Will We Ever Learn?
Lessons from the Global Financial Crisis
The G20 meeting in Toronto in June was remarkable in only one respect. The familiar protests, the police in the streets, the hob-nobbing of the leaders were all on show. But, what was extraordinary, if not unexpected, was the speed with which most of the world’s most powerful leaders headed back to familiar territory – not to say, political prejudices – and not only embraced again the very nostrums that had brought about the global financial crisis in the first place, but used the crisis as an excuse to press for a smaller state and a decimated public sector, even though that threatens a renewed dip into recession.
This perverse reaction to the manifest failure of the model that had been so enthusiastically constructed over a 30-year period was a feature of not only the G20 meeting. It has characterised the responses of many individual governments around the world, and has certainly reared its head in New Zealand. Contrary to the expectations of many of us that the global financial crisis would be seen as a conclusive judgment on the failures of neo-liberal doctrine, it is the right that seems to have emerged, for the time being at least, unscathed and emboldened by the failure of their policies.
It is worth reminding ourselves of the precise lessons that the global financial crisis should, and briefly appeared to, have taught us.
- 1. Markets are not self-correcting. This simple and obvious proposition, so strongly confirmed by the failure of many of the world’s financial institutions, had been conveniently overlooked and even flatly denied by neo-liberal theorists. They chose to believe that operators in a market are perfectly informed and enjoy a parity of bargaining power and that market outcomes are therefore the best available and should not be second-guessed. We now know that this is self-serving nonsense, and that the natural tendency of the unregulated market is to lead to excess, irresponsibility, inefficiency and eventually collapse.
- 2. Financial markets are especially prone to excess. The huge power wielded by the manipulators of international capital and the unprecedented wealth gained by operators in financial markets, resting largely on their ability to create new forms of financial assets out of nothing, led many to believe that they were the lords of the universe and could do no wrong. But, as Keynes pointed out, financial markets are the most likely to fail, depending as they do so much on hunch and guesswork and on assets whose value depends on subjective assessment and uncertain futures rather than on objective criteria.
- 3. Risk cannot be quantified according to reliable mathematical formulae. A great deal of modern economics has been driven by esoteric work aimed at providing an apparently reliable basis on which risk can be quantified. It was on this basis that much of what are now recognised as having been worthless assets were happily traded from one interest to another, each trader taking a profit as the asset appeared to grow in value as it passed from hand to hand. The huge superstructure of debt and valueless assets, built initially on the sub-prime mortgage market, eventually came crashing down.
- 4. Decisions taken by business leaders alone are a poor guide to a successful economy and society. Business leaders have been so eulogised over recent decades that many people were persuaded that more and more decisions affecting our lives should be handed over to them, and that they could be more trusted in many cases than our elected leaders. We now know that business decisions are invariably taken for reasons of self-interest and take little account of wider or longer-term interests. Those countries – like the US and the UK – that most enthusiastically accepted that societies should be run in the business interest are those which have, on the whole, suffered the most severe consequences of business failures, with the greatest damage to the social fabric and environmental sustainability.
- 5. Increasing the wealth of the rich so that inequality widens does not produce a better economy or a stronger society. The “trickle-down” theory was often used to support the proposition that, if the rich got proportionately richer, the rest of us would benefit in absolute even if not comparative terms from the lift in economic activity that the increased wealth of the rich would produce through increased investment and employment. This theory has been discredited in the absence of any credible evidence to support it, and in the face of evidence to the contrary that shows that in countries where inequality has widened the most, the living standards of the poor have actually declined.
- 6. Government matters. Contrary to the constantly repeated mantra that the best thing that government can do is to “get off our backs”, the global crisis shows that in the end it is only governments that have the resources, will and legitimacy to underpin a failed banking system and therefore the currency and the economy more generally. Without decisive government intervention, the recession would undoubtedly have become a depression. In a recession, governments have a duty to act against market logic in a way that individuals, either people or corporations, cannot.
- 7. The market cannot perform effectively without government help. The great benefits of the market can be optimised only if government, too, plays its part. The government must do those things in economic terms, like investing in fundamental infrastructure, that the market cannot do. It must protect wider and longer-term interests that the market treats only as potential (and preferably “externalisable”) costs – interests such as those of people who are left behind by the market, or the value of a whole, healthy and integrated society, or the importance of maintaining scarce resources and a clean and sustainable environment. It must correct mistakes made by the market and regulate the market to avoid excess and failure.
- 8. If the market cannot be challenged, the whole point of democracy is lost. The most significant aspect of the global economy that has developed over the past three decades has been the extent to which governments have been sidelined by the power of international investors to move capital around the world, and to hold governments to ransom by withholding investment if their requirements are not meant. The role of democratic government is, after all, to bring the power and legitimacy of the people’s will to bear so as to offset what would otherwise be the overwhelming economic power of capital. If the market is held to be infallible, and government must not intervene, we not only produce bad economic and social outcomes; we lose the point and effectiveness of democracy itself.
