The financialization of the state: Government debt management reforms in New Zealand and Ireland
Abstract
The financialization of sovereign debt management has received attention in comparative political economy studies. While previous studies have highlighted the cross-national commonality of this process and the congruence of interests between finance and governments, the analysis of the role of finance and state agency in domestic reform processes is still under-exposed. By analysing the financialization of government debt management in the two early adopter countries, New Zealand and Ireland, this study seeks to close this gap. The study shows that differences in the structure of financial markets and the civil service systems resulted in different policymaking processes through which Treasury civil servants brought financial economics into the reforms. In New Zealand, economists had an in-house position within the Treasury and were able to frame the decision-making process (ideational explanation), while in Ireland, finance successfully lobbied senior civil servants who sponsored these efforts (interest explanation). With this finding, this article reveals the multiple channels that lead to sovereign debt management financialization.
Introduction
In the last few years, not only the financialization of the economy, firms and households (e.g. Aalbers, 2008; Bieling, 2013; Krippner, 2005; van der Zwan, 2014), but also of sovereign debt management (SDM) has gained increasing attention in comparative political economy (e.g. Dutta, 2017; Fastenrath et al., 2017; Gabor, 2016; Lagna, 2016; Lemoine, 2017; Preunkert, 2017; Trampusch, 2015). According to Fastenrath et al. (2017), financialization of government debt impacts how and from whom governments borrow money. This not only affects a greater reliance on market-based modes of refinancing and related financial market transactions (e.g. issuance of marketable debt, use of auctions) but also the underlying intellectual framework of debt management. This sense-making framework of debt management is now predominantly grounded in the models of financial economics and not any more in monetary policy. Debt is viewed as liability portfolio, which governments seek to optimize by diversification of the investor base and the interest rate or currency risks of their loans through the use of complex financial innovations like derivatives. This optimization is based on the calculation of cost-risk trade-offs through mathematical modelling for which standard portfolio theory provides instruction.
There are several reasons, why it is important to direct our attention to SDM (and state) financialization. First, if Mosley (2004: 183) is right, that the sovereign bond market is ‘a most likely locus of financial market influence’ on government policies, the analysis of how finance enters SDM promises to generate insights for our understanding of the finance–state nexus. A second reason is that state financialization turns governments into prominent financial market actors which raises the question whether there is a conflict of interests for them between this activity and state regulation of financial markets. Thirdly, SDM financialization may have impacts on states’ fiscal performance as greater capital market exposure may reduce borrowing costs as well as increase the risk of losses (Fastenrath et al., 2017; Lagna, 2016). Therewith, SDM financialization brings us back to the debate whether the discipline of the capital market or democratic control over public finances and debt is more favourable for states' fiscal performance (North and Weingast, 1989).
Despite major achievements of previous studies on exploring the cross-national commonality of this process and the mutual interest of states and finance in financialized SDM (e.g. Dutta, 2017; Fastenrath et al., 2017; Gabor, 2016; Lagna, 2016; Lemoine, 2017; Preunkert, 2017), the domestic decision-making processes which brought models of financial economics into public debt policy and the role of state agency in these reforms are still under-exposed. As a result, our knowledge on the specific roles state actors and finance have played in these reforms is still limited. By analysing the interaction of civil servants with the financial industry in designing and implementing the debt management reforms in the two early adopter countries, New Zealand and Ireland, this study addresses this gap.
In the late 1980s, in New Zealand and Ireland, the general political-economic context of the public debt management reforms was one of substantial deregulation of the economy, triggered by fiscal crises (Evans et al., 1996; Kelly and Everett, 2004). After decades of economic interventionism and protectionism, New Zealand became a vocal advocate of liberalization, dominated in its economic and trade policies by the needs of its agricultural export industry. Also in Ireland, intensive liberalization and massive structural change enjoyed priority on the political agenda, turning the country to an international IT- and financial service economy. Under these conditions of comprehensive economic reforms, both countries made themselves more susceptible to the influence of international markets.
With respect to these massive changes, both countries were also ‘among the early reformers’ (Wheeler, 2004: 2) of the financialization of debt management (see also Fastenrath et al., 2017). Both were under pressure with high public debt-to-GDP ratios and high foreign currency borrowings at that time and adopted private sector financial market practices in order to manage their debts at a given level and imitate the portfolio management practice of financial economics. They shifted their borrowing and debt management powers to newly established Debt Management Offices (DMOs) which separated debt management from monetary policy. Well-paid financial experts from private investment banks were recruited. These professional debt managers very quickly made New Zealand and Ireland into users of active trading strategies because then currency and interest rate risks of public loans and securities could be managed through swap deals with private investment banks (Wheeler, 2004: 117).
For two reasons, New Zealand and Ireland are interesting cases for a comparative analysis on the decision-making processes which brought financial economics into the debt management reforms of the respective Treasury departments. The first is that their early adopter status makes it reasonable to assume that the two reform processes were less affected by external factors (e.g. diffusion), thus were independent from each other and not affected by the behaviour of other governments. Internal domestic factors explain the reforms.1 Secondly, New Zealand and Ireland are suitable for a paired comparison research design (Tarrow, 2010: 249) which adopts the method of difference because they are ‘comparable but exhibit different processes or outcomes’. The two countries are similar in a few important economic, political and institutional conditions which previous literature has theorized as being of importance for the finance–state nexus (see section ‘State, finance and public debt management reforms’). According to the method of difference, which explains differences in the explanandum by differences in the explanans, these similarities cannot explain the different dynamics in state financialization.
Our in-depth analysis of the decision-making processes through which the financial market logic entered government debt management reveals that in both countries top civil servants of the Treasuries were the main change agents. However, the way through which these top civil servants brought financial economics into sovereign debt management was different. In Ireland, a business–state alliance was the main driver, while in New Zealand the impact of financial economics was triggered by the professional authority of economists within the civil service. While the tight connections between finance and civil service in Ireland point to an interest explanation and the importance of finance lobbying efforts, the institutional position of economists2 in the New Zealand Treasury is more in accordance with an ideational explanation.
