Tuesday, March 1, 2011

Review of Dept. of Finance - Damning

The review report assessing the policy advice and performance of the Dept. of Finance has just been released. While it does not tell us anything new, it is still a damning indictment of successive governments and highlights serious gaps in ability and processes. Here are some conclusions:

In virtually all countries, responsibility for monetary policy is delegated to a Central Bank that is independent of the political process. This occurs because it has proven to be virtually impossible for the political process in any democracy to sanction explicitly action to restrain economic growth early enough in the business cycle to avoid dangerous overheating of the economy.As a relatively small nation now within a large monetary union, the Irish Central Bank has fewer tools available to constrain monetary conditions. This puts much more onus on fiscal policy to constrain spending and tax expenditures to levels that are sustainable from the underlying growth of the economy.

5.2 Ireland failed this test of prudent fiscal management.
... in recovery from its current circumstance, the country must constrain its ambitions for Government supports to sustainable levels.

5.4 We believe that Government must substantially improve budgetary processes, enhance ministerial accountability to parliament and publicly release substantially more departmental analysis for public consultation.

5.5 The Department needs to be more effective and needs to remake itself. This requires a series of changes of structure, professional capacity and internal working methods, together with a more outward looking attitude. These issues need to be addressed urgently.

Some interesting points from the report:
Generally speaking, we found that advice prepared by the Department for Cabinet did provide clear warnings on the risks of pro-cyclical fiscal action. These views were signed-off by the Finance Ministers of the day who would submit the Memoranda to Cabinet.

... a very poor budgetary process obscured ministerial and Government accountability to Parliament, and was overwhelmed by other spending processes – Programmes for Government and Social Partnership. Second, while departmental advice in June was generally appropriate, we have a number of observations as to how departmental advice could have been more effective over the entire budgetary cycle.

Economic overheating, along with the Social Partnership Process, led to a major deterioration in competitiveness in the Private Sector and to very high Public Service wages, especially relative to international partners. Primary School teacher salaries, for example, rose from seventh of ten countries in
the OECD comparator group in 2002 to third, behind only Germany and Switzerland by 2008.

Over the ten year period of review, the Programme for Government and Social Partnership Processes helped overwhelm the Budget process. Instead of providing an appropriate fiscal framework for prioritisation of competing demands on the Government’s overall agenda, the Budget essentially paid the bills for these dominant processes.

In the current budgetary process, the period for public dialogue on economic and fiscal challenges facing the economy is far too short. Departmental advice on the economic outlook and sectoral challenges, for example, should be subject to more public and external scrutiny before Budgets are finalised

Given the record of advice and concern on pro-cyclical fiscal policy in the Department, a forecast scenario of a major correction could have been very informative, in retrospect. An improved budgetary process overall would also strengthen the forecasting function.

Had departmental and ministerial advice to Cabinet at the start of the budgetary cycle been accepted and sustained, Ireland would have been better positioned to deal with the current economic challenges. We have reviewed some systemic reasons for this failure. The Department should have done more to avoid this outcome. It should have adapted its advice in tone and urgency after a number of years of fiscal complacency. It should have been more sensitive to, and provided specific advice on, broader macroeconomic risks. And it should have shown more initiative in making these points and in its advice on the construction boom and tax policy generally.

The Department did not adapt the tone of its advice against pro-cyclical action over time....after several years of fiscal action well above that clearly recommended by the Department, one would have expected the tone, and shape, of advice on the risks of this path to increase vigorously. We would have expected more initiative to make these points in new ways. This did not happen.

The lack of a coherent record of budgetary advice represents a major shortcoming in the systems of the Department of Finance.

The Department paid insufficient attention to broader macro-economic risks. While suitably direct on the risks of excessive spending and tax relief, annual departmental advice to Cabinet generally did not consider the broader set of macroeconomic risks. It did not, for example, consider the risks related to the extraordinarily expansive monetary conditions, which substantially heightened the risks of pro-cyclical fiscal action identified by the Department. This too, represents a significant deficiency. In part, this was due to
insufficient oversight of the various agencies tasked with contributing to Ireland’s financial stability. It was also due, at least in part, to a shortage of highly-trained economists and financial market experts in the Department. The Department also appeared to have had too limited a view of its own responsibilities to monitor the comprehensive set of macroeconomic risks to Ireland.

A key lesson from Ireland’s recent banking regulatory failure was that the Department needs to be enabled, and clearly accountable, to report on broader risks to the economy. This must include new activities such as NAMA. The role of the Department would not be to manage this initiative but to be in a position to assess and report on systemic risk.

... the Department did provide advice on the risks of on overheated construction sector as far back as 1999. The Department’s assessments of the risks from the Irish housing bubble were at least as strong as any public analysis over the period.
Despite repeated expressions of concern over the construction sector in Budget Memoranda to Cabinet and elsewhere, the Department did not organise a strategic response to the problem, or identify a full range of options to moderate activity in the sector. The Department also lacked coherence across its divisions in dealing with the issue. An example of this was the Department’s response to concerns elsewhere in Government, and in some areas of the banking sector, about the introduction of 100 percent mortgages. Admittedly, the Department would have had a hard time fighting 100 percent mortgages given the Government’s strong concern about home affordability for first-time buyers. Once the Financial Regulator, who is accountable for such authorisations, declared himself to be fully satisfied with the introduction of these instruments, the Department stopped considering the issue. This was an opportunity lost.

... the Department was very clear on the risks to the Exchequer of a downturn in the construction sector, providing specific estimates of the fiscal risks, and clear advice on the dangers of relying on related tax revenues.

3.9.2 However, there was no analysis or advice on the broader risk to the tax system from a more general downturn in economic activity from levels created in part by pro-cyclical fiscal policy. This lack of policy initiative is again disappointing, given the very active tax agenda of the Government over the last ten years.

.... the Department:

• does not have critical mass in areas where technical economic skills are required;
• has too many generalists in positions requiring technical economic and other skills;
• is more numbers driven than strategic;
• does not have sufficient engagement with the broader economic community in Ireland;
• often operates in silos, with limited information sharing;
• is poorly structured in a number of areas, including at the senior management level; and
• is poor on Human Resources Management.

... progress on Public Service Modernisation generally has been very disappointing. The Department of Finance must bear its share of the responsibility for this. The Department has not prioritised Public Service Modernisation, and has devoted limited resources to the area.

4.5.2 The Irish Public Service confronts much greater rigidity in managing change than do other EU and OECD countries. During the Celtic Tiger years, with an abundance of resources, the need to improve the efficiency of the public service was not as clearly seen as a priority as it is now.

... we believe the top priority should be to strengthen the core functions of the Department of Finance. This will be a major undertaking.
A substantially improved budgetary process that would enhance ministerial accountability to Parliament, as recommended above, would in our view be more effective than the creation of new agencies of Parliament. Resources to enhance economic analysis could be more effective if assigned to the Department of Finance than to new agencies.

In its cadre of 542 staff, the Department has only 39 economists trained to Masters level or higher. Many of these individuals are public servants of the highest calibre and excellent practitioners of applied economics.

... 39 economists in the Department of Finance is extraordinarily low by international standards. Even excluding the public service cadre of 135 people, this represents less than 10 percent of the total staff complement in the core of Finance. In contrast, 60 percent of the Canadian Department of Finance are economists trained to Masters level or higher; and about 40% of staff in the core areas of the Dutch Finance
Ministry are trained to Masters level or higher.