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Why no one shouted stop

Rory O’Donnell

Policy Failures and the Irish Economic Crisis, by Ciarán Michael Casey, Palgrave Macmillan, 258 pp, €59.77, ISBN: 978-3030079543

This valuable book argues that although there is a strong consensus about what happened to the Irish economy in the crisis that began in 2008, and the systemic weaknesses that left it so exposed, there has not yet been a detailed analysis of the discourse on the economy in the years preceding the crash. In seeking to address this deficit, Ciarán Casey argues that the key questions yet to be fully answered include: why were most commentators so unaware of the scale of the risks to the Irish economy? what was distinctive about the analysis conducted by those who warned about systemic threats? did the newspapers intentionally downplay the risks to the property market and the economy? what role did academics and politicians play in the discourse? and, was the Irish crash ultimately attributable to poor policy, flawed analysis or both?

The book examines the economic analysis and commentary by key international organisations (such as the IMF and the OECD), by domestic institutions (such as the Central Bank and the ESRI), by researchers in academia, in the newspapers and in politics, particularly in Dáil Éireann. This allows the author to examine the linkages and intellectual dependencies between these institutions, as well as their structural limitations. Indeed, Casey argues that “these core institutional shortcomings remain essentially intact, and some are so systemic that nothing short of radical restructuring will address them. The relatively modest reforms implemented since the crisis have been entirely insufficient.” If this is so, those concerned about Ireland’s future will be keen to hear, and engage with, whatever radical restructuring Casey’ suggests.

His clear and well-written analysis opens with a broad overview of the elements of what he calls the “Irish depression”, noting the official reports commissioned by the Irish government (the Honohan, Nyberg, Regling and Watson and Wright reports), and the existing explanations ‑ including behavioural, ideological, political and institutional. He includes here a useful summary of the history of asset bubbles and financial crises, emphasising two main points. First, asset price bubbles and bursts are a long-standing, and have been particularly common, feature of the international economy in the twenty years from 1980 to 2000. Second, perhaps their most important characteristic ‑ indeed, a condition for a bubble ‑ is that those involved believe that the world has somehow changed, that the economy has become more stable, and that the old rules of valuation are no longer relevant.

A strength of the book is that Casey resists the easy generalisations and accusations that characterise much of the commentary on the Irish crisis and recovery. Indeed, he makes many interesting and subtle observations on the factors that tended to deflect attention from the vulnerability of the banking and housing systems, or to reduce the impact of the few analyses and commentaries that warned of the danger of a crash. A few examples will illustrate.

The temptation to attribute Ireland’s acute crisis to greater moral or intellectual failings on the part of bankers, politicians and regulators than those exhibited by their counterparts elsewhere is, he suggests, to succumb to a vein of Irish exceptionalism that is not particularly helpful. The credit boom followed a decade of genuinely exceptional performance. Commentators and policy-makers had grown accustomed to high growth rates, and this helped to mask the extent of the problem.

The Irish financial regulatory institutions were established in the light of scandals, and proceeded to adopt a greater focus on consumer protection than macro-prudential stability.

The book contains a very interesting, and largely persuasive, account of the way in which the effort to understand the changes in the Irish economy in the period from 1993 to the early 2000s had the effect of camouflaging the build-up of unsustainable trends. The radical changes in the economy also made it more difficult to tell the wood from the trees in recognising what was temporary or unjustifiable. Rising incomes and falling interest rates were used to rationalise the abandonment of long-standing methods of housing valuation. The collapse of Telecom shares after privatisation reinforced the belief that investment in property was superior to investment in equities. Although the Irish agencies, such as the Central Bank and the Department of Finance, were certainly short of expert staff, “a number of countries with large teams of highly trained economists showed comparable complacency at the same time”. In the long debate on whether Ireland should join the euro, “what received conspicuously little attention was the enormous impact that EMU membership could have on credit flows within Europe”.