Our analysis reveals that these different patterns of interaction between state and finance can be explained by differences in the structure of financial markets and the civil service systems in the two countries. With these findings, this article addresses not only the financialization literature by further exploring the finance–state nexus through a contextualized analysis of the interaction between state and finance actors but also returns to the research on the relationship between ideas and interests in explaining the relationship between finance and public policies, or, to put in more general words, between an interest-based and ideational explanation (Bell and Hindmoor, 2014; Hirschman and Berman, 2014; Jacobs, 2015). Moreover, by identifying the contextual conditions of these two modes of explanations, the paper contributes to the debate on the relationship between causal processes and their scope conditions which is a major issue in the literature.3
The study is based on an intensive assessment of primary evidence, such as officially published primary documents on the reforms (Treasury, cabinet, parliamentary and central bank documents), as well as newspaper articles and interviews in the national and international daily and financial press which were accessed using the online database ‘factiva’ as well as the internet. In addition, secondary evidence such as academic works on public sector reforms in both countries is used. In order to improve the validity and reliability of this study, basic information has been double-checked. The periods under investigation are for New Zealand 1988–1990 and for Ireland 1987–1991, during which both countries formulated reform agendas and installed DMOs.
This article is structured as follows: Based on a short discussion of the literature on state financialization and the relationship between finance and bureaucratic actors in policy reforms, the second section presents the theoretical framework of this study. The third and fourth sections demonstrate the two different patterns of interaction between private finance and bureaucrats in the financialization reforms. The cross-country comparison reveals the structural conditions which triggered these different processes. The final section concludes and elaborates the implications for further research.
State, finance and public debt management reforms
Financialization is often broadly defined as the ‘increasing role of financial motives, financial markets, financial actors and financial institutions in the operation of the domestic and international economies’ (Epstein, 2005: 3). After the financialization of the economy, firms and households, the financialization of the state has also received increasing attention in comparative political economy (e.g. Hendrikse and Lagna, 2017; Karwowski and Centurion-Vicencio, 2018). Studies on the financialization of the state refer to the increasing role of financial motives, etc., in the management of its own investments (e.g. Cumming et al., 2017; Wang, 2015),4 on the one hand, and, in the management of public debt, on the other (e.g. Dutta, 2017; Fastenrath et al., 2017; Gabor, 2016; Lagna, 2016; Lemoine, 2017; Preunkert, 2017; Trampusch, 2015).
Pressurized by soaring debt-to-GDP-ratios with a high debt stock in foreign currency, and vulnerability to changing interest and currency rates, sovereign debt management has fundamentally changed in major OECD countries between the 1970s and 1990s. Fastenrath et al. (2017) have shown that SDM has become financialized because governments (a) rely more and more on financial markets in the governance of their debt, and (b) adopt in this context ideas and models of financial economics as the sense-making framework for debt management decisions. Financial economics conceptualizes ‘debt as a portfolio instead of focusing on individual loans’ and leads debt managers to seek to optimize cost-risk trade-offs by using mathematical models such as Monte Carlo simulations in line with standard portfolio theory (Fastenrath et al., 2017: 278). Splitting the governance and the framework dimension into nine indicators and applying it to data from 23 OECD countries between 1980 and 2010, Fastenrath et al. (2017: 274) have found ‘overarching commonalities accompanied by country-specific differences in both dimensions’, with New Zealand and Ireland as forerunners regarding the establishment of DMOs, the increase in shares of marketable debt or the use of swaps, for example (Fastenrath et al., 2017: supplementary file).
This overall trend of SDM financialization is strongly affected by congruence of interests between private finance and governments (e.g. Fastenrath et al., 2017; Gabor, 2016; Lagna, 2016; Preunkert, 2017). A major reason for this joint interest is that financialized SDM fosters the integration and expansion of global financial markets, which serves both the material interests of finance and the state’s own stake in financial markets (Dutta, 2017; Gabor, 2016; Lemoine, 2017; Trampusch, 2015). For states financial market deregulation, securitization and SDM financialization foster the liquidity of the sovereign debt market which in turn is associated with lower debt services costs. This means deregulation of capital markets coincides with states’ fiscal interests (Dutta, 2017; Fastenrath et al., 2017; Gabor, 2016; Lemoine, 2017; Wang, 2015). For example, Dutta (2017: 5) claims that there is a ‘deep material interdependence between private financial institutions and sovereign states in the working of global finance’.
While the international importance of SDM financialization is not only revealed but also suspected to be driven forward by the joint interest of finance and states in liquid and global financial markets, the role of finance and state agency in domestic policymaking processes in fostering this commonality is still under-exposed. By analysing the domestic decision-making processes that brought financial economics into the debt management reforms in New Zealand and Ireland, this study contributes to closing this gap. As already mentioned in the Introduction section, the early adopter status of these two countries makes them particularly suitable for an in-depth analysis of internal (domestic) factors.
Building on the finding that finance and states may have a joint interest in SDM financialization, this study adopts a state-centric account (Campbell and Pedersen, 2014; Christensen, 2013; Skocpol, 1985) which assumes that the role of the state in SDM financialization is a pro-active one and SDM financialization is not the passive result of private finance colonizing the state.
With regard to this role of the state (shaping SDM financialization), according to Campbell and Pedersen (2014: 7), two main frameworks can be distinguished. The first account refers to electoral politics and partisanship and expects that since conservative and liberal parties have a close relationship with finance, they foster SDM financialization. However, in our two cases, political parties seem to count much less. The Irish debt management reform was adopted by centre-right and centre-right Thatcherite governments (Fianna Fail 1987–1989; Fianna Fail and Progressive Democrats 1989–1992) and the New Zealand one by the Fourth Labour Government (1984–1990). As different parties pursued the same reform agenda, the partisan explanation does not help to understand this similarity and the key role of civil servants seems to provide a more effective account.
