What Policy is Best to Counter Global Depression?
Keith Rankin, 17 June 1998
The simple way to find the answer to this question is to ask what would be the correct policy if the whole world was a single nation with a single government. Each country in the real world should do what would be correct for such a hypothetical global nation.
Problems arise when some countries do not comply with this rule. In particular, problems apply when a dominant country moves in the very opposite direction of the direction prescribed by the rule. Hence the concern that Japan is a very large part of the problem, when it needs to be a part of the solution.
Economic historians generally agree that the United States did "too little, too late" in 1929, allowing not only itself but the whole world to enter a "Great Depression". There are indeed parallels between the USA in 1998 and Great Britain in 1929, as there are parallels between Japan in 1998 and the USA in 1929. (There are differences, too; especially the fact that Japan's difficulties have been going on for 8 years, whereas America's in the 1920s were quite sudden.)
In a single-nation world economy, there is little doubt that the antidote to depression is expansion, or reflation as was called when it meant "growing out of a hole" rather than "expanding into the economic yonder". The Greens might have reservations about expansion as a general panacea. A Green prescription is a little more complex, but it still involves getting people working - especially on projects that are restorative for the planet - while also ensuring that people are not overworked.
The single-nation prescription requires more spending, not more saving. (More saving, by definition, is less spending.) A more equal distribution of income would also be of considerable help. That suggests more social investment, and more distribution of social wage goods and social dividends.
Individual governments are tempted to do the very opposite of what they would do if they were world governments. Whether Japanese or Kiwi, they see economic recovery in national terms. Kiwis are exhorted to raise the national rate of savings. Japanese don't have to be exhorted to.
The reason is that increased savings are seen as the means to give one nation a relative advantage over other nations, or (as in New Zealand's case) a diminished disadvantage. In this case, doing better means importing less but not exporting less. When nations each seek to do better by allowing others to do worse, all in fact do worse.
The counterposition is that to pursue a policy of decreased savings (ie the correct policy) when other nations are wrongly saving more, then the world moves into a depression and the spending nation is both relatively and absolutely disadvantaged; double jeopardy for the virtuous.
The reason the spender is disadvantaged is that, at least in conditions of free trade, the benefits of that country's spending are dispersed throughout the world, but the balance of payments headache is confined to itself. Unless the spender is a very large country, the impact of that country's spending will not be enough to get rid of a world depression. It takes reflationary spending from most if not all countries to put an end to a global slump.
There is a simple solution for countries that are obliged to act unilaterally. Protective tariffs. Tariffs ensure that the reflationary effect (from increased national spending) is confined to the domestic economy.
To get out of a depression (or to avoid getting into one at a time like June 1998), either all countries must reflate their economies in unison (multilateral action) or each country reflates independently, with tariff protection. In practice, each country has to find its own means to reflate its own economy, rather than waiting for a cargo cult solution from "offshore". Protection, the sine qua non of domestic reflation, can be removed once all (or most) have recovered.
A global depression is a kind of "third-best" situation. While free trade can deliver "first-best" in theory (ie subject to a number of unrealistic assumptions), it is perhaps more likely to deliver third-best (or worse!). Protection delivers second-best, which happens to be a whole lot better than third-best, and not much worse than first-best. (In fact, second-best may be more stable, though less efficient, than first-best.) It makes sense to move to second-best when first-best is unattainable. It makes no sense to obstinately stick to third-best when second-best is easily obtained. In the real world economy, it makes no sense to hold out for perfection; for what Karl Polanyi calls the "liberal utopia".
NOTE: See Peter Harris's comments on the present state of panic.
Peter Harris, senior economist of the New Zealand Council of Trade Unions, is author of the chapter "Manufacturing Lessons from New Zealand" in the 1998 book Manufacturing Prosperity, Ideas for Industry, Technology and Employment, published in Australia by Federation Press (see publication information at the head of my article, "Ideas for New Zealand Industry").
Rankin File | 1998 titles