When Will We Ever Learn? Lessons From The Global Financial Crisis - Bryan Gould The Group of 20 (G20) meeting in Toronto in June 2010 was remarkable in only one respect. The familiar protests, the police in the streets, the hobnobbing of the leaders were all on show. But, what was extraordinary, if not unexpected, was the speed with which most of the world’s most powerful leaders headed back to familiar territory – not to say, political prejudices – and not only embraced again the very nostrums that had brought about the global financial crisis in the first place, but used the crisis as an excuse to press for a smaller State and a decimated public sector, even though that threatens a renewed dip into recession. This perverse reaction to the manifest failure of the model that had been so enthusiastically constructed over a 30 year period was a feature of not only the G20 meeting. It has characterised the responses of many individual governments around the world, and has certainly reared its head in New Zealand. Contrary to the expectations of many of us that the global financial crisis would be seen as a conclusive judgment on the failures of neo-liberal doctrine, it is the Right that seems to have emerged, for the time being at least, unscathed and emboldened by the failure of their policies. It is worth reminding ourselves of the precise lessons that the global financial crisis should, and briefly appeared to, have taught us. 1. Markets are not self-correcting.
2. Financial markets are especially
prone to excess. 3. Risk cannot be quantified
according to reliable mathematical formulae. 4. Decisions taken by business
leaders alone are a poor guide to a successful economy and society.
5. Increasing the wealth
of the rich so that inequality widens does not produce a better
economy or a stronger society. 6. Government matters. 7. The market cannot perform
effectively without government help. 8. If the market cannot be
challenged, the whole point of democracy is lost. None of these conclusions is revolutionary or even particularly radical. Each is evidence-based and arrived at through the merest common sense based on our own recent experience. This makes it all the more remarkable that these lessons are increasingly discounted by world leaders as they move into what we might all have hoped would be a post-crisis environment. New Zealand is not, of course, a member of the G20. We would be mistaken to think, however, that we had not been infected by, and contributed to, the emerging consensus as to the best response to make to the crisis. And, in our case, we can add the lessons from our own less than glittering performance to those that can be drawn from the global experience. Lessons From New Zealand’s Experience For New Zealand, the global financial crisis came on top of our own home-grown recession. By the time Lehman Brothers collapsed, we were completing our third quarter of decline in a recession that for us had begun at the end of 2007, and that was the latest episode in a tale of economic under-performance that had extended for 25 years or more. Paradoxically, our early experience of our own recession may have led us to understate the significance of the global recession. When it struck, around September 2008, we felt that we had already weathered much of the storm, particularly when our own, Australian-owned, banking system seemed relatively immune from the global collapse. The truth is, of course, that while we have been sheltered from the worst of the global recession by the buoyancy of our main markets in China and Australia, and the relative stability of our banking system, the deleterious consequences of the recession are still working their way through our economy and are proving very difficult to dislodge. The lessons from the crisis are just as applicable to us as they are elsewhere – and just as likely, it seems, to be ignored. Indeed, our enthusiasm to apply the free market agenda further and faster than anyone else has given us particular reason to pause and reflect. It is only our small size and inability to develop a large-scale financial sector that has protected us from the worst ravages of the global crisis. But, our commitment to neo-liberal policies has meant that, in addition to the lessons to be learnt from the global fallout, we have our own lessons to learn and apply, by virtue of the fact that we have committed a series of mistakes over a long period that are all of our own making. If we are to bring the recession to an end, instead of just bumping along on the bottom, and if we are to usher in an era of improved economic performance, it is essential in other words that we learn not only the more widely applicable lessons but also those that should hit us in the eye when we review our own recent experience. 1. Free trade is not always
the best option. We continue to be assured that free trade will best serve our interests. The argument is typically conducted by paying great attention to any increase in exports that could be attributed to free trade and ignoring other less convenient factors. The sharp increase in our exports to China, for example, is said to be a direct consequence of the free trade agreement; but the agreement has been in force for only a year, so most of the increase precedes and is not attributable to the agreement, is largely a function of the fact that China – almost uniquely – has continued to grow through the recession, and has occurred at the expense of an even greater increase in Chinese exports to New Zealand (and consequent loss of jobs and domestic manufacturing) over the same period. We might have expected that this dogged pursuit of free trade would have demonstrated its benefits to our exports and growth rate over the period. But, on the contrary, both have languished and are well behind comparable levels for other countries, and particularly for Australia. The experience of other countries also shows that free trade is not invariably the right option, but its appropriateness depends on the stage of development by comparison with trade partners and competitors. Developing countries, for example, have usually found some form of protection to be helpful until they build up their economic strength and both Japan and China have trodden that path. The Chinese are still sceptical of the benefits of free trade and it is no accident that they have so far chosen only New Zealand as a free trade partner. We, however, seem convinced that we can prosper in the face of direct competition from some of the most powerful and efficient economies in the world. We might do better to regard ourselves as a developing economy and to behave accordingly.