The second framework refers to the role of bureaucratic actors and their interaction with finance. With regard to bureaucracy, in the newer literature on relationships between financial markets and bureaucratic actors, two main mechanisms are distinguished (e.g. Bell and Hindmoor, 2014; Blyth, 2002; Culpepper and Reinke, 2014; Fourcade, 2009; Hirschman and Berman, 2014; Jacobs, 2015; James and Quaglia, 2017; Schmidt and Thatcher, 2013). While political scientists often highlight the impacts of the interest logic of action, e.g. of the instrumental and structural power of business groups which find state officials to sponsor their demands in the law making process (e.g. Bell and Hindmoor, 2014; Culpepper and Reinke, 2014),5 scholars of economic sociology and the power of ideas follow more social-constructivist considerations of an ideational explanation. This strand of literature refers to framing effects, meaning the impacts of cultural dimensions of institutions and cognitive ‘power resources’ (e.g. Campbell and Pedersen, 2014; Christensen, 2013; Chwieroth, 2010; Fourcade, 2009; Hirschman and Berman, 2014). In his analysis on the IMF, Chwieroth (2010: 23) argues that ‘common professional training and administrative recruitment patterns’ have shaped the ‘productive power of the economic professions’ in this international organization. In her study of economists in the United States, Britain and France, Fourcade (2009: 21) analyses, inter alia, how the ‘modes of construction and incorporation of economic knowledge through policy making and policy advice’ shape the social and political role of economists through the impact on their profession and discipline. Campbell and Pedersen (2014: 2–3) claim that, along policymaking regimes and production regimes, comparative political economy should scrutinize knowledge regimes6 since these produce and disseminate ideas.
While the first, the interest explanation, requires us to study the activities of the financial services industry as well as its material interests,7 the ideational explanation highlights more the impact of the cognitive framing power of financial economists because of the ‘institutionalization of economic knowledge into the state apparatus’ (Fourcade, 2009: 247). Evidence which may confirm the plausibility of the interest explanation are business lobbying activities, its privileged access to the bureaucracy, tight connections between business and state actors or business finding politicians and civil servants which are sympathetic to the interest of business (Culpepper and Reinke, 2014: 428, 433). The ideational explanation requires that ideas are not ‘wholly endogenous to objective, material features of the choice situation’ (Jacobs, 2015: 43) and that the ideational commitments of the decision makers have an ‘ideational source external to the choice situation’ (Jacobs, 2015: 48). ‘[E]vidence of exogeneity’ of the relevant ideas (Jacobs, 2015: 45) are not only the existence of civil servants’ internal documents on the reform prior to any parliamentary or public debate or even lobbying efforts of finance but also that the Treasury civil servants came into contact with the ideas of financial economics before they initiated the reform process because of academic economics training, for example. According to the ideational logic of action, the relationship between agents and ideas can be conceived in a positivist way, where ideas legitimize interests, or in a constructivist frame, in which ideas are constitutive for actors’ material interests (Schmidt and Thatcher, 2013: 22). Ideational scholars do not neglect the influence of interests; however, they argue that interests need ideas to gain impact because ideas interpret and construct interests (e.g. Blyth, 2002).
In my analysis, I will show that the Irish reforms were more driven by the interest logic, while the New Zealand ones were more in accordance with the ideational explanation, reflected by the cognitive influences of in-house economists.
How can we explain that in two countries these different causal processes have unfolded? Which are the scope conditions which triggered them? As the ‘context’ of causal mechanisms may cover ‘all possible aspects of the environment that could be interconnected with the outcome we must use theory to identify’ the important surrounding (Falleti and Lynch, 2009: 1159). To the best of our knowledge, the recent literature on the relationships between financial markets (and economic ideas) and bureaucratic actors point to the following contextual conditions, potentially mediating impacts of financial economics on bureaucratic actors: (1) the political system and models of public administration (policymaking regime), (2) the economic system (production regime), (3) crises and uncertainty, (4) issue salience and (5) preference homogeneity on business side (e.g. Blyth, 2002; Campbell and Pedersen, 2014; Culpepper and Reinke, 2014; Fourcade, 2009; Hirschman and Berman, 2014; James and Quaglia, 2017).
At first sight, these five probably influential contextual ‘surroundings’ appear to be rather similar in our two cases. New Zealand and Ireland share a Westminster model of parliamentary representation8 and the Whitehall model of public administration. Both institutions not only lead to strong executive (lower parliamentary) control over public finance but also strengthen civil servants’ impact on public policy making (e.g. Grube, 2015; Halligan, 2003). In addition, the countries are representative of small states with open, liberal market economies challenged by severe economic and fiscal crises in the 1980s that triggered a series of reforms. Moreover, the archival evidence does not confirm heterogeneous financial industry interests or a high level political salience of the technically complex SDM reforms. The data sources assessed for this study do also not indicate conflicts of interests among financial actors or increased attention among the electorate on how the sovereign debt should be managed and whether DMOs should be installed.
However, despite these overall similarities, our comparison of the two cases reveals that the different patterns of state–finance interaction in the two countries are conditioned by differences in the structure of financial markets and the civil service systems which – according to the logic of our paired comparison research design (method of difference) – can be distilled as necessary conditions for the interest and ideational trajectory leading to SDM financialization.