None of these conclusions is revolutionary or even particularly radical. Each is evidence-based and arrived at through the merest common sense based on our own recent experience. This makes it all the more remarkable that these lessons are increasingly discounted by world leaders as they move into what we might all have hoped would be a post-crisis environment.
New Zealand is not, of course, a member of the G20. We would be mistaken to think, however, that we had not been infected by, and contributed to, the emerging consensus as to the best response to make to the crisis. And, in our case, we can add the lessons from our own less than glittering performance to those that can be drawn from the global experience.
Lessons from New Zealand’s Experience
For New Zealand, the global financial crisis came on top of our own home-grown recession. By the time Lehman Brothers collapsed, we were completing our third quarter of decline in a recession that for us had begun at the end of 2007, and that was the latest episode in a tale of economic under-performance that had extended for 25 years or more.
Paradoxically, our early experience of our own recession may have led us to understate the significance of the global recession. When it struck, around September 2008, we felt that we had already weathered much of the storm, particularly when our own, Australian-owned, banking system seemed relatively immune from the global collapse.
The truth is, of course, that while we have been sheltered from the worst of the global recession by the buoyancy of our main markets in China and Australia, and the relative stability of our banking system, the deleterious consequences of the recession are still working their way through our economy and are proving very difficult to dislodge. The lessons from the crisis are just as applicable to us as they are elsewhere – and just as likely, it seems, to be ignored.
Indeed, our enthusiasm to apply the free-market agenda further and faster than anyone else has given us particular reason to pause and reflect. It is only our small size and inability to develop a large-scale financial sector that has protected us from the worst ravages of the global crisis. But, our commitment to neo-liberal policies has meant that, in addition to the lessons to be learnt from the global outfall, we have our own lessons to learn and apply, by virtue of the fact that we have committed a series of mistakes over a long period that are all of our own making.
If we are to bring the recession to an end, instead of just bumping along on the bottom, and if we are to usher in an era of improved economic performance, it is essential in other words that we learn not only the more widely applicable lessons but also those that should hit us in the eye when we review our own recent experience.
- 1. Free trade is not always the best option. It has long been accepted as an article of faith in New Zealand, ever since the end of managed trade brought about by the UK’s accession to the Common Market, that we can do nothing but benefit from the widest possible extension of free trade. The issue has rarely been ventilated or debated; it is simply accepted as axiomatic that free trade is beneficial in practice and correct in principle.
That conviction continues to drive policy. There has been a veritable explosion in free trade agreements over recent years, culminating most importantly with a free trade agreement in 2008 with China and now the prospect of an extension of the earlier P4 agreement with Chile, Singapore and Brunei to include – most importantly – the United States.
We continue to be assured that free trade will best serve our interests. The argument is typically conducted by paying great attention to any increase in exports that could be attributed to free trade and ignoring other less convenient factors. The sharp increase in our exports to China, for example, is said to be a direct consequence of the free trade agreement; but the agreement has been in force for only a year, so most of the increase precedes and is not attributable to the agreement, is largely a function of the fact that China – almost uniquely – has continued to grow through the recession, and has occurred at the expense of an even greater increase in Chinese exports to New Zealand (and consequent loss of jobs and domestic manufacturing) over the same period.
We might have expected that this dogged pursuit of free trade would have demonstrated its benefits to our exports and growth rate over the period. But, on the contrary, both have languished and are well behind comparable levels for other countries, and particularly for Australia. The experience of other countries also shows that free trade is not invariably the right option, but its appropriateness depends on the stage of development by comparison with trade partners and competitors. Developing countries, for example, have usually found some form of protection to be helpful until they build up their economic strength and both Japan and China have trodden that path. The Chinese are still sceptical of the benefits of free trade and it is no accident that they have so far chosen only New Zealand as a free trade partner.
We, however, seem convinced that we can prosper in the face of direct competition from some of the most powerful and efficient economies in the world. We might do better to regard ourselves as a developing economy and to behave accordingly.
- 2. Foreign investment is not beneficial if the effect is to sell off existing capacity rather than develop new capacity. New Zealand, true to its overnight conversion to free markets and the free movement of capital, has opened its doors to foreign capital to a greater degree than any other comparable country. We have sold a greater proportion of our economy into foreign ownership than any other developed country. This has been partly a matter of choice, based on ideological conviction, and partly – though not advertised in this way – a matter of necessity; the proceeds of selling our assets into foreign ownership have been an important, not to say essential, factor in balancing overseas accounts that our economic failures have condemned to serious deficit.
It might be thought that this sell-off was a once-for-all effort to balance our books and is now behind us. The figures show, however, that the process continues apace. By March 2008, we had sold off $93.3 billion’s worth of our assets, up 900% from 1989. We soon won’t have anything left to sell.
