You and the Prolonged Depression

Anglican Taonga, Spring 2010.

<>Keywords: Macroeconomics & Money;

The world has just gone through its greatest financial crisis since the 1930s. We may be grateful that things were not as bad as was feared, but we need to recognise that while the financial stage of the crisis may be over, there are still economic consequences working through the international economy.  We dont fully understand them; the only people who are sure about what is happening are those who have not been following events.

However, one thing which seems reasonably certain is that the Western economies are going to come out of it on a lower growth track than before 2008. That means that when the economies start growing again, they will settle down at a similar growth rate to the past, but they will not fully recover the lost level of production, a situation I have tried to capture in the accompanying stylised graph.  The transition between the two growth paths will look like a prolonged recession —  a period of stagnant growth with up and down wiggles and bouts of false optimism followed by dire pessimism. We seem to be in one of the downers at the moment, so gloom is the fashion.

How long will the recession – the period of stagnation  – be? We dont know, but it is probably related to how  much lower the new growth track is. My impression is that the slowly forming consensus among informed economists is that the step down for New Zealand may be about 5 percent of output (and a bit more of expenditure, as I shall explain shortly). That would represent a recession of at least four years – so that we cannot expect it to end before 2013. Admittedly  the government may generate a boom for election purposes, but it will be unsustainable and in the long run delay the sustainable upturn.

<>The accompanying graph gives a stylised representation of the underlying trend described in the previous paragraphs. There will be short fluctuations around the trend (including a downer in 2008) but it gives the basic idea that we are likely to have a period of stagnation for at least four years, and when we get back on the growth track it will be a lower one.

This (probably four-year recession) means higher unemployment and greater hardship for some people. Implicit in much public policy is how that hardship is going to be shared among the population. Think of it this way. If output is going to step down five percent then incomes will be five percent lower too. Expenditure will be even lower, because we were heavily borrowing before the Global Financial Crisis at a level that we now know was unsustainable.  (A moderating complication is that the expenditure wont be cut overnight. Rather we shall have to show expenditure restraint until 2013 and probably beyond.)

So the question is who will be cutting their expenditure by five and more percent? Too often we hope that it will be someone else. Thus the rich are demanding – and getting – tax cuts so someone else has to take a bigger reduction in their standard of living. That is what happened during the Rogernomics Recession when average incomes stagnated for seven years. The tax cuts ensured that incomes of the top ten percent continued to grow as if nothing had happened, so the rest of the communities’ after-tax incomes declined.

One solution is to argue for cuts in government spending. (The British government is talking of cutting most of its agency spending by 40 percent.)  Let’s dismiss those who claim that there will be quality improvements which will offset the spending reductions. (They said the same thing during the Rogernomics Recession.)  Let’s acknowledge there are some inefficiencies which we should address as best as we can. We are always doing that, and the one thing we have learned is that dealing with wasteful expenditure without affecting valued spending is really difficult. It is nicely summarised by the notion that the fat in government spending is like that in prime beef – stippled through – and you destroy the meat if you try to eliminate it.

The reality is that cutting government spending is going to impact harshly on the poor and those on middle incomes who will get insufficient offsetting tax cuts. The reality is that we are going to have to take a cut in our private spending and public spending and some will take more than others.

The balance between public and private spending involves political judgements (which we often try to obscure by pseudoscientific arguments). Each reader will have their own view on the degree of tax cuts and public spending cuts. However, whatever that is, I want to make a suggestion. If you can cut back on your spending, give some of the savings to charity –  perhaps the parish charity, or the local one, or even an international one – to try to share the hardship more evenly. Try to make it a permanent cutback and a permanent pledge. When there were brutal hardships generated in the early 1990s, people initially gave generously, but charity fatigue set in. This time think about giving generously for at least four years.

I reckon that is what the Good Samaritan would be doing, and what the man who told his story would be advising.