Post-meltdown
The horror stories keep coming but – even so – it is doubtful whether we have yet grasped in New Zealand the scale and seriousness of what is happening in the global economy, and how greatly we will be affected by it. We know that others are in deep trouble but we see ourselves so far as transfixed spectators rather than actors (or victims) in the drama.
We may not remain in that comfort zone for long. As the world enters recession, and the markets for our goods are decimated, we will feel the pain. And, although our financial system seems unscathed for the moment, the price we will inevitably pay for being one of the world’s most indebted countries is waiting just round the corner. As foreign investors take their money home, and as our banks have to re-negotiate the credit arrangements on which they rely, stand by for a succession of damaging body blows to the already fragile underpinnings of our economy.
There is little sign yet that our political and business leaders have grasped the dreadful vulnerability of our position. The cool reception given to the thoughtful paper issued last week by Mark Weldon and David Skilling – with Peter Dunne expressing concern about the impact on the government’s deficit, as though that was the foremost of our worries – shows that we do not yet recognise the imperatives that have driven governments around the world to take steps that would have been unthinkable just a couple of months ago.
There is of course room for considerable discussion about the precise recommendations of the Weldon/Skilling paper. But it does at least represent the first awareness of the scale of the problem and of the need for new thinking. Even more interestingly, it points the way to a post-meltdown future where the world will (hopefully) never be the same again.
The paper is notable mainly for its (perhaps unconscious) willingness to slaughter some sacred cows to which we have been solemnly assured for nearly three decades “there is no alternative”. Governments must be kept well away from the main levers of economic policy? No. As the paper now asserts (and as even George Bush agrees), government action is essential. Monetary policy is all that matters? No. The paper says that fiscal policy is now the most important weapon in the armoury. Bankers should be entrusted with the important decisions in our economy? No. As is apparent to everyone, banks worldwide have failed us and must in many cases be taken into public ownership. “Free” markets must be left unregulated and will always produce the best results? No. The market has failed and created a catastrophe. All that matters is the bottom line? No. The goals of economic activity are wider than profit for a few.
The truth is, in other words, that if we are to survive the crisis in reasonable shape, we must now abandon the nostrums that have proved so self-destructive. We need governments to acknowledge their responsibilities, to take a major role in the rescuing of our economy, to use a much wider range of policy instruments, and to treat markets as hugely valuable servants but dangerous masters.
We should be in a better position than most to recognise this, since we have given those nostrums a longer and more comprehensive trial than anyone else. While the great super-tankers and luxury liners of the big economies have plied their trade on the great ocean of the global economy, and amassed large fortunes until they suddenly sprang a leak and began to sink, our tiny craft has been waterlogged for years. For us, the dogma of the unregulated “free” market has not led so much to sudden collapse as to long decline.
We now have the chance, if our leaders have the necessary wit and imagination, not only to change direction in order to escape the worst of the world recession in the short term, but to set a new course which will produce in the medium term a better balanced economy in a world where markets are no longer regarded as infallible.
The lesson of this crisis is that unregulated markets lead to economic disaster and – even more importantly – that they are incompatible with democracy. If markets are always right and must not be challenged, the result is not only economic meltdown but government by a handful of greedy oligarchs rather than by elected representatives.
The whole point of democracy is that it ensures that political power will be used to offset the otherwise overwhelming economic power of the big market players. If democratic governments do not, will not or cannot exercise that power to protect their electorates, the course is then set inevitably not only for the crisis we now face but also for the abuses and failures that disfigured our economies in the years preceding the crisis.
Shouldn’t our politicians be called to account? Shouldn’t these issues be what our general election is all about?
Bryan Gould
12 October 2008
Rescuing the New Zealand Economy
Bryan Gould’s new book “Rescuing the New Zealand Economy: What Went Wrong and What We Can Do to Fix It” will be published in New Zealand by Craig Potton Publishing. It will be in the bookshops on 22 September. Below is a short article about the subject-matter of the book.
As the Reserve Bank struggles to deal with both recession and inflation, it is time to review the course of the New Zealand economy over the past 25 years and to seek reasons for the cumulative failures which have led us to such disappointing long-term outcomes.
