• The Wilful Obstinacy of Europe’s Leaders

    The first duty of political leaders is to deal with the world as it is and not how they want it to be. Yet too many of our global leaders insist that the world should accommodate to them and not the other way round.

    Nowhere is this more true than in today’s Europe. Not only are Europe’s leaders grappling with problems they created themselves; they are wilfully refusing to learn the lessons of their past failures. We will all pay the price of their ideological tunnel vision.

    Europe’s leaders created the initial problem by focusing exclusively on a political goal – the creation of a single European super-state – and ignoring economic common sense. The single-currency euro zone was never going to work. A single currency requires a single monetary policy – and Europe’s weaker economies were never going to live with monetary conditions framed to suit the interests of stronger economies like Germany.

    But they were induced to take the gamble by the implied promise that the strong economies would help them out if they got into trouble. They survived for as long as times were good; and they tried to keep pace by taking on extra debt. But when the crunch came, the strong economies reneged on their promise.

    The result? A debt crisis that has engulfed Greece and Portugal, to a lesser extent Ireland and Spain, and now – potentially – Italy. But instead of recognising their mistakes, Europe’s leaders have continued to ignore economic realities. They have treated debtor countries – not as victims of a failed political doctrine – but as moral lepers who must don hair shirts and pay for their sins.

    Even more sadly, they have insisted that their political goals should take priority and be reinforced. Far from acknowledging that the single currency did not wash away economic differences across Europe, but exacerbated them by trying to suppress them, the remedy they now contemplate is an even more determined bid to create a single European state by moving further towards economic union.

    What they obstinately refuse to recognise is that economic weakness cannot be wished away. Even if it is buried in a political framework so that it is out of sight, it will simply manifest itself in another way. Even if Greece or Portugal or even Italy became simply provinces in a wider Europe governed from Berlin, their lack of competitiveness could not be hidden; it would just mean that they became depressed regions, with no prospect of seeking their own salvation.

    They would have no chance of pursuing a monetary or exchange rate policy more suited to their needs. They would have to rely on decisions made in Berlin or Paris; and those decisions are unlikely to be helpful. German and French taxpayers, whose patience has already worn thin, would have little tolerance of regions whose weakness was seen as threatening living standards right across the continent.

    But the people of Greece and other debtor countries not only have to put up with the loss of self-government and lectures about their profligacy. Remarkably, the measures that Europe’s leaders now insist upon will make matters worse, not better – not just for the debtor countries, but for all of Europe and the rest of us as well.

    As the Irishman said when asked for directions, “I wouldn’t start from here.” But what Europe’s leaders should do is accept that they have to start from here, and to prescribe policies that offer a chance of turning things around.

    What they should do is cut Greece loose from the euro so that the Greeks can devalue sharply and then – on the basis of improved competitiveness – trade their way to generating the wealth needed to pay back their debts.

    Yet, Europe’s leaders insist that Greece – already going backwards at a rapid rate, with national output dropping like a stone – must cut a further hundred thousand public-sector jobs, slash salaries and pensions, cut health spending, raise taxes and sell off assets. It is impossible to see how – by slashing and burning – an economy that is already overburdened by debt, and with no capacity to service that debt, let alone repay it, can hope to work and trade its way out of its problems.

    And that problem will be compounded as other debtor countries are given the same advice. The whole European economy faces a bleak future if that advice is taken.

    Does any of this matter to us, or is it a problem for the Europeans alone? If the European economy tips back into recession, and if European bank failures were to provoke a renewed financial crisis, we would all suffer. Global liquidity would dry up, interest rates would rise sharply, markets would contract.

    But there would be longer-term implications as well. We might, for example, pause to consider, in the trans-Tasman context, whether a currency union as advocated by some would really be the panacea it is said to be.

    And, in case we feel a sense of superior wisdom when we contemplate European difficulties, let us not delude ourselves. If by some miracle of geography we were to find ourselves in Europe, our government would support the same failed nostrums as are insisted upon by Europe’s leaders and for the same ideological reasons.

    Bryan Gould

    23 September 2011

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

  • If Things Are So Good, Why Are They So Bad?

    It is a measure of how subdued is the national mood and how modest are our current ambitions that we expect so little of our elected governments. Even nearly four years after our own home-grown recession began, we are, for example, expected to acclaim as a triumph of economic management the first signs of a patchy and fitful recovery that still leaves us well short of 2008 levels.

    We might have expected much better. We were largely insulated from the direct effects of the global financial crisis. Our two major export markets remained surprisingly buoyant. And we have enjoyed record high commodity prices.

