An Ideological Straitjacket
With inflation falling, a full percentage point cut in interest rates at the end of the month now looks like a done deal. But while a relaxation of monetary policy is both welcome and overdue, it does not remotely measure up to what is now required if we are to ward off what could be the most serious recession in most people’s lifetimes.
That isn’t to say that home owners should not see some small reduction in their mortgage interest payments. Businesses – at least those still willing to borrow – should get marginally better deals from those lenders still willing and able to lend. And lower rates should mean that overseas speculators are less likely to push up the value of our dollar by chasing the interest rate premium we have insisted on offering them over recent years.
Even so, the impact of the Reserve Bank governor’s expected decision will be pretty marginal. Any slight easing in the cost and availability of credit at home will be offset by the higher cost and greater difficulty our banks will encounter in borrowing overseas. And even if credit is a little cheaper and easier, that may not be of much use if fears of a recession mean that people are no longer willing to borrow and spend. Relying on monetary policy in these circumstances is a bit like pushing on a piece of string.
When Treasury advised the government a week or two ago that the economic situation had worsened over the three weeks of the Christmas break, they revealed themselves as the only observers who failed to see – from some months back – that a further and rapid deterioration was inevitable. The suspicion must be that they are still fighting the last war, still fondly hoping that the measures that were too late to deal with last year’s home-grown recession – already well entrenched long before the global meltdown – will now serve to deal with the world crisis. Following along in the wake of events, relying on tax cuts planned last year and a belated cut in interest rates, will simply not cut the mustard now that the world economy is in free fall.
It is of course true that we have not so far had to grapple with the financial crisis that has engulfed much of the world’s banking system. Our (largely Australian) banks have so far avoided those problems, though they may find the going gets tougher over coming months. But what we haven’t seemed to have grasped is that the shattering loss of confidence in the world’s banks is now spilling over in to the real world economy – the one where people actually live and work and spend and try to make a living.
As recession gathers pace overseas, we have yet to feel the full impact of export markets that are going backwards, of commodity prices that are falling, of import prices that are rising, of credit from overseas sources (on which – as proportionately the world’s second most indebted nation – we are dangerously dependent) becoming more difficult and expensive to arrange.
Nor have we understood the impact on our domestic economy of falling house prices, rising unemployment, tighter government spending levels and more bankruptcies, closures and bad debts. As people feel less wealthy – as the perceived value of their assets falls, and doubts grow over their future income levels and job security – they become less likely to spend and invest, compounding the recessionary impact of the meltdown overseas.
This is not to say that there is an easy consensus about what does need to be done. But what is clear is that most overseas governments, with varying degrees of reluctance, have accepted that simply cutting the cost of credit when people may not wish or be able to borrow is not the answer. What is now needed, as Keynes recognised 75 years ago, is a fiscal stimulus that will raise the actual level of spending in the economy. That means government investment in infrastructure and services that will benefit the economy, and possibly putting money into the pockets of people – like the poor and the retired – who will spend it, even if this means temporarily rising government deficits.
While others have accepted that difficult times require special measures, we seem locked into an ideological straitjacket which is obsessed with monetary policy and seems more frightened of a burgeoning government deficit than of national bankruptcy. Yet there is no reason why we should be less courageous than others in making our response to recession. The one bright spot in our economic situation, after all, is that the government’s finances are, by comparison with other countries, reasonably healthy. We must hope that our new government will have the courage to recognise this, to understand what they must now do, and to do it before it is too late.
Bryan Gould
21 January 2009
This article was published in the Sunday Star-Times on 25 January.
Saving Labour
I surely cannot have been the only reader to stop short mid-sentence at Nicholas Watts’ statement (Guardian, 13 January) that Tony Blair, Gordon Brown and Peter Mandelson had “wrenched Labour out of the wilderness”. The trio may have a number of achievements to their credit but the claim that they saved the Labour Party is – at the very least – open to question. It is precisely this kind of apparently casual but seriously misleading assertion which – unless challenged – can quietly become part of the accepted wisdom. History should not so easily be re-written.