For too long, our policy-makers have argued that our poor performance – particularly in terms of productivity – is the result of everything other than their policies. Our comparative decline is now so endemic and so damaging to our living standards and even our continued viability, however, that we must draw the obvious conclusion that our policy-makers must take some of the blame.
The truth is that the simple certainties of monetarism, which seemed such a sure-fire recipe for success in the mid-1980s, have long since given way to a more balanced view of the true role of macro-economic policy. We now know that there is a huge downside to locking economic policy into a straitjacket from which only a single unelected official armed with one single target and one single instrument knows the escape route.
If we want a better economic performance, and in particular an improved productivity outcome, we must find a way of controlling inflation without burdening our producers with the highest interest rates in any advanced economy and with the perennial threat and reality of an overvalued exchange rate. The constant inhibition to competitiveness that results from an overvalued dollar means that New Zealand industry is never profitable enough to re-invest in new capability and innovation.
There is no shortage of options for dealing with inflation that are both more effective as counter-inflationary measures and less damaging to the productive economy. It is only the ideology of the “free market” fanatics that prevents us from taking these sensible steps.
Bryan Gould
12 September 2008
So Much for Liquidity – Now Let’s Have a Serious Approach to Inflation
The Reserve Bank’s announcement of new provisions to improve the trading banks’ liquidity in the face of the world-wide credit crisis will be widely and justifiably welcomed. It is just a pity that the Reserve Bank is not similarly proactive when it comes to the battle against inflation.
Any liquidity problem for our banks is, of course, prospective rather than actual or immediate. It nevertheless makes sense, both for current confidence and as a practical response to the possibility of problems ahead, to ensure that the banks have a wider base of liquidity on which to operate. As the Reserve Bank makes clear in its Financial Stability Statement, we cannot assume that a banking system that relies heavily on borrowing from overseas will remain immune forever from the problems that threaten the liquidity of overseas financial institutions.
While the Reserve Bank deserves a tick for its foresight in this respect, it is less deserving of plaudits when it comes to other areas of its operations. It is reassuring that it has moved promptly to forestall liquidity problems, but this contrasts sadly with its failure to exercise effective prudential supervision over non-bank lenders. The failure of so many finance companies over the past year or so – at a cost to investors of over $1 billion – has left the Reserve Bank seeming more concerned with the viability of the banks than with the savings of ordinary New Zealanders.
Perhaps we should not be surprised at this apparent peculiarity in the spectrum of the Bank’s concerns. The Reserve Bank is, after all, a bank. It owes a particular loyalty to and has a particular concern for the interests of other banks. It has acted quickly, and properly, to ensure that the banks are able to maintain their operations – something that is very much in everyone’s interests of course – but it has been much less assiduous in meeting its other responsibilities.
That criticism applies with even more force if we look at a field of operations that is even more significant than the viability of the banking sector or the prudential supervision of finance companies – the Bank’s role in controlling inflation. It is now apparent to everyone that the Reserve Bank is struggling – and failing – to keep inflation under control except at a price that threatens the rest of us with recession.
The search is therefore on for counter-inflationary policy measures that are both more effective and less damaging than the single blunt instrument of constantly raising interest rates. The Reserve Bank went so far in 2006 as to commission a report on what it described as “supplementary stabilisation measures” – in other words, on further measures that might be taken in addition to what we are usually assured is a policy instrument to which there “is no alternative” – while the Finance and Expenditure Select Committee is currently engaged in a similar exercise in preparing its report on the future monetary policy framework.
In neither case, however, is it likely that the Reserve Bank or those who advise them will notice what is staring them in the face – that the most obvious (and easily dealt with) cause of inflation in our economy is the high and fast-growing volume of bank lending. Private sector credit has grown by six times over the last twenty years, from $44 billion in 1988 to $266 billion in 2008; the largest and fastest-growing element in that credit growth has been bank lending on mortgage for the purpose of buying residential property.
Current interest rate policy actually makes matter worse. As interest rates have risen, the banks have had to market their lending more and more aggressively – and they have protected themselves against the consequent risk of lending inappropriately by concentrating especially on the housing market where they can at least take adequate security over people’s houses.