    Yet, to hear our leaders tell it, even our woes are a sign of success. The soaring kiwi dollar, we are assured, shows that foreign investors see us as a “safe haven” – a claim that sits oddly alongside the repeated warnings about the risk of a credit downgrade and of the need to wind back public spending so as to reduce a rampant government deficit.

    The truth is that the soaring dollar reflects a conviction on the part of overseas speculators – based on 25 years of experience – that our governments will go on paying them a premium and that the short-term demand for our currency thereby engendered will produce a capital gain as well.

    This is entirely consistent with the growing evidence that, as the recovery at last manifests itself, we will use the opportunity to repeat the recurrent mistakes of the past 25 years all over again. We will continue to treat any prospect of growth as an inflationary threat, to be knocked on the head by a combination of high interest rates and an overvalued currency. We will continue to express puzzlement as to why – in this policy framework – productivity languishes and our economic performance falls behind that of our competitors.

    There are occasional flickers of interest in a change of policy. Geoff Simmons, for example, points to the prospect of using tighter rules for bank lending as a counter-inflationary tool and as an alternative to high interest rates. But he also warns that the Reserve Bank – with its single focus on inflation (and it is, after all, a bank) – is unlikely to change course.

    And governments, of course, particularly at this stage of the electoral cycle, may wring their hands at the high dollar, but will secretly welcome the consequently cheaper imports – a short-term advantage that helps to holds down a soaring cost of living through to election day but that is bought at a huge cost to our long-term economic performance.

    It could be said that these problems are like old friends; they may be a nuisance and somewhat boring, but they are at least predictable, and it is true that there is a certain comfort to be drawn from getting what you expect. A right-of-centre government could be expected, for example, to stick closely to monetarist theory, and to pin its hopes for an improvement in economic performance on tax cuts for the well-off, asset sales, cutting government spending, taking a tough line on benefits, and seeking free-market solutions to most problems.

    That is exactly of course what we have got and presumably what people voted for. In the past, after giving these measures a fair trial, they have judged that they have not worked and then voted to get rid of them. This time, the policies look like surviving for a little time yet. It is not that the policies are different – merely that the salesman is better.

    But there is one consequence of current policy that even the most brilliant salesmanship cannot so easily sell to the public. The now unmistakable evidence of rising poverty, with children as the most vulnerable victims, is the inevitable result of widening inequality, higher unemployment, falling real incomes for the poor, less effective public services, and rapidly rising living costs.

    The myth that families choose poverty as a lifestyle option can only be sustained in a society that is divided – where the well-off are comfortably shielded from the realities of life for the worse-off.

    One of the advantages of being well-off is that it is possible to buy your way into a better neighbourhood, to go to better schools, to mix with better-off work colleagues and friends.

    You do not then need to venture into the poorer neighbourhoods, to sit around the table to share inadequate and poor-quality food or to feel the cold and damp in overcrowded bedrooms. You do not feel the humiliation of being rejected for job after job or having to present yourself for close questioning as the condition for receiving a weekly benefit which – in a well-off family – might be entirely spent on a single meal for family and friends at a good restaurant.

    Individual instances of hungry children might be dismissed as cases of fecklessness and inadequate parenting. But a rising tide of such children, whose health, education and very lives are threatened by hunger, is a social phenomenon with widespread social and economic causes. It might be – indeed, is – a predictable consequence of current policies, but that, surely, does not make it acceptable? Predictability in this case should not produce resignation but rather a clarion call for action.

    If things are so good, why – for so many of us – are things so bad?

    Bryan Gould

    27 July 2011

    This article was published in the NZ Herald on 2 August.

  • The Death Spiral

    There are times when one can’t help feeling sorry for the government. After two years of framing economic policy to please the credit rating agencies – last year’s budget was virtually dictated by Standard and Poor’s – their reward has been a warning last month that our credit rating is on negative watch.

    That blow has been followed by the revelation that the government’s deficit has blown out by $2 billion more than forecast. This intrusion of economic reality may not be welcome but it has been salutary.

    The government’s response so far to these twin developments has been to maintain a stiff upper lip, and to continue to target a return to surplus by 2016. Others have not been so restrained. The air is thick with urgings – from the Reserve Bank, the Treasury, the Business Roundtable, and not least the Herald’s own leader-writers and columnists – that the government’s deficit must be cut and cut faster.

    It is hard to see these warnings as anything more than a knee-jerk reaction to what people think they heard, or wanted to hear. They see or purport to see a substantial connection between the threatened downgrading of our credit rating and the size of the government’s deficit.

    A careful reading of Standard and Poor’s statement, however, reveals that the government’s deficit (which remains perfectly manageable by international standards) played only a minor part in their expression of concern about our credit rating. Their focus was on the country’s external deficit – our propensity to finance an inflated consumption by borrowing from overseas.