By the time Tony Blair became leader of the Labour Party in 1994, the Labour Party had substantially recovered from the nadir of its fortunes in 1983. That recovery owed a great deal to the leadership of Neil Kinnock. Under Kinnock, the Party had stopped the rot by 1987, had begun to divest itself of outdated policies, and had averted the real risk of falling behind the Liberals and Social Democrats. It had made further strides towards electability by 1992, and lost that election against many predictions only because – despite his substantial qualities – Kinnock could not seal victory by reaching out to that further range of middle-class opinion which had succumbed to the claims of the Tory media that he was nothing but a garrulous working-class boyo.
It is very much to Kinnock’s credit that he recognised this and relinquished the leadership accordingly. Although I had my reservations about John Smith (and would have hoped for a more positive approach to the prospect of government), few can doubt surely that Labour was, under new leadership, heading for a comfortable victory at the next general election.
The reasons for that optimism are, and were, not difficult to substantiate. General elections are almost always lost by the governing party. By 1994, the heyday of Thatcherism had long passed. Mrs Thatcher herself had been deposed by her own party some years earlier because the electorate was increasingly out of sympathy with her extreme views and policies. John Major had won an unlikely victory in 1992 but had failed to convince the electorate that he was made of the right stuff to lead the country.
My own view is that when voters woke on the morning after the 1992 election, they were dismayed to realise that they were faced with another five years of Tory government. From that moment onwards, the die was cast. They were determined to secure a change of government at the next opportunity.
It was certainly a signal achievement of the Blair/Brown/Mandelson “project”, (what later became “New Labour”), to persuade a Labour Party starved of electoral success that only a wholesale abandonment of its values and policies would guarantee victory. But this was a piece of sleight of hand. Not only was aping the Tories not needed; the electorate was actually very clear that it wanted change and a decisive move away from the Thatcherite agenda.
This contention is supported by what actually happened in the 1997 general election. No one would doubt that Tony Blair was an electorally attractive candidate and that his appeal could well have added a margin to the Labour victory. But the real story of the 1997 election was that, after 18 years of right-wing and (especially after the debacle of the Exchange Rate Mechanism) incompetent government, Tory voters were disheartened and stayed at home. It was that lack of commitment, and the recognition that change was inevitable, not the abandonment of Labour principles, that accounted for the “landslide”. If, under a first-past-the-post system, your opponents stay at home, you win big.
The real issue in assessing the role of the Blair/Brown/Mandelson trio in the Labour Party’s history is to ask, not what did they do to bring about election victory (which was largely assured by the time they arrived on the scene), but what did they do with power once the general election had delivered it to them. The answer to this question is much less flattering to them than Nicholas Watts’ claim about their “wrenching Labour out of the wilderness” would suggest.
Every day that goes by makes it clearer that the contribution of New Labour in government has been to provide an unexpected, unwarranted and unnecessary prolongation to the Thatcherite era. New Labour has assiduously followed George Bush in foreign policy and Alan Greenspan in economic policy. On the central question of politics – the relationship between government and the market – New Labour has settled decisively on the side of the “free” market, with the consequences we are now living with. We should be very careful about investing those responsible with encomiums of praise for allegedly saving what is valuable in left politics.
Bryan Gould
18 January 2009
Lessons from the Crisis
As the global crisis unfolds, the great gurus of the world economy – those who have presided over its fortunes for much of the last two or three decades – have largely ducked for cover. Some – like Alan Greenspan – have had the courage to admit that there was a “flaw” in his thinking. Others – like Gordon Brown – have made an apparently effortless overnight conversion to Keynesian economics after decades of monetarist orthodoxy. A few – like Bernard Madoff – have been unmasked as fraudulent, as well as foolishly irresponsible. But most have watched from the sidelines, silent and confused, as the results of their handiwork have become apparent.
The immediate task and focus of governments around the world is, of course, to put in place measures which will limit the damage, avoid a depression, and restore the world economy to some semblance of health as soon as possible. In this endeavour, the supposed experts of yesterday necessarily have little to say. It is, after all, their nostrums that have driven us to this point, and the crisis has cruelly exposed the limitations of the monetary policy which they said was all that was needed. What does liquidity matter if no one wants to borrow and spend?