Why has the Reserve Bank not focused immediately on this and imposed limits on the banks’ freedom to inflate the economy in this way? If the key to controlling inflation is to limit the growth in the money supply, why not deal with the fastest-growing element in that money supply? If the Reserve Bank is ready to improve the banks’ liquidity at times of credit stress, why do they not intervene to restrain that liquidity at time of inflationary pressure? Why destroy the viability of large parts of our productive economy, but leave the banks free to do as they please?
The answer is that there is a perhaps unconscious and certainly unstated bias in the way the Reserve Bank looks at these issues. They are unwilling to act against the banks, and would rather burden the rest of us with the responsibility for grappling with inflation. They see measures such as regulating capital requirements or loan-to-value ratios for bank lending – as amended and sometimes extended by the Basel II international agreement – as appropriate for prudential supervision and for ensuring adequate bank liquidity but not for controlling inflation. This point is made explicitly by the Bank’s External Monetary Policy Adviser in his submission to the Select Committee.
The Bank gets away with this bias because the bank economists who dominate the economic policy debate in the media have a vested interest in diverting attention away from it. It is time that the darker corners of this debate saw the light of day and that the banks were brought within the purview of counter-inflation policy.
Bryan Gould
8 May 2008
This article was published in the NZ Herald on 16 May 2008
Let’s Hear It For The Macro Economy
The decisions announced last week by Fisher and Paykel and the ANZ Bank to relocate parts of their operations overseas grabbed the headlines and sent a shock wave through New Zealand industry. What may not be so apparent, however, is that the factors that led to those decisions have been part of our day-to-day experience over 25 years – and they continue to inflict their damage on all of us on a daily basis.
Last week’s news, in other words, is just the tip of an iceberg – just the latest high-profile instalment in the slow-motion but inexorable crumbling away of our economy. Very few understand the damage that has been done to our economic fortunes by the literally counter-productive effects of current policy settings over a quarter of a century. Very few accept that – as long as our macro-economic policy relies on the highest interest rates in the developed world and a grossly overvalued exchange rate – it is inevitable that there will be more news stories like last week’s.
Faced with current policy, even the strongest and most successful of our enterprises are less able to grow and compete than they should be. They do not generate the return on investment that they need to re-invest in future success. Because they are not profitable and competitive in international terms, they are always vulnerable to being bought up at bargain basement prices by foreign buyers or tempted to move their operations overseas. And when the tough times come, they are less able to withstand the shock – rather like tall trees with weak root systems that surprise everyone by keeling over in a high wind.
Weaker enterprises simply close down or fail to get off the ground. Innovation and productivity improvements are inhibited. The economy as a whole is less able to invest in future capacity. Our brightest talents go overseas or seek opportunities elsewhere than in productive industry. Instead of growing and becoming more efficient at the margins, we see loss of performance and decline.
Most of these instances fail to make the headlines but they are constantly happening nevertheless. When these debilitating effects are felt over decades, as they have been in New Zealand, the culture itself changes. People become risk-averse, lose interest in new wealth creation and concentrate on safe investments like housing or on manipulating existing assets in the money markets.
We have lived with this for so long that we no longer realise how sharp has been our comparative decline and how precarious is our ability even to sustain our current disappointing performance. We are fed a constant diet of assurances that our problems are nothing to do with policy; indeed, some apologists for monetarist orthodoxy urge us to push further down a track that we have already travelled further and longer – with correspondingly worse results – than anyone else.
Others tell us that we must simply accept that other economies are more efficient and have lower costs than we do. But, if that is the case, why do we make matters worse by deliberately ensuring that we destroy our own ability to compete?
Perhaps the most commonly touted advice is that no change in macro-economic policy is required and that what we must do instead is boost innovation and productivity by spending more on education and research.
As a former university Vice-Chancellor and the incoming Chair of the Foundation for Research, Science and Technology, I am the last person to question the need for more investment in education and research. That investment is an essential element in improved economic performance. But how is that investment to be made, and how is it to be made effective, if the tide of macro-economic policy is running so strongly against innovation and productivity improvements?