The consequences for our economy have been disastrous. A current account in perennial deficit (eased only temporarily by the slow-down in imports caused by the recession) has been further burdened by the repatriation of profits to foreign owners, adding to the interest payments we must make to that other group of foreign owners (the proverbial Japanese housewife and Belgian dentist) who help fill the hole in our accounts by buying short-term debt as a response to our very high interest rates. The repatriated profits represent not only a drain on our foreign accounts but a very real loss of national wealth that could otherwise be applied to raising living standards and public services in this country.
That loss is not merely economic. We also suffer a very real diminution in our ability to control our own affairs. Increasingly, under foreign ownership, decisions over major parts of our economy are taken in Sydney or Los Angeles or Shanghai. New Zealand jobs and businesses depend on people in boardrooms where our interests are remote from their concerns.
- 3. The government’s role in a successful economy should not be limited to trying to control inflation through adjusting interest rates. It is hard to separate New Zealand’s relatively poor performance over the past 25 years – something that has increasingly concerned successive governments as we have dropped down the OECD tables – from the policies pursued by those self-same governments. Our policy-makers have insisted that the only important goal of policy is the control of inflation, that that is simply achieved by controlling the money supply, that there is only one instrument – interest rates – that is effective to control the money supply, and that that instrument is best placed in the hands of a central bank whose decisions cannot and should not be challenged.
The consequences of this extremely narrow view of policy are there for all to see. Even in its own terms, the policy has struggled to succeed. The control of inflation has proved increasingly difficult, and achieved only at considerable and growing cost to other objectives; even the Governor of the Reserve Bank has complained that interest rates alone are no longer an adequate instrument even for this narrowly defined task.
The real failures become apparent, however, only when the focus is widened to include other desirable economic goals, such as sustainable growth rates, full employment, well-directed investment, effective public services, a cohesive society and acceptable living standards. It is in these areas that we have failed, and have fallen markedly behind our trans-Tasman neighbours in particular. The average New Zealand family would need at least a 40% increase in real income to reach Australian standards. Little wonder that our economic performance is constantly undermined by the flight of skills and talents across the Tasman!
What seems to be a simple mechanism for dealing with inflation has become, in other words, a major deterrent to a better economic performance. The high interest rates apparently needed to control inflation make investment more expensive, favour wealth owners rather than wealth creators, stimulate a rise in the exchange rate that handicaps our own production in markets both at home and overseas, inhibits our investment, distorts our balance of trade, and then – to complete the vicious circle – requires a further round of high interest rates to attract the short-term “hot” money that is needed to fill the hole in our balance our payments.
These problems will not be overcome without an “agonising reappraisal” of the policy we have doggedly pursued without success for 25 years. The global financial crisis might have been thought to offer just the opportunity we need for such a reappraisal; the evidence is though that we are intent on both overcoming the recession and correcting our own individual past failures by returning stubbornly to the policies that have consistently failed us.
Turning Our Backs On The Lessons
However clear the lessons – both from the global recession and from our own longer-established New Zealand disappointments – our leaders both overseas and at home seem determined to ignore them at the first opportunity. It is already clear that the majority of the world’s governments are keen to return to business as usual, and to reproduce the errors that produced and compounded the crisis in the first place. What are those errors?
- 1. The first priority is to deal with the deficit. Governments around the world, with few exceptions, have responded to the post-crisis environment by insisting that governments that had moved into deficit in a partially successful attempt to avert depression should now concentrate on cutting their spending so as to balance their books. Nothing is more likely to risk a “double dip” recession.
Governments in Europe, Britain and here in New Zealand have succumbed to one of the most common fallacies of economic policy – that governments are no different from individual actors in the economy and should behave accordingly. According to this view, if a recession means that individual people or corporations should retrench and cut their spending and investment, so too should governments. If reduced government spending – not to say savage cuts – should mean that people are thrown out of work, so be it; the deficit will otherwise hang over our heads for years to come.
It is hard to detect any rationality in this view. The best way of getting a government deficit down is to restore the level of tax revenue. A buoyant economy will generate a buoyant level of revenue. An economy that is flat on its back for the second time, on the other hand, will ensure that the deficit is persistent and deeply entrenched. You don’t get your deficit down by throwing people out of work.
But, say the “deficit hawks”, the deficit needs to be funded, and the money markets will lend for that purpose only if they see strenuous efforts to get the deficit down. But this is to allow prejudice – a visceral dislike of public spending per se – to displace rationality. As Paul Krugman points out, our policy-makers run scared of the “bond vigilantes” on the one hand, and seem on the other to have a naïve believe that the “confidence fairy” will somehow convert policies that are intended to produce retrenchment into a recipe for recovery. And, since it was only a year ago that the financial sector was totally dependent on public finance for its very survival, how is it that their fantasies are again so soon able to dictate terms to the rest of us?
