Thursday, June 2, 2011

No Going Back

How do we get back to the way things were in 2007? To a high employment, high investment, high spending economy? The short answer is: we won't. 2007/8 was the apex of a credit-fuelled boom - caused not by the euro (the Dutch somehow missed the bubble) but by our own excesses (generously fuelled by domestic and foreign financial crack dealers).

This struck me reading a post by Michael Taft on the TASC blog. Michael points out the collapse in domestic demand since the peak, and challenges those proposing that wage cuts to explain how this would help us get back to the peak. He's right of course, supply side measures are necessary but not sufficient to get Ireland back on a path towards sustainable growth. But there's more to it than that. I left a long-ish comment on his post - which I have reproduced below:
A few things strike me about the issues you raise Michael. One is that consumer spending in 2007/8 'overshot' what was sustainable/appropriate for the economy because of a credit bubble.

Too many businesses (especially in retail) were established or expanded on the basis of a mis-reading of the underlying reality. They geared up through borrowings for 'more of the same', but instead have gotten a lot less. But the debts are still there of course. As I remind people from time-to-time: debt is a fact, wealth is an opinion.

That said, consumer spending this year will be back to where it was in 2005/6 in nominal terms, maybe a little higher in real terms (due to deflation). Enough for many businesses to survive on, but not for all of them.

So yes, the problem is a collapse in demand from the peak - but the peak was the problem: the subsequent collapse was an inevitable (and very painful) consequence.

As for sustainable recovery, investment is part of the story to be sure. But only part. A return to full employment will come through the services sector which is more labour intensive than capital intensive (with some obvious exceptions).

Wage-led consumption will help in this process - but you can only have a wage if you have a job. Which is why I continue to be perplexed by the view that lowering entry level wages (which is mostly what we are talking about in the case of the minimum wage) is somehow a bad thing.

Getting people (and let's be clear - we're talking mostly young males) into the labour market is vital. Employers will only hire unskilled workers when they believe that the marginal cost of doing so is a risk worth taking given the potential additional staff provides to deliver better or more services.

The same goes for entrepreneurs: in the current climate their main set up cost will be staff wages. So lowering the cost of setting up a service business in Ireland will make it easier to set up business.

The issue isn't aggregate demand - it is marginal demand. No employer cares about GDP and other abstractions like aggregate demand: they care about cost of hiring the next employee and serving the next customer.

Economic recovery will be 'a game of inches' - we'll get their one job at a time, one customer at a time, one start up at a time. Alchemy has nothing to do with it. 
 As I've said before about the minimum wage - it victimises the unemployed, not the employed. And it creates a barrier to entry into labour-intensive industries that only benefits incumbent employers.  Restoring full employment - and the dignity and hope that will bring to hundreds of thousands of unemployed men and women - will only come about through an expansion of the services sector. Which will certainly require a return to consumer spending growth. The one can help bring about the other - there is a significant, negative correlation between the change in the unemployment rate and consumer confidence. And confidence is positively correlated with retail sales.

So reversing the rise of unemployment is vitally important to reversing the collapse in domestic demand - even if that entails reducing the hourly rate of unskilled, zero-experienced, would-be workers with no alternatives but unemployment or emigration.

2 comments:

  1. John Stuart Mill said way back, “Panics (financial crises) do not destroy capital; they merely reveal the extent to which it has been destroyed by its betrayal into hopelessly unproductive works.”

    In other words, what underlies this financial crisis is unproductive works - the making of 'works' we don't really need; making them badly (eg. in aesthetics, or pschological and social value for example); making them inefficiently; exploiting and profiteering from productive resources and activity; speculating on productive resources and activity... making trophy goods for elites, making throw away goods for the poor...

    To realign our productive activity to making (humanly) well a true wealth that nourishes the body, mind and soul of our people (and keeping in mind the symbiosis of production and consumption)... I really think that promoting a minimum wage mindset is taking the wrong road.

    There is more in economic equilibrium than purely monetary phenomena.

    Maybe someone can try to put this a bit more clearly and succinctly than I have done.

    ReplyDelete
  2. Great stuff, Gerard. I am really sorry that I missed this until now.

    Nail hit squarely on the head, IMHO.

    ReplyDelete

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