Independent Review Panel

Independent Review Panel: On Ireland’s, Department of Finance by Annette J Dunlea

Ireland’s Department of Finance is to be the subject of an independent review following the monumental failures of Irish government economic management.The Independent Review Panel was established by The Minister for Finance, Mr Brian Lenihan TD on 10 sSeptember 2010. It was chaired by Mr Rob Wright. It was to advise how the Department might adapt to meet the challenges of the future. The members were: Mr. Rob Wright, Chairman of the Group, Mr. Hans Borstlap and Mr. John Malone. Mr Pat McArdle provided support and assistance to the Panel.The Terms of Reference state that the Independent Review Group will undertake a comprehensive evaluation of the systems, structures and processes of the Department of Finance relating to those elements of budgetary, economic, financial and public service management that are relevant to its role.In this regard the review will assess the department’s : performance in the past 10 years, advice (appropriateness and quality), forecasts, risk analysis including of non-consensual opinion) and communications strategy, and, development and management of responses to the current crisis.This assessment should have regard to the policy, legal and institutional framework within which the Department worked during this period.The review was to last for three months. The Independent Review examined the systems structures and processes used by the Department of Finance in relation to those elements of economic management that are relevant to its role and operations.

The Group will, based on the conclusions and lessons drawn from this assessment, make recommendations for the future development, structure and resourcing of the Department. In making its recommendations the Group will have regard to best practice regarding the organisational structures, skills, training, staff mix and levels required by a modern Finance Ministry in order that it can best fulfil its role in relation to (i) economic and financial management; (ii) policy analysis, development, advice and implementation; and, (iii) communication, transparency and accountability.

The Panel’s mandate was limited, to the performance of the Department of Finance not other agencies of the State. A separate Statutory Commission of Investigation into the Banking Sector, chaired by Mr. Peter Nyberg, is providing a comprehensive assessment of all agencies involved in this issue and is due to report in March 2011. The Panel has been deliberate in ensuring that its work does not overlap with the work of this Statutory Commission.

To provide a focus for our review of departmental advice over the last ten years we examined three key questions:
• How appropriate was the Department’s advice on the risk of pro-cyclical fiscal policy?
• Was the Department aware of the risks of overheating in the property sector and did it provide advice appropriate to the circumstances?
• Did the Department provide sufficient advice on the vulnerability of the tax system to an economic downturn?

The Panel reviewed in detail the annual June Memoranda to Cabinet on Budget Strategy. 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. The Department’s advice was more direct and comprehensive than concerns expressed by others in Ireland, or by international agencies. With very few exceptions, however the quantum of spending and tax relief outlined in December Budgets was very substantially above that advocated by the Department and Minister in June.

We see three key reasons for this failure of fiscal policy. First, there were extraordinary expectations of Government in Ireland to create spending and tax initiatives to share the fruits of recent economic gains. These pressures were reflected in the political debate of the day where all political parties were eager to meet public expectations for more and better services. As well, the Irish economy was regarded by most as a model. The EU fiscal rules, the Stability and Growth Pact, were respected, debt fell and spending appeared to be well below EU levels. The underlying dangers were either missed or ignored.

Second, the Government’s Budget process was completely overwhelmed by two dominant processes : Programmes for Government and the Social Partnership process. We recommend major changes to the budgetary process that would enhance ministerial accountability to Parliament, expand the release of detailed departmental analysis for consultation well before Budget time and provide oversight by some form of Fiscal Council. Third, the Department of Finance should have done more to avoid this outcome. It did provide warnings on pro-cyclical fiscal policy and expressed concern about the risks of an overheated construction sector. However, 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 sector, and tax policy generally.

Third, the Department of Finance should have done more to avoid this outcome. It did provide warnings on pro-cyclical fiscal policy and expressed concern about the risks of an overheated construction sector. However, 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 sector, and tax policy generally.