These fallacies certainly seem increasingly to dictate policy in Europe and Britain and are alive and well in New Zealand. Our own government has been lucky in that living with the recession has been easier than it might have been, because our export markets have held up surprisingly well – not least because the Australians pursued a braver and more stimulatory course than we did. But it is becoming increasingly clear that the recession in New Zealand is proving stubbornly difficult to move; we continue to bump along the bottom with no real recovery in sight. The recession will be longer and more serious because we give priority to getting our (perfectly manageable) deficit down, rather than to ensuring that government plays its full part in helping recovery. This is a triumph of ideology over common sense. And that brings us to the next error.
- 2. The deficit provides a good reason for cutting back on the public sector in any case. In both Britain and New Zealand, the emergence of a counter-recessionary government deficit has coincided with the election of a right-wing government. In both countries, the response has been to focus on getting the deficit down, rather than on trading our way out of recession. In both cases, the suspicion must be that the opportunity to trim back the public sector for largely ideological reasons under the guise of dealing with the deficit has been too tempting to resist.
The result has been and will be in both countries a substantial loss of jobs in the public sector, and a dangerous drop in the level of public services, including support for the poorest, just at a time when they are most needed. And while public sector cuts may seem easy to make in the short term, the longer-term consequences can be severe – Cave Creek comes to mind.
The rationale for these measures – that otherwise the public sector’s demand for resources will crowd out necessary investment in the private sector – is simply not credible at a time when the economy is operating so far below capacity. It is hardly helping the private sector to throw a substantial portion of their customers on the dole. The projection might of course become self-fulfilling if mistaken policies are maintained long enough to mean that capacity does fall as resources that are kept out of use simply lose their economic value and utility.
- 3. The banks must be protected at all costs. The determination on the part of many governments to respond to the recession by cutting back the public sector, and therefore the role of government, is all the more surprising when it was the public purse that had to be opened, at the taxpayer’s expense, in order to save the global economy from the consequences of the private financial sector’s irresponsibility. The sharply increased indebtedness of governments around the world is the direct result of the money borrowed and spent on bailing out a failed banking sector; in addition, the current deficits in government accounts are a secondary outcome, via a recession-induced slump in government revenues, of the same failure.
Rather than sheet the responsibility and the burden home to where they belong, however, governments have spent billions on helping the banks to shore up their balance sheets, with the perhaps unintended result that the banks have continued to pay out massive bonuses to their employees. It is the taxpayer that must now pay the burden, not just in repaying borrowings made to deal with the crisis, but in suffering the cutbacks in public services and the loss of jobs that are the inevitable consequences of current policies.
The G20 were not even able to compel the banks to accept, as had been foreshadowed, tighter rules about capital reserves and lending ratios. While President Obama has introduced tighter regulation of US banks, other governments have dragged the chain – and, while individual voices have been raised in support of measures like a Tobin tax on financial transactions, no government has so far given them consideration. In view of this timidity in dealing with the banks, we cannot be surprised that no one apparently stopped to wonder why, if the taxpayers put up the money, they did not acquire the ownership interest – and, even more pointedly, why it did not occur to anyone that, if banking so obviously relies in the last resort on underpinning by the public purse, we should perhaps recognise that banking is in essence a public function.
- 4. Free trade is the only answer. Our experience in New Zealand of free trade over 25 years, during which the much-touted benefits have failed to materialise, has not deterred our policy-makers from pressing on. Potential free trade agreements are now coming thick and fast, and include most recently a Trans Pacific Partnership Agreement which would, if completed, bring us into a free trade relationship with, amongst others, the United States. Typically, the attempt is being made to sell the deal by focusing entirely on the supposed benefits to our dairy exports, despite the growing evidence that powerful American interests are making it their business to ensure that tariff-free access to the American market for those exports will not be made available.
Little attention is paid, on the other hand, to the obvious downsides, which include threats to the organisation (through cooperative marketing) of some of our major exports, to our effective strategy (through Pharmac) in keeping down the cost of pharmaceutical imports, and to our (theoretical) ability to resist overseas purchases of our assets. These are remarkable blind spots for a country that seems in any case to have derived so little benefit to its economic performance from two and a half decades of free trade.
- 5. The sale of our assets to overseas buyers is good for us and our economy. It might be thought that, having sold off a large proportion of our productive capacity and economic infrastructure to overseas owners, and having suffered the consequences of loss of wealth and loss of control over our own economy, to say nothing of the increased burden on our balance of payments, we might be a little chary of going further down that path. Our government, however, is not deterred by our experience or by the blow delivered by the global crisis to the neo-liberal doctrines that apparently endorse the policy of an open market in New Zealand assets; their policy is to further weaken such protections as we still have against an overseas buy-up of our remaining assets and to welcome what they choose to treat as an “expression of confidence” in our economy rather than as a fire sale.
