June 28, 2010

Tackle the debt, reduce regulatory uncertainty to tackle economic woes

Filed under: Economics, Europe, Government, History — Tags: , , , , — Nicholas @ 08:59

In a difficult business environment, companies take precautions to avoid getting deeper into debt or engaging in risky new projects. Companies and individuals do this because the penalty for getting too deeply into debt is bankruptcy: at best, you survive financially but in much reduced circumstances. Governments, despite evidence to the contrary, seem to think they’re immune to this problem and pile on additional debt even when there’s no reasonable short-term hope of getting out of debt. They should learn from Margaret Thatcher’s approach:

A group of 346 noted economists had just written a scathing open letter to Prime Minister Margaret Thatcher, predicting that her tough fiscal policies would “deepen the depression, erode the industrial base, and threaten social stability.” Thatcher wanted to make absolutely certain her unpopular attack on huge deficits and rampant spending, in the face of high unemployment and a weak economy, was the right one.

So Thatcher summoned Meltzer, along with a group of trusted advisors, to explain why the experts were wrong. Even leaders of her own party advised Thatcher to make what they called a ‘U-Turn,’ and enact a big spending program to pull Britain out of recession. “Our job was to explain why lower deficits and spending discipline were the key to recovery,” recalls Meltzer.

Thatcher was regally unamused by arcane jargon. “Being right on the economics wasn’t enough,” intones Meltzer. “She made it clear that our job was to explain it so she could understand it. If we didn’t, she made it clear we were wasting her time. She’d say, ‘You’re not telling me what I need to know.'”

Thatcher stuck with draconian policies, invoking the battle chant “The Lady’s Not for Turning.” She launched Britain on years of balanced budgets, modest spending increases, falling joblessness, and extraordinary economic growth.

The classic Keynesian theory called for governments to run deficits during tough economic times in order to “prime the pump”: using government money to make up for the lack of private spending in the economy for a short period of time, until the private sector recovered. Governments worldwide grabbed on to this theory, but dispensed with the balancing notion that as soon as the economy recovered, the government had to pay off that debt to return to a balanced budget (or even go into surplus).

Politicians, as a class, love spending money. The more money, the better. They also have remarkably short timelines: the life of this parliament, the next election, pension eligibility date1. Anything that happens beyond that short window of time isn’t important. Spending money the government doesn’t have now is a good thing, to a sitting politician. Paying off the debt later can be left to some mythical future politician.

The other problem that individuals and companies have, but governments don’t, is uncertainty due to regulatory change. Governments don’t have that worry because they’re the ones making the rules (and ignoring them when it’s politically convenient). If you want to depress investment in a given area of your economy, a swift way of doing so is to start faffing with the rules governing that sector. Until you stop changing rules, no company in that sector is going to spend any more than they absolutely have to spend, because you’re creating regulatory uncertainty beyond normal operating levels.

Multiply this by the number of separate government branches involved in making (overlapping, and sometimes conflicting) rules and you can get most major companies to stop expansion, reduce sales, slow or even cease hiring staff until the regulatory environment settles out and the “real” new operating conditions become clear.

[1] Interestingly enough, today happens to be the day that 75 members of parliament qualify for their lifetime gold-plated pensions. I didn’t realize that when I posted this item. Thanks for the heads-up, Kevin Gaudet.

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