drive change, particularly in administrative and technocratic areas with few if any political implications.

Consider, for instance, the issue of the department’s own human resources during the boom years when massive increases in spending were taking place. Why was it beyond the ambition of senior officials to take advantage of this to beef up their own capacity and bring on board the sort of expertise that any finance ministry needs in a modern economy? (This apathy appears all the more curious when one considers the huge effort and long hours many officials have put in since the onset of the crisis.)

Brian Lenihan has shown characteristic bravery in launching an investigation into the past performance of those with whom he currently works day in and day out and upon whom he depends so heavily. It will do nothing to lower stress levels in Merrion Street and can only cause – at the very least – some distraction from the daunting policy challenges ahead. But it is the way to go. There can be no lasting and fundamental improvement without it.

* The Public Finances in EMU, 2007, pages 130-145;

** Country Report, 2003, pages 25-60;

*** Article IV Staff Report, 2006, pages 15-16

Dan O’Brien is Economics Editor

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