The report provides recommendations to formalise Department’s records of Budget advice, to strengthen the rigour of the Department’s policy advice and expand resources for tax policy and medium term economic planning. The Panel recommends formalising in legislation the Department’s accountability for assessing systemic macro-economy risks.

Turning to the issues arising from the structure and staffing of the Department; based upon our analysis, submissions from others, and consistent with views of Finance employees and managers we met, 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.

The panel has been direct in our analysis and advice, but do not accept the notion that the Department is not fit for purpose. It has worked hard in response to the banking and economic crisis and must now apply the same determination to remake itself in the light of our observations in this report and the major challenges confronting Ireland. The Panel recommends that the Department sharpen its focus on core business and then substantially strengthen its capacity to manage that core business. The Public Service Management and Development Division should be managed as a separate entity, as either a separate Department, or reporting directly to the Minister of State for Public Service Modernisation. The Minister and the Department of Finance should retain authority over the overall wage bill, negotiating mandates for new collective bargaining processes and manage a single window with other Departments to control public spending.

This change should help focus effort on the extraordinary opportunity provided by the Croke Park Agreement to modernise the capacity of the Public Service. We recommend two other processes to help – a fulltime Task Force from across Government to include individuals from the leading Departments and a Private Sector Advisory Board to help drive the process. The Panel believes that the Sectoral Policy Division is a core function of the Department especially given the need to implement the economic recovery plan and the requirement for medium-term economic planning. The Department would be at risk of losing critical mass with any transfer of core functions. To strengthen the remaining core Finance structure, we offer a set of recommendations to modernise management, reform existing organisation structures and add substantially more people with technical economic and other skills.

Working structures of the Department are less than optimal. We recommend removing a level of management from line management responsibilities. We also offer recommendations to reform working level structures and increase the effectiveness of the Department’s Management Advisory Committee, including the creation of a Corporate Secretariat that would help enhance internal communications and outreach to the public.On people, the Department needs to increase substantially its numbers of economists trained to Masters level or higher and add other technical capacity, especially accounting, banking and financial markets expertise. Over the next two years the Department should double its number of economists trained to Masters Level. It should organise itself to engage more University recruits at that level every year.

On processes, the Department should commit to modernising the HR Management function. It should engage a professional Human Resources expert from outside Government to help develop HR systems. This should include performance management where dramatic improvements are necessary.The Secretary General of Finance should lead this management renewal, presenting a change management plan to employees and reporting on progress in an annual accountability session with staff.

For most of the past twenty years, the Irish economy was regarded as a model. The move from one of the poorest countries in the EU to one of the richest, in terms of annual income, fuelled expectations for increased spending towards levels in the rest of Europe. The EU fiscal rules, the Stability and Growth Pact, were respected, debt fell and spending appeared to be well below EU levels. The underlying dangers were either missed or ignored. Ireland was by no means unique in this, but the size of the hidden imbalances was greater and the subsequent correction more severe.

“Fiscal policy heightened the vulnerability of the economy. At the macroeconomic level, it should have done more to dampen the powerful monetary and liquidity impulses that were stimulating the economy. Budgets that were strongly countercyclical could have helped to moderate the boom, and would also have created fiscal space to cushion the recession when it came. But budgetary policy veered more toward spending money while revenues came in. In addition, the pattern of tax cuts left revenues increasingly fragile, since they were dependent on taxes driven by the property sector and by high consumer spending. Ireland was also unusual in having tax deductibility for mortgages, and significant and distortive subsidies for commercial real estate development, yet no property tax.”

The Panel reviewed international assessments of the risks of pro-cyclicality. A summary of commentary by the EC, OECD and IMF is at Appendix 6. These institutions frequently pointed to the risks of overheating prices and wages in Ireland, thereby decreasing its international competitiveness. Signals of overheating were especially loud in the early 2000s, when the Council gave an official warning to Ireland under article 99.4 of the Treaty, but became more muted as the global (and Irish) economy recovered from the burst of the ICT bubble. Nevertheless throughout the period, and especially from 2004 to 2008, these criticisms were leavened by favourable comment and even praise for Irish policy.