On the one hand, the financial markets in both countries display huge structural differences, and, on the other, the civil service systems – although of British origin – have strongly diverged. In both countries, the domestic financial markets have been deregulated since the early 1980s. However, while in Ireland financial market integration became the backbone of its economic growth model, in New Zealand, the domestic financial market remained politically and economically rather unimportant (at least until the early 2000s), as the country’s growth strategy is based on the export of agrarian products (e.g. dairy and meat products, kiwi fruit and apples). With respect to the civil service systems, the following differences are important (e.g. Boston, 1991; Christensen, 2013; Newberry and Jacobs, 2008; Wallis and Goldfinch, 2013): While New Zealand lacks an administrative class and has an open civil service system with regard to recruitment of higher civil servants, the Irish public administration has clung to the British Whitehall tradition of a closed civil service in which the entry system is closed which prevented the recruitment of economic knowledge from outside by hiring processes (on which see Christensen, 2013: 566, 570; Fourcade, 2009: 19; Zimmerman, 1997: 535, 537). As the Irish civil service system was a ‘rigid hierarchical system’, reform-oriented forces in the Irish civil service had to ‘hive off’ functions to special agencies to be able to hire professional experts required (Hyndman and Connolly, 2011: 43; Zimmerman, 1997: 537). However, in New Zealand, economists have been inside the civil service before the reform, having occupied top-level positions since the 1970s. The following two sections argue that these small contextual differences explain why different causal processes have led to the incorporation of financial economics into the management of public debt.
New Zealand: Treasury economists and the ideational explanation
New Zealand’s debt management reforms, as well as the creation of the New Zealand Debt Management Office (NZDMO; est. 1988) as a self-contained unit of the Treasury at arm’s length from the Minister of Finance (MoF), were the result of the State Sector Act of 1988 and the Public Finance Act of 1989 (NZDMO, 2007). Both acts were part of a major structural, organizational and management reform of the public sector in which top civil servants were the major change agents (Boston, 1991; McKinnon, 2003: 270; Mascarenhas, 1993: 324; Nagel, 1998: 242; Newberry, 2014, 2015; Newberry and Jacobs, 2008: 122–123; Pallot, 1991: 170–179; Singleton et al., 2006: 143–147; Treasury, 1987; Wallis et al., 2012). These reforms made New Zealand the first country which replaced cash-based through accruals accounting in the government’s financial statements and financial reporting systems (Newberry, 2014, 2015). An important forerunner of these organizational reforms was the Reserve Bank Act (RBA) of 1989 which separated monetary policy from debt management, located the last to the NZDMO and left the first at the Reserve Bank of New Zealand (RBNZ), committing the central bank to the objective of price stability (Kelsey, 1997: 159–160).
The State Sector Act made it possible for the NZDMO to recruit debt managers from private investment banks, while the Public Finance Act delegated the power to borrow from the Minister of Finance to the NZDMO (2007).9 This act also created the legal framework for the NZDMO’s debt management activities (NZDMO, 2007; Richardson, 1991). Concomitantly, in 1987, the Treasury started to use swaps as a risk management instrument, as the MoF (1984–1988), Roger Douglas (1988a, 1988b), explained in response to parliamentary questions (see also Caygill, 1990). Soon after its establishment, the NZDMO further extended the use of new financial instruments and consolidated its own as well as the other governmental departments’ portfolio management practices (Wheeler, 1996, 2004).
The State Sector Act as well as the Public Finance Act were influenced by the reform agenda of the Treasury which its civil servants had devised in various publications more than a decade before the legislation process had taken off. Thus, prior to any parliamentary or public debate on the debt management reforms and the creation of the NZDMO, the general reform line was fixed. The sense-making framework of the reforms was grounded in financial economics and had its source exogenous to the material conditions of the legislative decision-making process.
By 1978, Treasury civil servants had already started formulating their preferences regarding public sector and financial management reforms (King, 2001: 148–149; McKinnon, 2003: 270; Newberry and Jacobs, 2008: 122–123; Singleton et al., 2006: 143–147). These were published in several papers and the first was the publication of ‘Economic Policy Package’ which was prepared by the Treasury Civil Servant Doug Andrew who before his Treasury time had worked at the Economics Department of Auckland University and spent time at the World Bank (King, 2001: 148, Fn. 8). Under Graham Scott (an economist who entered the Treasury in 1977), the Treasury finally summarized its reform package in the two Treasury publications ‘Economic Management’ and ‘Government Management’ which were the Treasury Briefings to the incoming Government in 1984 and 1987 (King, 2001: 150–151; Mascarenhas, 1993: 324; Pallot, 1991: 170–179; Treasury, 1987). In addition, in the late 1970s, Treasury civil servants, together with those of the RBNZ, also began developing ideas and suggestions on how to facilitate open market operations in public debt policy; that is essentially, how to use ‘market mechanisms’ in the ‘purchase and sale of financial assets’ and the issuance of government securities (RBNZ, 1980: 3–4). In 1979, the Treasury and the RBNZ established the Open Market Committee which met fortnightly and formulated recommendations (RBNZ, 1980: 4).
In its 1987 publication, the Treasury (1987: 8) suggested a fundamental shift in the responsibility and accountability structures of the civil service sector by implementing institutional arrangements which made public policies and administrations ‘effective in meeting their objectives at minimal costs’ (see also: Beyer, 1988: 74; Scott, 1996: 61). It complained that the ‘Government’s flexibility to operate in financial markets is limited’ (Treasury, 1987: 220) and that it ‘is not free to manage the public account actively’ (Treasury, 1987: 220). Furthermore, the Treasury (1987: 216–217) urged that the banking and debt arrangement should be separated from the Reserve Bank and monetary policy because this would allow the ‘Government to make its banking arrangements with a view to managing its finances more efficiently’. An internal Treasury document of 1987 stipulated the need to ‘manage the Government’s overseas assets and liabilities in line with commercial management principles that apply to private sector institutions’; the document argued that the ‘Government’s overseas currency assets and liabilities [need to be managed] within a profit-maximization/risk-minimization framework’ (Treasury, internal document, quoted in: McKinnon, 2003: 392). The Treasury’s early publications and activities as well as the findings of various studies on the 1988 and 1989 acts (e.g. Hardiman, 2010: 17; Hardiman and MacCarthaigh, 2010a; Newberry, 2014, 2015; Wallis and Goldfinch, 2013) suggest that the New Zealand debt management reforms were fundamentally shaped by the Treasury. Its top civil servants were the major agenda setters. Nagel (1998: 242, 243) even highlights the Treasury’s ‘near-monopoly position … with respect to economic policy advice’ in the late 1980s; the Treasury was admired ‘for its competence, discipline, persistence and political skill’, ‘became the principal initiator’; if one wanted to know ‘what government would do, one had to read the Treasury’s briefing papers, not party programmes’.
