Kiwis are very likely heading into the worst economic downturn since the Great Depression.
But the nature of this downturn harkens back to even earlier business cycles. Rather than stemming from any indigestion in the financial or monetary systems, this downturn is real. And that brings the need for some slightly different thinking.
Economists have lots of different business cycle models because there are lots of different kinds of business cycles.
If business and consumer confidence, along with spending, slump for no apparent reason, that’s a traditional Keynesian downturn. If Central Bank monetary policy runs too hot, artificially low interest rates can spark investments in things that don’t make a lot of sense – leading to the kind of recession economists of the Austrian school worry about – and the need to purge the system of those “malinvestments.”
On the other side, tight monetary policy can cause the kind of recession monetarists worry about. Milton Friedman blamed accidental contractionary monetary policy by the US Federal Reserve system for the Great Depression. New Keynesians also worry about those kinds of recessions, warning that when wages cannot drop in response to a downturn, unemployment can spiral upward.
Each of these traditional business cycles start in the monetary or financial system. What’s happening today is different – its origin is “real,” rather than monetary. And that brings us into Real Business Cycle theory.
For millennia, fluctuations in agricultural output were the primary drivers of business cycle activity. A bad harvest wasn’t just Keynesian animal spirits, or the result of complex derivative structures and highly leveraged assets – it was something real, and bad. British economist William Stanley Jevons studied how sunspots impact the price of corn with the hope of building better economic forecasts.
Recessions emerging from the real side of the economy, as opposed to the monetary side, are a bit different than the ones we are used to.
They require businesses to fundamentally reorganise to respond to changes in the real world. For its part, the Government must make it easier for the supply side of the economy to pivot away from defunct opportunities, take up new ones and reconfigure their operations.
No recession is purely of one model. A Reserve Bank failing to respond properly to a real shock can compound a real recession with a monetary one. Second-round effects from a real shock, as unemployment rises and people fear for their jobs, can bring a more Keynesian-flavoured problem. And easy credit to prop up zombie firms can sow the seeds of more Austrian-style problems down the line.
But this time, it’s real – or at least that’s the underlying problem. Let’s go through some of those issues.
The major changes in business practices brought on by a contagious disease – for office desk spacing and consumer preferences about being near other people – mean that existing configurations of workers, buildings and equipment will evolve.
Economists will describe this as a technological shock. Five months ago, the recipe for mixing workers, equipment, buildings and supplies yielded profits.
After the shock, that recipe becomes impossible but no new recipe is as profitable, yet. Meatpacking plants were never designed for 2m worker spacing, for example.
Some of these changes will only last until New Zealand returns to Alert Level 0. But some will linger as the virus remains overseas. The international arrivals lounge may take some time to get back to normal.
But that is hardly all of it.
The collapse in tourism is a lot more like a huge negative price shock to an important export commodity than it is to a traditional Keynesian domestic aggregate demand problem.
Supply chain issues when international suppliers and deliveries are less reliable is another kind of technological shock: firms used to rely on speedy delivery of needed materials, now they need to store greater stockpiles.
Shifts to working from home is its own kind of shock to the demand for services in cities – simply giving people more money will not jumpstart demand at Lambton Quay lunch counters or retail outlets when fewer people want to be downtown. It’s a real change, not just one caused by issues in aggregate demand.
More than anything, firms now need an easier path to reconfigure and change. Policy must embrace greater dynamism, rather than building in protections to entrench current practices.
Last week, The Spinoff reported Vodafone’s adaptation includes training its retail staff as online chat agents to help clients which have shifted to digital. In many countries, rigid labour market regulation stymie that kind of change – and it is easy to imagine similar policy changes might happen here.
The Government has so far mainly reached for familiar tools and policies to fix this recession: quantitative easing to avoid unintentionally contractionary monetary policy, fiscal stimulus to boost aggregate demand. Things like the wage subsidy scheme were more directly keyed to the specific nature of the Covid-19 problem.
But who is thinking about simplifying business adaptation?
If a restaurant wants to turn its disused car parks into outdoor seating areas, would city planners get in the way by enforcing minimum parking restrictions that never made sense and now make even less sense?
If a building owner wants to change some commercial offices into apartments, would the zoning laws allow it?
If a company needs more capital to leverage a post-Covid opportunity, would new restrictions in the Overseas Investment Act and a lack of domestic capital sources scuttle the business?
And if a tourism operator wants to pivot to support high-income visitors for months’-long stays, rather than a fortnight (with appropriate quarantine and testing), will the border even be open?
Coming out of months of restrictions, the Government must start thinking of ways to enable everyone to get on with the job of recovery. There is a lot of work to do.