• Learning the Lessons

    As the world-wide recession seems to be bottoming out, one question is being asked with increasing frequency and urgency. Have we learnt the lessons so that it will not happen again?

    The answer – at least in the US and the UK – is not a reassuring one. As the hard-pressed taxpayer, already burdened with the threat to homes and livelihoods, is left to pick up the bill for market failure – a bill in the billions which will not be paid for years, not to say decades – those whose recklessness and greed caused the crisis have already returned to the bad old ways.

    We see the same outrageous bonuses, the same disregard for prudence, the same confidence that the price of failure will always be paid by someone else. It is almost as though the publicly financed bail-out has provided the fat cats with a renewed belief in their own infallibility, by convincing them that they will always be protected because they are too big and too important to be allowed to fail.

    In New Zealand, where the financial sector is too small to exhibit these attitudes, we have nevertheless seen our own somewhat paradoxical response to market failure. It might have been thought that, in an economy where public finances had been unusually well and prudently managed over recent years, the public sector would be the last place that would be required to bear the brunt of recessionary retraction.

    In other countries (notably Australia), and in line with the revival around the world of Keynesian insights into how to respond to recession, the public sector has been seen – not as the problem – but as an important part of the solution. We, however, seem to have become obsessed with the size of the government deficit, which is still relatively low in historical and international terms, with the result that the salami slicer has been applied with very little discrimination across the whole range of public spending.

    No one can cavil at an increased drive to ensure value for money in public spending. The suspicion must remain, however, that the recession has been a not unwelcome excuse to rein back the public sector on ideological rather than economic grounds.

    There is, however, a more significant respect in which we seem to have decided not to apply the lessons we should have learned. We should not forget that we have been in recession since the end of 2007 – long before the financial crisis broke. That home-grown downturn was the direct consequence of the policy directions we had been following for 25 years having finally run into the buffers.

    Inflation then was still enough of a worry to lead the Governor of the Reserve Bank to keep interest rates at an internationally very high level. That in turn, through pushing up the exchange rate, had destroyed the competitiveness of our industries, created a current account in serious imbalance, increased our need to borrow to finance the gap between what we earned and what we spent, pushed up the exchange rate and stoked inflation still further as “hot” money flowed in to take advantage of the high interest rates, and so on round an increasingly vicious circle.

    As we contemplate the post-recession scenario, those fundamental problems are no nearer solution. Indeed, some are a good deal worse; the overvalued dollar is destroying our productive economy with every day that passes. Our only response to these pressing problems seems to be that “there is nothing we can do.”

    But there are things we can do. We could acknowledge that the strategy of defining macro-economic policy in exclusively monetary terms, and of directing the whole force of that policy to the single goal of controlling inflation, using a single instrument in the hands of a single unelected official, has failed – both as an effective way of controlling inflation, and in terms of its disastrous impact on our overall economic performance.

    If we want to do better, and in particular, if we want to raise our poor productivity levels, we have to do things differently. If we go on with the same policy prescriptions as we have applied for the last 25 years, we will get the same disappointing results as we have endured over the last 25 years.

    What is needed is a fundamental shift in perspective. It would mean, in line with the revival of Keynesian thinking, re-defining macro-economic policy so as to include the whole range of fiscal as well as monetary measures. It would mean setting the goals of macro policy (including interest and exchange rates) in terms, not of inflation, but of competitiveness, as the Singaporeans do. It would mean, rather than clobbering the whole economy with a poorly focused counter-inflation strategy, continuing the battle against inflation with specific micro measures directed at defined inflationary pressures, such as excessive bank lending and the favourable tax treatment of housing, and encouraging saving by strengthening the incentives to save.

    It probably won’t happen. It is amazing that an orthodoxy that has been so thoroughly discredited by experience still has such a hold on official thinking. The government might be encouraged, however, to undertake an “agonising re-appraisal” by the thought that a change of tack might produce a better outcome, not least for their own pet preoccupation. Nothing, after all, would do more to get the government deficit down in a hurry than a newly buoyant economy.

    Bryan Gould

    26 September 2009

    This article was published in the New Zealnd Herald on 1 October.

  • 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