Tuesday, November 22, 2011

What is a Recession?

John Banks, sole-surviving Act party parliamentarian.

Andrew D Atkin:

Recessions are painful but they are the medicine - not the disease.

Let's say I bought myself a little restaurant. I employed, say, 20 people. But because I refused to put enormous amounts of sugar and dairy into my food my business failed, because New Zealander's generally don't like food that doesn't come with the diabetes and heart disease. I then go bankrupt, close my business, and lay off all my staff.

What next? The premises that my business was on are open for new lease, the equipment that I owned is up for sale, and relating to the job market my staff are up for sale too of course. However, there's a time-lag on the sale because the (ex) staff and (ex) landlord asked for too much money for their premises and labour. But naturally, they eventually drop their prices because some income is better than none. They drop their price to the point where entrepreneurs get excited about the opportunity to start a new business, using the [then] redundant premises and labour. The new business has a good (or appropriate) idea and they want to start it up at a good price, which is now being offered.

The new business does well because it sells McDonald's instead of Kebabs. The people are re-employed, the landlord gets some rent, and the customers get their service. So we have our recovery.**

So what happened exactly from a macro-economic outlook? What happened was basically a micro-scale recession and then correction. The original business was selling a product out of sinc with the demand and the possible asking price - that is, the asking price that can cover costs and achieve a tangible profit. The original business was effectively a "distortion" and likewise it naturally failed.

At the point that that business failed it was creating a recession. A recession is basically just the point where parts of an economy dissolve back into the resource base, and in turn this functions as a precursor that allows other more appropriate businesses to reabsorb the resources and take over.

A surplus of resources created by a recession drives new business development, as the glut lowers the price of base resources. So the recession facilitates the price signal for the following correction.

A 'real' recession is when the entire economy goes through a retraction as mass businesses fail or recede, for whatever reason.

Delaying the recession:

Now let's imagine another scenario. Rather than letting our micro-economy get rid of its "errors" and re-adjust to the corrected demand, I instead lobby the government to provide me with a subsidy to keep my kebab business alive. My staff and I all promise to vote for the National party if they rip off the tax payer so as to keep me afloat. The National party then plays ball and invents ambiguous economic or moralistic reasons to not let my business fail, along with lots of scaremongering.

And so the National party borrows more money to subsidise my business and in the name of "protecting jobs" and "driving the recovery" etc.

Good idea? No. In fact it's a very bad idea. First because the economic distortion just goes on, and as the economy is imbalanced it can only be supported with debt-financing. An imbalanced economy does not pay its own way. So instead of getting your correction you just drive the economy into debt - for supposedly economic (but really political) reasons.

Alas, sooner or later the debt used to fund my non-viable business will have to be paid back. When this finally happens the recession will be more painful than needed had been, because not only must your economy adjust to what it should have adjusted to in the beginning, it must also now adjust to paying off its debt - the pendulum swings the other way. This means maybe not a recession but a depression (which is just an extreme recession) with the final result being a much reduced living standard. And riots if you can't afford to pay people their dole.

-And for the record, this is exactly what has happened to the USA and many other countries around the world today. They are now fighting bankruptcy.

You cannot cure an economy of the need for a recession once you have an imbalance*. You can only delay it. Delaying a recession requires debt-financing and a callous disregard for the long-term social cost of fueling, rather than purging, the economy of its original distortion.

Our current situation in New Zealand:

The National government is borrowing $300m per-week to avoid a (needed) recession. That is serious money. Remember that with their debt-fuelling they are only delaying the recession (that is, the full intensity of it) and likewise making the problem worse. If the government carries on its merry way we might be a Greece in 3 years time, and the country officially bankrupt. We will then be in the hands of the IMF (like we nearly were in the 1980's until 'rogernomics' saved us from third-world status). The IMF is basically the global pawn shop. They will bail out NZ but with operational dictations and asset sales included.

This is what happens when politicians say "I don't want a recession during my tenure" and so delay it, and therefore worsen the problem with debt-fuelling for until the next political term.

It was originally the Labour government that created New Zealand's problem by facilitating a distortion in demand, by artificially inflating property prices. I explain this in detail here, but in short they induced people to borrow on the backs of their houses which created a 'rouge' debt-input into the economy. This in turn led to an "economic growth" which could only be as temporary as an individuals ability to live off their credit card. It was faulty economic growth because it was based on a distortion in demand leading to a structural distortion of the supply base. And the supply-response was not an increase in internal manufacturing or other real production (which is the Keynesian economists wishful-thinking ideal), but an increase in the importation of other people's goods (BAD!).

But then the current National government, rather than letting our economy go into a proper recession (and employing appropriate reforms) preserved the problem with chronic debt-fuelling from the governmental end of the game. New Zealand's [massive] public sector needs to retract.

We celebrated Labour for making us artificially rich because all the voter's could see at the time was the money. Fools gold! And now, just as foolish, we celebrate National for keeping us away from the recession of which would have been the necessary pay-back from Labour's mismanagement. But in time, when we really have to pay the piper, we will probably be despising both of these governments. Some of us already do. The others don't get what a recession is and why we have to go through with it.
Where is public education when you need it?

So who should you vote for?

There is only one political party that seems to be prepared to seriously confront New Zealand's two great immediate problems (housing unaffordability and massive national debt) today - ACT. And no they didn't pay me to say that. It's just the way it is and this is why I endorse them. I don't agree with everything they want to do but they are the best political option in terms of critical policy today.

Our other major parties seem to be willing to bankrupt the country. They talk about the problem of debt but offer no realistic solution except the image of solution. Like suggesting we put out our house fire with a garden hose when really we need a fire truck.

And sadly the media has allowed our main parties to operate presidential-style soundbite debates and in the process the minor parties have been sidelined, so no one is there to truly hold our government to account. And also of course, the distractions have been helped with childish (and probably deliberately engineered) sideshows such as the 'tea cup' saga.


*Unless by chance you discover a way of achieving a major boost in productive capacity with your given resource base, or there is a major increase in international market prices for the goods that your economy sells. But that's hoping and gambling. You should always spend within your known means.


**I will include that once you have your basic recovery so that your resources are back in production, the developmental phase from there is that the tighter job market drives up the cost of labour (good!). In turn, businesses are forced to substitute labour with capital and operational improvements, which in turn increases productivity per-capita/hour worked, over time. This is how real economic development works.

However, it can be (and historically has been) undermined by saturating the New Zealand job market with too much immigrant labour too soon, which takes away the pressure on business to invest in capital and technique (ahead of labour) for a qualitive improvement in economic development.