From Notting Hill Editions
Tom Kremer, the founder of Notting Hill Editions, says active government intervention can have a benign, if limited, effect on an expanding economy, but rarely on a contracting one. During a recession, the government has no option but to spend less.
In medical circles, it is customary to diagnose the ills of a patient before commencing treatment. There are, of course, exceptions when an immediate response is mandatory. A heart attack, a raging fever, or breathing difficulties require radical intervention, even before their cause is fully investigated. The authorities in charge of the crisis are at great pains to depict the recession as just such an emergency, in need of instant government intervention to save the life of the economy. Blood transfusions, electric shocks, pumping liquidity into the ailing patient, are typical metaphors used to reinforce that perception.
Even in dire emergencies, a thorough medical analysis is crucial for administering the most effective course of treatment. Once the vital functions of the patient are secured, doctors usually proceed to establish the cause of the heart attack, the fever or breathing difficulties. You would expect those who claim to take charge of the crisis to do the same; you are bound to be disappointed.
Worldwide, the economic and financial establishment is driven by what to do, content to attribute the cause of the crisis to aberrant behaviour within the financial markets. Blaming bankers has huge advantages: as a convenient lightning rod for the rising anger of the population; as a diversion from delving into the underlying causes of the crisis; as a relatively easy target for systematic reform.
I deeply disagree with such a cavalier dismissal of the origins of the crisis. Greed is a constant factor in the human psyche, and financial excesses are part and parcel of every free market. Greed is an exaggerated form of ambition, just as paralysis is an extreme form of fear. The question remains, why is paralysis such a feature of the crisis and, more significantly, why was greed rampant in the period leading up to it?
The parliamentary select committee grilled the head of Barclays Bank as to how the entire financial world, composed of highly experienced and intelligent people, failed to realise that the sector was vastly over-borrowed, mired in indiscriminate deals and running habitually insane risks. His answer was revealing: such a monumental failure cannot be understood without taking account of the whole financial culture of the period. Money was plentiful, growth was accelerating, profits, at least on paper, materialised out of nowhere and general optimism rode sky high. He may have added, with equal justification, that such a culture also applied to the whole economy.
As you must be aware, no smoothly functioning, well-balanced, sound economy can be brought to its knees by the speculative excesses of bankers, no matter how influential. They certainly had a disproportionate impact, and their collective failure undoubtedly triggered the collapse. But triggering is not the same as causing. They could not have operated as they did if economies across the world had been sound. The key to understanding the underlying cause of the crisis lies in the culture of expectations.
The culture of expectations is all-pervasive in our society. As a household, as a business, as a nation, as a race, we all generally tend to expect to be better off tomorrow than we are today. This wasn't the case in the Middle Ages and may not be so from here onwards but it has been for centuries a sign of the times. Expectations are an integral part of the human psyche; they are the spur to the evolution of mankind. We strive to achieve goals set by ourselves and most of the goals have a material component. The umbrella term for this drive is the improving of living standards. And overall, in terms of relative creature comforts, possessions and relief of suffering, over the last two millennia, we have not done too badly.
There is, however, one critical condition for expectations to be beneficial. They have to be within reach. If they stray too far from a reasonable likelihood of fulfilment, the outcome is bound to be painful. In psychological terms, an individual in the grip of endemically disappointed expectations makes for a miserable specimen. In economic terms, an unmanageable gap between excessive expectations and reality inevitably leads to the kind of crisis that is engulfing us now.
That such a gap is at the very root of our current crisis is not yet common knowledge. But the evidence of its existence is incontrovertible. The demands of our society, in terms of health, welfare, education, social justice, legal protection, leisure and lifestyle, have been permanently on the rise. Net revenues to meet these demands have increasingly failed to keep pace. Pre-crisis property prices made no economic sense and stock markets virtually the world over were moving only one way. The overall world debt, personal, corporate, and national, bore no relation to the underpinning assets. Neither could they be totally repaid or serviced in a conventional manner. In our hearts, we all knew we lived beyond our means. Common sense told us that this would end in tears. The writing was on the wall but the people running our countries and operating our economies, with a few notable exceptions, chose not to see it.
In hindsight, all this is obvious. But a question still remains: why did the people at the top close their eyes and refuse to even envisage the probability, or at least the possibility, of a crisis scenario? After all, in the micro-world of households and businesses, we constantly make reasonable assessments of the status quo, even if we do not always act rationally in response.
An average family knows quite well what its income is, and possibly likely to be, what its debts are and how to curtail its expense. Similarly, all companies have annual balance sheets reviewed by independent auditors to make management fully aware of debt in relation to assets. Individuals and companies do still go bankrupt, but not in blissful ignorance of the health of their finances.
What distinguishes economic awareness in household and business from the corresponding national perception is transparency, or the lack of it. When it comes to clearly seeing net income versus net spending, household and business have it; the national economy has it not.