But, once the authorities have done their best, and the course to recovery of a sort is (hopefully) set, the debate will move on. The issue then will be not so much the steps needed for recovery as the lessons to be learned if the disaster is not to be repeated in the future.
At that point, we can expect the champions of “free” markets to re-enter the debate. The battle will then be on to write (or re-write) history, and what now seems undeniable will again become hotly contested. There will be no shortage of explanations and excuses for what has happened, ranging from the nonchalant (the crisis was a minor blip in what has otherwise been a triumph for the “free” market) to the aggressively ideological (it was the failures and mistake of governments that frustrated and distorted legitimate market operations).
It is vital, therefore, that – while reality still imposes itself on perceptions – an account is drawn up of the lessons we must learn from this disastrous episode. Some of those lessons will be widely accepted, but others – even for those who are most critical of the errors of recent times – will be more difficult to digest.
The crisis has been so damaging and so all-engulfing that it might be argued that virtually nothing of past doctrine can survive. There are some particular lessons, however, that absolutely demand attention. I would select six leading contenders.
The first and most obvious is that “free” or unregulated markets are extremely dangerous mechanisms which inevitably go wrong. All markets, left unregulated, will produce extremes, and that is particularly true, as Keynes pointed out, of financial markets, because of their inherent instability. The case for regulation cannot be disputed, but even so, the counter-attack will certainly come. The merits of self-regulation, the salutary effects of competition, and the advantages of a “light hand” will again be rolled out in order to deflect any real attempt at disciplining market operators. That is when our public authorities must be strong-minded, and remind themselves that is their responsibility to the public interest that demands effective regulation.
The second lesson is that government involvement in the management of the economy is essential. After decades of being told that the only thing we should ask of government is that it “get off our backs”, we can now see that it is governments – not banks or the private sector – that, as the authority of last resort, maintain the value of the currency, guarantee appropriate levels of liquidity and credit, and make irreplaceable investments in essential infrastructure. We must not wait again until the eleventh hour before we deploy the power, responsibility and legitimacy of government to keep the economy on the right track.
The third lesson is that fiscal policy, decided by governments, is more important and effective than monetary policy. We have again been told for decades that monetary policy is all that is necessary, and indeed all that is effective, both in controlling inflation and in setting the real economy on a sustainable course. We now know that using monetary policy to ward off recession is no more effective than pushing on a piece of string and that an exclusive reliance on monetary policy to restrain inflation is just another reflection of the view – now surely discredited – that the markets always get it right.
My fourth inescapable lesson is that gross imbalances in the world economy will inevitably cause it to topple off the high wire. The growing gap between rich and poor nations is bad enough, from both an economic and moral viewpoint. But the imbalance between surplus and deficit countries is equally damaging as a strictly economic phenomenon. The surpluses drive us toward recession because they represent resources that are hoarded rather than spent, while those countries with deficits are likely, as Keynes pointed out, to try to control them through deflating their economies, thereby reinforcing the deflationary bias. To the extent that others are willing to finance the deficits (as, for example, China’s financing of the US deficit), this simply encourages uneconomic production and an excessive reliance on credit, meaning that the world economy wobbles perilously on an unsustainable foundation.
A related and fifth lesson is that the freedom to move capital at will around the world has exacted a heavy price. The total removal of exchange controls meant that international investors could ignore and, if necessary, blackmail national governments; this became a major factor in allowing market operators to escape and defy any attempt at regulatory controls. We have to make up our minds whether we trust accountable governments, with all their imperfections, or the unrestrained and totally irresponsible market. Our recent experience surely makes this a no-brainer. What we now need is a new international regime, negotiated between governments, to regulate exchange rate volatility, international lending practices, and the obligations of international investors.