In New Zealand, economists have an institutional position in the Treasury. McKinnon (2003: 262) argues that in the 1970s the Treasury’s focus changed ‘from managing public accounts to managing the economy’ and shows how in the 1960s and 1970s the Treasury fundamentally changed its programmatic-intellectual direction by sending promising young staff to the US for post-graduate study in economics and hiring economists (McKinnon, 2003: Chapters 6–9). The establishment of a special division ‘Economics II’ for civil servants with ‘strong professional identification as economists’ (McKinnon, 2003: 298) consolidated this process and led to an ‘in-house think tank’ (Wallis et al., 2012: 286). Among the newly recruited economists were Roger Kerr (in 1976) and Graham Scott (in 1981) (McKinnon, 2003: 292) who both played a major role in the preparation of the State Sector Bill and Public Finance Bill (Bolger, 1988; Goldfinch, 1998; Lye et al., 2005: 790, 799). Scott was Assistant Secretary for economic and fiscal policy (1977–1980) and Secretary to the Treasury (1986–1993).10 Roger Kerr was director of Economics II by 1981 and served later as Assistant Secretary (McKinnon, 2003: 292). Scott graduated at the University of Canterbury, Christchurch, in 1963 (Master in Economics and Accountancy), which, according to King (2001: 155, fn. 14), ‘was the home of a group of influential monetarist and Chicago-model theorists’. Roger Kerr majored at the University of Canterbury in mathematics and graduated in economics at the Victoria University of Wellington. Sir Roderick Deane who lectured economics at the Victoria University in Wellington said of Roger Kerr that he was ‘the most outstanding economics student I ever had when I was teaching’ (quoted in: McKinnon, 2003: 292). Both, Scott and Kerr, attended joint seminars of the IMF, the World Bank and the Treasury, as, for example, the seminar ‘Economic Adjustment: Policies and Problems’ which was sponsored by the IMF, in collaboration with the Treasury and the RBNZ in 1986 (Holmes, 1986). Goldfinch (1998: 179) contends that the institutional position of these civil service economists was further strengthened by the fact that ‘the New Zealand Treasury had no significant rival within (and arguably outside) the public service in the provision of public advice’.
All in all, the historical record suggests that in New Zealand, top-level civil service economists had an institutional position in the Treasury and these actors designed the reforms along the ideas of financial economics. However, there is still a need to explore which contextual conditions made this mechanism effective and contributed to the financialization of public debt management in this country.
A closer analysis of the structures of the financial market and the civil service system at the time of the reforms reveals the following: First, New Zealand’s financial market systems did not allow the finance industry to be a major lobby group at that time and, secondly, New Zealand did not follow the British Whitehall system of a closed civil service class but was open to specialization and the recruitment of academics from outside.
Concerning the structure of the financial markets, the following aspects deserve our attention: In New Zealand, banks and the financial markets developed services to meet the needs of the family-run agricultural economy, which meant that banks were insulated, intensively regulated, less capital-intensive and of small size (Singleton and Verhoef, 2010: 541, passim). The minor importance of domestic finance industry and banks’ profits for New Zealand’s economic growth strategies did not change very much when, after 1976, and especially after the 1984 elections, measures were implemented to free the banking sector from controls over foreign exchange, interest rates and reserve ratios as well as conditions of market entry. Until 1987, only four trading (=commercial) banks were registered (Grimes, 1998: 300). These reforms in which Treasury economists, e.g. Graham Scott, played a central role (on which see, McKinnon, 2003: Chapter 8; Singleton et al., 2006: 93–96; Singleton and Verhoef, 2010: 544–545), not only liberalized banks from purchasing undervalued government bonds and permitted them to increase their overseas borrowing but also enabled foreign firms and derivatives to enter the New Zealand capital market (OECD, 1987: 39–45, 1998: Chapter IV; RBNZ, 1980: 3, 1985: 513). Although these reforms slightly deregulated the financial market, they did not lead to the development of banks which mutated to global players such as Dexia in Belgium. The Finance and Expenditure Committee received 32 submissions on the Public Finance Bill, and among them were 21 from government departments and state-owned enterprises, six from parliamentary offices and others and only five from private sector financial organizations (FEC, 1989: 5). The Report of the Committee on the Public Finance Bill gives no evidence that the banks had any influence on reform. Apparently, the Committee was more bothered about parliamentary control over public finance than with hearing advice from financial companies (e.g. FEC, 1989). Despite the financial market reforms, New Zealand’s capital market has remained internationally peripheral. This minor role of finance in the New Zealand political economy and the Treasury’s public policy making end-of-1980s (see also King, 2001: 166–167) is contrary to the Irish situation.
With regard to the structure of the civil service system, it is reasonable to argue that the openness of New Zealand’s civil service was beneficial to the economists’ institutional position. Despite Britain’s influence on institution building in New Zealand’s political and administrative system, the civil service ‘carved out some distinctive traditions’ (Mascarenhas, 1993: 321, 2003), which also differed from Ireland. Unlike the British and Irish systems, its civil service lacked the identity of an administrative class, as ‘New Zealanders’ initial tendency was to reject any suggestion of an administrative class that reminded them of the class-oriented society they had left behind’ (Mascarenhas, 2003: 121). This made civil servants more open minded about change (Mascarenhas, 1993: 321). It was further strengthened by a system which encouraged specialist education in public administration instead of the British tradition of generalist education (Mascarenhas, 2003: 120). As in New Zealand a ‘more open and egalitarian system’ had developed, changes have generally met less opposition from the inner core of the higher ranked civil service (Mascarenhas, 1993: 321, 325–326): The lack of development of an administrative class meant that common beliefs and ethics, as well as a common role perception, which often prevents change in public administration could not emerge. Mascarenhas (1993: 325) states bluntly that because New Zealand had not ‘adopted the British system of administrative class, the shift to an enterprise culture was less conflictual than in Britain’. In his study of tax reforms in New Zealand and Ireland, Christensen (2013: 579) argues that the main differences were ‘differences in the institutionalization of economic knowledge within the state’ which he explains by different degrees of openness in the two public administration systems. Grube (2015) shows that the New Zealand top civil servants are less politicized than their British counterparts and that standards ensure their political neutrality.