Some experts in the field will tell you that governments do publish annual, even quarterly, balance sheets, showing clearly their assets and liabilities. This is, of course true, but such an objection misses the point. The government balance sheet is not the same as the balance sheet of the national economy. The government collects VAT, whether the transaction involved is profitable or not. Individuals in the public sector, a significant share of the population, pay income tax from salaries and wages provided directly or indirectly by the government itself.
Households pay property taxes irrespective of their income and business provides massive sums in national insurance even if they make no profit. Balancing the books is a rare government pastime, but theoretically, government budgets could be in surplus while the national economy is in a parlous state. Not enough money is made to sustain the life style demands of its population.
This is not an academic speculation if you care to remember the economies of the Soviet states. In a mixed economy, a top-heavy public sector must result in either substantial budget deficits or the erosion of the asset base of the country. Very likely a toxic mix of both. I am afraid that the panic measures currently being taken lead down this very road.
The government is assiduously measuring the country's Gross Domestic Product. This roughly corresponds to total household spending, turnover of every private sector entity, as well as government expenditure. Judging by GDP, two households could engage in equal spending, with one financially healthy and the other struggling to make ends meet. Similarly, two companies could have the same turnover, one building its capital base whilst the other is accumulating liabilities. GDP is a measure of volume, rather than of quality.
Nobody in his right mind would assess anything in the whole wide world by this single dimension. Difficult as it may be for you to believe, governments have made this GDP a religion and worship on the altar of its growth. What every discussion is about, what every governmental action is focused on, is the reversing of GDP decline. Reducing interest rates to near zero, implementing tax cuts, quarantining toxic debt, buying corporate bonds, cultivating huge budget deficits, subsidising failing enterprises, multiplying infrastructure projects and, if all else fails, engaging in quantitative easing (printing money), have all but one purpose: to grow GDP. By this parameter alone, everything is now judged.
In contrast to the prevailing view, I believe that the banking failure, the credit crunch and shrinking GDP are not the causes of crisis; they are the symptoms of a much deeper malaise - the yawning gap between expectation and reality. And we are all aware of the perils of treating symptoms instead of the disease. Such treatment will not only fail to cure; it is likely to make matters worse.
This is precisely what is happening all around us. The government has pledged to restore confidence, thereby raising expectation and, in other words, increasing the fatal gap. To this end it has undertaken to expand its own expenditure, to borrow and print quantities of money, to encourage the banks to lend and the people to spend. You may find it weird to be forced to swallow a medicine that caused the disease in the first place but there it is. Strange pronouncements fill the airwaves - such as we must borrow our way out of the recession and we must borrow from ourselves - with few people batting an incredulous eyelid.
This scenario calls to mind the famous Rasputin principle. A charismatic peasant and a man of the cloth, he bestrode the firmament of pre-revolutionary St Petersburg. A most influential figure at court and intimate friend of the Czar and Czarina, he exercised considerable influence over Russian government and military affairs during WWI. His message, addressed particularly to adoring female members of the high society, was that in order to gain redemption one had to sin first. The greater the sin, the more profound the redemption. And he practised what he preached. The orgies he conducted in the bathhouses of the city proved very popular, with the ladies loving the sin as much as the true forgiveness that followed.
So we are asked to indulge ourselves now with the reward of a redeemed economy later. There may be something to be said for the Rasputin principle, so long as we remember that he came to a sticky end. He was successful for a while and governments now are doing everything to gain popularity, at least to see them out until the next round of elections. Redemption is in the distant future, to be secured through someone else.
But enough of bad medicines; are there any good ones? If you want to tackle the illness itself, you will have to try and reduce the fatal gap between expectations and assets. This can only be done by cutting back expectations or enlarging the asset-related sectors of the economy. Almost certainly, you will need to do both.
Perhaps the first step in this direction should be the construction of a device capable of measuring the width of the gap. Such an analytical tool would be helpful not only in the midst of a crisis but in the normal course of economic cycles as the gap shrinks and expands periodically. Taking account of it may even help moderate the heights of inflation and the depths of depression. The challenge is to distinguish between asset-producing and asset-using activities within the national economy. This distinction is easily made on a household or business scale and should not be impossible to define for the substantially more complex economy of a nation. After all, the same fundamental principles must apply, irrespective of the size or complexity of any economy.
As a necessary first step in reaching a better understanding of the state of the economy, I put forward the concept of the Net Domestic Product. In contrast to GDP, which is a measure of quantity, NDP is a yardstick of quality. In outline, export revenues, inward investments, and home-produced industrial and consumer goods, virtually uncontaminated by expectation, form the backbone of the NDP.
Excluded from NDP are activities that do not contribute to the asset base of the economy. By far the greater portion of the public sector falls within this category. Health, education, the administration of justice and the enforcement of law, defence, consumer protection and the civil service, are all key ingredients provided by the state of any civilised society. We cannot do without them. But they are an expense, not an investment. I say that because hospitals, for example, or submarines, are often loosely considered assets. There is nothing wrong with considering them assets, as long as they form no part of the NDP.
