Recovery? What Recovery?
It is surely beginning to dawn on us, nearly three years after our recession began, that anything approaching a full recovery is still a long way off.
It is now clear that unemployment remains stubbornly high, that the housing market is depressed, and that property values have fallen sharply so that most people no longer feel as wealthy as they did. Lower housing values and employment uncertainties explain why domestic demand is sluggish so that – barring an unlikely pre-Christmas boom – we can expect to see increasing numbers of empty retail premises in our high streets in the New Year. Little wonder that confidence in the economy is ebbing and that employment and investment intentions are at low levels.
As a consequence, the exodus across the Tasman has resumed. Australian living standards continue to rise faster than our own, as both demonstrated and assisted by the growing strength of their dollar against ours.
Yet a great deal is going right for our economy. Our major export markets in Australia and China are performing strongly and demand for our goods is buoyant. Commodity prices generally and dairy prices in particular are at historically high levels. Our trade figures mean that a trade imbalance is not so much a constraint on expansion as it has been over such a long period.
Inflation is not an immediate problem and the Reserve Bank governor has signalled his intention to keep interest rates at low levels. Our banks are in good shape (though, sadly, the same cannot be said of our finance companies). The warnings of the “bond vigilantes” that increased government borrowing to fund their deficits will mean rapidly rising long-term interest rates around the world have not materialised. Our own government’s finances are stronger than forecast and are in any case among the healthiest of any advanced country; most European governments can only dream about our relatively and historically low levels of government indebtedness
In these unusually favourable circumstances, there is something wrong with us if we cannot make a good fist of coming out of recession in good order. So, what is going wrong?
What we are seeing, I believe, is a simple failure of analysis. An economy in recession is by definition an economy in which there is a deficiency of demand. If we want to recover from recession, we have to see somewhere a lift in demand. The question is, therefore, where is it to come from?
For once, a partial answer is provided by the export sector. The improvement in export prices is helping to re-balance the economy towards exports and away from domestic consumption –something the government is keen to see and a process that could be made even more beneficial by a more competitive exchange rate.
But is the relatively strong performance of the export sector enough to counter the impact of lower levels of activity in the other two sectors – the private sector and the government? If the answer to that question is no, then we have our answer as to why our recovery is so sluggish.
It is of course only too evident that activity and confidence in the private sector have suffered during the recession. Consumers are keeping their wallets closed, and businesses are cutting costs rather than taking on employees and investing in new capacity.
So, if we are to lift ourselves out of recession, we need the government sector to be playing its part in stimulating the level of demand, so as to offset and eventually reverse the current depressed state of the private sector. Yet, when we look to what the government is doing, we see priority given to the government’s finances rather than the health of the wider economy – to getting the government’s deficit down, rather than on using fiscal policy to stimulate the economy as a whole. The effect is that depressed demand in the private sector is reinforced rather than offset. The government is not, in other words, helping towards a solution but contributing to the problem.
The government says of course that it must cut back because it has to borrow just to maintain current spending, let alone spending at a higher level. But that is simply to re-state the problem rather than resolve it. The government has a deficit because a depressed economy means that its revenues are down. If the government is not helping but hindering recovery, then it will take longer to reduce the deficit and the recession will drag on for longer. And the longer it takes, the greater the risk that less than optimal levels of employment, investment and output will become permanent features of our economy.
The government is quite right to insist that it must, like the rest of us, get value for every dollar it spends. But isn’t it time that ministers took a wider and longer view of the role they must play if we are to shake off the shackles of recession?
Bryan Gould
2 October 2010
This article was published in the NZ Herald on 12 October.
Why Not for the Unemployed?
Two South Island crises in the last couple of weeks have seen the government step up to the plate. The failure of South Canterbury Finance and the Canterbury earthquake were very different disasters but both required government – acting on behalf of all of us – to make good losses suffered initially by a minority but threatening to impact on the whole community.
Despite their differences, the two crises shared common features. The initial bill in both cases will reach into the billions. The losses occurred through no direct fault of those who will bear the main brunt. The government quickly calculated that the cost of doing nothing would greatly outweigh the cost of doing what seemed necessary.
It is of course the case that there will be many victims of earlier finance company failures who will ask why they were left without help while investors in South Canterbury Finance had their chestnuts pulled out of the fire. But the government correctly calculated that the economic black hole – if left unfilled –would do terrible damage to the South Island economy. And in any case, the expectation is that much of the government’s initial outlay will be recovered through an orderly winding up of SCF’s affairs.
