Monday, 1 June 2009

An expanded comment: Paul Sweeney on Sean O Riain

Paul Sweeney: This is a thoughtful commentary on the banking crisis and what might transpire after it. At present as Sean O’Riain says, there is little serious debate on how we might, as a country, make the best out of this crisis, by radically addressing policy deficiencies especially around encouraging indigenous industry and services.

I was struck buy the third point made by Sean on state support for developing industry and services. Well, we can all say this till we are blue in the face and do things really change? For example, here is a similar comment in the final paragraph of the submission by TASC to the Industrial Policy Group, chaired by Mr O’Driscoll, way back in the heart of the boom – in October 2003:

The encouragement of FDI through low corporate profit tax rates has clearly been an important factor in Ireland’s recent economic success. However, it would be a mistake to continue to rely on this policy to the same extent in the future. Specific focus on high value added, innovative enterprises must be the mainstay of industrial policy. This includes both R&D and non-R&D innovation. How can we attract (from abroad) and encourage (from within) innovative firms? An innovation-rich environment, with universities, research institutes, state agencies all providing support, skills and knowledge, is essential. A sustained policy of investment in research is fundamental to this. In addition, quality of life issues, including housing, transport and culture, are essential to attract and keep the highly mobile qualified labour that will undertake the research and implement the innovations.

It is also worth quoting another paragraph from that same submission made a long 6 years ago! This focused on “Irish banks” DEFPA, which is now part of Hypo and collapsed gloriously.

“Among the downsides of the low tax policy is that, in order to conform to EU regulation, Ireland has had to apply this (low tax) policy across the board. This has made it impossible to adopt a strategically selective policy in relation to corporate tax rates. It has also reduced the revenue from indigenous firms’ tax payments. Moreover, the very success of the low tax policy in some instances, for example the IFSC, has engendered intense criticism from such significant European partners as Germany. This is not surprising, seeing as the single largest block of funds managed at the IFSC is from Germany. It cannot have escaped the attention of the German Finance ministry that the largest bank in Ireland (DEPFA bank) is in effect a German bank which, although its main operation is in Germany, has its ‘headquarters’ in the IFSC".

During TASC’s oral submission, made by Jim Stewart and myself, I pointed out the myriad of subsidies to property investors in tax breaks and warned of the likely (!) property bubble bursting. One of the members, who knew me, said that I had been saying that there was a property bubble for two years. I reiterated that there was a bubble and that it was state inflated with pro-cyclical tax cutting policies and subsidies.

On Sean’s fifth point on regulation reform, don’t hold your breath. The defenders of the status quo are already out in force against reform, in the Business pages of the Irish Times. My good colleague Pat McArdle wrote a stirring piece against rules based regulatory reform in the weekly Economics section, last Friday, arguing that all we need to do is implement existing regulation. He has a point, but would enforcement be adequate? He, like many in finance, are against enforceable “rules based” regulation favouring the supposed alternative of very light (so light it is often non-existent) principles based regulation. In a rules-based system, the state and regulators prescribe in some detail what companies must and must not do to meet their obligations to shareholders, clients and us suckers – the taxpayers, who bail ‘em out! In the principles-based systems, regulators worry less about details, and instead look at companies’ behavior according to broad principles. The U.K.’s Financial Services Authority has eleven such principles, which are often deliberately vague. For example “A firm must observe proper standards of market conduct.” We know where that got banking!

Pat is the economist with Ulster Bank and a member of the Financial Services Consultative Industry Panel. By pure coincidence, the Chairman of that august body, David Went, (formerly CEO of IL&P who built the former state Assurance company up with that takeover of Irish Permanent) was quoted in the business pages of the same Irish Times, the following day, as saying we must avoid “a one size fits all” approach of bank regulation. (I should say that I had a piece in the main pages of the Irish Times a few weeks earlier arguing for the radical reform of corporate governance and regulation). Mr Went again raised the issue of rules based or principles based regulation, while not apparently taking sides. But he was firmly against nationalisation of the banks as it would not be “good for the industry”!

But, in a 2005 submission to the Dept of Finance, the Panel said “The Industry Panel believes that enabling, principles-based primary legislation, combined with an appropriate process/structure operating under the aegis of the Department of Finance at the “newly constituted” secondary level, would be a more effective option”. This body is an advisor to the failed Financial Services Regulator, perhaps the costliest public sector failure ever in modern Irish history. It appears to be dominated by the same guys who captured the Regulator! In fact, the panel was described as "industry insiders" by Labour Finance spokesperson Joan Burton TD, who called for the panel to be scrapped as part of an overhaul of the system.

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