Ireland: Civil servants and their tight connections with the finance industry
In Ireland, the National Treasury Management Act of 1990 enabled the MoF to delegate by ministerial order all borrowing and management of debt to the National Treasury Management Agency (NTMA; est. 1990), which, however, was established as a separate organization outside the Treasury. Like in New Zealand, top civil servants were the main driving forces at that time (Hardiman and MacCarthaigh, 2010a, 2010b; Hyndman and Connolly, 2011; Keenan, 2009: 5; McCarthy, 2011: Chapter 7; McGrath and Taylor, 1989: 8). Immediately after the NTMA’s inception Michael Somers, the chief executive of the NTMA between 1990 and 2009, began head-hunting ‘financial wizards’ from the private sector and Dublin’s International Finance Center (The Irish Times, 1990b: A3). This recruitment process was handled by Price Waterhouse (The Irish Times, 1990a: A3). The conduct of swap activities followed suit (Ahern, 1991). Through an advisory board and extensive consultancy (Dáil Éireann Debate Vol. 416, No. 6, 3 March 1992), the links to the finance industry were consolidated (Somers, 1992: 144). The NTMA quickly built up contacts with international rating agencies and Ireland’s overseas investors (Somers, 1992: 146).
As with New Zealand, Irish civil servants in the Treasury were actively engaged in the policymaking process, supported by officials of the office of the Irish Prime Minister, the Taoiseach (McCarthy, 2011: Chapter 7). The two key actors in the civil service were Michael Somers and Padraig O’hUiginn (Keenan, 2009: 5; McCarthy, 2011: Chapter 7; McGrath and Taylor, 1989: 8).
Padraig O’hUiginn, who holds an MSc in Economics and Social Planning, entered the civil service in 1941 and joined the Taoiseach’s department in 1982 (McCarthy, 2011: 170). Michael Somers has a BCommerce degree as well as a Master degree and PhD in Economics (University of Dublin) and joined the Department of Finance (DoF) as a civil servant in 1963 where he established the widows and children’s State pension scheme. Between 1968 and 1970, Somers was a civil servant in the Irish Central Bank where he ‘learned the theory of credit, money supply and how it worked’ (quoted in Carswell, 2010). Between 1970 and 1985 and between 1987 and 1990,11 he was Secretary at the DoF responsible for debt management and in 1990 he was appointed the first Chief Executive of the NTMA. Like Scott and Kerr, Somers got his financial expertise through academic training and on the job, through different positions within the civil service. Somers, as well as the domestic press at that time, claimed that O'hUiginn and he were the main agents within the civil service who put debt management reform on track (Keenan, 2009: 5; Kenney, 1989: A2; McCarthy, 2011: 176; McGrath and Taylor, 1989: 8).
At the outset of reform, the Irish government asked international banks for advice (Reynolds, 1990b: 1940) and these consultants played a significant role in the agenda setting process. They not only suggested the DMO’s separation from the DoF (Currie et al., 2003: 16) but also massively lobbied for shifting to market-oriented debt management in order to increase their profits. Indeed, there is evidence of tight finance–civil service connections before the NTMA was installed.
It was the fund manager Dermot Desmond (the founder of the stockbroker company, NCB Stockbrokers), who by 1985 had already suggested not only the establishment of the International Financial Services Centre (IFSC) in Dublin but – as confirmed in an interview by Somers (see Kenney, 1989: A2) – also the adoption of the business practices of the financial market actors in the debt management of the government, together with the launch of a professional public debt management office (e.g. Cooper, 2010: 150; Haughey Family, 2011; Keenan, 2009: 5; McGrath and Taylor, 1989: 8). Desmond advertised his projects prominently at a conference organized by Fianna Fail during the 1987 election campaign, to which he was invited (The Irish Times, 1987a: 6; Wren, 1987: 17). Charles Haughey integrated these demands into his election manifesto of 1987 and after his election immediately set both projects in motion (Desmond, 1987: 14; Gallagher, 1991a; Keene, 1999; McCarthy, 2011: 206; MacLaran and Kelly, 2014: 24; The Irish Times, 1987a: 6; The Irish Times, 1987b: 33).12 Later, Charles Haughey himself gave evidence of the importance of Desmond in the creation of the IFSC and the NTMA and claimed that both ideas had already been explored during his opposition period (1982–1987) (Haughey, 2009). Padraig O’hUiginn who viewed Desmond as an ‘economic patriot’ claimed that Desmond was the ‘one and only begetter’ of the IFSC (O’hUiginn; quoted in Cooper, 2010: 149; see also Hardiman et al., 2011: 119). In our context, it is also important to note that, before founding his own business, Desmond worked at Citibank (Gallagher, 1991b: 5), the bank which the government commissioned to prepare the NTMA Bill (Murray Brown, 1997: 2; The Irish Times, 1990c: 12). Thus, the initiatives of making Dublin to an international hub of finance and of establishing the NTMA were closely linked and both stem from Dermot Desmond.
