ECONOMICS:Developments since 2008 have shown capital spending can be easily wasted and misallocated

BETWEEN THE beginning of the last decade and 2008, when government expenditure peaked, capital spending came close to trebling, reaching almost €10 billion. The rate of increase was higher than that of total government spending and only just below the increase in welfare spending, the component that saw the biggest increase.

As chart one shows, Irish capital spending has been very volatile compared to the rest of the euro zone. In the late 1990s and early 2000s growth rates were appropriately rapid – a fast-growing economy needed more infrastructure and the money was there to invest.

After the pre-election splurge (in all areas of spending) in 2000-02, and once victory in that contest had been secured, the government applied the brakes. In most areas, spending growth slowed. Capital spending was cut. Given that capital spending needs to be planned and rolled out over long periods of time, it is particularly wasteful and damaging when it is jerked back and forth in this way.

Once the budget was restored to balance, however, a new National Development Plan was launched. It was big and ambitious. Chart two shows where the spending went (the areas included are the five largest and have typically accounted for more than two thirds of the total capital budget).

Completing the motorway network was consistently a priority. Fortunately, it was largely done by the time the bubble burst.

Stung by accusations that it was uncaring, and once Charlie McCreevey had been dispatched to Brussels, the government ramped up its social housing programme to the point that it was the largest single area of capital spending in 2007.

Despite the halting of economic growth in 2007 and the descent into recession in 2008, capital spending continued to soar. As chart one shows, it peaked at 5.2 per cent of GDP, more than double the euro area average.

The fiscal crisis left no choice but to slash spending. A considerable decline in spending would have have happened even if there had been a soft landing. Many of the motorways were built and even if there had not been such a violent crash, there would have been an oversupply of homes, rendering the public house-building programme an inappropriate means of providing social housing.

But even after slashing capital expenditure by 40 percent , it remained well above the EU average as a percentage of GDP last year, as the first chart shows. At just under €6 billion last year, the spend was back to 2005 levels in nominal terms. In real terms the decline was smaller owing to the price effects.

Given that economic activity is 15-20 per cent down on peak, the case for keeping capital spending so high is very difficult to make in the context of a loss of sovereignty associated with the EU-IMF bailout and the serious risk that the situation could get worse if the external environment deteriorates.

When public investment is discussed it is often in the same terms as motherhood – how can anyone be against it? But as post-2008 developments have shown, capital can easily be misallocated and investments can be wasteful. In post-bubble Japan after 1990, much spending was wasted on infrastructure that had no chance of paying for itself.

Can anyone doubt this happened in Ireland too? Drive through Dublin’s eerily quiet port tunnel for anecdotal evidence of this.

Alas, there is not much beyond anecdotal evidence when it comes to weighing up the costs and benefits of spending. Among the greatest policy failings over the boom period was, and remains, the absence of rigour in assessing whether the return on public investment warrants the outlay involved.

Not only are cost-benefit analyses most common and easy to conduct in big investment projects, the capacity to conduct them once existed. When Ireland was dependent on EU funding for much of its capital spending, Brussels insisted that such mundane practices were adhered to.

While politicians ultimately must take responsibility for public policy failings, in areas of detail such as driving the use of cost-benefit analyses, officials have a duty to adopt and use such standard practices in the interests of taxpayers. That they allowed a pre-existing institutional capacity to wither is a terrible indictment of them. A failure to improve how thing are done is bad. Regression is unforgivable.