No such backward glances are warranted in the case of the Canterbury earthquake. Immediate emergency help and a prompt beginning on the task of reconstruction are clearly needed, and only the public purse is deep enough to get this underway. And, encouragingly, the longer-term consequences of a recovery programme might actually be beneficial in economic terms.
No one should discount the immediate personal and social price that the earthquake has exacted. But the injection of significant new capital into the regional economy could prove to be a shot in the arm to Canterbury – and beyond. We need only think of the new jobs in construction, the boost to manufacturers of materials, the lift in services from transport to accountancy, to understand how this might work.
In both cases, too, it is significant that – at a time when the current emphasis seems to be on smaller government – it is again to government, as at the time of the global financial crisis, that we turn for the kind of help that no other agency can deliver. It seems that no matter how often we learn this lesson – whether in wartime, or in economic crisis, or following a natural disaster – we are quick to forget it as soon as what passes for normality is restored.
A case in point is our recent treatment of unemployment. The disaster that overtook tens of thousands of Kiwis in the aftermath of both the global and our own domestic recessions, when they lost their jobs or businesses, may not have had the dramatic impact of a single terrible event like the earthquake or even the SCF failure, but the consequences for individuals and families are equally destructive.
And the parallels with the two South Island crises are clear. The victims of unemployment are equally innocent of responsibility for the calamity that has struck them. They did not cause the recession. The numbers involved are just as large. The economic consequences are equally serious, not just for those directly affected, but also for the rest of us.
The loss of the productive capacity of tens of thousands of our fellow citizens makes us all poorer. The personal and social consequences for individuals and families make our society weaker and less cohesive. The longer-term impact – such as the renewed exodus across the Tasman – blights our prospects as a nation.
Just as in recent days, action and investment by government would be a proper response to this disaster. A dollar invested by government now, just as in Canterbury, could be repaid not just immediately through the relief of distress but also in the longer term through more jobs and a stronger economy. If we can do it for earthquake victims, why not for the unemployed?
Yet, in our response to unemployment, there has been no sense of the community pulling together to provide help to those who need it, no recognition that we will all benefit both economically and socially if we invest in the productive potential of all our citizens.
Instead, we have turned and pointed an accusing finger at the unemployed. Not only can we not afford to help them with a crisis for which they are not to blame, we tell ourselves; they should bear not only their costs but ours as well. So we cut the minimal benefits on which they are forced to live, and salve our consciences by seizing on the occasional well-publicised anecdote about welfare cheats and scroungers.
And instead of investing (as in Canterbury) in economic reconstruction, we give priority instead to getting a government deficit that is already one of the lowest in the developed world down a year earlier than it would otherwise be.
Shouldn’t we step back and have a good look at ourselves?
Bryan Gould
7 September 2010
This article was published in the NZ Herald on 8 September.
The Lump of Labour Fallacy
Popular wisdom and what passes for common sense are not always the best guides to running a successful economy. That is why businessmen who have a good practical grasp of what it takes to run a successful business are often wide of the mark when it comes to making policy for a whole economy.
An economy, contrary to what is often asserted, is not like a business. Particularly in down times, the measures that might be required in the interests of an individual business are the very reverse of what is needed by the economy as a whole. Cutting costs, deferring investment, and laying off workers will help to balance a single set of business accounts but are the last thing that a whole economy needs if it is to avoid continued recession.
It is often the case that good economic management may seem counter-intuitive. A case in point is what economists call the ‘lump of labour” fallacy – the belief that there is a fixed amount of work available and that the task is to decide how that is to be shared out fairly.
The fallacy is alive and well in the minds of even experienced policy-makers. We saw shades of it in the “nine-day fortnight” that emerged as a counter-recessionary strategy from last year’s job summit. The idea, which not surprisingly had little impact in practice, was based on the notion that if a fixed amount of work could be shared out, more jobs would be created, or at least saved. By diverting attention from what was really required – a policy which would increase the number of jobs – it actually hindered the fight against unemployment.
The fallacy rears its head unhelpfully in other contexts as well. In the perennial debate in developed countries about immigration, one of the main arguments advanced against allowing an inflow of newcomers is that they will “take our jobs”. There is little recognition of the real possibility that a controlled rate of immigration could create jobs and expand the economy.
There are of course many considerations in determining what are appropriate levels and kinds of immigration; but we would no doubt reach better decisions on matters such as this if we could free our minds of intuitive fallacies and look at the practical evidence. The great economic success of a Hong Kong, for example, was greatly helped by the constant inflow over many years of (often illegal) immigration from across the Chinese border.
