The Fire Economy: New Zealand’s Reckoning
Bridget Williams Books, $50.00,
“Imagine,” said the great physicist Richard Feynman, “how much harder physics would be if electrons had emotions!” Harder still, if not just emotions but consciousness, memory and reasoning power. Perhaps they do – I don’t know. I do know that people have these attributes and more, and I have come to appreciate just how difficult that fact makes life for those of us who study the human or social sciences, such as economics.
But it’s not just the complexity of humanness that causes us problems. Actually, in an important sense, we have an advantage here over natural and biological scientists. A physicist cannot get into the head of an electron, nor a biologist into the mind of a gene. But we can get into our own – smart, experienced, sentient – mind and interrogate it. Would I eat less ice-cream if the price went up? Well, I suppose I would. Ergo demand curves slope down. Next theorem please.
Of course, introspection can only get you started – the scientist must then formalise the hypothesis and test it empirically on real-world data. We’ve done a lot of this in economics, and with success: yes, demand curves do slope down (with the small exception of “snob” goods), and we’ve succeeded in establishing the proposition as common ground amongst – for example – both pro- and anti-contingents in the debate over the recently concluded Trans-Pacific Partnership Agreement (TPPA) negotiations. Cutting tariffs on imports will affect the demand for them – agreed. Good idea? Not agreed.
So what is it that does make human science unusually hard? The problems arise when we move beyond relatively straightforward buyer/seller market transactions to more complex social interactions. What if my decisions depend importantly on what I can only expect – not know – many other people are going to decide? What if their decisions in turn depend on how they respond to circumstances which may have never been observed before in the history of the world?
This may sound rather dramatic, but it is not melodrama. Three times over the past hundred years, the world economy has been convulsed by massively unpredicted reactions to major unprecedented events. Here is the procedure. A Big Economic Idea sweeps the world. Great things happen as a result. But it turns out that the great idea has an immanent flaw – unforeseen because none of this has ever happened before. The flaw is so serious that it threatens to reverse all the gains made. In the nick of time, however, saviours appear – one or two geniuses who are first to understand what is going on, and how to deal with it. But their theory is novel as well, and so their remedy also turns out to generate yet another unprecedented difficulty.
The first Big Idea was the theory of comparative advantage – originating geniuses Adam Smith and David Ricardo – which led to the doctrine of free trade and eventually to the First Great Globalisation Age, from around 1870 to 1914 – an unprecedented expansion of international commerce, abetted of course by steam-powered ships and the trans-Atlantic telegraph cable, and fuelled by plunder of Europe’s new colonies. The immanent flaw of free trade was its lack of – indeed, scorn for – international political institutions of governance, and the major unforeseen consequence was revealed when the bursting in 1929 of a Wall Street stock price bubble – which in earlier times would likely have been no more than a local difficulty – ended up sweeping the world into the Great Depression of the 1930s – the worst slump in modern history.
The genius-saviours here would be Maynard Keynes and Adolf Hitler – one with the economic theory that made sense of it all; the other with the foresight and political will to apply the theory in practice – actually, before Keynes had himself got it all figured out. Keynes (and Hitler) realised that, when the private sector is in a funk, it’s the role of government to step up and spend big – completely contrary to the then orthodox wisdom that the public sector should cut back in a slump, to give the more efficient market sector room to sort things out for themselves.
Keynesian stabilisation policy was a major contributor to the great post-war boom, which lowered unemployment and kept it low for around 30 years, transforming in the process the standards of living of working- and middle-class households. But this fine programme carried within it the seeds of its own downfall: low and stable unemployment prices and wages increased, and by more each year as the cautionary racial memories of the 1930s faded – again, a totally unprecedented event in history. By the mid-1970s inflation was running at double-digit rates – a big problem for Keynesianism.
Enter to the rescue, from stage right, the superstar geniuses of Monetarism: Milton Friedman and Robert Lucas of the University of Chicago, with enthusiastic political backing from those whom we now call neoliberal – Thatcher, Reagan, Roger Douglas in New Zealand – and their regime of microeconomic “reforms” – deregulation and union-bashing in particular. Monetarism quite quickly replaced double-digit inflation with double-digit unemployment, but over the 1990s and then into the new millennium, unemployment rates did gradually drop; inflation and thence inflationary expectations stayed very low, and so did interest rates, as the need for a prudent inflation premium dissipated.
