Friday, 15 February 2013

Lessons to be learnt?

Will things be different the next time around?
Booms and busts are an inevitable but undesirable element of a capitalist economy.  The current slump in the global economy is a harsh reminder of what can happen after the good times end.  Recessions following financial crises are particularly severe as a loss in confidence in the banking system leads to the wheels of finance seizing up.  The current stagnation in the global economy and the resulting economic suffering would suggest the potential for the collective will to push to apply the lessons that have been learnt in the aftermath of the financial crisis.  However, what is plausible in theory may prove difficult to implement in practice when the economy is growing again and the recession seems far off.   
Favourable circumstances enable a quicker pace of economic growth and help to spur on investment in a range of new technological and business fields.  Yet amongst this, inefficient and nonviable companies will also prosper and increased competition for resources will push up prices for labour and materials which acts as a brake on growth.  The slowdown as part of the business cycle is necessary as it helps to weed out the weaker companies and free up resources for the stronger businesses. 
There seems to be links between the boom time and the recessions that follow – the excesses which are generated amid rapid economic expansions have to be purged before the economy can begin to grow again.  The length and pace of the economic growth can be interrelated to the scale of the problems that are created during the good times and these have to be dealt with before growth can resume.  Excessive lending both fuelled the surge in growth and also has hampered the economic recovery with both households and government weighed down by too much debt.  More restrained growth could in theory result in more temperate slowdowns.

Therefore, it would be preferable for the governments and central banks (who control fiscal and monetary policy) to be more aggressive in moderating periods of expansion so as to limit the extent to which problems can build up.  Your Neighbourhood Economist would argue that the Eurozone crisis, high unemployment, and weak growth is too much of a price to pay for the previous lending binge and that governments and central banks need to be more alert to excesses which amass during rapid economic growth.  An assortment of measures such as higher interest rates, lower government spending, and specific policies to lower borrowing need to be considered as the economy approaches the top of the business cycle.
Yet, politicians would loathe being the ones to turn off the party music and put an end to the economic good times by popping the balloons.  Voters could instead be easily persuaded to vote for a party who would permit a higher level of growth.  There is also the possibility of hubris – it was Gordon Brown, the chancellor of the government in the UK, who infamously claimed that his government had put an end to boom and bust.  Even the conservative types in central banks want to court controversy by limiting economic expansions.  Even Alan Greenspan who was revered during his stint as the head of the Federal Reserve in the United States believed that it was not the role of the central bank to pop a bubble but only to deal with the consequences afterwards.
The argument for moderating growth over the business cycle is easy to make when the economy is in the doldrums but the timing and policies required will be more difficult to judge and find support for when the economy is roaring.  This problem is made even trickier by what seems to be a form of collective amnesia that takes hold during the good times.  Rather than remembering back to the previous boom and bust, even the most brilliant of minds tend to get caught up in the euphoria.  There is also typically a story to back up why this time is different –whether it be the potential of the internet during the surge in popularity in tech stocks or the steady hand of central banks and new financial wizardry in the lead up to the current bust.  

So it remains to be seen whether the leaders across the globe will apply the lessons from the past five years and whether voters will enable them to do so.  History suggests not.  But perhaps an even more depressing thought is that, even if there is sufficient commitment to apply the lessons, high levels of debt in developed countries and better prospects for investment elsewhere may mean that a level of growth where the policies above are required may not be reached for a long time (if ever). 

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