The “lump of labour” fallacy also underpins an important current debate in our own country. The stubborn refusal of comparatively high unemployment to melt away has again prompted discussion of what the government could or should do to “create” jobs. The very suggestion that something could be done has, however, been greeted – even by very experienced commentators – with the apparently incontrovertible objection that “the jobs just aren’t there.” And that means, it is said, that there is nothing the government can do.
If that were really the case, of course, the government’s push to get people off benefits and into jobs would be futile. The jobs cannot both be non-existent for the purpose of getting unemployment down, yet waiting there for lazy beneficiaries to take up. And while it is certainly true that there are strict limits as to how far (if at all) governments should try to create jobs by putting in place “make work” schemes, that is not the real issue.
The reality is that the number of jobs in an economy is not a given, but is a function of the level of demand and therefore of economic activity. The number of jobs falls in a recession and rises in better times. If we want to recover from recession, we need policies that will stimulate demand and purchasing power so that people will buy what producers make, and retailers can boost sales, and employers can see that it is worthwhile to take on more staff, and more people earning good wages will keep the virtuous circle going – so that the government’s finances benefit as well through a higher tax take.
There is no mystery about this. And the level of demand is very largely determined by policy. A government that provides stimulus to the economy through maintaining or increasing its own levels of spending and investment, as the Australians did, can achieve a great deal in avoiding recession and fighting unemployment.
If the policy priority, however, is to get the government’s (perfectly manageable) deficit down, the outcomes are equally clear. We may comply with good business practice by pleasing our bankers in the short term, but our economy will be smaller, unemployment will be higher and the recession longer. If we really want to please our bankers in the longer term, we should be growing the proportion of our resources devoted to production and exports. That will not be achieved by allowing a prolonged recession to close down parts of our productive capacity.
Bryan Gould
15 August 2010
This article was published in the NZ Herald on 31 August.
It’s The Economy, Stupid
A week, as Harold Wilson famously said, is a long time in politics, but the day-to-day ups and downs that hog the headlines rarely determine the outcome of elections. Voters’ preferences are usually shaped over longer periods and reflect underlying perceptions about the competence of governments and the preparedness of oppositions to meet the challenges of running the country.
Recent reports of government policy reversals or of Labour’s disciplinary problems matter less, in other words, than what is happening over the long term to the issues that really matter – and principal among those, as Bill Clinton’s campaigners declared, is “the economy, stupid”. For as long as the economy is seen to be on the right track, the Prime Minister will retain a good deal of political capital in the bank, and the government will not be too worried by the kind of occasional, short-term difficulty that afflicts all administrations.
But that scenario could change if, over time, the perception should grow that the economy is heading nowhere. A better economic performance, even if the goal of closing the gap with Australia is now said to be only “aspirational”, is after all at the very core of the government’s agenda. Other disappointments might well be accommodated without difficulty, but an economic policy that was seen to take us down a dead-end would be serious for any government, not least this one.
That is why the faintest of alarm bells might now be audible in John Key’s office. It is bad enough that the steady recovery from recession now looks as though it might have stalled. The current economic news suggests that, whatever the statistics might show, people are now much less confident that their economic circumstances will improve over the next year or so. And that is exactly the kind of perception that can have a big influence over election outcomes.
What will worry the government even more is that they seem to have few weapons left to try to improve matters. Even our relatively benign experience of recession over the past couple of years is now seen as owing more to the buoyancy of our major export markets in China and Australia than to any initiatives taken by the government. And, as those markets falter, the heat will turn up on the government to find its own way forward.
The trouble is that they have already fired what seem to be their best shots, to little avail. The jobs summit produced little. The priority to getting the government deficit down is said to preclude any further stimulus to demand and economic activity. The welcome focus on funding for research will take some time to bear fruit.
In the meantime, almost all of measures they have turned to have failed to carry conviction. They have either been tried before without achieving much or have provoked such opposition that they have been abandoned before they even got started.
So, removing “labour market rigidities” through amending employment law in favour of employers is a favourite nostrum of neo-liberal ideologues but has stubbornly failed to produce any benefits to productivity or growth when it has been tried before. Pressing on with the free trade agenda looks and sounds good but – in a country which has given it a more extended trial than almost anywhere else – has resulted over a couple of decades in a more rapid growth in imports than in exports.
The move to attract foreign capital by increasing our willingness to sell even more assets into foreign ownership seems to have stalled in the face of the Prime Minister’s recognition of the political risks involved. The attempt to transform our tiny financial institutions into world players in capital markets seems unlikely to get off the ground. And the latitude planned for international mining companies to prospect in prime conservation land quickly flew in the face of environment sensitivities.
