Economic Crisis Part II – What Should We Do?

This is the second of three posts that takes a look at the current global economic crisis:

Part I – looks at historical crises and the solutions employed and the trends that led to the current crisis;
Part II – this post looks at the solutions for the current crisis;
Part III – looks at the bailing out of big business and whether we’re going at this the right way.

As the Conservatives craft their budget – possibly the most crucial political document to be issued by a Canadian government since the Free Trade Agreement – I have to ask, objectively, what should be in it? As governments around the world talk of, and provide, stimulus packages of staggering proportions; and Harper has been brought to his knees under the coalition’s demands for stimulus, the discussion around the effectiveness and application of government stimulus has been more political rather practical.

I have indicated my preference in the past for active government in two separate blog posts: Liberal vs. Conservative Economic Ideologies (I would also like to point to the comments section where I am engaged in a conversation about the role of government) and Liberal vs. Conservative Economic Ideologies – Liberalism Still Winning. My arguments in these posts are that when governments are engaged on an ongoing basis in ensuring a distribution of capital to assist the disadvantaged, regulation of markets and the responsible balance between revenue and expenditures then a nation experiences a better standard of living. However, when this isn’t done and there is severe economic turbulence, then what can government do to help? I’ll take this moment to make my obligatory qualification that I am not an economist and I invite any and all feedback on my observations and suggestions.

Government impact on the economy works through two avenues: fiscal and monetary policy. Fiscal policy is the employment of taxes and spending. Monetary policy is the control of the money supply and the price of money through interest rates. The interesting thing history teaches us is that massive government spending – fiscal policy - hasn’t worked all too well in the past, but that may be too general a statement as spending has been utilized in different ways. Central banks have employed a monetarist approach by slashing interest rates practically to zero in recent weeks and are running out of room. Despite these moves credit has not loosened up and individual spending continues to decline. As this option dries up it really only leaves, for governments, the fiscal approach of either cutting taxes or increasing spending – or both.

I have argued strenuously in my past posts on economics that tax cuts are an ineffective means of economic stimulus. Tax relief should be reserved for when there is strong growth and increasing wealth. Since people hoard tax cuts when they fear for their jobs and their retirement savings are plummeting, tax cuts do not inject spending into the economy. Cutting corporate taxes is entirely a question of competitiveness. Conservative approaches in this area have created a race to the bottom where countries (and states and provinces) continue to slash corporate taxes in order to maintain competitiveness. But in a global crisis I don’t see much headway being made by increasing companies’ competitiveness in one country through reduced taxes. The problem isn’t that money is being spent elsewhere; it’s that it’s not being spent at all.

Just like the 1930s, 1970s and 1990s we’re experiencing a crisis in a changed world economy and the problems are much the same: too much debt, a lack of confidence leading to reduced spending and growing problems with unemployment and a loss of wealth. The US response, and now that of more and more other governments, is to aggregate private debt into public debt in order to grow individual confidence and increase spending and credit. While this and the reduced interest rates will help I’m not sure it’s going to lead to growth – and I’m not sure that’s such a bad thing.

Much of the wealth that has been lost was made by either borrowing money that couldn’t be paid back, lending money that couldn’t afford to be lost or by trading in service industries that were growing through the benefits of the first two. If the US does the right thing and restricts the practices that led to the first two, they can’t spur growth through the third fallen pillar of wealth creation. It’s also too late for the US to retreat into a production economy – despite Obama’s musings about renegotiating trade policies. Japan tried stimulus through massive infrastructure projects and while it didn’t hurt, it didn’t help either. Certainly this is an avenue that must be explored but only because Canada and the US have underinvested in infrastructure for too long and can benefit from this spending in more than just economic terms. The caution here is that this spending should not be pursued as the be-all and end-all.

Ultimately the US is going to have to restructure their economy. They need to strengthen their manufacturing base in areas where they are still dominant (to be honest, I’m not sure what these are but I assume there are a few outside of the military). Their service economy is going to be their lifeblood but at best will only hang on for the next while until wealth creation begins again. For the US, wealth creation will only begin in earnest when the rest of the world exhales and starts spreading their money around. We are going to see the first truly modern international economy with no dominant player. Everyone’s success will depend on the livelihood of others so expect more and more free trade agreements. The US will have to eventually raise taxes and start paying down their debt which will only improve the cash flow of other nations, especially China.

Mostly the US and others are going to have to weather the storm by helping those hurt by this downturn. Yes, the New Deal approach though with a few caveats. Excessive spending on social programs comes with the inherent risk of developing dependence on them which in turns makes them permanent and an ongoing albatross on our budgets. Also, the political pressure to save everyone hurt in this situation is strong, so there’s also motivation to overdo it (I’m talking to you, Jack Layton). What are needed are temporary but broad relief programs to help people who don’t normally qualify for employment insurance, grants or other means of distribution. The distributions must also be tied to essentials so they’re spent and not saved.

There is no quick fix to this crisis. Changes are needed to our fundamental approaches to finance both privately and publicly. Regaining confidence will be slow and gradual but most importantly, the means of wealth creation must be watched to see if its based on sound principles of value for work, services and products and not on pyramid schemes of false debt and inflated markets. We need to focus less on growth and more on sustenance.