As the rand collapses and global recession threatens South Africa, the Mail & Guardian has invited leading economic thinkers to explain what these recent, sudden changes in our economic environment mean and what we can do about them. Despite the writers’ diverse backgrounds, there is agreement that a major rethink of the government’s economic strategy is required
Charles Feinstein
What will happen to the world economy over the coming six to 12 months? There can be little doubt there will there be a period of slow growth following the tragedies on September 11 in the United States, and a few countries may even experience an actual reduction in real output. This was already likely before the destruction of the World Trade Centre, and the short-term economic consequences of the attack on the US will almost certainly be negative.
But some commentators are much more pessimistic than this. They envisage not just slow growth but a serious depression (with actual falls in output, incomes and employment) starting in several of the major developed nations and spreading to the rest of the world, including South Africa. Some even see parallels with the ”great Depression” that devastated the world economy in 1929/33. In my view, however, there are a number of powerful factors that make it extremely unlikely that there will be a major depression on anything even remotely approaching the scale of the interwar catastrophe.
The most important reason for confidence that there will not be a serious depression is the profound change in economic understanding and in the role that is played in the modern world by national governments, central banks and international agencies. On October 3 the Federal Reserve cut US interest rates by 0,5 percentage points. This was the ninth occasion on which it had lowered interest rates this year, and the key rate is now only 2,5%, the lowest in almost 40 years. The European Central Bank and the Bank of England have similarly been cutting interest rates and injecting liquidity into their economies by purchasing bonds from the banks. Lower interest rates encourage firms to borrow for investment and households to borrow for consumption; greater liquidity enables the banks and other financial institutions to supply the necessary funds. The experience of Japan shows that low rates are not sufficient to ensure expansion, but there are special circumstances in Japan, and we can expect the policy to be successful in the US and Europe.
The contrast with the policies followed in the 1930s could hardly be greater. In response to the deepening global crisis, Alan Greenspan’s predecessors at the Federal Reserve raised US interest rates by two full percentage points at the beginning of October 1931. In addition, the Fed steadfastly refused to provide relief for the stricken domestic banks by purchasing government securities from them, and it sustained this perverse stance until the middle of the following year. A further demonstration of their view that the correct response to a depression was to increase interest rates was provided in early 1933, when the US suffered a third and even more serious wave of bank panics and failures. Once again the Fed reacted by driving up interest rates by a percentage point, and once again it declined to help the banks by open-market operations.
In the United Kingdom high interest rates were also the initial response to the crisis. It was not until the ”golden fetters” were broken with the decision to abandon the gold standard in September 1931 that policy began to change, and from June 1932 the country enjoyed cheap money and a period of rapid economic recovery.
The differences in attitudes to fiscal policy then and now are equally striking. In the US the Bush administration is currently discussing with Congress a package of further tax cuts, and a figure of $100-billion has been mentioned as part of a programme of spending designed to stimulate the economy. Compare this with the policies that prevailed under the ideology of the gold standard in the interwar period. In the US a substantial tax increase was enacted in June 1932 in the hope that this would balance the federal budget. Franklin D Roosevelt proclaimed the virtues of a balanced budget even as he promoted his New Deal.
In Germany the policymakers and their advisers, most notably under Heinrich Brning (chancellor from 1930 to May 1932), espoused similar doctrines, and so attempted to overcome the unprecedented economic crisis by a policy of deflation. This involved a series of austerity decrees leading to higher taxes and successive reductions in government spending on benefits and public sector wages. The inevitable failure of this programme helped prepare the way for Adolf Hitler’s rise to power. In France, a succession of governments followed the same disastrous deflationary course for most of the 1930s. In Britain Ramsay McDonald’s Labour Ministry collapsed in 1931 when it split over the attempt of the ultra-orthodox chancellor of the exchequer, Phillip Snowden, to force through reductions in unemployment benefits, civil service salaries and other items of government expenditure.
The structure of the modern international monetary system provides yet another stark contrast with the situation in the interwar period. The policies of the International Monetary Fund and the World Bank have attracted considerable criticism, but they are able to provide very substantial sums to countries that find themselves in economic difficulties. There was no comparable international ”lender of last resort” to which bankrupt countries could turn during the 1920s or 1930s. The free trade policies promoted initially by the General Agreement on Tariffs and Trade (GATT), and today by its successor, the World Trade Organisation, are also an important part of the story. Various forms of protection remain, most obviously in relation to agricultural products, but the ruinous ”beggar-thy-neighbour” policies to which so many countries resorted in the interwar period are no longer advocated by responsible policymakers.
These aspects of modern economic policy are among the fundamental factors that help to explain why most economies have enjoyed sustained expansion since the end of World War II. There have been occasional periods of slower growth, but no cyclical crises of falling output and rising unemployment. The world economy can continue to rely on appropriate policy measures to prevent a serious downturn in the coming months.
There are also a number of less substantial reasons why we should not expect a major depression. The pessimists typically note only one aspect of the consequences that follow from the attack on the US and fail to recognise the related aspects. They emphasise the adverse effect on air transport and on the airlines, but fail to note that if money is not spent on travel and tourism it is available for spending on other goods and services. They highlight the vast sums that the insurers will have to pay out, but fail to mention that the recipients of this money will be constructing new buildings, installing new computer systems, buying new furniture and office equipment. Yes, we could talk ourselves into a recession, but there is surely no good reason to do so.
Charles Feinstein is emeritus professor of economic history at Oxford University and is currently a visiting professor at the University of Cape Town