The danger for the government is that these abortive steps will be seen not just as failures but as having been ideologically driven – reflecting the belief that economic salvation lies in tilting the balance in favour of employers – rather than directed at solving real economic problems. And that problem will be compounded as we seem to be preparing yet another re-run of measures – high interest rates and an over-valued dollar – that have already been seen to make the problems worse rather than better.
John Key has so far shown a sure political touch. He will know that perceptions about the government’s ability or otherwise to kick-start our economy will be critical to his chances of re-election. Stand by – if we are lucky – for an “agonising re-appraisal” of economic policy.
Bryan Gould
1 August 2010
Holding Banks to Account
The dramatic and damaging collapse of the New Zealand finance company sector over the last three or four years has attracted a good deal of attention, largely because of the multi-billion losses that investors have suffered. One of the consequences has been a boost to the confidence felt in banks which have reinforced their reputation as the best place to put one’s money.
It is certainly true that, while overseas banks are up to their necks in scandal, our largely Australian-owned banks have maintained an enviable stability and reliability. But the tribulations of banks worldwide make it inevitable that the role of banks in the global economy should increasingly come under the spotlight.
The revelations that many of the world’s leading banks have been guilty of dishonestly rigging markets and misleading investors have already claimed one victim, in Barclay’s Bank, and seem certain to involve many more. And that comes on top of the role – dubious at best, irresponsible and dishonest at worst – that the banks played in bringing about the global financial crisis in 2008.
Not surprisingly, the British government is establishing a full-scale review of the banking sector, and few would now bet against the pressing of criminal charges. But it could be argued that these scandals are not just a reflection of the criminality of a handful of bank leaders but arise inevitably from the role that banks in general have been allowed to play.
Most people still see banks as institutions that provide a safe repository for our savings and that from time to time lend us money either on overdraft or on mortgage. But this is seriously to underestimate the power that banks wield in our economy and the extraordinary nature of the concessions that allow them to do so.
The central feature of banks, which seems only dimly understood even within the banking sector itself, is that they are private commercial enterprises which have been granted a unique and virtual monopoly over the creation of money. By far the largest proportion of the money in our economy (and in the economies of all advanced countries) is not notes and coins but bank-created credit. That credit represents no more than bank entries by bank officials; its status as money rests entirely on the suspension of disbelief – or, to put it another way, on our willingness to accept that it is money because the banks say it is money.
The failure to understand this fundamental aspect of our economy leads to serious errors in formulating economic policy. The overwhelming role of credit-creation by the banks in inflating the money supply should be our central concern in controlling inflation, particularly when the vast majority of that credit is created and lent for non-productive purposes like house purchase.
Because we don’t understand this inflation-engendering phenomenon, we grapple with inflation using seriously inadequate and inappropriate instruments like interest rates, which are not only slow-acting and poorly focused but do great damage to the rest of the economy. A more accurate analysis of inflation-producing pressures in our economy would lead to more effective measures to restrain them and at the same time encourage a more productive and competitive economy.
We can see how privileged and unaccountable banks are from the fact that their unique capacity to create and lend vast quantities of “money” for private profit passes under the radar, whereas a democratically accountable government that occasionally “prints money” in the public interest draws screams of blue murder.
But it is not only this aspect of the banks’ operations that should cause concern. Over the last two or three decades, the banks have used their ability to create money to invent a whole range of new financial instruments of dubious value which they are then able to sell to gullible investors; so profitable was this trade that it became much more important to banks than their traditional role.
It was this prospect of unlimited profits created out of nothing (to say nothing of the huge rewards and bonuses paid to individual bankers) that led in due course to the global financial crisis. And when that irresponsibility inevitably ended in collapse, it was that same mentality that led bankers into the realms of fraud and criminality. In a world where anything goes, the rules are made to be broken, and personal fortunes are there for the taking, who can wonder that bankers could not accept that the ordinary rules applied to them? We have reaped what we have sown.
In case we should assume that none of these problems afflict us, let us not forget that our own banks, pillars of propriety as they may seem by comparison with their overseas counterparts, have made strenuous attempts to avoid their tax liabilities and have only been made to pay up by court action.
And in our case, the banks have not only made huge profits by exploiting their unique capacity to create money, but have then exported those billions across the Tasman, thereby placing a huge burden on our already beleaguered balance of payments. Isn’t it time to establish a banking system that supports the economy rather than places it at risk?
Bryan Gould
8 July 2010
This article was published in the NZ Herald on 12 July.