Opinion & Commentary
Accepting the recession
As Australia gets caught up in the global financial crisis, there has been much discussion about how to fix our economic ills. The reality is that the government cannot fix the current problems, and they shouldn’t be trying.
Australia is in a recession. In the September quarter we recorded real GDP growth of 0.1%, but we also saw population growth of about 0.4% so per capita growth was negative. The December quarter will likely show more negative per capita growth and confirm that Australia is already in a ‘per-capita recession’, even if we are not quite yet in a national recession.
Our recession has been imported from America. Over there, three explanations have been offered for the crisis. Neo-classical economists suggest it was caused by the US government; Keynesian economists suggest it was caused by the market; and Austrian economists suggest it was caused by the US Federal Reserve. All are correct.
The US government clearly provided the wrong incentives to the market, which encouraged mistakes to be made. The market then built on these errors through its systematic underpricing of risk. And finally, the loose monetary policy in America allowed ever more money to be shovelled into the booming housing market, which exacerbated the problem.
The important thing to note is that the seeds of the current crisis were planted many years ago. The mistakes of government, market and the US Federal Reserve have been building up for at least ten years and, while we might wish it different, history is not something we can change through debate. We have to accept that mistakes have been made.
These mistakes resulted in ‘mal-investment’ all around the world, where resources (capital and labour) have been directed to the wrong parts of the economy. There are only two options at this point – continue driving the economy in the wrong direction, or unwind those mistakes of the past and put the resources back where they belong.
Unwinding the mistakes of the past leads to business failures and job losses. The problem is that the only way to avoid the immediate pain is to keep going down the ‘wrong road’, leading to more mal-investment and repeating the mistakes of the past. The longer we wait to change direction, the bigger the eventual pain is going to be.
The current global economic crisis is devastating to many people. But it is necessary.
Government policy will not fix the recession. By trying, the government risks building more mal-investment and sowing the seeds for future economic problems.
The first government response was to start bailing out companies that were in financial trouble. This will not solve the underlying problem. The harsh reality is that some companies should close and others should shrink so that their resources can be shifted to other, more efficient, parts of the economy.
Just as important, the bailing out of inefficient companies contributes to the growing menace of moral hazard, where risky business decisions are increasingly becoming a game of ‘heads I win, tails you lose’ as businesses take the profits but the government pays for the losses.
For financial markets to work properly the investors must succeed or fail based on the quality of their decisions, and they must face the consequences of the risks they take. In contrast, when the government uses taxpayer money to support failed businesses, they create an environment where their success or failure depends on political favour, populist politics and lobbying. This leads to poor investment decisions, and sows the seeds for future problems.
Some commentators have argued that certain companies are ‘too big too fail’. Despite the dramatic predictions of doom, there is no reason to believe that a business failure (even a business as important as AIG) would harm the economy more than the total cost of the bailouts.
The second response by the government has been to pursue an active fiscal policy by spending big and taking the budget into deficit. It is natural for the budget to deteriorate during an economic downturn (as fewer people pay tax and more people receive welfare). However the government has gone beyond these ‘automatic stabilisers’ and is pumping billions of dollars into the economy.
There are plenty of problems with activist fiscal policy. A large government deficit will lead to a partial offsetting increase in private saving and crowding out of private investment. The long and variable lags of fiscal policy will undermine their effectiveness. Finally, in their haste to get money into the economy the government faces the risk that they will introduce poor policy.
And all of this in pursuit of a policy that has never worked before.
Last December the government offered nearly $9 billion in handouts, which produced no meaningful benefit. Instead of learning from their mistakes, the government now wants to repeat this failed policy and waste billions more of taxpayers money. This might make for good politics, but it is bad economics.
Instead of throwing good money after bad, the government should be looking at ways to improve the long-term efficiency of the market through quality infrastructure investments and tax cuts.
A recession is a terrible thing. But once the economy has built up enough mal-investment and structural problems, it is not possible for governments to buy their way out of trouble. And their attempts will only make the problem worse.
John Humphreys is a research fellow at The Centre for Independent Studies.