By around 2006, hubristic right-wing economists had proclaimed a new era: The Great Moderation. It was certainly a very moderate, not to say stingy, period for working- and middle-class wage increases, but, hey – as President George W Bush may have said – let the poor eat their house. He meant that with low interest rates everyone could buy a house, which they would then re-mortgage every year for a bit more cash, based on the increase in property value, which surely would never end. Except, of course, that the United States property bubble did burst, and with it went the solvency of many banks and other financial institutions, in a contagion – the Global Financial Crisis (GFC) – which spread around an unprotected world – shades of the 1930s – and from which we are yet fully to extricate ourselves.
What New Zealand and other countries should do about the GFC is a subject of The FIRE Economy, the new book by my friend and colleague Professor Jane Kelsey of the University of Auckland Law School. This is a typical Kelsey production, revealing formidable energy and synthesising intelligence; supported by nearly 1,400 endnotes, as well – as Kelsey acknowledges – as a useful little $336,000 public grant from the Marsden Fund. FIRE stands for Finance, Insurance & Real Estate, and it is the growth in this sector – the “financialisation” of the economy, and the roots of this in “imbedded neoliberalism” – that are the two principal aspects of the GFC focused on in the book.
As an economist, I am not totally happy with the treatment of finance in the book. We are shown series of graphs of various variables, but the accompanying text can veer into polemics and – it often seems to me – miss what is going on behind the simple trends. Figure 3.3 shows sectors’ shares of GDP in New Zealand from 1972 to 2011. The share of the “goods-producing” industries (manufacturing, etc) goes down; the share of the sector including FIRE goes up: the two lines meet in 1997 and diverge thereafter. Not pretty!
But if you dig into these data, as I have done, you find that nearly all the increase in the FIRE etc share is due to increases in commercial real estate and various services to business, such as computing and research and development. The GDP share of the part of the actual finance industry that shelters activities such as the trading in derivatives and so on that did all the damage in the GFC is just a few per cent and hasn’t changed for 20 years (in New Zealand – it has gone up in the United States). Indeed, what has startled me is not how big finance is, but how small, to have perpetrated so much mischief, as indeed Kelsey and I agree it has.
Kelsey makes much of increases in ratios of personal and public debt to GDP, drawing in particular on the very accomplished (but not uncontroversial) research of the American economists Carmen Reinhart and Kenneth Rogoff. The graphs here do look scary, and perhaps they are; but I would just offer the following three cautions: that for every debtor there is a creditor, who is not on Mars (though possibly, in the case of our household mortgage debt, is in Australia); that the debt-servicing burden is lower than it used to be, because of much lower interest rates; and that much recent personal debt (eg credit card debt) has been taken on by households trying to maintain family consumption in the face of stagnant or declining wage incomes, and that this is an income distribution matter – a consequence of neoliberalism, not financialisation per se.
As for neoliberalism and its “imbedding” in the intellectual, political and even social structure – well, this to me is the strongest part of the book. It is amazing and a bit sickening to read just how entrenched by now is this political and economic system, despite its demonstrable failure to deliver a better life for the bulk of the people – not just since the GFC, but for a couple of decades previously. We know this better than most in New Zealand, as we have lived to be outstripped economically by Australia, with their commendable reluctance to dispose of all the institutions of the Keynesian social democratic mixed economy.
What to do? Jane Kelsey has some good ideas, especially with respect to reclaiming national sovereignty over matters such as capital controls – what is called “financial repression”. I would go further, to put the strengthening of the nation state as a prerequisite for developing civilised and sustainable economic systems in all states. Such will require a forthright and creative refutation of the still-dominant neoliberal “There-Is-No-Alternative” economic model.
We are all, understandably, a bit confused, living through this unprecedented and dangerous period of modern history with no Keynes in sight to be our genius-saviour. (Anyone who thinks they aren’t confused is confused.) We just have to cope somehow, and – in New Zealand and elsewhere – will be grateful to have on hand the learning, passion and insights delivered by Kelsey in The FIRE Economy.
Tim Hazledine is a professor of economics in the University of Auckland Business School.