The Panel reviewed in detail the annual June Memoranda to Cabinet on Budget Strategy. 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. Department officials do not, of course, participate in Cabinet discussion. This advice was more direct and comprehensive than concerns expressed by others in Ireland, or by international agencies.

As noted earlier, very strong economic and fiscal performance in the 1990s created an extraordinary sense of optimism in Ireland. This fuelled enormous expectations of Government to create spending and tax initiatives to share the fruits of recent economic gains, even as the country’s overall competitiveness degenerated substantially and revenues became unsustainable. These pressures were reflected in the political debate of the day where all political parties were eager to meet public expectations for more and better services.  Consistently higher growth and revenue outcomes late in the Budget cycle further inflated expectations. Finally, the public and policy makers were insufficiently sensitive to the effects of extraordinarily expansive monetary conditions at the time, and to the fact that fiscal policy was the key potential counterbalance to this pressure.

Beyond a general sense of optimism, we review below two other aspects that contributed to this massive, sustained slippage from the June Fiscal Plans. First, 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. We review these factors below.

All parties establish a platform going into an election. A vital part of coalition Government is the preparation of a joint Programme for Government by governing coalition partners. Such agreements are core to the political stability of the governing coalition and often include very specific spending and tax expenditure commitments. These initiatives are presented as given, without a full economic or fiscal analysis by the Department of Finance.The process leaves the Department to debate the pace of delivery of new spending and tax initiatives but not the Government’s commitment to these important fiscal matters. The Department could, and did, argue for reallocation of existing spending to offset new commitments in a Programme for Government. But this proved increasingly difficult, and ineffective, given the magnitude of Programme for Government commitments and the availability of resources. Included below is an excerpt from the 2002 Programme for Government that illustrates the specificity of these commitments.

The 2002 Programme for Government, like others, undertook to achieve these changes while promoting “low inflation” and “responsible fiscal policies” and maintaining the “public finances in a healthy condition”. However, the dominant impact of Programmes for Government was to create a ready list of politically driven spending and tax initiatives to insert into Budgets, including to the extent of any last minute revenue availability.

The Social Partnership process was also a major driver of spending. Initiated in the 1980s, this process led to a number of national social and economic agreements between 1987 and 2009, which included pay settlements in the private and public sectors. The 1987 agreement and agreements in the 1990s tended to trade-off wage moderation for lower personal tax rates, with the effect of increasing take home pay. In the negotiations leading up to these agreements, the general levels of increases were effectively settled between the private sector employers and trade unions, with the increases applying by extension to the public service.This process was extremely important to Ireland emerging as an economic growth leader in Europe. Wage costs were set at competitive levels. The process also created a climate of labour harmony that further enhanced the investment climate.An over-heated economy generated labour shortages and high wage demands.These pressures overwhelmed private sector wage negotiations and, through the Partnership Process, also inflated public sector outcomes.Over the ten year period of review, the Programme for Government and Social Partnership Processes helped overwhelm the Budget process.

The report made no less than 50 recommendations:

