Mr. David Begg:

Well, thanks very much, Mr. Chairman and members of the committee. I understand that I've been asked to give evidence to the inquiry by virtue of my roles as non-executive director of the Central Bank and as General Secretary of the Irish Congress of Trade Unions. As you know, Chairman, the regulatory regime was altered radically as a result of the Central Bank and Financial Services Authority of Ireland Act 2003, which amended the original Central Bank Act of 1942. It established the Irish Financial Services Regulatory Authority as an autonomous entity and it was given responsibility for prudential regulation. The powers formerly held by the Central Bank for the regulation and supervision of the financial institutions were transferred to the regulatory authority under section 33C of the new Act. The Central Bank was left with residual responsibility for stability of the financial system and various functions related to the European system of central banks. Henceforth, the regulator was accountable to the Oireachtas and communicated directly with the Department of Finance. The regulator also published a separate annual report.

The Central Bank was opposed to the changes, as they would essentially interdict the line of sight between financial stability and the soundness of the banks. My personal view supported this evaluation and I also felt that the change was, to some extent at least, motivated by ideological considerations. I was involved with the Governor and other board members in making representations to the Minister for Finance about it. And, clearly, the 2008 crisis exposed the institutional flaws in this structure and it was reversed, as you know. With the enactment of the Central Bank and Financial Services Authority of Ireland Act in 2003, I was reappointed to the board of the Central Bank but not to the authority. Thus, I had no further involvement in supervision or regulation of the banks.

This change coincided with the advent of EMU, the financialisation of the global economy, a sea change in the volumes of financial transactions and the emergence of shadow banking. One consequence of the liberalisation of capital markets was that large financial flows looking for investment outlets contributed to keeping real interest rates low worldwide. The abundance of liquidity and low interest rates encouraged financial institutions and asset holders to try to increase the rate of return on their portfolios by increased leverage at the cost of higher risks. The global financial crisis emanated from the conjunction of widespread financial fragility and a lopsided globalisation process proceeding rapidly amidst large financial imbalances. A principles-based regulatory system was unsuitable for these circumstances, and the problem was compounded in the Irish case by competitive pressures associated with the presence of foreign banks regulated from outside the jurisdiction and also a remit to promote the financial services industry. In a sense, it was like trying to control a blaze with a mixture of both water and oil.

It is manifestly the case now that supervision was neither effective nor appropriate but principle-based or light-touch regulation was not exclusively an Irish phenomenon. It was derived from the ideas governing regulation generally in Europe and, indeed, internationally. Almost certainly, the regulator subscribed to those ideas but did not originate them. It is worth recalling that, in 2007, the IMF ranked Ireland’s regulatory system highest in a study of accountability and independence in 32 countries. The truth is that, notwithstanding the shortcomings of the Irish approach, regulatory policy was located in an international context that was deeply flawed.

The problem of assuming that self-interest – Adam Smith’s invisible hand – would make people do the right thing was that it wasn't actually correct. This is the flaw to which Alan Greenspan referred when he recanted his views about efficient markets before a US Congress committee in October of 2008. He accepted that the pursuit of self-interest, however beneficial in the economy as a whole, does not necessarily lead to financial stability. Unfortunately, Greenspan’s conversion came too late. Regulators elsewhere who followed the same set of beliefs had, for too long, taken a benign view of the banks and the risks they were taking. In Ireland’s case, this was reflected back to the assessments of macroeconomic stability by the Central Bank. Financial stability reports did identify major vulnerabilities building up in the financial system leading to credit growth and indebtedness and house prices increases and increasing repayment burdens to the household sector, but these were located in a context where the banks were assessed to be generally sound, usually in accordance with the Basel II directive, which has subsequently found to be fairly flawed.

These assessments were also made in the context of the eurozone Stability and Growth Pact. The Stability and Growth Pact failed in a number of ways to prevent deficit and debt, both public and private, problems arising within the euro area. It was overly focused on current budget balances and not enough on the sustainability of member states’ public finances or underlying economic conditions. In the case of Ireland and Spain, the criteria specified in the pact were consistently met even though the property markets were booming.

It is a matter of record also that neither the IMF nor the OECD were any more prescient. As recently as 2006, the IMF financial assessment programme concluded in relation to Ireland that "financial soundness and market indicators are generally very strong". In the years when the crisis was incubating all the international agencies - the IMF, the OECD and the ECB - took a positive view of the performance of the Irish economy. Earlier, in or around 2003, the European Commission disagreed with the Minister for Finance about budgetary policy but their case was undermined by the fact that Ireland was fully compliant with the Stability and Growth Pact while Germany and France were not. In summary, the likelihood of a gradual adjustment dominated official thinking. The soft landing hypothesis might have been possible up until the Lehman Brothers collapse but not afterwards. We were seriously exposed in the banking sector and we didn't know it. The risks to the economy were identified in the financial stability reports but they were qualified by assurances about the fundamental strength of the banks which were wrong.