My final lesson is that bankers should not be trusted with the most important decisions in economic policy. No policy measure was more widely welcomed than the handing of monetary policy over to “independent” central banks. We now have good reason to know that their decisions are not only likely to be wrong, but will certainly be self-serving – no more reliable or impartial than those of casino operators who will always set the odds in their own favour. If we are truly to grapple with the lessons set out above, we need to restore the main decisions of economic policy, including the effective regulation of markets, to democratic control.
Bryan Gould
18 January 2009
This article was published in the online Guardian on 19 January and the New Zealand Herald on 26 January.
Fiscal Stimulus? Not Quite
The decision by the US Federal Reserve to cut interest rates to virtually zero, and the similar steps taken by other central banks, show how desperate are the world’s monetary authorities to avert a deep and entrenched global recession. This is, in effect, their last throw. There is nowhere else to go. If anything were needed to expose the limitations of monetary policy, it is the fact that even zero interest rates are – in a world where there is increasing reluctance to spend, lend alone borrow – as ineffectual as pushing on a piece of string.
That is not to say that the interest rate cuts overseas will have no effect. We in New Zealand have discovered that sooner than most. The Fed’s unprecedented action has meant that our own meagre cut in interest rates has left the interest rate differential pretty much where it has been all along – offering a standing invitation to speculators to take the New Zealand taxpayer for a ride. The rise in recent days in the Kiwi dollar’s value on the back of a renewed inflow of hot money now threatens to snuff out one of the few bright spots in an otherwise dismal New Zealand outlook.
Our caution in responding to the growing global downturn is part of a wider failure on our part to grasp the true dimensions of what is unfolding worldwide. We assume that the steps we have taken to counter our own home-grown recession (which was well entrenched long before the global crisis struck) will be enough to see us through the impact of the global downturn when it hits us. We don’t seem to recognise that we have yet to feel the full impact of declining export markets, falling commodity prices, more expensive credit, and higher import prices, to say nothing of the deflationary effect in the domestic economy of a foundering housing market, higher unemployment, lower wage growth, more bankruptcies, closures and bad debts, and tighter limits on public spending.
Most importantly, we appear to take no account of what Paul Samuelson calls the “wealth effect” – the impact on consumer confidence and therefore spending of a perceived decline in people’s wealth as house prices fall and unemployment threatens. The result? We are still looking to the early end of a recession that has barely begun.
This picture seems much clearer to policy-makers in other economies. But, in view of the ineffectual nature of monetary policy, little wonder that many overseas governments are now looking more and more to fiscal policy for salvation. Keynes, “thou shouldst be living at this hour!”
Not everyone of course is persuaded of the need for fiscal stimulus. For many conservatives, this use of fiscal policy (or deficit financing or printing money as it is often pejoratively labelled) is absolute anathema. Indeed, the British government’s readiness to create and live with a rapidly growing deficit has provoked a bitter row with German Ministers who would, apparently, prefer to see the recession take its course rather than use Keynesian measures to forestall it.
Yet the accuracy of Keynes’ prescriptions for dealing with recession has brought about what has been in many cases an overnight conversion to Keynesian economics. Our own policy-makers however – like the Germans – seem reluctant to recognise that, if recession is not to become endemic, exceptional measures have to be taken.
Their excessive caution in bringing down interest rates to a level which is still well above world rates has been matched by a similar reluctance to take effective action on the fiscal front. We have been assured that our economy is already benefiting from a large fiscal stimulus but it is difficult to see anything in the current policy stance that is likely to impact greatly on the real economy in the immediate future. True, we had some tax cuts a month or two ago and there are – marginally – more to come in April, and there are proposals (yet to be implemented) for an accelerated public spending programme in infrastructure. But what seems to be offered as the main element of our so-called “fiscal stimulus” is a growing government deficit as a consequence of falling tax returns and writing down the value of government assets.
It is certainly true that the government’s books look a lot less healthy than they did a year ago, (though it is also true that they are in better shape than in most countries). But declining tax revenues are simply the inevitable consequence of recession – not a stimulus to economic activity – while falling values for government funds are accounting provisions which have no immediate impact on the real economy. Neither is a substitute for a real boost to spending power, which – as Keynes explained – is the only factor that will really counteract a threatened recession. Without it, we are in for a long hard road.
