• Spend Now, Prosper Later

    The global recession dominates the thinking and writing of the world’s best economists – and not surprisingly, they exhibit a wide range of views as to what is really happening. There is not even a consensus about how deep and how long the recession will be, let alone what should be done about it.

    In New Zealand, we are now reaching a more sober assessment of how we will be affected. After an early period that was somewhat akin to a “phoney war”, we are now beginning to realise that the worst may be yet to come.

    We must of course be careful to avoid undue pessimism. Deflation feeds on itself, as people prepare for hard times by battening down the hatches and thereby make the times even harder. But we must also be alert to the policy measures that could help – and there is at least an emerging consensus that the earlier such measures are put in place, the more effective they will be.

    We also know now that the “jobs summit” – however well-intentioned – may have succeeded in creating a sense of pulling together but has not managed to produce much by way of measures to stop the slide into further recession. If we are to be effective, we need to decide now on what needs to be done.

    The time may be right, in other words, to rehearse the arguments for government intervention. Virtually all of the world’s economists agree that the central feature of recession, and of threatened depression, is a deficiency of demand or purchasing power. In New Zealand, we are being hit by a double whammy in this regard; our export markets are contracting at the same time as unemployment and a deflated housing market mean that consumers at home are also spending less.

    Left to itself, an economy will take a long and damaging time to correct this deficiency. But, it will be asked, what can governments do about this, when their own finances are being hard hit by recessionary factors? And if the government spends money it doesn’t have, isn’t this just building up problems for the future?

    Our own Treasury is not immune from this kind of thinking. Its projections show – even without further interventions – a sharp rise in the government deficit in the next year or so, and they then extrapolate that rise so that the deficit appears to soar into the stratosphere over the next decade. This, they say, means we should be cautious about boosting government spending further.

    This is not, however, an accurate way of looking at the issues. There is a good deal of evidence, supported by a growing number of economists, that the key is timing. A dollar spent now to boost the economy could save several dollars in government deficit later on.

    The argument runs as follows. The government deficit rises and falls in line with the fortunes of the economy as a whole. A buoyant economy will generate a large tax revenue so that -as has happened over recent years – the deficit can actually be reduced by paying off debt. A flat or shrinking economy, on the other hand, will increase the deficit, as the government struggles to maintain essential services with falling tax revenues; and if the government does respond by trying to cut the deficit by spending less, this will make matters worse by dragging the economy even lower and making the deficit bigger in the long term.

    If, on the other hand, the government has the courage to intervene now with carefully judged spending so that economic activity is boosted, the recession will end sooner and government finances will improve quicker. What might look like a frightening short-term deficit may well be the best protection against a bigger deficit in the long term. The priority is to spend the government dollar now, when it is most needed and will be most effective in correcting what would otherwise be a growing deficiency of demand.

    Government spending now would of course depend for its efficacy on exactly what it was spent on. If increased government spending went mainly on consumption, little would have been achieved; that is why many believe that tax cuts are not necessarily the most effective means of boosting the economy and countering the recession.

    If, on the other hand, the government spends now on investment projects that will strengthen our economy in the long term, we not only counter the current recession effectively, but will be better equipped to prosper in the future. Investment for this purpose need not be limited to physical facilities in areas like transport, communications and energy, but could also include programmes for improving our research effort and the skills of our people.

    The ideologues and the faint-hearted will quail at the sight of a rising government deficit at this particular juncture. But common sense is our best guide. We are all familiar, in our personal lives and in our businesses, with borrowing now to invest in a more prosperous future. Let’s do it for our country too.

    Bryan Gould

    23 March 2009

    This article was published in the NZ Herald on 26 March.

  • Treasury Must Look Past Interest Rates To Boost Economy

    As the participants prepare for the “jobs summit” this week, they will be hoping for a strong lead from Treasury and the Reserve Bank as to the way ahead. But, on the evidence so far, our policy-makers are floundering. After trying and failing to use monetary policy to grapple with our own home-grown recession throughout 2008, they now have to meet the new challenge of a world that has changed dramatically and to do so with a monetary policy instrument that now seems even less relevant.

    What, after all, is now the goal of monetary policy? For decades, we have been told that inflation is all that matters and monetary policy all that is needed to deal with it. Now that inflation is the least of our worries, and the limitations of monetary policy are evident, a significant change in mindset and a new range of policy instruments are surely needed.

    We should in any case temper any sympathy we might feel for our policy-makers with the thought that it is their mistakes that created many of our problems in the first place. Our 2008 recession – well-entrenched by the beginning of 2008 – was the end result of decades of ideologically-driven policy errors that had eventually run us into the buffers. Those mistakes had seen the average New Zealand family end up $80,000 a year worse off than their Australian counterparts, and even that disastrous performance was achieved at the expense of massive overseas borrowings, a huge trade deficit, and the fire sale of many of our national assets.

    It is from this unfortunate starting-point that we now have to face the threat of world recession. The measures put in place just to deal with our own recession were hardly adequate for the task, but they certainly need reinforcing now if we are to ward off the worst effects of the global downturn as well.

    That is not to say that the steps that have been taken are not welcome, as far as they go. The cuts in interest rates may be far too late but are better late than never. Tax cuts will also help but fall far short of what is needed and, according to most observers, are less effective than public spending in stimulating economic activity. The promise of a rolling programme of public investment in infrastructure is certainly welcome, though it seems to be proceeding on a somewhat leisurely, drip-feed timetable and to be just tracking along in the wake of a crisis that is relentlessly gathering pace.

    Worryingly, there seems to be more concern in some quarters about allowing the government deficit to grow than with the increased and substantial fiscal stimulus the economy now needs. But that is to put ideology ahead of practicality. The whole point of the last decade of reducing government debt was surely to equip us to use public spending to stimulate the economy when it proved necessary. The prudence of past governments has meant that, in that respect, we are better placed than most to use government spending to help counteract recession – and that, rather than the size of the government’s deficit, is surely our top current priority.

    We are of course constantly assured by Treasury that the size of the fiscal stimulus already delivered to the economy is very large by international standards. But that assertion was made last year, before the crisis truly hit and before other countries had made responses that dwarf ours by comparison. The stimulus so far provided (including tax cuts and spending yet to materialise) is estimated to equate to 2.8% of GDP. But in the US and the UK (where huge sums have also been spent on bailing out the banks), packages the equivalent of several multiples of our own have been put in place, and our response is of course also much smaller than the fiscal stimulus announced by the Rudd government in Australia. These countries have, in other words, done much more than we have, from a starting-point that was much less difficult; they were not already in recession, as we were, when the global downturn struck.

    It is time to forsake ideological purity (for whatever that is worth) and focus on what pragmatically needs to be done. On top of our domestic woes, we now need to address a desperate international situation that is unprecedented in most people’s lifetimes. If jobs and businesses are to be saved, we will need more than occasional, case-by-case interventions. We must recognise that, if bank lending and credit creation are falling back, the case for the government to fill the gap with programmed credit for investment is overwhelming.

    The Prime Minister, at least, seems aware that more needs to be done, and that spending on infrastructure is the way to go. We must hope that this week’s summit – and his own advisers – will agree with him.

    Bryan Gould

    19 February 2009
    This updated version of an earlier article was published in the NZ Herald on 26 February