The Cedar Lounge Revolution

From the IT editorial on Monday.

WHEN THE building boom reached its peak less than two years ago, one in six of the labour force worked in the construction industry. Since then, the numbers employed in the sector have fallen sharply and the Construction Industry Federation (CIF) has warned that a further 100,000 may lose their jobs unless a decline in public investment is quickly reversed.

The Government, in its emergency budget last April, again cut the public capital programme and this year capital spending is likely to be one fifth lower than in 2008. CIF director general, Tom Parlon, presenting his mid-year review, said that as house building and commercial property projects remain stalled, the Government’s infrastructure programme offers the construction industry its only hope.

Well, it’s true that the construction industry did rather too well, to be kind, out of the boom. But doing well hasn’t been an impediment to the current largesse of the state to say… the financial sector. And while it is also true that a functioning financial sector is necessary…what of this?

The Government aims to bring the public finances into greater balance over time. This requires major spending cuts – both current and capital. A sharp contraction in the construction sector is part of the necessary adjustment to achieving a healthier and more balanced economy in future. And financial constraints now impose difficult choices. For the Government this means, as a recent Economic and Social Research Institute working paper has suggested, that “public capital projects should be undertaken on the basis that they have a long-run return to the whole economy”. Any other basis is likely to prove wasteful of taxpayers’ money, and counterproductive.

But…

This year the economy is likely to shrink by 8 per cent, while from 2008 to 2010 the International Monetary Fund has forecast a cumulative decline of 13.5 per cent – the largest contraction among advanced economies. By year-end the budget deficit could reach 12 per cent of Gross Domestic Product. These figures clearly demonstrate the Government has very limited scope to help a sector struggling to adjust to a new and painful economic reality. In any downturn, governments find it much easier to cut capital spending, rather than current spending. Lower capital spending, affecting the provision of roads, schools and hospitals, results in a poorer public infrastructure – but the repercussions are delayed. On the other hand, lower current spending has an immediate and direct impact.

So, is the IT arguing for or against capital spending? Is the point about repercussions being delayed meant to indicate a positive or a negative. Ad likewise with ‘lower current spending’ having an ‘immediate and direct impact’…

After all, it’s hardly an original thought that the poor standard of many areas of our public infrastructure has in the past and currently, as for example those of us with even a passing familiarity with our primary and parts of our secondary, education sector is an embedded problem. Sure, we could put off expenditure on these areas… and no doubt for some ‘repercussions will be delayed’, although again only for those who have been blind to the continuing protests about that infrastructure during the ‘boom’ and how many areas haven’t even been addressed. But isn’t that precisely the sort of short term thinking that has plagued this state since its foundation?

And isn’t it fascinating the way the public discourse is shaped as regards certain areas of the private sector, for that, after all is what the construction industry is and the financial sector too. Favoured and less favoured. And we pay for it either way.

Or is this another classic IT editorial which skillfully evades settling down in a specific ideological position while tilting a certain way?

Mind you, in view of the thoughts about the budget deficit reaching 12% of GDP interesting to read in the Observer this weekend an article by Will Hutton which, while admittedly dealing directly with the UK experience (and there are obvious divergences from that in our own case), engages with the thoughts of Japanese economist, Richard Koo of the Nomura Research Institute… whose…

…prognosis is alarming. The Americans, British and especially the mainland Europeans are far too complacent. We simply don’t understand what happens to firms and economies after a credit crunch.

And that…

We are anticipating green shoots and sustained recovery far too early. Indeed, unless western governments spend and borrow beyond anybody’s current imagining, the risk is that the west – and Britain with it – could still topple into a 1930s-style depression. David Cameron’s Tories insist Britain has to reduce its budget deficit fast – just like German fiscal conservatives – but they are basing their judgments on fair-weather times and fair-weather economics. What we are living through is so abnormal it requires abnormal responses.

Koo believes that the Japanese experience of crunch and aftermath provides us with a better template of how things will go.

Koo observed that Japanese firms in the 1990s and early 2000s had changed from profit maximisers to debt minimisers. Between 1970 and the early 1990s during the long yang (“sun” or “light”) upswing, they had steadily built up their debts to finance investment and growth; from the early 1990s on they used every spare yen to pay these off. Even as interest rates fell to zero and firms seemed to have profitable opportunities for growth, they would still pay off their debts rather than invest. Japan’s $15tn collapse in asset and share prices – equivalent to three years’ GDP – traumatised them, because it meant that their grossly devalued assets no longer matched their liabilities. To restore their balance sheets to health they had to reduce their debts. Demand from Japan’s corporate sector dropped by 20%.

But he also notes something that is intriguingly familiar…

Japan is criticised widely for allowing its national debt to rise to 180% of GDP after year after year of high budget deficits. Koo’s reply is that, given the scale of the shock, without government deficits Japan would have experienced a 1930s-style US depression. Indeed, in The Holy Grail of Macro Economics (2008), he explains the Great Depression as a result of US companies becoming debt minimisers in the wake of a property crash and banking collapse that was not compensated by sufficiently large increases in federal spending and borrowing. Koo’s “super Keynesianism” applies in the downward yin [downswing] phases of the cycle; he is much more orthodox on yang phases [upswing]. Don’t worry about debt-rating agencies marking down high-spending governments’ debts, he says; investors will buy public debt in yin phases – just as they will Britain’s or the US’s.

And here are other echoes…

Companies may be less indebted than Japan’s in the 1990s, but by British standards debt is high. Lending to companies fell in both April and May. Part of the problem is that loans are astonishingly expensive because of Britain’s monopolistic, risk-averse banks charging the highest margins and fees in the G7. The result is that companies are repaying debt and not investing. As in Japan, low interest rates are having little traction.

The pound’s huge devaluation and starting with low levels of public debt means that we are better placed than others. Yet, looking around the North Atlantic economy, it is clear that debt minimisation strategies are becoming commonplace. This is the story in the US and in Germany. Indeed, as Paul Krugman argued in my interview with him last month, Germany could become “Nipponised”, relying on exporting its problems to the rest of Europe.

And Hutton concludes…

Even if Koo is only partly right, the economic debate in Britain and beyond is out to lunch. The consensus is to assail Gordon Brown for dishonesty and political disingenuity for still arguing that the state can maintain spending and borrowing despite a budget deficit this year of £175bn; leader-writers across the political spectrum congratulate themselves for their economic literacy in damning him for not saying where and what he is going to cut. A more telling criticism is that he is not spelling out how serious the situation is – and has lost his nerve over the radicalism that will still be needed to get through.

Obviously Britain cannot run deficits of 12% of GDP indefinitely – but cutting them aggressively in a world of debt minimisers will prompt a depression. The correct policy is three-pronged. The government must spend and borrow radically until the downward phase stabilises – but in such a way that spending commitments can then be radically reduced in stabler times. New banks need to be created and old banks broken up to deliver more competition, more credit flows to business and less systemic risk.

It’s an interesting question, is it not, as to how long a state can run a 12 – 13% deficit? We don’t, I’d hazard, have the luxury of being able to sustain it as long as the UK (albeit Michael Taft believes it is sustainable to borrow €16bn per annum for at least two years above our current levels and still not be hitting the Eurozone average). But nor does it seem like we can avoid running deficits larger again than 13% for quite some time. Quite a conundrum.