State investment bank can shift focus from property

OPINION: Traditional banks have funded construction with disastrous results. A new State-run entity could fuel the economy

OPINION:Traditional banks have funded construction with disastrous results. A new State-run entity could fuel the economy

INVESTMENT WILL be crucial to Ireland’s recovery – both in driving economic development and in repairing some of the social and infrastructural damage left after the crisis and the cuts that have resulted. The dust has not yet settled on our inglorious property bubble and hapless banking collapse, but some of the structural fault-lines in our economy are becoming more obvious.

Our industrial development is very much an unfinished project and, since the momentum of the late 1990s was lost, we have been struggling to build the firms and industries that can be the basis of sustainable prosperity.

Ireland’s “economic miracle” may have seen relatively high levels of private research and development expenditure in the Irish economy, but the reality is that much of this capital comes from abroad through multinationals.

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Even with the boom of the past decade, our banking, enterprise and social investment sectors have major structural defects that will weaken the effects of any efforts to increase cost-competitiveness.

However, crucial as it is to kick-start productive investment, it is a challenging task. In particular, it is highly unlikely that the banking and financial system will provide the necessary funds. Well before the crisis, our ability to channel finance into productive investment was weak.

Awash in money in the 2000s, our financial institutions channelled Irish savings towards a speculative asset price bubble and have been reluctant to provide capital to Irish entrepreneurs.

Worse, the poor record of Irish banks in providing capital for investment extends back well before the property bubble. Even in the 1990s era of economic development, the contribution of the financial sector was minimal. And the surge in bank lending in the 2000s systematically misallocated capital to the point where, in 2007, approximately two-thirds of outstanding loans were related to property and another one-sixth to the financial sector itself.

Our financial institutions have not been fit for purpose for some time. Much of this misdirection of capital has resulted from the poor quality of retail, private and investment banking in Ireland. Nor is this likely to change as the incentives for managers in the newly recapitalised banks to lend and invest will be minimal. Indeed, the provision of credit to Irish enterprises over the past two years has been very weak.

To transform Irish investment will require a more structural solution, changing the model of banking as well as recapitalising banking institutions. Therefore, the recent announcement of the establishment of a strategic investment fund as a precursor to the formation of a State investment bank is welcome.

A State investment bank can address the problems created by very weak lending activity by the banks.

However, to be truly effective it must address the long-standing puzzle of capital misallocation in Ireland and it must be structured in an innovative and far-sighted way.

This bank could raise new capital and put existing funds to better use. It would be funded largely by private savings (and potentially through large international private equity and wealth management institutions).

One innovation may be to seek capital from the very large cash holdings of international multinationals. Many of these companies have manufacturing bases in Ireland and, given their largely positive experiences here, may well also be willing to act as operational partners in investment projects.

Specifying the goals and investment criteria of a State investment fund is challenging. The basic criteria is that projects will generate a return greater than the cost of capital, but this does not rule out the incorporation of strategic development goals with purely commercial ones.

Most crucially, the State investment bank would promote shifting the structure of the Irish economy from property and construction towards industries that respond to and reflect new global megatrends.

A strategic investment bank can do much better than existing lenders in funding projects in newly emerging sectors (from “green technologies” to “social investments”), in supporting infrastructural projects with longer-term returns and in connecting existing innovative ideas with funding that enables them to develop further.

The State’s ties to universities and their research foundations may also be better catalysed through the existence of a strategic investment bank.

A State investment bank can help to support important public-good projects that would perhaps be beyond the capability or remit of more straightforward investment funds. It could also be the institution that designs and manages the issuance of Government-backed convertible-type bonds linked to specific infrastructure projects. The ability of the bank to bring about synergies through its connections across the public and private sectors would be a crucial resource.

Commentary on State institutions tends to assume they are ineffective. But state investment banks and agencies have played key roles in development in Israel, Taiwan, Brazil and across Europe, among many other places.

More surprising perhaps is that existing research shows that public institutions such as Enterprise Ireland have a good record in financing business development in Ireland. State aid to exporting companies has been found to have promoted manufacturing employment in the 1980s and in the 1990s, and research into Irish-owned software firms in the 1990s showed that those firms that received the most State grant aid exported more, employed more people and grew faster.

It was investment from State sources that led the financing of enterprise in the late 1990s and again after the dot.com bubble burst in the early 2000s. Private finance only took over after growth had resumed.

The expertise in the relevant agencies is clear from the fact that, quite early in the course of the economic crisis, officials from Enterprise Ireland were sent to advise staff in the banking organisations on business lending.

Therefore, it is important that this investment bank should be run as a State body – to break the cycle of bad practice in private banking, to reinforce the focus on strategic and developmental goals, and to take advantage of the business lending and development expertise already built up by State agencies.

To “deleverage” the property and banking bubble is one thing, but to build a more sustainable productive economy requires that we put all of our assets to use.

A strategic investment bank is a valuable instrument in that urgent task.


Seán Ó Riain is professor of sociology at NUI Maynooth, and Michael OSullivan is author of Ireland and the Global Question (Cork University Press)