In sum, the historical record makes it reasonable to assume that in Ireland, top civil servants also greatly influenced the reform of public debt management. However, contrary to New Zealand, the process through which they affected the reform was triggered from outside, namely by the efforts of the major domestic finance wizard, Dermot Desmond, who had tight contacts with the civil servants Michael Somers and Padraig O’hUiginn. The Taoiseach Charles Haughey supported the demands of Desmond.
The question is which contextual conditions were responsible for this difference in how the civil service brought financial economics into debt management? How can we explain that in two similar countries which followed similar reform agendas such different decision-making dynamics were at work? What was the context in which the interest mechanism operated in Irish debt management reforms? A closer look at those conditions, in which New Zealand and Ireland strongly differed, helps to answer these questions.
The first condition of importance for this study is the significance of the financial market service industry for Ireland’s political economy, as initiated by the ‘progressive steps’ which were taken from the mid-1970s onwards and which abolished capital, interest rate and credit controls (Kelly and Everett, 2004: 95, box 1). As in New Zealand, the reforms in Ireland were embedded in a political-economic context of economic and fiscal crisis and massive deregulation of the domestic financial market. However, the Irish government responded to this crisis with policies that left the traditional agricultural economy behind and made Ireland an international IT- and financial service economy, backed by enormous corporate tax reductions and wage restraining social partnership agreements. While until the 1980s, Ireland shared with New Zealand domestically oriented, relatively small, banks (Clarke and Hardiman, 2012: 6), this similarity rapidly evaporated in the late 1980s, when Dublin’s IFSC was created.
As indicated above, in particular, Taoiseach Charles Haughey (Fianna Fail; 1979–1981, 1982–1982, 1987–1991) pushed Ireland’s financial market integration forward. The climax of his strategy was the establishment of the IFSC in the Custom House Docks area in 1987 (Finance Act of 1987) which was permitted by the EC and was part of the EC’s financial market integration (Rudnick, 1992: 86). With the approval and support of the EU Commission, Dublin became a hub of the international financial industry in order to strengthen the EU’s power in competition with overseas financial markets (Clarke and Hardiman, 2012: 8; Loughlin, 1991). All in all, these reforms turned Ireland very quickly into a political economy with close links and revolving doors between the state and the financial industry (Chari and Bernhagen, 2011). During the reform process, advocates argued that establishing a separate DMO would facilitate the recruitment of highly skilled and well-paid portfolio managers from private financial institutions. Stemming the loss of qualified but lower ranked and not well-paid treasury personnel to Dublin’s finance centre was one of the main purposes of the reform (Currie et al., 2003: 15–16; Murray Brown, 1997: 2; Reynolds, 1990b: 1938; Somers quoted in Kenney, 1989: A2). In the parliamentary debate on the bill, the MoF (1988–1991), Albert Reynolds, also claimed that his department had been ‘examining the potential for savings on the national debt portfolio in consultation with a number of leading international banks’ (Reynolds, 1990b: 1939–1940; see also: Reynolds, 1990a: 2010). It is reasonable to argue that these financial service surroundings triggered the debt management reforms and the inception of the NTMA. These circumstances set the New Zealand and Irish cases apart.
Ireland did not change its civil service after its independence from Britain and maintained the ‘narrow and rigid classification system’ and offered a ‘job for life’ (Millar and McKevitt, 2000: 40–42). Being embedded in a closed system, reform-oriented civil servants require outside external political support (on which see also Hyndman and Connolly, 2011: 43) which, besides party-political and governmental support, could include efforts of business interests. As Somers, the first Chief Executive of the NTMA, claimed retrospectively about the foundation of the NTMA:
More importantly, Somers also argued that he and Padraig O’hUiginn were met with opposition within the Civil Service when they suggested installing a debt management agency outside the DoF (McGrath and Taylor, 1989: 8). This opposition is linked to the Irish civil service structures which generate rigidities with regard to career progression and high salaries for qualified staff recruited from outside (see also Hardiman and MacCarthaigh, 2010a: 370).One of the problems in this country is that we have so many closed systems. The church is a closed system; the political establishment is a closed system – the civil service very much so. People join, and stay till they retire. (Somers, quoted in Keenan, 2009: 5)
While New Zealand strongly diverged from the British Whitehall system, Ireland has stuck with it until today (Halligan, 2003: 2; Millar and McKevitt, 2000: 41, 48). As Hardiman and MacCarthaigh (2010a: 370) argue, ‘[t]he Irish civil service adopted an organizational practice and structure similar to that of the British Whitehall system’, which was generalist, closed and hierarchical. Hardiman and MacCarthaigh (2010a: 370) highlight that ‘[c]areer progression has thus been based on hierarchical advancement within the civil service’. Also the main key player of the NTMA reform, Michael Somers, admitted in an interview in 1989 that the Irish civil service system did not abandon the British structures and as a result was not able to initiate fundamental institutional change (Kenney, 1989: A2). A further feature of the closed structure of the Irish civil service is that at the time of the reforms, salaries were fixed by the relativity principle which meant that wage increases in one salary class always have to encompass the whole civil service. In the parliamentary debate on the NTMA bill, the relativity principle was named as one reason why the DMO was to be established as a separate agency because this separation ‘will enable the Minister to provide higher pay and better conditions to the same people, to do the same job, and the organization model used will prevent the pay increases from running through the public service in relativity claims’ (Noonan, 1990).
These aspects make clear why the top Treasury civil servants have been so receptive to the efforts and advice of the finance industry which suggested such a separation. Salary and recruitment rigidities, caused by the closed civil service system (Zimmerman, 1997: 535), were overcome through external support and through setting up a separate office with autonomous recruitment and salary scales.
Conclusion
The financialization of sovereign debt management in New Zealand and Ireland was driven by the top civil servants in the Treasuries. But in these two early adopter countries financial economics entered public debt management through different processes of decision making: In New Zealand, financial economics entered debt management because economically skilled senior civil servants, who held institutional positions in the civil service, led the way in the reform process. In Ireland, financial economics were carried into debt management by the efforts of the domestic financial industry, supported by civil servants of the Treasury and of the office of the Taoiseach. In Ireland, it was an interest-based decision-making process; in New Zealand, an ideational process which led to the financialization of sovereign debt management. The study has also confirmed the hypothesis that differences in the structure of the financial market and the civil service have been decisive for explaining these two different patterns of interaction between state and finance. What are the implications of these findings for the literature on state financialization?