This laissez-faire approach has been seen most recently in the Chinese bid to buy a significant part of our dairy industry. That bid, whose effect would be to remove from New Zealand hands, and – in an almost physical sense – from New Zealand itself, a measurable part of our wealth-producing capacity, so that the wealth produced by that capacity went more or less permanently overseas and New Zealanders were left as relatively low-paid wage slaves on what had been their own land, is currently being considered by the Overseas Investment Office as merely a matter, apparently, of the business reputation of the prospective buyers. There is no indication so far that any issue of principle is involved.
- 6. Private ownership and the profit motive are the best guarantors of economic efficiency. New Zealand, consistently with the commitment of successive governments to the “free” market as the driver of economic efficiency, has a 25-year history of privatisation. Like so much else in the neo-liberal agenda, repeated privatisations have done little to raise the level of performance, and in all too many cases, privatisation has meant only profit-gouging by private owners who have then sold back the enterprises – inadequately invested and saddled with debt – into public ownership; the New Zealand railway system is an obvious case in point.
Post-crisis governments, however, including New Zealand’s, have not lost their faith in privatisation as a panacea for all economic ills. The current government is already moving towards a partial privatisation of the Accident Compensation Corporation, and further privatisations – Television New Zealand, for example – are clearly in sight. The fallibilities of the global masters of the world economy have not dimmed the faith of our leaders in the ability of business leaders to work the oracle.
- 7. There is no alternative to the macro-economic policies that have been pursued for 25 years. It might be thought that the greatest economic upheaval in 75 years might have prompted a re-appraisal of the policies that have served us poorly over two and a half decades. Sadly, this seems not to be the case. To be fair to the Governor of the Reserve Bank, he has indicated from time to time that he is prepared to look at measures to supplement the current reliance on the sole instrument of interest rates, and his requirement on prudential grounds that bank lending should be more responsibly tied to capital reserves may be the first swallow of a new summer.
The government, however, shows little interest in widening the goals of policy, or in adding new counter-inflationary instruments to the armoury. As a consequence, there is increasing evidence that, if we were able to haul ourselves painfully out of recession within the current policy framework, any recovery would be quickly knocked on the head by the familiar combination of high interest rates and an overvalued dollar which is already gearing up before our very eyes. Little wonder that investment languishes and recovery is uncertain.
What is to be Done?
It would be easy to subside into despair as we see the greatest economic crisis of most lifetimes – a crisis brought about by manifest and egregious errors of policy and understanding – come and, hopefully, go without apparently disturbing the simple certainties of a self-serving orthodoxy that should surely have been discredited. If, at this precise moment, governments cannot learn lessons and strike out in new and better directions, what hope is there of a better future?
There are of course never any final battles in politics or economics. The balance of advantage swings from one position to another in often belated response to our understanding of real events. The consequences of the global financial crisis will be real enough, and our understanding of those consequences will evolve and grow for years to come. We must hope that the lessons will not be driven home all over again by an almost immediate relapse into a double-dip recession, brought about by the failure to recognise what went wrong in the first place and what must be done to correct it.
In the meantime, we must equip ourselves with the knowledge and the arguments to carry the debate to those who are reluctant to listen. We should ensure that the lessons are so clear that they cannot be ignored.
Bryan Gould
2 July 2010
This article was published in the August issue of Watchdog, the journal of CAFCA (Campaign Against Foreign Control of Aotearoa)
Joy In Heaven – A Sinner Repents
When I left British politics in 1994, the Independent published a leading article in which, alongside some generous comments, they regretted my adherence to “Keynesian macroeconomics” and my “fervent Euro-scepticism”.
I imagine that support for Keynesian macroeconomics does not seem as anachronistic today as it apparently did then. And, I would argue, my “Euro-scepticism” (which was so easily and wrongly translated into anti-Europeanism) should now more readily be recognised as all of a piece with the Keynesian view that keeping control of one’s own macroeconomic policy, rather than handing it over to an unaccountable international central bank, was an important safeguard against recession.
I was reminded of all of this by last week’s Financial Times piece by the veteran economics commentator Sam Brittan. He argued that the introduction of the euro had been premature, and that the plight of Greece (and perhaps of other euro-zone states to follow) was a direct consequence of failing to recognise that a common currency could succeed only if there was a convergence of costs across the whole economy – and if the common currency helped towards, rather than hindered, that end.
Sam Brittan’s current view is of course in marked contrast to what he thought and wrote on many previous occasions. I recall that, in 1988, when Britain’s membership of the Exchange Rate Mechanism – the euro’s precursor – was a live issue in the Labour Party, Sam Brittan spoke at a meeting of the party’s backbench economic affairs committee, and advised my colleagues to “put Bryan Gould on a slow boat to China” while the party changed its policy in favour of supporting ERM membership.
