BU's Emeritus Professor Nigel Jump writes the next in a series of economic blogs looking at the impact of Covid-19 on the economy.
REAP WHAT YOU SOW
In the long run…
John Maynard Keynes famously said, “in the long run, we’re all dead.” This was meant to convey the idea that you cannot just wait for the economy to correct itself or change favourably when it is under severe stress. Sometimes, you have to make change happen by interfering in the short run. He was focused on the Great Depression after 1929 as an example of an economy needing help from government policy (to break out of a severe downturn), arguing that it was only after President Roosevelt’s “New Deal” that the spiral of decline was curtailed.
In essence, this approach is what has been behind state involvement in the economy ever since the 1940s, including the “Furlough” Scheme for the recent Pandemic and the rescue of the Banks in the financial crisis 2008-2010. In such cases, the costs of doing nothing and letting the “market” (businesses and households) find their own way through the mess are considered too high and prolonged in terms of unemployment, financial losses and social disruption.
It is always a key aspect of political debate as to how much government interference is justified versus letting shocks run their course. It can be difficult to judge the right balance for the distribution of costs and other relative impacts between current and future citizens and taxpayers.
This is all too relevant to today’s situation.
- Should the Bank of England allow inflation to run its course or is the cost of letting an upward price spiral become embedded too high?
- Should the Treasury spend now and cut taxes, against future borrowing, in order to keep demand up? Should a painful adjustment to new patterns of demand and supply, (with ‘zombie” firms going to the wall and higher near term unemployment), be tolerated for the benefit of better resource reallocation to more productive uses further out?
- Should authorities act against the uncertainties of climate change now, at the cost of immediate disruption to lifestyles, living standards and behaviours, or should action be deferred until better technologies and infrastructures are available?
- Should individuals/households be helped through events or not? The cry, “the government must do something” is common to many socio-economic-political problems and is largely based on the view that “in the long run, we’re all dead”. We cannot wait for impacts to run their course because we cannot guarantee that they will be self-correcting.
In the short run…
Meanwhile, there are also problems with acting too often and too quickly.
This may be termed “in the short run, we’re too late”. Often, when risks become manifest, it is already too late, (and potentially damaging), to intervene to assuage a shock working through an economy. Putting up an immediate “dam” may just delay negative effects or, perhaps, divert worse flooding somewhere else. Policy may be about incentivising effective and efficient adjustment and mitigation rather than just solving an initial cause “after the horse has bolted”. “Knee jerk” reactions to events may exacerbate issues if poor knowledge/data, inadequate implementation and unsound analysis are allowed to drive state action.
Calls made during the current Conservative leadership campaign for immediate tax cuts to offset high “costs of living” may be a case in point. It depends where the inflation is coming from. If it is a “demand pull” form of inflation (people spending too much), giving tax cuts may make inflation worse, fuelling over-consumption. If it is “cost push” (people producing too little), it may distort the output adjustment process. Recently, we have heard these arguments with regard to windfall taxes on energy suppliers: whether this would dissuade investment and innovation, limiting future growth, or whether its was ‘fair’ to limit “unjustified and temporary” returns in certain parts of the economy.
If inflation is a mixture of both demand and supply factors, as it usually is, and is “always and everywhere a monetary phenomenon” (as Milton Friedman said), is it better for the central bank to jack up interest rates and ‘quantity tighten’ quickly or to move more cautiously? The monetary policy problem is about being “ahead or behind the curve”. The Monetary Policy Committee does not want to “scare the horses” but it also does not want to have to “play catch up”. August’s move to increase base rates by 0.5% to 1.75% is a case in point of the short run being potentially too late. Is the MPC now ahead or behind the real world? With the MPC forecasting a 13.4%+ inflation peak this autumn and a 15-month recession through to the end of 2023 (with a 6%+ unemployment rate), the Governor and his colleagues need to balance the risks between allowing an inflation spiral to accelerate and prolonging and deepening the recession.
In all these policy debates, businesses and households crave more certainty. The call goes up, “tell us what you are doing, when you are doing it, and why you are doing it and we can plan”? The trouble is, recently, we have had so much uncertainty – from the Financial Crisis, through Brexit, the Covid Pandemic and the Ukraine conflict. This uncertainty has manifested itself in a prolonged period of weak growth, low productivity and disappointing living standards. Moreover, this poor economic performance also encapsulates emerging new demographic, trade and climate trends. The “the end of globalisation”, (with greater emphasis on domestic resilience and insecure supply chains, skills mismatches, Russian and Chinese political/military threats, and ageing populations) requires a period of profound consideration by public and private economic actors alike.
So, the trick is to balance “in the long run, we’re all dead” against “in the short run, we’re too late”. Be careful what you wish for and focus on underlying realities and principles rather than immediate responses and wish lists. Sound policy judgement has to be based on strong principles. Evidence-supported action remains paramount.
The principles of development remain intact:
- access to open markets based on accurate information and trust – policy is about the internalisation of externalities and the rule of law;
- access to more trade based on exchange and specialisation – policy should promote the workings of the law of comparative advantage; and
- access to higher productivity through the drivers of investment, innovation, skills, entrepreneurship and competitiveness – policy is about creating the conditions and ingredients for wealth creating growth and development.
We must hope for social, economic and political leaders who can carry and articulate these arguments into a policy regime that builds acceptance, compliance and engagement amongst us all. Meanwhile, we have to accept and deal with a period of real incomes dropping. There is no way to avoid a hit on most people’s living standards over the next year or two. In the medium term, you reap what you sow. The goal is to minimise damage and maximise recovery whilst ensuring an optimal distribution of the inevitable pain.