The Lilac Cruiser

This article in the FT by William White, ex public sector banker, makes the point that simple extrapolations of potential growth like this are an oversimplification and macroeconomic policy needs to look beyond short term crisis management.  White argues that some industries will have significant overcapacity caused by above trend growth in recent years and structural adjustment will need to take place to take out excess capacity and allow these sectors to reduce production to lower levels commensurate with lower levels of demand.  The role of fiscal stimulus is to facilitate adjustment, but implicitly the stimulus needs to be moderate and short term, lest we end up zombie economies like Japan.  A good, old fashioned recession is like healthy forest fires which “burn away the undergrowth that might accumulate and make any eventual fire uncontrollable”.

I wonder if Mr White is protected from the economic equivalents of natural selection, which he views so complacently, by a comfortable public sector pension.

His metaphors from the natural world give us a clue as to what drives his muddled thought processes.  I suspect that, like many who apply metaphors from the natural world (”survival of the fittest”) to the social sciences, his world view is unpleasantly Darwinist.

The biggest confusion is between a short term demand deficiency caused by recession (what we are experiencing now across the board) and the need for declining industries whose day has passed to die off and allow reallocation of capital to more productive sectors (true of certain industries at any time).  In a recession short term demand deficiency leads to loss of business confidence.  Via the mechanism of destocking this feeds through to a vicious contraction in economic activity.  When business confidence recovers, inventory is replaced leading to a sharp recovery in economic activity, which usually (though not always) kicks off a return towards long term trend growth.

Unlike Mr White, I would argue that the role of government spending in a recession is to mitigate the worst part of the economic contraction and thereby ensure that economic capacity is not needlessly and wastefully destroyed, allowing a quicker return to trend growth.

There are clear perils to oversimplifying this – for example in the 1970s economists and politicians in the UK arguably became transfixed by early and simplistic analysis of the trade off between unemployment and inflation and lost sight of the long run limitations of managing the economy solely by reference to this relationship.  Associated with this, the need, for instance, for long run fiscal discipline and appropriate microeconomic policies was lost.

But this is not where we are today.  And simplistic analogies from the natural world are crass and misleading.