First, New Zealand’s and Ireland’s trajectory of SDM financialization demonstrate that bureaucratic actors (states) play an active role in state financialization. Future research should further scrutinize the state’s own motivations in fostering the financialization of government debt and financial market deregulation.
Secondly, this study shows that financial economics uses different channels to enter the state apparatus. Consequently, our explanations of the financialization of the state have to be attentive to these multiple ways in order to achieve credible explanations of the relationship between financial markets and states. Viewing the state as an agent of predominant private financial industry interests would misinterpret the present relationship between financial markets and governments. Even in times of massive financial market deregulation and financialization of economies, governments and bureaucracies do not simply reflect the profit interests of finance, especially, since state financialization is also concerned with a cost minimizing motive of the state. Hence, in a broader perspective, this study indicates that the relationship between finance and governments is a complex one and by no means one-sided as bureaucratic actors may even antedate the financial industry’s lobbying efforts to foster the state’s own financialization.
Thirdly, the findings of this article indicate that further studies on state financialization should be more attentive to the context in which reforms take place, in particular, to the structures of the financial markets and the civil service (public administration) systems. Contextualized comparative analyses help to specify processes which carry financial economics into the state apparatus.
Penultimately, although the case-oriented research design of this study limits its external validity, its findings suggest avenues for future research to generalize them. On the one hand, the two scope conditions which this study distilled as necessary conditions can be tested in other early adopter countries (US and Sweden). On the other hand, in the late adopter countries, the relative importance of international and domestic influences could be scrutinized (e.g. Germany and Japan). In accordance with the literature on diffusion (Gilardi et al., 2009), it is also of interest to scrutinize, whether the institutional context (of domestic financial market and civil services structures) matters more for early adopters than late comers.
Finally, SDM financialization shall redirect our attention to the problem of the complex relationship between democracy and public debt. How we normatively assess and empirically analyse greater capital market exposure of public debt depends on our understanding of democratic states. From a market perspective, the use of portfolio theory to refinance debt and the financial deepening of sovereign debt markets may be reasonable if it saves money and reduces risk for the state. However, if we define democracy as an institution dedicated and necessary to ensure socio-political objectives such as solidarity, grounding SDM in financial economics may narrow the policy space and potentially run against citizens’ collective preferences.13
Acknowledgements
I thank Susan Newberry and Charlotte Rommerskirchen for their enlightening advice, the participants of the 2016 CES conference for valuable comments on an earlier version of this paper, and the reviewers of this journal for their instructive comments. I gratefully acknowledge the tremendous support from the Department of Politics at University of Otago (Dunedin, New Zealand) which gave me the opportunity to research on New Zealand's public debt management reforms.
Declaration of Conflicting Interests
The author(s) declared no potential conflicts of interest with respect to the research, authorship, and/or publication of this article.
Funding
The author(s) received no financial support for the research, authorship, and/or publication of this article.
Footnotes
1 As the Controller and General Auditor put it in his submission to the New Zealand SDM reforms: ‘These reforms are enormous, ambitious, and, in large part unprecedented anywhere in the world’ (Controller and General Auditor, quoted in FEC, 1989: 7). Interestingly, some of the followers sent delegates to the early adopters (Murray Brown, 1997: 2; Wheeler, 2004: 22, Fn. 4) in order to study the Irish and New Zealand reforms. No such official exchange characterized the process in New Zealand and Ireland when they initiated their respective SDM reforms, implying neither learning nor spill-over effects – or more general: processes of diffusion.
2 I have borrowed the term ‘institutional position of economists’ in government from Hirschman and Berman (2014).
3 For the ideational mechanism: Hirschman and Berman (2014: 782); for the interest mechanism: James and Quaglia (2017: 6); for the methodological literature on causal mechanisms: Falleti and Lynch (2009).
4 For example, as an institutional investor by establishing sovereign wealth funds which Wang (2015) calls a ‘shareholding state’.
5 Because Treasury civil servants were decisively affecting the reforms, I do not further discuss the structural power explanation which maintains that the threat of disinvestment (or the announcement of such a threat) by business groups explains the role of business interests in policy making. Thus, the structural explanation contains some kind of automatism (‘the market as prison’, Lindblom) of a direct hierarchical influence of finance on bureaucrats, making the behaviour of state actors to a negligible factor.
6 With knowledge regime, they mean ‘research institutions like think tanks, government research units, political party foundations, and others that produce and disseminate policy ideas …’ (Campbell and Pedersen, 2014: 3). Thus, their analytical focus lies less on the analysis of why and how ideas matter in policy change but were ideas come from and how they are disseminated.
7 It seems reasonable to focus on the material interests and activities of financial services industry as the previous literature on SDM financialization has not highlighted that producer interests (industry and agriculture), which are important in the financialization of the economy matter for SDM financialization as well. I thank one of the reviewers for highlighting this aspect to me.
8 But note that in New Zealand the upper house was abolished in the 1951.
9 Please note that already the Public Finance Act of 1977 transferred the power to borrow from the parliament to the Minister of Finance. I thank Susan Newberry for reminding me of that.
10 Available at: http://blogs.worldbank.org/team/graham-scott (accessed 18 June 2018).
11 Between 1985 and 1987, he was in the Department of Defense (Kenney, 1989: A2).
12 Later, the close connection between the Prime Minister and Dermot Desmond led to corruption allegations, with the resignation of both in 1991 (see The Irish Times, 1991: 10).
13 I thank one of the reviewers to highlight this aspect to me.
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Article first published online: September 23, 2018
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