This “charitable” approach means that when Casey does point the finger, his criticisms are all the more telling. Notwithstanding the poor institutional design and political signals, the financial regulator failed egregiously in not recognising and acting on the credit explosion in the Irish banks. In politics, Charlie McCreevy, as well as his allies in the PDs, come particularly badly out of Casey’s account and this confirms my sense that history will not be kind to the former finance minister.

Likewise, he shows how a range of financial sector economists, writing in Irish newspapers, not only predicted a soft rather than a hard landing but often asserted there would be no landing at all. In his excellent chapter on the newspapers, be discusses whether their commentary reflected bad faith or “misplaced conviction”. He convincingly critiques the argument of Julien Mercille of DCU that the newspapers’ coverage is explained by the interests of their owners. This allows him offer a more forensic assessment of the ways in which newspaper managers and editors did fail.

A great strength of the book is that Casey goes into considerable technical detail in assessing the methods and models used by economists in the years between 2000 and 2008. In the case of the international organisations, like the IMF and OECD, he shows how, as early as 2000, they presented general papers outlining the frequency of financial and housing bubbles but still misread the degree of risk in the Irish economy. ‘”Both organisations ... came to the brink, but shied away from making the conclusions that their highly-commendable studies of historical precedent demanded”. Casey sums up his thoughtful discussion noting that “We cannot definitely know the reasons for this, but political and market sensitivities were potentially just as important as analytical failures.” In addition, the international organisations were keen to present Ireland as a poster child of what could be achieved by adopting what they considered to be “good policies”. The tone of the international commentary was all the more significant, because Irish ministers then cited the IMF in seeking to rebut arguments presented by the opposition and critics. As he notes, this raises difficult questions about how analysis should be presented and used in sensitive, live, political and economic conjunctures ‑ questions on which he offers some interesting suggestions.

He also makes a telling point in distinguishing between the technical issues on which international organisations like the IMF and OECD should properly offer advice (but partly failed to), and other areas which belong in domestic politics (on which they expounded too freely). The advice on keeping spending increases under control was entirely warranted, and unsustainable spending commitments were a key factor in the ensuing malaise of the Exchequer. “However, recommendations from the international agencies about redistributive issues like optimal social welfare levels or tax rates arguably constituted an encroachment from notionally objective economic analysis and advice into subjective opinion about preferred political-economic approaches.” Such advice “was based on strikingly little empirical evidence or research, and it marked a discernible shift into the realm of ideology and conjecture”.

In assessing the work of various agencies and economists Casey tends to narrow the question: “was a collapse of housing output predicted?” and, sometimes even, “what scale of contraction was envisaged?” The book is based on his PhD research at Oxford; and it is understandable that the focus has to be narrow to make the problem tractable. But his frequent reversion to this narrow question, in the context of a generally thoughtful account of wider strands of economic discourse, does, in my view, create a number of imbalances and tensions in the text.

Thus, really thoughtful papers by Philip Lane on the way in which the boom was eroding the social consensus that had been fundamental in maintaining wage moderation, published as early as 1999 and 2003, are criticised for not anticipating the collapse of the construction sector and thereby “decisively underappreciated the scale of the problem”. But fairly formulaic calls for an annual property tax are lauded excessively.

This prompts both a methodological and a substantive worry. Methodologically, Casey’s view on economic prediction is somewhat unclear. He draws on the work of Tetlock and Taleb and suggests that the fact that almost nobody successfully anticipated the nature and scale of the crash is probably in keeping with what we should expect. But a few pages later he says of several economists “they had access to all the relevant data but failed to predict the crash because they had strong preconceptions about the likelihood of a deep recession happening in a country like Ireland”.