The consequences for our economy have been disastrous. A current account in perennial deficit (eased only temporarily by the slowdown in imports caused by the recession) has been further burdened by the repatriation of profits to foreign owners, adding to the interest payments we must make to that other group of foreign owners (the proverbial Japanese housewife and Belgian dentist) who help fill the hole in our accounts by buying short-term debt as a response to our very high interest rates. The repatriated profits represent not only a drain on our foreign accounts but a very real loss of national wealth that could otherwise be applied to raising living standards and public services in this country. That loss is not merely economic. We also suffer a very real diminution in our ability to control our own affairs. Increasingly, under foreign ownership, decisions over major parts of our economy are taken in Sydney or Los Angeles or Shanghai. New Zealand jobs and businesses depend on people in boardrooms where our interests are remote from their concerns.
The consequences of this extremely narrow view of policy are there for all to see. Even in its own terms, the policy has struggled to succeed. The control of inflation has proved increasingly difficult, and achieved only at considerable and growing cost to other objectives; even the Governor of the Reserve Bank has complained that interest rates alone are no longer an adequate instrument even for this narrowly defined task. The real failures become apparent, however, only when the focus is widened to include other desirable economic goals, such as sustainable growth rates, full employment, well directed investment, effective public services, a cohesive society and acceptable living standards. It is in these areas that we have failed, and have fallen markedly behind our trans-Tasman neighbours in particular. The average New Zealand family would need at least a 40% increase in real income to reach Australian standards. Little wonder that our economic performance is constantly undermined by the flight of skills and talents across the Tasman! What seems to be a simple mechanism for dealing with inflation has become, in other words, a major deterrent to a better economic performance. The high interest rates apparently needed to control inflation make investment more expensive, favour wealth owners rather than wealth creators, stimulate a rise in the exchange rate that handicaps our own production in markets both at home and overseas, inhibits our investment, distorts our balance of trade, and then – to complete the vicious circle – requires a further round of high interest rates to attract the short-term “hot” money that is needed to fill the hole in our balance our payments. These problems will not be overcome without an “agonising reappraisal” of the policy we have doggedly pursued without success for 25 years. The global financial crisis might have been thought to offer just the opportunity we need for such a reappraisal; the evidence is though that we are intent on both overcoming the recession and correcting our own individual past failures by returning stubbornly to the policies that have consistently failed us. Turning Our Backs On The Lessons However clear the lessons – both from the global recession and from our own longer established New Zealand disappointments – our leaders both overseas and at home seem determined to ignore them at the first opportunity. It is already clear that the majority of the world’s governments are keen to return to business as usual, and to reproduce the errors that produced and compounded the crisis in the first place. What are those errors? 1. The first priority is to
deal with the deficit. It is hard to detect any rationality in this view. The best way of getting a government deficit down is to restore the level of tax revenue. A buoyant economy will generate a buoyant level of revenue. An economy that is flat on its back for the second time, on the other hand, will ensure that the deficit is persistent and deeply entrenched. You don’t get your deficit down by throwing people out of work. But, say the “deficit hawks”, the deficit needs to be funded, and the money markets will lend for that purpose only if they see strenuous efforts to get the deficit down. But this is to allow prejudice – a visceral dislike of public spending per se – to displace rationality. As prominent US economist Paul Krugman points out, our policymakers run scared of the “bond vigilantes” on the one hand and seem on the other, to have a naïve believe that the “confidence fairy” will somehow convert policies that are intended to produce retrenchment into a recipe for recovery. And, since it was only a year ago that the financial sector was totally dependent on public finance for its very survival, how is it that their fantasies are again so soon able to dictate terms to the rest of us? These fallacies certainly seem increasingly to dictate policy in Europe and Britain and are alive and well in New Zealand. Our own Government has been lucky in that living with the recession has been easier than it might have been, because our export markets have held up surprisingly well – not least because the Australians pursued a braver and more stimulatory course than we did. But it is becoming increasingly clear that the recession in New Zealand is proving stubbornly difficult to move; we continue to bump along the bottom with no real recovery in sight. The recession will be longer and more serious because we give priority to getting our (perfectly manageable) deficit down, rather than to ensuring that Government plays its full part in helping recovery. This is a triumph of ideology over common sense. And that brings us to the next error. 2. The deficit provides a
good reason for cutting back on the public sector in any case.
