As the global recession gathers force and pace,
spare a thought for our policy-makers. They are trying to confront a crisis whose
dimensions they have only belatedly begun to recognise and to do so with policy instruments that the rest of the world has
already rejected as irrelevant.
Relying on monetary policy may have just about seemed
adequate when we slipped into our own home-grown recession at the beginning of last year.
Notwithstanding that it was that self-same monetary policy that had driven us into recession in the first place, our
economic gurus at the Treasury and the Reserve Bank seemed satisfied that a few touches on the monetary tiller, plus the tax
cuts offered as an election sweetener by both major parties, would be enough to turn the economy around.
They were of course shaken, as were we all, by the
sight of the world’s financial establishment coming apart. But they comforted
themselves, no doubt, with the thought that our own banks and financial institutions (give or take a few dozen finance companies
and a couple of billion dollars of people’s savings) were not under threat.
It has taken them a long time to understand that
the global crisis is no longer – or at least isn’t just – a financial crisis. As the unbelievable greed and stupidity of the world’s banking institutions have produced their inevitable
consequences for the real economies in which most people live and work, we are now faced with a global economy in which consumer
spending, jobs and investment are in free fall – with inevitable pain for a small, vulnerable, export-dependent economy
like our own.
In these circumstances, cuts in interest rates –
while welcome at the margins, if only to help redress what would otherwise be an even greater than usual interest rate differential
for us – simply will not cut the mustard. Relying on monetary policy in
the face of a full-scale, real-live, worldwide recession driven by falling demand is like pushing on a piece of string. While the rest of the world has experienced a miraculous overnight conversion to Keynesian
economics and the merits of fiscal stimulus, we are still tracking along as though our own comparatively small-scale recession
is all that we have to worry about.
So, while countries like the US and the UK have
put in place huge fiscal packages to try to ensure that their economies do not freeze over altogether, (and that is in addition
to the huge sums they have spent on shoring up their banking sectors), and while Kevin Rudd has announced a massive public
spending programme in Australia, we continue to rely on taxing and spending decisions that were essentially taken in mid-2008
when they might or might not have been adequate to arrest our own mini-recession.
As far as further fiscal stimulus to address
the reality of global recession is concerned, we are apparently relying on a drip-feed of small measures whose main purpose
seems to be to show that our policy-makers are at least doing something, however ineffectual.
We are constantly assured that – at just 2.8% of GDP – our fiscal stimulus is among the largest in the
OECD. We can only conclude that this calculation was made before the British,
American and Australian packages – at several multiples greater than 2.8% - were actually announced.
Such a cautious approach overlooks the very real
point that what is now needed from governments is not just a boost to spending that is appropriate in dollars-and-cents terms,
but that also helps to turn round the psychology of deflation and recession.
One of the main lessons of Keynesian economics,
after all, is that economics is above all a behavioural science. Economic issues
have a nasty habit of springing off the page of the textbook or the latest mathematical model and biting real people in ways
that the theorists do not predict. The danger of deflation is that it feeds upon
itself – exactly what it is doing now. The more people take individual
decisions to protect themselves against hard times, the more they ensure that those hard times will get even harder.
As Robert J. Samuelson has argued, we are now entering
that phase of the recession where people begin to respond to the “wealth effect”.
Just as rising equity in their homes and continuing job security encourage people to go out to spend, so they jam on
the brakes when house prices fall and unemployment rises. Samuelson calculates
that for every dollar’s fall in perceived wealth, people reduce their spending by 5 cents, and that is enough to build
in to the economy a massive deflationary impetus.
An important part of government’s role, in
other words, is to show everyone that effective, immediate, large-scale action is being taken – action that will put
more money in people’s pockets and give them the confidence to go out and spend it.
If we can’t or won’t do that, we might as well all hunker down and prepare for the worst.
So, what should our policy-makers be doing? The first thing they should do is to throw their ideological baggage out of the window
and make a pragmatic response to the practical situation that confronts us. They
should acknowledge that their first priority is to get the economy moving; there are of course limits as to how far increased
spending should push the government deficit, but we are far from having reached them yet.
What, after all, was the point of ten years of reducing the government’s debt if we are not allowed to use the
fruits of that prudence when they are needed?
The second thing they should do is take a more clear-eyed
and realistic view than they have managed so far of the true dimensions of our problems.
That is far from an easy task. They now have to add to their earlier preoccupation
with our domestic woes, which now include sharply rising unemployment and a nose-diving housing market, with the much greater
international threat posed by collapsing export markets, falling commodity prices, more expensive imports, and more difficult
and expensive international credit.