Since Keynes is now once again all the rage, Sam Brittan is entitled to quote the great man’s famous response that “when the facts change, I change my mind. What do you do sir?” The problem here is that it is not the facts that have changed; it is the minds that were wrong. The arguments against a common currency across such a wide and diverse set of individual economies were as strong in 1988 as they apparently have now become.
The essence of the case for the euro (and of the EMS and the ERM before it) was always a political one. A common currency can only work and make sense if the whole economy is subject to one central monetary policy which must supplant other elements, such as a national fiscal policy, that would ordinarily constitute macro-economic policy. In a democracy, a power of this kind could only be properly exercised by a democratically accountable government. The unstated conviction of the proponents of a single European super-state was that this logic would mean that a common currency would inexorably lead to the creation of a single European government to provide at least the illusion of democratic control over what would otherwise be government by central bank..
The economic consequences of such an arrangement pointed to the same outcome. The improbability of the whole of such a diverse economy being appropriately served by a single monetary policy was so great that it could only be contemplated if a sort of Faustian bargain were struck by the participants.
The powerful advanced economies would inevitably dominate monetary policy which would be framed to suit their interests; and that would mean that weaker economies would have great difficulty in living with it. In the absence of the ability to deploy an independent fiscal policy or to devalue, their only recourse would be to deflate and accept unemployment. They could be persuaded to accept this only if the stronger countries would implicitly undertake to treat them as – in effect -social security claimants and recipients of regional aid, and that could be made palatable to the taxpayers of the richer countries only if they could be induced to see those in poorer countries as fellow-citizens.
That bargain has now – as evidenced by the difficulties that Greece and their euro-partners are facing and failing to resolve – broken down. The Greeks, having long struggled with an inappropriate monetary policy, are finding the required deflation extremely painful; while the Germans have reneged on their implicit undertaking to maintain the integrity of the euro by bailing out countries that find the going tough.
The collapse of that bargain may well signal the end of the euro-zone. But it should also sound an alarm. We ignore the importance of a broader-based, democratically accountable, properly focused macroeconomic policy at our peril. The economic interests of a wider European economy – to say nothing of small matters like a functioning democracy – will be best served, not by a forced but failed attempt at convergence through a single monetary policy, but by country-sized governments deploying all the instruments of macro policy to suit the needs and interests of the economies for which they are responsible. The European dimension should rest mainly on a high and growing level of co-ordination of policy and functional cooperation among separate and well-performing economies which see their future as developing together.
Keynesian macroeconomics and a scepticism about forcing the pace on creating a single European state and economy should be seen as going hand in hand. As we now know, a failure to learn the lessons threatens recession and drags down all parts of an artificially constructed single economy. Hopefully, that has now become clear; and it might have served us well if it had been recognised in 1994.
Bryan Gould
25 February 2010
This article was published in the online Guardian on 27 February.
A Matter of Luck?
As the Australian economy motors forward, while we continue to bump along the bottom of the recession, it is not surprising that envious glances are cast across the Tasman. How, it is asked, have the Aussies managed it?
The most obvious explanation is that they have a huge mineral resource that the world – and particularly the Chinese – are keen to buy. If only we were similarly blessed, so the argument runs, we would do just as well. That, presumably, is why such high hopes are pinned on the discovery of new oil and gas reserves, and why it is proposed to dig up some of our most beautiful and vulnerable landscapes in search of coal and other minerals.
I take leave to doubt, however, that success in these ventures would improve our fortunes. Each economy has a different mix of components, and it does not matter very much whether – over the longer term – one component is bigger in one economy than in another. What matters is how we respond in policy terms to the mix we have and to changes in that mix. It is not the hand we are dealt but how well we play that hand that counts. And the omens in that respect are not encouraging.
A classic case in point was the UK experience with North Sea oil. By the time the oil came on stream, in the early 1980s, the UK had adopted a monetarist policy stance. Monetarist theory predicted that an increase in oil production would lead to a rise in the exchange rate. A higher pound would make manufacturing less competitive, with the net effect that the oil production would simply replace a swathe of manufacturing capacity with little or no gain to total production. As the oil revenues began to flow, policy-makers – convinced as they were by the theoreticians’ predictions – were content to watch the exchange rate rise and did nothing to counteract it, with the result that manufacturing did indeed contract as oil production rose. The Dutch had a similar experience – to the point that the adverse effects for their economy were dubbed the “Dutch disease”.
The Norwegian experience of North Sea oil was very different. They paid no attention to monetarist theory. They succeeded in ring-fencing the proceeds of the oil (largely by using them to buy assets abroad) so that their exchange rate remained stable. The benefit to the trade balance allowed them to grow faster than would otherwise have been the case, and – as growth in oil production eventually slowed – the repatriated profits from overseas assets were re-invested in the Norwegian productive economy so that good levels of growth were maintained.
There are no prizes for guessing which course we would follow in the event that we discovered major new sources of mineral wealth. We do not need a crystal ball when we can read the book. Not only have our policy-makers slavishly followed monetarist prescriptions over a long period, but we have some useful case studies of our own to guide us.