The result has been and will be in both countries a substantial loss of jobs in the public sector, and a dangerous drop in the level of public services, including support for the poorest, just at a time when they are most needed. And while public sector cuts may seem easy to make in the short term, the longer-term consequences can be severe – Cave Creek comes to mind (where 14 people died in a 1995 West Coast Department of Conservation viewing platform collapse. Subsequent inquiries established that under-funding was a major contributory cause to the systemic failures that led to that tragedy. Ed.). The rationale for these measures – that otherwise the public sector’s demand for resources will crowd out necessary investment in the private sector – is simply not credible at a time when the economy is operating so far below capacity. It is hardly helping the private sector to throw a substantial portion of their customers on the dole. The projection might of course become self-fulfilling if mistaken policies are maintained long enough to mean that capacity does fall as resources that are kept out of use simply lose their economic value and utility. 3. The banks must be protected
at all costs. Rather than sheet the responsibility and the burden home to where they belong, however, governments have spent billions on helping the banks to shore up their balance sheets, with the perhaps unintended result that the banks have continued to pay out massive bonuses to their employees. It is the taxpayer that must now pay the burden, not just in repaying borrowings made to deal with the crisis, but in suffering the cutbacks in public services and the loss of jobs that are the inevitable consequences of current policies. The G20 was not even able to compel the banks to accept, as had been foreshadowed, tighter rules about capital reserves and lending ratios. While President Obama has introduced tighter regulation of US banks, other governments have dragged the chain – and, while individual voices have been raised in support of measures like a Tobin tax* on financial transactions, no government has so far given them consideration. In view of this timidity in dealing with the banks, we cannot be surprised that no one apparently stopped to wonder why, if the taxpayers put up the money, they did not acquire the ownership interest – and, even more pointedly, why it did not occur to anyone that, if banking so obviously relies in the last resort on underpinning by the public purse, we should perhaps recognise that banking is in essence a public function. *Named after its proponent, the economist James Tobin. Ed. 4. Free trade is the only
answer. Little attention is paid, on the other hand, to the obvious downsides, which include threats to the organisation (through cooperative marketing) of some of our major exports, to our effective strategy (through Pharmac) in keeping down the cost of pharmaceutical imports, and to our (theoretical) ability to resist overseas purchases of our assets. These are remarkable blind spots for a country that seems in any case to have derived so little benefit to its economic performance from two and a half decades of free trade. 5. The sale of our assets
to overseas buyers is good for us and our economy. This laissez-faire approach has been seen most recently in the Chinese bid to buy a significant part of our dairy industry. That bid, whose effect would be to remove from New Zealand hands, and – in an almost physical sense – from New Zealand itself, a measurable part of our wealth-producing capacity, so that the wealth produced by that capacity went more or less permanently overseas and New Zealanders were left as relatively low paid wage slaves on what had been their own land, is currently being considered by the Overseas Investment Office as merely a matter, apparently, of the business reputation of the prospective buyers. There is no indication so far that any issue of principle is involved. 6. Private ownership and
the profit motive are the best guarantors of economic efficiency.
7. There is no alternative
to the macro-economic policies that have been pursued for 25 years. What Is To Be Done? It would be easy to subside into despair as we see
the greatest economic crisis of most lifetimes – a crisis
brought about by manifest and egregious errors of policy and understanding
– come and, hopefully, go without apparently disturbing the
simple certainties of a self-serving orthodoxy that should surely
have been discredited. If, at this precise moment, governments cannot
learn lessons and strike out in new and better directions, what
hope is there of a better future? There are of course never any
final battles in politics or economics. The balance of advantage
swings from one position to another in often belated response to
our understanding of real events. The consequences of the global
financial crisis will be real enough, and our understanding of those
consequences will evolve and grow for years to come. We must hope
that the lessons will not be driven home all over again by an almost
immediate relapse into a double dip recession, brought about by
the failure to recognise what went wrong in the first place and
what must be done to correct it. In the meantime, we must equip
ourselves with the knowledge and the arguments to carry the debate
to those who are reluctant to listen. We should ensure that the
lessons are so clear that they cannot be ignored. Non-Members:
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