Those who offer this advice are still, it seems, prisoners of the comfortable illusion propagated by monetarist theory that monetary policy has little or no impact on the real economy. We know now beyond doubt that this is simply not true; to believe otherwise is a triumph of ideology over practical experience.
If our producers struggle simply to stay afloat, because the policy settings ensure that they are inadequately profitable and competitive, where is the extra resource to come from to turn things around? How are they to afford the new equipment and technology, the new product development, the skill training for their workforces, the marketing to develop overseas opportunities, the improved after-sales service and all the myriad and hugely expensive elements that go to make up a successful campaign in international markets, including our own? Neither the New Zealand investor nor the taxpayer can produce those resources out of thin air.
The need now is not for glib advice but for positive action. That action must take as its starting point a recognition that the current macro-economic policy settings must change if micro-economic measures are to be as effective as they should be. The search for a better way – and in particular, a better way of controlling inflation – will not be easy but it must not be shirked.
Bryan Gould
20 April 2008
Rogue Markets
While the economy burns – the conflagration fuelled by the mounting failures of monetary policy – some politicians prefer to fiddle. The Opposition promise us several weeks of focus on David Benson-Pope and the minutiae of what they hope will turn into a minor scandal. In the meantime, all they can offer on the burning issue of the day is the view that there is nothing to be done but sit back and wait for the worst to happen.
National’s Finance spokesperson, Bill English, should have been a World War One general. His is exactly the mindset that committed thousands of soldiers to the trenches and refused to countenance any alternative. Like so many politicians, he prefers to chase a short-term political gain – by hoping to embarrass the government of the day – rather than address the real long-term issues. So committed is he to this view that he would oppose not only any new thinking but the very idea of discussing the issues at all.
The refusal to contemplate any economic policy option other than one that is demonstrably failing is, in other words, to take a political rather than an economic stance. There are those on the right who believe with religious fervour that markets are always right and that government intervention, however urgent the need for it may seem, will always be counter-productive. Those who venture to disagree, and who challenge what is now established as the current orthodoxy, are labelled as extremists.
But those rigidly adhering to that orthodoxy and refusing to budge in the face of mounting evidence are the real extremists. The adherents of Rogernomics and the denizens of the Business Roundtable have rightly been dismissed from the nation’s counsels on most issues, but they maintain their inviolable position as the guardians of economic policy rectitude because they have sold us on the ludicrous idea that the market must be obeyed, whatever its failings, when it comes to macro-economic policy. No one is allowed to question the dangerously ill-founded assumption that the only issue that matters is inflation, and that it can only be controlled by a single unelected official given a single ineffective and potentially destructive instrument and unchallengeable powers to use it.
The view that the market must always prevail is of recent origin and has never before been given an extended trial in practice. Hitherto, it has usually been seen as the preserve of extremists. It was only when international capital was freed to roam the world at will and thereby escaped the political constraints of what we used to call democracy that we have been brainwashed into accepting that there is no alternative to such an extreme view.
What is astonishing is that so many of those who claim to be representing business can be heard parroting the same dangerous nonsense. As they watch the policies they profess to support destroying their businesses before their very eyes, we can only conclude that this is a remarkable triumph of political obscurantism over economic rationality.
Markets are like elephants – immensely powerful, and valuable. We would all be hugely worse off without both of them. There is nothing else as effective at doing their job. But they work best when they are constructive, disciplined and working well with other factors.
From time to time, an elephant will override these considerations, throw off the shackles and run amok. A rogue elephant can do enormous damage.
So, too, with markets. A rogue market can be immensely destructive. To allow a rogue market – or elephant – not only to carry on doing that damage, but to give it priority over all other considerations, is to take an irrational and extreme view which can be justified only by prejudice and not by argument.
Yet that is where we now are. Only someone with a closed mind could fail to see that our current monetary policy is not only failing in its purpose but is doing great damage to our economic prospects. Any serious politician – especially one with a realistic hope of exercising power – should be joining in the search for better options.
Bryan Gould
24 July 2007.