The deficit hawks ruled the roost at this weekend's G20 meeting in Toronto. Governments agreed to cut their deficits in half by 2013. Is this move a good thing, or a bad thing? Markets reacted tepidly on Monday, as fears that austerity could trigger deflation countered positive sentiment that lowering deficit rates could prevent future inflation. Actually, that last statement is only my interpretation, but everyone who writes about market movements is free to express such opinions as received wisdom. Caveat lector (reader beware)!
Paul Krugman writes that this move could continue and even deepen Great Depression III. Readers of this blog got my perspective on why this economic disturbance is more than an ordinary recession --but a full blown depression-- months ago.
Depressions can be distinguished from recessions by severity, but perhaps also by underlying causes. A recession can be triggered by a change in one reasonably large part of the economy: a crisis in a major industry (automobiles in the 1970s, after the Oil Shock) or demobilization after a war (1919-20 or 1946-7). Depressions result from pervasive, long-term, so-called "secular" changes in technology, demographics, and world conditions. That's why depressions affect more people and last longer.
In the Great Depression of the 1930s, industrialization of agriculture meant that the forty acre family farm was well on the way from the dominant way of life in America to a nostalgic anachronism. The growth of cities had peaked; population started flooding into new suburbs as a new era of cheap energy enabled cheap transportation. National brands had emerged in consumer and industrial products from beer to typewriters. These are just a few of many trends that developed after the Long Depression of 1873-79 and reached full impact by 1929.
In part, the Great Depression was so severe because so many things had changed, yet many attitudes and institutions were still geared for an America of the Civil War: fueled by wood and wind, not coal and oil; agricultural, not industrial; a continental power, not a world power.
We face at least as many secular changes today. Here are just a few:
- Population growth is moving back to core cities, away from suburbs, and particularly from the farthest-out "exurbs." The hottest real estate developments of just three years ago are ghost towns.
- Energy, or at least oil, is becoming expensive, meaning that transportation is no longer cheap. Global brands and outsourcing make less sense when transportation costs more.
- Information technology, including telecommunications, have become cheap and ubiquitous. Cheap energy no longer drives economic development; cheap IT does.
- Hostility to immigration reduces access to willing and cheap labor. This affects both the lowest and highest skill levels.
- The military confrontation between superpowers is over, yet we maintain a defense establishment that tries to respond to the threats of 1948 and the threats of 2001 at the same time.
- As women approach pay parity with men in the work force, sectors that historically depended on a continuing supply of well-educated but poorly-paid women (K-12 education and health care) are in crisis to the point where the entire economy is impacted
There are many, many other such secular trends, but these should suffice to make the case that we face a combination of changes in underlying conditions not seen in almost a century.
Unlike an ordinary recession, we cannot spend our way out of this one. That is not to say that stimulus spending is wrong: most economists agree that without the stimulus bill, the economy would still be in a nose dive. The real problem is that spending alone will not get most of the unemployed back to work. Why? Because of the secular changes previously discussed, the old jobs disappeared for good. Spending on the same old same old just doesn't have anywhere to go.
We also can't save our way out, as it seems the deficit hawks would like. Cutting spending and/or raising taxes to balance budgets may have its own virtues, but either path reduces the capacity of the economy to invest. We forget that FDR took office just as deficit-averse as any of his predecessors. When signs of recovery showed in 1933, his reaction was to back off on spending. History records that the market took another nauseating drop. Not to be deterred, FDR actually tried to balance the budget in 1937. It seems that the G20 forgot how that worked out.
The only way we can get out of Great Depression III is to invest: specifically, to invest where the new growth will come. Some of the areas are obvious: urban rental housing, alternative sources of energy, health care IT, and broadband come to mind. These areas call for both private and public investment.
As a consequence of costlier transportation, local and regional businesses will become better investments than national or global enterprises for a great many fields. The "local food" trend among gastronomes presages a massive shift in agriculture. The nascent field of micro-manufacturing may entirely transform how and where our "stuff" gets made. Hint: it's not China.
"Information technology defeats economy of scale," intoned Chuck Exley, former CEO of NCR. A small Internet merchant has the same reach as Wal*Mart or Amazon. This humble blog has the potential to reach most of the billion people who read the English language.
Prosperity will look very different in the 21st Century. In the 19th Century, large firms employed tens or hundreds of people. The adjustment to 20th Century firms of thousands, even hundreds of thousands, was wrenching, but ultimately successful. Most successful 21st Century businesses will, I think, be small.
The investment world is currently poorly organized for a large number of small firms. The recent dominance of traders rather than bankers as heads of major financial institutions just exacerbates the problem. Currently, far too little capital is being directed the right way, and the private sector is equally guilty with the public sector.
I still have hope for the long run. Trillions of dollars of capital sit on the sidelines, waiting to be deployed in something that can grow faster than inflation. This capital represents the retirement hopes and dreams of the 250,000,000 or so people in the First World aged 45 to 65. It needs to get into the hands of people with ideas and ambition aged 25 to 45.
With the pressure of that much capital, eventually it will find its way to the right places. When we evaluate policy proposals, I suggest that the traditional values of Right and Left, Keynesian or deficit-hawk, provide poor guidance. The real question should be, "Does this policy accelerate or retard investment in growth?" How well we answer that question --as individuals, as companies, and as a society-- will determine how long we wallow in misery before we build a better future for ourselves and our posterity.