Drawing up a list of our pluses and minuses shows
how difficult a calculation of our true position really is. On the one hand,
there are factors at work that offer some better prospects for growth. The cut
in interest rates will certainly help those with mortgages by leaving more purchasing power in their pockets. Those looking for bank loans will benefit, provided they are willing to borrow in the first place. And lower interest rates have partially corrected the dollar’s over-valuation
that was the single most damaging aspect of our monetary policy over more than two decades.
At least our exporters can now approach export markets without both hands tied behind their backs.
The world recession has seen a marked fall in oil
prices (only partially reflected so far in prices at the pumps), so that disposable income is no longer so greatly absorbed
by fuel costs. The world will still need food, so that our commodity prices,
though having fallen back from their peak, may still stay comparatively strong. Reduced
emigration and a flow of returning ex-pats might help to stabilise the housing market and add a margin to retail sales. Tax cuts, those delivered last October and those yet to come in April, will help consumer
spending. The relatively small public spending programme so far announced might
still save a few thousand jobs. And tight conditions in retailing should help
to put a lid on price increases.
But for every glimmer of hope, there is a weightier
reason for apprehension. Domestic interest rates might come down further, but
the interest rate differential between us and other countries will be largely unaffected, and the high proportion of domestic
lending that is financed from overseas will soon reflect the greater cost of borrowing from overseas sources. And, as we have already seen, mortgage rates don’t necessarily fall as fast as the OCR, and even
when they do, they don’t necessarily revive a dying housing market. Samuelson’s
“wealth effect” will be felt with a vengeance.
Commodity prices are bound to fall further, as the
recession gathers pace, and we will see more of what the reduced Fonterra payout has already shown us – a multi-billion
deflationary shock to our total economy since the heady days of 2007. As well,
our food products tend to be at the higher end of the market which will probably be more vulnerable to reduced purchasing
power in overseas markets. And although the inflationary effects of a lower dollar
are consistently overstated, there is no doubt that there will be upward pressure on import prices, including petrol prices.
Tight retail conditions might rein back price
rises, but they will also reduce margins and increase closures and job losses. Higher unemployment, and the fear of more of it, will cut consumer spending. And the whole of this deflationary momentum will be supercharged by the growing impact of what is happening
overseas, and particularly in those export markets that matter most to us. Fisher
and Paykel’s tribulations are just the start.
The third requirement is courage. Having focused, without ideological preconceptions, on the job in hand, and having made a clear assessment
of the scale of the challenge, we should then look for a response that matches the needs of the moment. So far, that response has been too late and too small.
Yet, we might perhaps feel a twinge of sympathy
for our policy-makers. They face the most difficult economic situation of modern
times. And, like each individual, and especially each individual company and
company board, they face the perennial challenge posed by recession – that the actions that each individual are most
likely to take in their own interests are precisely the actions that will intensify the recession.
It is at this point that we need to be strong-minded
and to be clear about who is responsible for what. No one should be dissuaded
from thinking about the wider picture, but the responsibility of directors remains primarily to the company whose fortunes
they help to direct. It is for governments to look after the economy as a whole
and to work for an economic context in which companies can thrive.
That is not to say that directors need do nothing
in this regard. While keeping their eyes firmly fixed on the interests of their
own companies, they should not shy away from expressing a view about how economic policy should be developed. This is a time for business leadership with the courage and wisdom to understand the context in which they
are operating. For too long, directors have gone along with a view of how economies
should be managed which we can now see was mistaken and which has led us to our current plight. We need business leaders who are less preoccupied with ideology and more aware of the real world.
We must never again make those egregious mistakes
that were scarcely ever challenged by business leaders over two or three decades. It
is not the case that markets work best if they are left unregulated. It is not
the case that governments should be kept at arm’s length from economic policy.
It is not the case that growing imbalances in the global economy have no adverse consequences. It is not the case that economies need only small technical adjustments of monetary policy and that fiscal
policy is too risky and too interventionist to be used. Nor is it the case that
the important decisions in the economy can be safely entrusted to bankers who will pursue the wider interest rather than their
We need, in other words, boardrooms that will not
only do their best for their companies but will also make a proper and thoughtful contribution to the wider public debate. There is no shortage of business leaders who do precisely that. They are directors who do not necessarily follow the herd by adopting the prevailing orthodoxy. They do their own thinking. We need more of them.
16 February 2009.
This article will be published in the March issue
of Boardroom (NZ Institute of Directors).