Education, on the other hand, is an expense that could be classified as investment since it creates a human resource, essential for the functioning of the economy. At the same time, it is an asset immersed in expectation. It takes maybe 10 years to produce blue collar workers and some of them will never be gainfully employed. It takes 16 years to produce media studies graduates who are unlikely to justify the investment during their working lifetime. Engineers, scientists and surgeons are better economic bets as are premature school leavers destined to become successful entrepreneurs. If expenditure on education is deemed an investment, it ought to feature in the NDP figures but not necessarily in full. Unlike material products, it has such a preponderant element of expectation that its value should not exceed 50% of the total.
The service sector relates primarily to safeguarding and maintaining existing assets and as such it does not naturally fall within the NDP. Yet inasmuch as it serves the commercial and industrial sector it does form part of the productive, revenue-generating economic activity. So perhaps 50% of the total should count. These are fairly arbitrary percentages that a more detailed statistical analysis could well modify. Even so, taken together with the more established categorisation of economic activity, the NDP would be a far better indicator of the true state of the economy than the universally accepted, and dangerously misleading, GDP. I am sure that my suggestion will be heavily criticised, and perhaps dismissed, as based on a distinction too crude and arbitrary to apply to 21st century economies. There is no doubt that it has to be developed, clarified and refined but something very much like it is absolutely necessary.
Replacing GDP with NDP, as a key measure of economic activity, would be of great practical benefit. The limits of what the government could afford to spend on improving our lot at any time would be more transparent and credible. The same principle applies to increasing money supply. For, in the absence of the gold standard, the total currency in circulation has to mirror the total value of the economy underpinning it. And this value has nothing to do with pure expenditure; it has everything to do with the generation of assets. So, beyond having a sobering effect on the volume of government expenditure, seeing the NDP as a ratio of the GDP should help re-prioritise the targets of monetary government intervention.
It follows that the only effective intervention in the present crisis is to support the NDP sector instead of propping up, indiscriminately, the whole economy. The political establishment is rife with initiatives: creating jobs, cutting taxes, expanding the public sector, borrowing more money, attacking tax havens, tightening financial regulations. They all resonate in the media, they all sound popular, but as medicine they are not only useless; they are positively harmful. As long as the government is obsessed with growing the GDP, all it is doing is enlarging the fatal gap between expectation and reality, the root cause of all our troubles.
Digesting the comparative figures of NDP and GDP would concentrate the mind on the cost/benefit aspect of new legislation. One of the characteristics of the post-World War II era has been society's wilful disregard of the economic consequences of the ever expanding stream of regulations coming from all quarters. The workings of the European Union have been, of course, a major contributor. Sadly, national bodies did not lag far behind. The sequence of events leading to so-called reforms has a familiar pattern.
Beyond targeting the NDP sector, the other beneficial treatment to reduce the gap comes at no expense whatever. It requires simply lowering our expectations. This has already happened throughout stock markets, to some extent in the property world and is in progress on the high street.
Where any signs of it are notably absent is in the level of wages, salaries and pensions in the public sector. Car workers have accepted part-time work and loss of earnings; state employees are merely discussing rates of increase despite virtually flat inflation. This will further deteriorate the NDP/GDP ratios. Instead of talking about tough times and early signs of green shoots appearing, our political leaders could tell people that their standard of living, on all fronts and for the foreseeable future, is bound to take a beating. This would really help individuals and society adjust to the world as is, and likely to be for the foreseeable future. Quite a refreshing political thought.
Periodic economic downturns are inevitable. The economy is not a self-regulating machine with fine automatic adjustments. The speed and direction of its movement is not uniform. It is bound to exceed the desirable speed limit and, in consequence, is subject to periods of frenetic braking.
But recessions are not all they are cracked up to be. We are fed on a diet of miseries with unemployment, struggling households, failing businesses and government panic. All this does reflect reality and is really sad but it is only one side of the coin. Recessions also have their merit. Household retrenchment changes patterns of behaviour. Luxuries are no longer necessities, humble things closer to home become more appreciated, priorities are likely to be better balanced, and people become more careful and may acquire new skills. Collapsing businesses are the most fragile entities, with problems of cash flow and profitability. Many of them may be duplicating enterprises without sufficient differentiation. Do we really need so many makers of cars, so many shopping outlets, so much travel to similar leisure destinations, so vast an array of choice?
Recessions, with all the pain in their wake, do clear the ground for stronger enterprises to survive and become stronger. They force essential savings long overdue. They encourage the exploration of more difficult, and perhaps eventually more rewarding, avenues, uncovering hidden talents and promoting innovation. Recession makes us value what we have and what we manage to retain. So in the midst of this crisis, let us welcome recession, the neglected guest whose time has come. Handled with respect, it may even do us some good. Let us not seek green shoots in the winter, but appreciate the winter for what it's worth.