Those instances exhibit the same errors in policy-making as those made by the British and the Dutch. A recent example has been the rise in world dairy prices. Our response was to allow the exchange rate to rise (thereby wiping out any gain to domestic profitability, investment and growth) all because we see high dairy prices as an inflationary problem – requiring a tighter monetary policy – rather than as a stimulus to better economic performance.
Even more telling – and depressing – is another instance. It can be argued (and I am indebted to my colleague, Brian Easton, for this point) that we have already discovered a new source of wealth – not new mineral discoveries or even higher prices for our primary produce – but overseas borrowing and the sale of our assets to foreign buyers. The impact of this “new income” on our productive capacity – under the current policy regime – is just the same as the impact that North Sea oil had on the British and Dutch economies. The only difference is that, unlike them when the oil began to run out, we will find when our borrowing capacity is exhausted that we not only have to do without it but have to pay it back.
Our policy settings ensure in other words that, even if we suddenly discovered huge reserves of oil or gold or whatever, we will waste the potential for growth by taking the benefits in higher consumption (through a higher exchange rate and therefore cheaper imports) rather than through production-focused investment. Moreover, the new wealth would actually displace productive capacity – the very reverse of the priority that the government believes it is giving to the productive economy. If we want to do better, we need not complain that we have not been as fortunate as the “lucky country”. We should be making our own luck.
Bryan Gould
7 February 2010.
This article was published in the New Zealand Herald on 23 March.
Macro Economic Policy Is What Counts
As we begin the New Year with the hope of climbing out of recession, we are in danger of overlooking – or misunderstanding – one of the lessons we should have learnt from the global downturn. What the meltdown should have taught us is that economics, as Keynes insisted, is a behavioural science. It is not subject – like physics – to inexorable scientific laws, nor is it to be captured or foretold through mathematical formulae. Economics is the attempt to account for and predict how people – with all their foibles – will behave in response to the stimuli that economic circumstances provide to them.
Governments, and economic policy-makers, understand this, even if they say they don’t. Otherwise, they wouldn’t bother with changing those stimuli in the hope of improving economic performance. Even monetarists, whose basic attitude is that all governments can do is to hold the ring and let people get on with it, are keen interventionists when it comes to pushing this button or pulling that lever.
What we seem to have difficulty in grasping, however, is that the most powerful economic stimuli are those provided by macro-economic policy – the way in which we manage the economy as a whole. We insist on treating that as a given, beyond the reach of policy-makers to influence. “There is no alternative” we are told, either explicitly or implicitly; the ability of governments to influence economic developments is said to be limited to pushing or prodding at specific supposed pressure points. Even 25 years’ experience of the failure of such measures to raise our overall economic performance does not deter us from pushing on doggedly with new versions of old and usually failed remedies.
But this represents a total failure to understand Keynes’ basic insight. The most important economic function of government is to adjust the macro-economic context so that – in a market economy – the overall market and the response people make to it will do the job for us. If macro-economic policy settings allow the market to function efficiently, then much specific intervention will be rendered unnecessary.
Conversely, the less attention we pay to the macro-economy, the greater will be the apparent need and temptation to intervene with specific measures, in an attempt to make up for the deficiencies in economic performance that our macro policy – or lack of it – has made inevitable, and the greater will be the (repeated) disappointment when those measures prove ineffective.
The basic concerns of macro-economic policy should be the overall competitiveness and profitability of our productive sector. The focus should not be any particular firm or industry but the economy as a whole. If those concerns were properly addressed, our productive industry would – without specific intervention – help us to balance our current account, invest in new capabilities for the future, provide worthwhile job opportunities to the whole population, pay proper attention to sustainability, produce buoyant tax revenues to the public purse, and generally produce a more successful and easily managed economy and society.
So, set alongside these goals, how does our macro-economic policy shape up? Does it provide the stimuli that will produce the right responses?
Well, we begin by defining macro-economic policy virtually out of existence. We insist that it is really just a question of monetary policy, and monetary policy for a very limited purpose – the control of inflation. We pay no attention to other policy objectives like competitiveness, profitability or full employment. We have, in other words, fallen at the first hurdle.
We then engage the limited tools of monetary policy – principally interest rates but also exchange rates as an inevitable concomitant – to do a job they are not designed for. Instead of helping efficient market operations by providing market-clearing prices, interest rates and exchange rates are used to distort the market in the interests of controlling inflation – and not very well at that.
Macro-economic policy thereby becomes, not an instrument for promoting the overall economy, but a guarantee that it will not be allowed to prosper. If, by virtue of superhuman efforts by our farmers and manufacturers, or of strokes of good luck such as the rise in dairy prices, we manage briefly to improve our trading performance, the response of our policy-makers (with the help of the foreign exchange markets) is to stimulate a rise in the exchange rate which will wipe out any gain in profitability. And that is a problem because unless there is improved profitability which can be re-invested in productive capacity, there is no escape from our disappointing economic performance.