1) After Cabinet review of Budget strategy in June, and consistent with its April submission to the European Commission, the Government should release for public and parliamentary review:
• the Department’s economic and fiscal forecast,
• the Department’s assessment of the economic and fiscal risks to this outlook,
• related sectoral analysis by the Department and
• the Government’s proposed quantum for fiscal action in new spending and tax expenditures.
The Minister and the Department should consult widely on this framework, particularly with the relevant Oireachtas Committee.
2) Departments would not seek spending enhancements beyond the spring
consultations leading to the Budget review at Cabinet.
3) To the extent that November tax results surprised to the upside, such revenue should be used for debt reduction, not new spending or tax relief.
4) The Panel supports the establishment of a Fiscal Council to review and publish commentary on the Department’s analysis and the Government’s proposed quantum for fiscal action. The Panel believes that such a Fiscal Council must be independent of Government, have qualified membership, a straight forward role and the ability to report in a timely manner. For example, following a June release of the Government’s fiscal plan, the Fiscal Council could review:
– the Department’s economic and fiscal outlook,
– the Department’s risk assessment,
– whether the proposed fiscal framework, including provision for
new Government budgetary action, entails acceptable risks for the economy.
5) To the extent the December Budget exceeds the quantum of action identified in June,the Fiscal Council should reassess the risks of these further actions for the economy.
6) The Fiscal Council could also usefully assess the impact of future Social Partnership wage and fiscal provisions on Ireland’s economic competitiveness.
Economic and Fiscal Forecasting:
7)  Forecasts in Budget Memoranda to Cabinet and for public consultations should include well articulated scenarios of alternative outcomes, consistent with the Department’s risk analysis.
8)  In addition, the Department should provide a public work-shop, with private sector and academic interests, once a year so that the assessment of the economic and fiscal challenges can be debated before the Department finalises its forecasts.
Advice over the Budget Cycle:
9) The Department of Finance should keep a written record of advice tendered and decisions taken as part of the budgetary process.
10) The Panel strongly supports the public release of substantially more economic analysis by the Department. However, policy advice to the Minister for Finance in the preparation of the Government’s Budget should not be subject to release under Freedom of Information for at least five years.
Macro-economic Risks:s part of its annual advice to Cabinet.
12) The Department should establish sufficient formal arrangements with the Central Bank, including its Financial Regulation function, the NTMA and NAMA and establish sufficient technical capacity internally to manage this process.
13) The Government should introduce legislation to establish a coordinating committee of these financial agencies, chaired by the Secretary General of the Department of Finance, which would require the full exchange of any information that could entail fiscal or economic risks to the country, among the above agencies.
Construction Policy:
14) The Department should include sectoral assessments in its annual economic analysis and forecast that is released for public consultation.
Tax Policy Advice:
15) The Department should substantially increase its analytical capacity in the tax policy area.
16) The Department should organise itself to consult with tax and financial experts and prepare advice that is most appropriate to an efficient tax regime for Ireland.
Tax Policy Advice:
15) The Department should substantially increase its analytical capacity in the tax policy area.
16) The Department should organise itself to consult with tax and financial experts and prepare advice that is most appropriate to an efficient tax regime for Ireland.
Department’s Interface with Other Departments:
18) The Department should integrate those sections of Public Service Management and Development Division dealing with administrative budgets into Sectoral Policy
Division to create a “single window” interface with line Departments.
19) Activities could be organised immediately under the Assistant Secretary level in the Sectoral Policy Division. The longer-term objective should be to establish Principal positions responsible for the interface of all activities with outside Departments.
Public Service Management and Development:
20) Public Service Management and Development Division should be established as a separate entity, either as an entirely separate Department or reporting directly to the Minister of State for Public Service Modernisation.
21) The Secretary General of the Department of Finance and Minister for Finance should retain authority over the overall wage bill, negotiating mandates for new collective bargaining processes and manage a single window on departmental control functions.
Public Service Modernisation:
22) The Panel strongly supports the creation of a Private Sector Advisory Board which it understands is under consideration by the Departments of the Taoiseach and Finance.
23) A full-time Task Force should be established and assigned responsibility for driving forward the reforms under the Croke Park Agreement.
24) The Task Force would comprise existing staff from the Modernisation Unit of the Department. The Task Force would also include key individuals from the leading Departments along with expertise in the area of change management on secondment from the private sector.
25) The Task Force’s Team leader should have direct access to the Minister of State
responsible for Public Service Modernisation.
26) In addition, there is a need to recruit expertise in the areas of change management and business process re-engineering.
Core Finance Functions:
27) With the possible exception of the Public Service Management and Development Division, no other core functions should be moved out of the Department of Finance.
Structure:
28) Assistant Secretaries should report directly to the Secretary General of Finance.