    It is true that the government’s deficit is an element in the country’s overall deficit but it is not the element that is of particular concern to S&P. What worries them – and they are quite explicit about this – is that, if and when a substantial recovery finally materialises, our appetite for imported consumer goods will re-emerge with a vengeance and we will be back to our bad old habits of borrowing to finance a persistent trade deficit.

    The real import of their warning is that they see nothing in our current policy settings to suggest that we will avoid this all too familiar outcome. They fear that any revival in economic activity will see the application of the decades-old “remedy” of high interest rates leading to a yet higher dollar, with consequent damage to savings and exports while we binge on artificially cheap imports. Sooner or later, they warn, the willingness of overseas lenders to fund this rake’s progress may be exhausted.

    But, say the deficit hawks, the external deficit, our poor savings record, and the narrow base of our export sector – all of which are fingered by S&P as causes for their concern – are problems for the future. Surely – whether S&P say it or not – the one thing the government can do to help is to get its own deficit down faster than planned, even if that means painful cuts that might impact the most vulnerable?

    Let us be clear. All other things being equal, it would clearly be beneficial for the government to eliminate its deficit as soon as possible. And the government is quite right to seek savings in respect of public spending that may be wasteful or poorly directed.
    But if cutting the deficit is the first and over-riding priority, we need to be sure that it would produce, in today’s context, the desired outcomes – and it is a pity that this realisation did not dawn before the government’s finances were further weakened by tax cuts that mainly benefited the better off.

    But there is no evidence that simply taking the axe to government spending would help matters. The main reason for the government’s increased deficit is that tax revenue – already depressed by the recession – is much lower than forecast, and that in turn is a direct consequence of the slowness of our economic recovery. To cut government expenditure, thereby further depressing demand and eventually tax revenue, is not the most obvious solution to this problem.

    The paradox is that, as many of us warned at the onset of the recession, the greater the priority and urgency given to cutting the deficit, the more persistent it is likely to be. The most effective course for a government worried about its deficit is – while maintaining proper controls over potentially wasteful spending – to play its part in ensuring that the level of economic activity rises.

    As it is, we are in danger of getting caught in a downward spiral. Our export income is being depressed by the high dollar. The consumer is facing higher fuel and energy prices and the threat of continuing job losses, and uses any margin of spending power to pay down debt. The business sector is struggling with inadequate demand and therefore keeping tight tabs on employment and investment plans. If the government, too, cuts its spending further, where is recovery to come from? And how do we ensure that recovery, when it comes, does not take us straight back – as S&P warn that it will – to the problems that have dogged us for decades?

    Bryan Gould

    15 December 2010

  • Recovery? What Recovery?

    It is surely beginning to dawn on us, nearly three years after our recession began, that anything approaching a full recovery is still a long way off.

    It is now clear that unemployment remains stubbornly high, that the housing market is depressed, and that property values have fallen sharply so that most people no longer feel as wealthy as they did. Lower housing values and employment uncertainties explain why domestic demand is sluggish so that – barring an unlikely pre-Christmas boom – we can expect to see increasing numbers of empty retail premises in our high streets in the New Year. Little wonder that confidence in the economy is ebbing and that employment and investment intentions are at low levels.

    As a consequence, the exodus across the Tasman has resumed. Australian living standards continue to rise faster than our own, as both demonstrated and assisted by the growing strength of their dollar against ours.

    Yet a great deal is going right for our economy. Our major export markets in Australia and China are performing strongly and demand for our goods is buoyant. Commodity prices generally and dairy prices in particular are at historically high levels. Our trade figures mean that a trade imbalance is not so much a constraint on expansion as it has been over such a long period.

    Inflation is not an immediate problem and the Reserve Bank governor has signalled his intention to keep interest rates at low levels. Our banks are in good shape (though, sadly, the same cannot be said of our finance companies). The warnings of the “bond vigilantes” that increased government borrowing to fund their deficits will mean rapidly rising long-term interest rates around the world have not materialised. Our own government’s finances are stronger than forecast and are in any case among the healthiest of any advanced country; most European governments can only dream about our relatively and historically low levels of government indebtedness

    In these unusually favourable circumstances, there is something wrong with us if we cannot make a good fist of coming out of recession in good order. So, what is going wrong?

    What we are seeing, I believe, is a simple failure of analysis. An economy in recession is by definition an economy in which there is a deficiency of demand. If we want to recover from recession, we have to see somewhere a lift in demand. The question is, therefore, where is it to come from?

    For once, a partial answer is provided by the export sector. The improvement in export prices is helping to re-balance the economy towards exports and away from domestic consumption –something the government is keen to see and a process that could be made even more beneficial by a more competitive exchange rate.

