The path out of recession: knowns and unknownsJul 28, 2020
Recovery from the recession will be slow and painful because of uncertainties: the coronavirus is just one of them.
“The economic and fiscal outlook remains highly uncertain” said Treasurer Frydenberg when releasing the Government’s economic and fiscal update last week.
It’s not clear that the government’s ministers, or those who advise them, appreciate the dimensions of uncertainty that are stifling economic recovery. Even if a vaccine were released and distributed tomorrow, the economy would not come roaring back.
For a start, whatever the cause, recessions result in business closures, personal bankruptcies and permanent job losses. Over-indebted businesses go to the wall, Virgin Airlines providing the starkest example so far. Over-indebted individuals face bankruptcy, homelessness or years of personal austerity, a situation worsened by forty years of policies that have encouraged people to borrow to speculate in real estate. And when companies put off labour, it is usually the least productive who lose their jobs. When those companies recover they do not re-fill those positions.
Because these impediments to recovery are common to all recessions, they do not count as “uncertainties”: they are really part of the normal business cycle. But in this recession there are at least three uncertainties, not normally present in business cycles, that will keep consumers reluctant to spend and companies reluctant to invest.
Uncertainty 1: the coronavirus
To adopt Rumsfeldian terminology, the future path of the pandemic is a “known unknown”. There is progress toward a vaccine, but we don’t know what large-scale clinical trials will reveal about the strength and endurance of immunity, how long trials will take and how long it would take to manufacture and distribute a vaccine to a majority of the world’s eight billion people.
Also it will be some time before we see the economic damage the virus has wrought on those economies where, either because of poor government or a desire to prioritise “the economy” over “health” (a weird prioritisation), the virus has spread out of control). The USA, Brazil and the UK are prime examples. Those countries achieved comparatively strong initial economic performance, but the medium-term and possibly long-term economic effects are likely to be costly, because the virus is still spreading in those countries. Any level of transmission within a country has a chilling effect on business.
Uncertainty 2: the world economic and political order
In three months’ time the USA will have a presidential election.
Trump’s treatment of the world economic order as a series of zero-sum win-lose conflicts, and his refusal to throw his country’s weight behind action on climate change, have done terrible damage to the world economy. Polling suggests that he will probably lose the election, but even if he does he would still hold office until mid-January.
A Democrat victory would see some maturity return to the White House, but the movement that elected Trump – and that has seen populists elected in other countries – won’t have gone away. And it’s not just the presidency at stake; a third of the senate is to be elected, and it would take a huge swing to give the Democrats a senate majority. Republicans holding a senate majority are likely to do everything in their power to disempower a Democrat president, regardless of the cost to the nation – just as the US senate did to Obama and as the Coalition has done to Labor governments here.
At the same time China is taking over from the United States as the world’s largest economy. This should not matter – it’s a re-establishment of a historical ranking, and surely the world is better off with a prosperous China than a poor China.
But it also involves a contest for shaping the world economic order, and a struggle for what diplomats know as “soft power”. One of the world’s two big nation-states is seeking to shape the world order to its own interests (as the US shaped the postwar Bretton Woods order) while the other is withdrawing from the world order. The other possible world economic bloc, the EU, is grappling to hold together under the weight of north-south fiscal tensions and a concerted UK-Russian attempt to weaken the Union.
Also, it now seems likely that even in the absence of a vaccine, those East Asian countries that have effectively eliminated coronavirus will enjoy a much faster economic recovery than European and American countries. Again, this is no bad thing, but it has particular implications for Australia, and judging by the direction of our government’s energies (negotiating a trade deal with the UK, and senior ministers making their first virus-time international trip to the USA), it appears that our government is hanging on to a world of declining relevance to our interests, while overlooking opportunities to shape an order in our long-term interests.