Chairman, an earlier witness has told the inquiry that pre-crisis regulation was conducted within the paradigm of the great moderation. The Great Moderation described the long period of macroeconomic calm which predated the crisis. It held that, through policy alone, central banks had managed to create stable conditions of strong growth and low inflation. The great moderation was constructed on three pillars, namely: first of all, the disinflationary influence of cheap Chinese manufactured exports; secondly, a cheap credit model; and, thirdly, the change in the balance of power between capital and labour consequent upon the growth of the global labour force by about 1.5 billion people following the demise of the Soviet Union and the decision of China to become capitalist by decree. The thinking was that cheaper goods would increase purchasing power. The decline in labour's share of national income due to the weakened collective bargaining position would exert a downward pressure on inflation and could be compensated for by the ready availability of cheap credit.

This paradigm was opposed by European and Irish trade union movement, which broadly remained committed to social, democratic ideas in politics and neo-Keynesian ideas in economics. It was only to be expected that these competing paradigms would cause a degree of creative tension between me and some colleagues on the Central Bank board from time to time. But by 2004 it became clear to me, as general secretary of congress, that the economy was heading in the wrong direction. Our pre-budget submission of that year called for the removal of all property-based tax incentives. By the following year, 2005, our pre-budget submission voiced concern about overheating in the economy in the following terms, "Future economic policy should consider focusing on optimising economic growth rather than continuing the relentless pursuit of growth for growth's sake which has both economic and social down sides." In May 2005, congress made a detailed submission to the Department of Finance, arguing the case for the abolition of property tax incentive scheme. And this theme of sustainable growth was covered in a speech I made to a social policy conference in UCD in October 2005, which I've actually furnished to you with the documents, Chairman. It was a theme re-echoed in up to ten speeches and newspaper articles between 2005 and 2008. It informed my contributions to the debates in the National Economic and Social Council and, indeed, the Central Bank and it was also the subject of representations made directly to the Minister for Finance at the time.

Mr. Chairman, you wrote to me on 26 May advising that a witness had named me in his evidence and I assume this relates to the following passage in his statement. The statement was:

In fact, I should say that one member of the Board did have grave doubts about what was happening; his words ring in my ears to the effect that 'it was all a house of cards and would end in tears.' However, his views appear not to have had any impact on policy-making in the Bank.

Now, frankly, Chairman, I can't actually remember precisely that ... whether I made that statement or not, but I can confirm that I did alert the board to what I saw happening in the real economy. I argued that what was happening in the construction sector was unsustainable because Irish people were borrowing to invest in buy-to-let houses built by immigrants who were then renting the same houses and it didn't take a genius to work out that a vicious circle with a huge vulnerability was being created.

I wish to turn now to the question of social partnership because the booklet of core documents sent to me contains a lengthy extract from the 2004 IMF review in respect of which I have submitted a supplementary opening statement. I found it difficult to identify any causal relationship between social partnership and the banking crisis. It seems to me that any adverse impact social partnership might have could only be in relation to fiscal policy.

The fact is that the Exchequer was in surplus for the five years preceding the crisis and Ireland’s gross debt-to-GDP ratio was less than 25%, one of the lowest in the OECD area. Ireland did not have a fiscal crisis up to that point; it had a banking crisis. In so far as there is any link between social partnership and the 2008 crisis, it is a mitigating one. According to Fritz Scharpf, who is the director of the Max Planck Institute for the Study of Societies in Cologne, the peripheral economies found no effective way to counteract domestic booms and were driven by the cheap money effect of uniform nominal and divergent real interest rates. But he acknowledges that both Spain and Ireland did try to use the instruments of macroeconomic policy that were still available nationally, including social pacts to restrain the boom; it's just that they were insufficient.

Social partnership sometimes seem as a domestic Irish phenomenon but this is not so. In 1985 an American academic, Peter Katzenstein, in a seminal work on industrial policy in the small open economies of Europe, attributed their success to systems of democratic corporatism. Democratic corporatism is built on three pillars: a strong situation of peak organisations of both unions and employers, an ideology of social partnership and, thirdly then, a constant process of bargaining. The small open economies of northern Europe that Katzenstein studied, essentially the Nordic countries excluding Finland and the Netherlands, realised that the cost of adjustment to international market forces could not be exported, as might be the case with a larger country. You had to be internalised and the only way to manage the situation was to combine openness to trade with flexibility and high levels of social protection. Internal disputes were an indulgence that could not be afforded. The trade unions in Ireland were attracted to this approach in 1987 because it seemed like a workable alternative to the zero-sum game that industrial relations in Britain had become. By history and culture, the Irish trade union movement is closely linked with Britain. While the overall assessment of the IMF paper is positive, it is a fact that over the 22 years of its existence, some misconceptions have arisen from time to time about how social partnership operated. Foremost amongst these, and it is mentioned in the IMF paper too, is that it undermines the powers of the Oireachtas. In my experience, social partnership only ever subsisted within the space ceded to it by Government and this is especially true where coalition partners in the Government had negotiated a programme. There is no evidence that this has been a problem in the other European countries where social partnership is the norm. Where fiscal issues arose, no Government has ever made a specific commitment outside of the budgetary process.