29) Second Secretaries should cease to have divisional line management
responsibilities, but should be able to call upon resources across the Department as and when necessary.
30) The Second Secretary currently responsible for Sectoral Policy Division should be designated as Chief Operating Officer for the Department. The function of this post would be to lead the co-ordination across the Department of major issues, for example, to lead the interaction between the Budget and expenditure sides of the Department, and otherwise to help ensure the entire Department is connected to key policy and management issues.
31) The Second Secretary post leading the Budget, Tax and Economic Division could focus primarily on the increasingly important role of interacting with the institutions of the European Union and other international institutions.
32) The Second Secretary responsible for Financial Services should retain responsibility for this function until such time as the banking crisis is considered to have abated sufficiently. At that time the post should be abolished. That Second Secretary could draw on the support of the Assistant Secretaries currently in that Division as necessary, but they would report directly to the Secretary General.
Management Advisory Committee (MAC):
33) The remit of the MAC should be broadened to include discussion of major strategic challenges confronting the Department.
34) All those that report to the Secretary General should attend MAC meetings. Given the pace of change underway, MAC meetings could usefully include a brief report by Assistant Secretaries on key issues in their area, where appropriate, as well as Secretary General and Second Secretary reports on high level issues.
35) Attendees at MAC should, as a matter of course, brief their own direct reports on outcomes from these meetings.
36) The MAC should meet more often at Budget time and during periods of major change to enhance internal communication and connect all employees to emerging issues. It should schedule regular meetings on key policy issues.
Corporate Secretariat:
37) A Corporate Affairs Unit, which should be headed by a Principal who would report directly to the Secretary General, should be established. It would bring together and enhance a number of functions which are located in different areas of the Department. The functions of the Unit would be to:
o manage the interface with the Minister’s Office;
o co-ordinate briefs and draft speeches for the Minister to ensure consistency and quality;
o help ensure effective internal communications;
o manage departmental outreach and the Department’s profile;
o co-ordinate, on a regular basis, the preparation of a brief for MAC on all major live issues and an early warning on significant emerging issues;
o help co-ordinate major departmental initiatives;
o co-ordinate departmental strategy statements;
o manage the activities of the Department’s Press Office; and
o manage the Freedom of Information function in the Department.
Structure at the Working Level
38) The Department should examine working level structures and the devolution of responsibilities to ensure the delegation of more responsibilities to middle management levels and to create larger teams throughout the organisation.
Enhancing the Department’s technical skills:
39) Even in this period of restraint, the Department must find a way to increase substantially the numbers of economists and other staff with relevant technical qualifications.
40) The Department should double the number of economists, appointed through open, public competition and trained to Masters level or higher, over the next two years. These appointees should comprise a mix of recent university graduates and experienced individuals and be assigned to positions throughout the organisation.
The Department should organise itself to maintain a regular inflow of new university recruits.
41) The Department should work to establish a welcoming professional environment for new economists. Economists at Masters level and above should be identified and their numbers reported on annually; a champion for establishing and promoting this “community of interest” should be named.
42) The economic seminars by external economists, which were recently introduced by the Secretary General, should be made permanent; the Department should permit the publication of professional economic analyses, by staff in the Department, that are clearly identified as not the views of the Department.
43) The Department should expand its complement of skilled staff in other disciplines, especially accounting, analysis, banking and financial markets.
44) The Department should immediately seek the secondment of skilled personnel on a two-year rotation from the Central Bank, NTMA, ESRI and other relevant bodies.
45) The Department should also promote exchange agreements with other Finance Departments internationally.
Enhanced HR function:
46) A senior HR specialist should be appointed to the Department initially, at any rate, on a short-term contract. The post would be advertised and preference would be given to an individual who had managed a dynamic HR function in the private sector.
47) The Department should reinforce its performance review process and require the identification of under-performance and an individualised plan to deal with problems identified.
48) Once each year, the MAC should take a full day to review individual performance in the Department. It should identify, of all supervisors, the top 20% on people management – those who recognise high performance and deal with poor performance. This process should also identify the bottom 20% – those supervisors who are not performing well in this area and those who are not taking a proactive approach to this issue. Plans to address under-performance should be required. A supervisor’s performance in “people management” should have a material impact on consideration for promotion.
Change Management:
49) The Secretary General should present a Change Management Plan to employees and report on progress in an annual accountability session to all staff.
50) He should be supported by all managers, by a champion for change management at Assistant Secretary level and by the newly recruited professional HR specialist.