Uncertainty 3: low (and negative) interest rates
At least two years before the pandemic the world was grappling with the phenomenon of low and even negative interest rates. To put it in simple terms, the world has been sloshing with money and those who have it – large corporations and the rich – can’t think of anything useful to do with it. Firms are returning money to shareholders rather than investing, such is the prevailing mood of uncertainty. Textbooks and established wisdom suggest that low interest rates encourage investment, but this time the formula isn’t working.
The rich – including the moderately well-off – are either spending on frivolous consumption such as luxury cars or pushing funds into already over-heated asset markets – real estate and equities.
The media and government spokespeople talk about the strong performance of the stock market, and take assurance in the fact that there has been only a small fall in real estate prices (so far). What they fail to see is that it’s all inflation – asset-price inflation – and that it has nothing to do with real wealth. It’s a sign of economic illness, that illness being a lack of real investment opportunities.
In such a situation where rich people don’t know what to do with their money and where firms can’t see anything useful to do with their profits, there are opportunities, for governments to do what the private sector isn’t doing. One is to reform the tax system – to restore progressivity to tax and welfare systems. The temporary distributive measures introduced by the Commonwealth Government seem to be working to sustain demand, but the government seems to be gripped by a terror that if these higher payments are continued too long no-one will want to work for a living – such is their distorted view of human nature.
The other opportunity is public investment in ventures that can be funded through government borrowing. Not makework projects, but projects with enduring public value, and ventures which, because of market failure, cannot be done efficiently (or done at all) by the private sector.
Possible public-good investments include an electricity transmission grid to take advantage of renewable resources, urban and long-distance transport infrastructure, completion of a proper broadband network, infrastructure to deal with climate-change risk (particularly bushfires and rising sea levels), and restoration of degraded natural resources.
A clear priority should be public housing. Some may see public housing only in terms of distributive welfare, and it certainly has such benefits, but it also an investment – an investment in tangible assets and in stronger, more cohesive and resilient communities if done properly.
Our priorities should also include spending that may not look like “investment” on the books, but that is still designed to yield future benefits in return for present outlays, such as child care, education and research.
Then there is the need for industry policies, particularly policies relating to climate change – structural adjustment assistance for no-longer viable rural industries, and for manufacturing and other industries to cope with the need for de-carbonisation. The usual accusation would be about “picking winners”, but ever since Federation the Commonwealth has favoured particular industries – the finance sector and fossil fuel industries in recent decades.
These are all investments that would go some way to dealing with our economy’s structural weaknesses – weaknesses revealed in our poor productivity performance, but unacknowledged by the Coalition parties.
There are advantages in an investment-based fiscal approach over relying on transfers and tax cuts. One is that spending can be prioritised to areas where there are spare resources, and there is an assurance that the money will be spent, providing a real fiscal stimulus. Tax cuts for the rich, by contrast, do nothing if they simply go into paying down debt or speculating in assets. The other advantage of public investment is that it yields benefits for the future, helping redress inequities necessitated in dealing with the pandemic, which have seen the burden falling disproportionately on the young.
The longer-term problem, however, is the failure of corporations or individuals to respond to low interest rates. Something is wrong with the basic economic model.
The big uncertainty
Those three uncertainties are the “known unknowns”. But to conclude with the Rumsfeldian framework, there is a huge “unknown unknown” – the future of our economic systems. Marxists may claim that capitalism is on its last legs, and that the GFC and now the coronavirus has exposed its weaknesses. But for now no other economic system is presenting itself as a serious alternative.
It is becoming increasingly evident, however, that capitalism as we have come to know it is not working: it is failing in its basic tasks of ensuring future prosperity and conservation of scarce resources, while achieving a fair and acceptable distribution of work and rewards and people’s health and security.
It’s not clear that our politicians – Liberal, Labor, National, Green – or our highly-qualified economists working in treasury and finance departments, really understand the extent of the economic challenge we face.
This is a short version of a paper I have prepared for a U3A class, with help from John Kerin, The Australian economy after Covid-19.