True to form, our policy-makers are sticking to the obsessive orthodoxy that has handicapped our economic performance over more than two decades, even when that orthodoxy has been identified as responsible for a recessionary crisis and has therefore been abandoned on a global scale. It will be a real test for the new government to see whether it has the courage to seek different and better advice.
Bryan Gould
19 December 2008
This article was published in the New Zealand Herald on 22 December.
Politics Not Economics
As Keynes’ biographer, Professor Robert Skidelsky, says in the British Sunday papers, “it is not surprising that the old Keynesian tool kit is being ransacked” in response to the global economic crisis. After decades of being assured that “there is no alternative”, and that Keynesian economics is a dead duck, we now find that Keynesian remedies are all the rage. Without government intervention to bail out failed banks, measures of counter-cyclical demand management, and the resurgence of fiscal policy, the world would be facing an even grimmer future than it currently is.
But we need not wait long for the failed nostrums of recent orthodoxy to re-surface. Already, the George Bush’s of this world are trying to re-write history. The crisis, they say, was not caused by the failure to regulate the “free” market. There is nothing wrong, they maintain, with the basic model of unregulated capitalism. All that is needed, once the current crisis is overcome, is a little tweaking here and there before business as usual is resumed.
These apologists for our current travails make it clear that the measures that their failures have made necessary are absolute anathema to them. According to them, the best thing that can now happen is that decisions on major economic issues should be returned as soon as possible to those who are accustomed to taking them – that is, to those who made these catastrophic mistakes in the first place.
What all this shows is that the response demanded by the crisis is as much a political one as it is economic. The economics are pretty straightforward, as Keynes himself would have argued. In his view, economics was not an arcane science but largely a matter of common sense. It does not require a genius to understand that short-term markets are inherently unstable and, without proper regulation, will topple over into disaster. Nor do we need to look far for the obvious (even if – to some – unpalatable) remedies for the financial meltdown and the imminent global recession.
What we do need to understand is that what creates a crisis of the kind that now engulfs us is not economics but politics. The triumph of the global “free” market which has dominated the world over the last three decades has been a political triumph. It has reflected the dominance of those who believe that governments (for which read the views and interests of ordinary people) should be kept away from the levers of power, and that the tiny minority who control and benefit most from the economic process are the only people competent to direct it.
This band of greedy oligarchs have used their economic power to persuade themselves and most others that we will all be better off if they are in no way restrained – and if they cannot persuade, they have used that same economic power to override any opposition. The so-called “economic” arguments in favour of “free” markets are no more than a fig leaf for this self-serving doctrine of self-aggrandisement.
It is that political stance that must now be challenged if we are to learn the real lessons of the current crisis and defend ourselves against a repetition of the disaster that has now overtaken us. What we must understand is that what has happened is not the consequence of some technical failure in economic management. It has happened because we allowed democratic forms of government to be sidelined and subverted by the economic power of a minority.
The uncomfortable truth is that democracy and “free” markets are incompatible. The whole point of democratic government is that it uses the legitimacy of the democratic mandate to diffuse power throughout society rather than allow it to accumulate – as any player of Monopoly understands – in just a few hands. It deliberately uses the political power of the majority to offset what would otherwise be the overwhelming economic power of the dominant market players.
If governments accept, as they have done, that the “free” market cannot be challenged, they abandon in effect their whole raison d’etre. Democracy is then merely a sham. The dice must then be allowed to lie where they fall, and no amount of cosmetic tinkering at the margins will conceal the fact that power has passed to that handful of people who control the global economy.
The challenges facing the world are now so great – the threat to our environment, the huge imbalances between rich and poor, the energy crisis – that they dwarf even the economic power of the high priests of the global economy. If the current crisis is to be overcome successfully, it must set us on a new course, not just to restore prosperity for the already well-off, but to confront these global challenges before it is too late – and that is a task not just for the economists but for the politicians – and all of us – as well.
Bryan Gould
24 November 2008
This article was published in the online Guardian on 26 November.