With regard to competitiveness generally, an ESRI paper, McGuinness et al., 2010, found in a survey of 6,500 firms that social partnership agreements enhanced the country’s competitiveness. In particular, they stated "This result suggests that there have been large gains, in terms of competitiveness, to [multinational companies] that locate in Ireland" and this actually was the experience of the ICT sector in Finland as well. It is worth recalling too that the convergence criteria required for membership of EMU were managed within the social partnership process. Not alone that, but the wage terms of the various agreements held, even where the economy was growing at rates exceeding 10% in circumstances of extremely tight labour markets and where labour’s share of national income fell from 65% in 1990 to 56% in 2009. The 2004 IMF paper advocates wage flexibility, short duration agreements and the incorporation of social partnership within a medium-term fiscal framework. Now most of this was taken on board subsequently. It is the case that a sophisticated system for dealing with employer inability to pay claim .... to pay ... inability to pay claims was dealt into the ... was built into the process, that worked by way of a panel of accounting experts, appointed by the Labour Relations Commission, which could be drawn upon by the Labour Court to assess the financial health of a firm claiming to be in difficulty. And this operated, I think, in a broadly satisfactory manner.

The last of the agreements, Towards 2015, was a ten-year framework agreement with provisions for pay reviews on a two-yearly cycle, thus detaching the process from fiscal policy. The other issue of concern raised in the IMF paper is the linking of tax concessions to pay agreements in the longer terms. And, as it happens, I agree with the IMF on this point, but, perhaps, for different reasons. When I became General Secretary of Congress in 2001, I started shifting away from the wage-tax trade offs and towards pay claims based on inflation and productivity. The reason is that I wanted to try to get closer to the Nordic model where universally available, high-quality public services like, for example, child care are part of the social wage.

Having a high level of public service provision is crucial for low to middle income earners. Wage activity alone will not create conditions of equality, or anything like it, for this cohort of the population. Quality public services cannot be sustained by low levels of taxation.

Refined down to its core, the essential purpose of social partnership was to settle the distributional issues leaving Government the freedom to get on with the business of growing the economy. My personal conviction is that it is not possible to successfully manage a small open economy without embedded institutions for managing distributional conflict. Now, I think the truth of this is implicitly recognised in the recent report of the five EU presidents - that's Juncker, Dijsselbloem, Tusk, Draghi and Schulz - setting out a plan for strengthening EMU, published on 1 July. It suggests that a common template for national competitiveness authorities to guide wage negotiations and to restrain wage divergence throughout the eurozone.

So, Chairman, we are now in our eighth year of wage restraint. I cannot see that lasting indefinitely. A combination of pent up wage pressures, competition between unions, free collective bargaining and a tightening labour market suggest to me that the kind of co-ordination proposed by the five presidents will be challenging outside of a framework allowing some harmonisation of social wage issues in addition to pay.

In terms of the cost of the crisis, the most significant learning for me out of this experience relates to how EMU actually worked in practice. I did not expect that, in the event of an exogenous shock, and absent the facility to devalue the currency, that the whole burden of adjustment would fall on labour markets. The Finns were better prepared as a labour movement than we were. They used their collective agreement to negotiate buffer funds to cushion the impact of adjustment but then again such funds might have been raided to bail out the banks as the National Pensions Reserve Fund was raided.

Congress opposed austerity. We feared it would lead to deflation and a Japanese-style slump. We knew that fiscal consolidation would have to happen but we wanted it to be spread over a longer timescale, to 2017, in fact, and back-loaded, not front-loaded, to try to keep up domestic demand and let growth do some of the heavy lifting of adjustment. We also wanted the consolidation to be more focused on tax measures than public service cuts and we campaigned for this approach under the banner, the better fairer way. But would this have been better? Well, Chairman, we really ... we don't know what the counter-factual is.

During the period when Ireland was a programme country, my colleagues and I met quarterly with the ECB-IMF-EU troika. I have to say it was a dispiriting experience and utterly valueless, in my view. My impression of the troika was one of an uncaring technocracy of neoliberal zealots devoid of empathy. I exclude the IMF from this description. They were more reasonable, which was a surprise to me because I had first-hand experience of IMF structural adjustment programmes in the developing world during the 1990s but we were able to establish a useful separate dialogue relationship with the IMF.

It is clear to me also that there is no social institution to balance the independence and power of the ECB. An institution with the sole remit of price stability is not concerned with 26 million people out of work. The remit of the ECB should be changed to reflect the same range of social and economic responsibilities as the Federal Reserve Board in the United States is.

The so-called Great Moderation, upon which so many incorrect assumptions about markets were based, turned out to be a chimera. In his seminal work, The General Theory, Keynes wrote about the differences between risk and uncertainty. Risk can be quantified and therefore mitigated - uncertainty cannot be.