We insist, in other words, on delivering the message to our most dynamic producers that there is no point in investing in New Zealand’s productive capacity because our policy-makers have other priorities. The power of the overall market forces we set in motion as a result of our neglect of macro-economic policy is such that no amount of poking or prodding at small parts of the economy will have much effect. Little wonder that Kiwis conclude that housing is a better investment than productive capacity.
The stimuli our macro policy provides to our overall economy are, in other words, the very converse of what Keynes would recommend. It is time to recognise that the Keynesian approach offers not just the only way of escaping from recession (as is now reluctantly recognised by most commentators) but is also a long-term blueprint for the health of our economy. If we want a better economic performance, we need to think harder about the “behaviours” that our policies make inevitable.
Bryan Gould
29 December 2009
This article was published in the New Zealand Herald on 4 January 2010.
We Owe the Brash Task Force A Debt of Gratitude
Don Brash and his Task Force, with their bizarre ragbag of extreme nostrums from thirty years ago, have – in at least one respect – done us all a favour. We now know that we can safely consign to history the doctrines that have dominated our economic policy for so long. If we are to make any sense of the goal of closing the gap with Australia, we need to look forward rather than backwards.
Even without the Task Force, it has become clear that the landscape of economic debate has changed substantially. The global recession has forced an “agonising reappraisal” of what works and what doesn’t. Phil Goff recognised this when he proclaimed that the consensus of the last 25 years was ended; and the Prime Minister was not far behind him in quickly acknowledging that the Brash Task Force report would be largely ignored.
So, the search is now on for a policy agenda that will make the difference. In that search, there is an immediate obstacle to overcome. We have been told for so long that “there is no alternative” that we are inclined to think that any departure from the former orthodoxy will require something dramatic and revolutionary. Nothing could be further from the truth.
The effective and sensible course that this country should now follow requires nothing more than the application of common sense and tried and true policies. It is only the absence of any real debate in New Zealand about economic policy over the past 25 years that has made them seem unfamiliar.
The first step we should take is to re-focus our macro-economic policy. The Brash theory has been that, if we focus exclusively on controlling inflation and leave the rest to market forces, everything else will fall into place. The problem has been that the counter-inflationary instruments we chose – ever higher interest rates and a consistently overvalued exchange rate – distorted the operation of market forces and did enormous damage to our productive economy. Little wonder that, by loading the dice against ourselves so that we made it difficult to develop export markets or to resist import penetration, we fell behind those who did not handicap themselves in this way.
What we need now is a better balanced, broader-based policy which treats inflation not as the sole focus of policy but as just one of the targets we should aim at. We need a macro-economic policy that aims at full employment, so that we fully use our resources, and above all maintains and improves the competitiveness and therefore profitability of New Zealand industry.
This requires both monetary and fiscal policy to be integrated so that a stable level of demand is maintained and New Zealand’s competitiveness in world markets is improved. Interest rates and the exchange rate should be allowed to do their proper job and set accordingly. Government has a role to play in doing those things that private industry finds difficult. Other countries, like Singapore – more successful than we have been – have shown how this is done. Only if we can set ourselves on the path of export-led growth can we expect to arrest the long decline in our comparative economic performance.
Oddly enough, this approach places more faith in the capacity of the market to show the way forward than the Brash-inspired distortions implicit in manipulating interest rates and the exchange rate for counter-inflationary, non-market purposes for which they are not intended. Only if our producers – in industry and agriculture – are able to compete effectively in world markets, including our own, can we expect them to make a return which will finance the investment in our productive capacity which is the key to better productivity and rising living standards.
None of this means that we should abandon the fight against inflation – far from it. To stop prostituting the whole of macro-economic policy to the single, narrow task of controlling inflation does not indicate that we need not bother about it. It simply means that we should use all the instruments of macro policy for wider purposes – the health of the economy as a whole – and deal with inflation through measures specifically targeted at inflationary pressures.
There is no shortage of appropriate measures available, if we are prepared to analyse carefully what stimulates inflation. It is increasingly clear that, with the prudent management of public finances over the last decade and the demands necessarily now made on public spending in recessionary times, it is not – as Don Brash continues to maintain – government spending that is the culprit.
What we need to target is the excessive investment in non-productive assets, like housing, that is both the consequence and cause of the bias in our economy against productive investment. The fastest- growing element in our domestic money supply has been bank lending on housing. That is where we should be concentrating our counter-inflationary attention; it is no accident that the tax treatment of housing as an investment and the restraint of bank lending are rapidly moving up the agenda.
A less doctrinaire and more commonsense approach to economic policy would, as a start, give us a level playing field on which to take on the Aussies – and, as we know, that’s all we need to give us a fighting chance.
Bryan Gould
6 December 2009