The substantive puzzle relates to housing, housing analysis and housing policy. Casey brings a sophisticated version of housing market analysis to bear, but doesn’t take it quite far enough. He endorses Shiller’s view on the way home prices go through a series of long boom and bust cycles, and even cites Shiller’s inference that there is no definitive way of calculating what the fundamental value of residential property should be. He notes several times the difficulty in assessing the extent of deviation of Irish prices from fundamentals: “There was no discernible moment at which the drivers of Irish growth changed, or house prices became unambiguously detached from the fundamentals.” And, as regards housing policy, he attributes too much potential to annual property taxes and taxing back the increase in land values, reforms which he describes as “best practice” and “structurally transformative”. A property or site value tax would certainly have helped to dampen the Irish housing market and remains a good idea. But much more would have been necessary to generate appropriate housing supply in the main cities and achieve housing affordability. Put another way, there are more pathologies in housing markets than booms and busts ‑ lack of affordability and insecurity being two enduring ills in a system reliant primarily on the market. Indeed Casey would seem to agree with this. After a strong emphasis in his first six chapters on economists’ (too intermittent) calls for a property tax, in Chapter 7, on politics, he strongly endorses the proposals on active land management in the 1974 Kenny report. This is correct, but widens the focus beyond economic prediction and market analysis.

Indeed, the linked issues of active land management, urban development, social housing provision and the need for a wider housing affordability policy through cost rental were analysed in great detail in NESC’s 2004 report Housing in Ireland: Policy and Performance. (Full disclosure, I was involved in that study and subsequent NESC work on housing.) In setting out his methodology, Casey notes that he examined the NESC publications from the period, but found that they “added little in the way of new analysis or prediction about how the boom would end”. But if we widen the focus beyond prediction of a bust, to include reforms that would have greatly lessened the need for an overheated housing market, then other work becomes relevant. NESC’s 2004 housing report offered a detailed analysis of the evolution of the imbalances in the Irish housing system and presented recommendations on how to achieve appropriate supply and affordability. Indeed this included analysis of why most economists’ confident advocacy of simply taxing back windfall gains in land value, based on the idea of a fixed supply of land, is not as good an idea as it seems ‑ even though it is ethically justifiable. Given the features of the land market and housing industry, the task of engineering the provision of quality affordable housing requires public institutions to actively lead urban development ‑ ideas further elaborated in NESC’s recent report Urban Development Land, Housing and Infrastructure: Fixing Ireland’s Broken System (2018).

Ciarán Casey’s book is a valuable contribution and should be actively discussed in several spheres. First, it is one of the few Irish contributions to the growing literature on the relationship between knowledge and policy. His forensic analysis of the economic discourse in the period 2000 to 2008 makes uncomfortable reading for all of us who were involved in policy analysis at that time. While it is an indispensible input to a discussion of the policy analyst’s role, it does not fully resolve the issues concerning the wisdom of simply asserting more strongly the results of analysis and the limits of existing policy. Beyond predictions of economic crash, which are thankfully rare, policy analysts face subtle day-to-day questions about how best to present their work and engage with policy actors.

Second, it is a valuable contribution to discussion of housing policy, and should be considered by all grappling with the current challenges of housing supply and affordability.

Third, it is immensely relevant to Ireland’s political economy. Casey’s book makes clear that, whatever the strengths and weaknesses of analysis, it was politics and policy that were decisive in the end. Through his careful sifting of a huge amount of material, he has sharpened our understanding of what was known and what was opaque, what was noted and what was ignored. In it 2010 report The Euro: an Irish Perspective, the NESC suggested that while some things were uncertain in the years before the crash (for example the temporary versus permanent elements of GDP and revenue growth, and the timing of the end of the housing boom), other, closely related issues we unresolved. The technical uncertainties interacted with, and partly reflected lack of agreement on key dimensions of Ireland’s political economy. These included the scale of the public sector, the level of taxation and the best way of meeting housing need. Consequently, the lessons of Ireland’s experience include not only better fiscal management and financial regulation, and a greater role for independent analysis such as that provided Irish Fiscal Advisory Council, but also “more thorough resolution of the distributional tensions and structural weaknesses that tend to create pressure for pro-cyclical fiscal policy and, indeed, crowd out clear analysis of the macroeconomic context” (NESC, 2010). Ciarán Casey’s valuable book also points, in the end, to politics and political economy.

1/10/2019

Rory O'Donnell was Economist and later Director of the National Economic and Social Council (NESC). He played a role in crafting the analytical foundations of social partnership and undertook analysis aimed at creating a shared understanding of a wide range of economic, social and sustainability issues.  

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