    But is the relatively strong performance of the export sector enough to counter the impact of lower levels of activity in the other two sectors – the private sector and the government? If the answer to that question is no, then we have our answer as to why our recovery is so sluggish.

    It is of course only too evident that activity and confidence in the private sector have suffered during the recession. Consumers are keeping their wallets closed, and businesses are cutting costs rather than taking on employees and investing in new capacity.

    So, if we are to lift ourselves out of recession, we need the government sector to be playing its part in stimulating the level of demand, so as to offset and eventually reverse the current depressed state of the private sector. Yet, when we look to what the government is doing, we see priority given to the government’s finances rather than the health of the wider economy – to getting the government’s deficit down, rather than on using fiscal policy to stimulate the economy as a whole. The effect is that depressed demand in the private sector is reinforced rather than offset. The government is not, in other words, helping towards a solution but contributing to the problem.

    The government says of course that it must cut back because it has to borrow just to maintain current spending, let alone spending at a higher level. But that is simply to re-state the problem rather than resolve it. The government has a deficit because a depressed economy means that its revenues are down. If the government is not helping but hindering recovery, then it will take longer to reduce the deficit and the recession will drag on for longer. And the longer it takes, the greater the risk that less than optimal levels of employment, investment and output will become permanent features of our economy.

    The government is quite right to insist that it must, like the rest of us, get value for every dollar it spends. But isn’t it time that ministers took a wider and longer view of the role they must play if we are to shake off the shackles of recession?

    Bryan Gould

    2 October 2010

    This article was published in the NZ Herald on 12 October.

  • Leaning Against the Market

    When Lord Myners proclaimed this month that “there is nothing progressive about a government that consistently spends more than it can raise in taxation” he gave support and comfort to one side of an argument that is at the heart of the new government’s agenda – what to do about the government deficit.

    Lord Myners’ intervention was all the more significant because it came from someone who, just a few weeks ago, was a minister in the Labour government. He weighed in on the side of those who seem to assert that the first priority of the new government must be to get the deficit down; but he may have also given us a clue as to why Labour’s position on this issue during the election campaign was so confused.

    Most commentators agree that the global financial crisis has prompted an overdue resurrection of the reputation of last century’s greatest economist. But, for Lords Myners it seems, Lord Keynes may never have existed. He continues to exhibit an unreformed attachment to one of the most common fallacies in economic thinking over the past thirty years.

    It is a common assumption in right-wing thinking that the government should be regarded as merely an individual person or corporation writ large, and that it should therefore always act as a prudent individual would do. Although most individuals would plead guilty to the charge of borrowing in order to build or acquire an asset (like a house), the government – according to this view – must never spend beyond its means. In a recession, when individuals stop spending and investing, and the government’s tax revenues therefore decline, the government must also slam on the brakes.

    This view is especially ironic when a large element in the government’s indebtedness is the money provided to bail out failed institutions, and especially banks, in the private sector. But, more importantly, it completely overlooks the responsibility of governments during a recession to lean against the logic of the market.

    As Keynes saw, a government that behaves in a recession as everyone else behaves will simply make the recession worse. It is the special role of government in that situation not to retrench but to use its huge resources, its ability to create new money through “quantitative easing”, and its responsibility to take the longer view and to act in the common interest, in order to stimulate the level of economic activity so as to shorten the recession and thereby restore its own financial position as soon as possible.

    A government that ignores that responsibility and focuses narrowly on its own short-term financial position is likely to see the recession last longer with inevitable longer-term consequences for its own tax revenues and finances. A braver government that lives with a deficit as its contribution to a counter-recessionary strategy will see its tax revenues recover faster and – paradoxically, it may seem – bring the deficit under control sooner than it would otherwise have done.

    None of this means that government spending should be let rip. If the deficit is to be effective in bringing the recession to an end, the spending must be economically worthwhile. The new government is quite right to scan the whole of its expenditure so as to eliminate wasteful, unnecessary or ineffective spending. The spending that is undertaken must not be focused on consumption but on encouraging investment, employment and improved productivity. The goal must be investment in an improved economic performance for the future so that a double bonus is obtained – an immediate counter-recessionary boost to the level of demand in the economy that takes the form of a counter-cyclical stimulus to longer-term productive capacity.

    To follow this course requires political courage and political leadership. The Lord Myners of this world are always quick to condemn a departure from what passes as orthodoxy. It is not something that should be sub-contracted to officials. The new government has received plaudits for setting up the Office for Budget Responsibility and George Osborne has now announced greater regulatory responsibilities for the Bank of England. But these agencies cannot be expected to take the tough decisions about the overall course of the economy that are now necessary. That is what we elect governments to do. The new government must step up to the mark.

    Bryan Gould

    16 June 2010.

    This article was published in the online Guardian on 14 June.