Successive governments ignored the Department of Finance’s pleas for restraint, over the past decade, in order to fulfil election promises and deliver politically popular policies. It said stern spending warnings were “consistently exceeded”, particularly ahead of the 2002 and 2007 general elections. And it said Ireland was now in a worse economic state because the department was not listened to. “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,” it said. The panel suggest it should of changed the tone of its warnings.

There the department regularly warned of the risks of pro-cyclical fiscal action. Its warnings, the report notes, were “more direct and comprehensive than concerns expressed by others in Ireland, or by international agencies”. But by December, what was announced on budget day – in the form of tax relief and higher spending – was “substantially above” what the department and its minister had advocated six months earlier. The reason for this change, the panel has suggested, was because the government’s budget process was overwhelmed by a need to meet commitments already made under programmes for government and social partnership.

Why didn’t some of the senior officials use the multiplicity of Oireachtas committees to publicly voice their objections to what the government was doing? However, even the report finds it incredible that after a decade or more of having its objections routinely ignored by the politicians, the department didn’t at least raise the tone of its warnings. The authors found that partnership failed, leading to the Budget process being taken over by the Department of the Taoiseach, rather than the Department of Finance.Not an entirely clean bill of health, but enough to point the finger of blame at the politicians. Ministers received the warnings on an annual basis about the danger of unsustainable taxation and spending. It should have raised its game or, as the report says, “adapted its advice in tone and urgency”.

Between the years 1999 and 2008, showed the government introduced tax and spending packages that were €6 billion more generous those recommended by finance officials.The greatest expenditure occurred during 2001 and in 2007 during general election campaigns.

The department’s failure was mirrored by the performance of the Central Bank in its watchdog role. It produced annual financial stability reports that also warned of the risks to stability of a credit-fuelled property boom. And it too advised governments of those dangers in public reports and private meetings. But ministers were not prepared to listen. Both the Central Bank and the Department of Finance could, and should, have done much more to articulate their concerns.The panel, while it accepts the department is fit for purpose, concludes that it needs to be more effective and must now remake itself. It recommends that the department change its structure, its working methods and its professional capacity – including doubling the number of economists employed. And it favours oversight of both the department and the budgetary process by some form of independent fiscal council.

But there remain some unanswered questions. Why has it taken so long to recognise, and address this issue? While the report is welcome its focus was too narrow.It failed to discuss the benchmarking, the banking crisis and accountability. No written records on oral advice or substantial written records were not kept by civil servants. Written reports should become compulsory and minutes taken of all oral advice given by senior civil servants. Not only should this advice be given but it should be made public so the government are forced to account for their spending. In a week where Bank of Ireland’s huge staff bonuses were published it showed the government’s naivity in accepting information and apologies. It is time to get tough. Lessons must be learned and these mistakes cannot be repeated.It would be interesting to have audits like this on other important departments in government. Promotions should be earned and given to the right person, even if they must be awarded externally.For too long in the civil service promotions were given on seniority, to the person longest in the job. Civil servants should sit internal exams or make a presetation for suitability to move to a higher grade.

The End

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About Author Annette J Dunlea Irish Writer

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