Present depression just as big as that of 1929
ANALYSIS:Comparative research shows that what we are living through is not that different from the depression that followed the Wall Street Crash of 1929, writes KEVIN O'ROURKE.
GENERATIONS OF students have learned about the policy mistakes which led to the Great Depression of the 1930s. The scale of the period’s economic collapse has served ever since as a cautionary tale of what can happen when policymakers fail to escape from the ideological straitjackets of their time.
This is why the statistics that started to emerge last winter were so frightening – the extent of the decline seemed comparable to what had been experienced 80 years ago, especially when viewed in a global context.
Now that we have a little more data we can make the comparison in a more systematic way – and the comparison is still frightening.
As the charts show, over the course of the past year the world economy has been doing as badly, or worse, than the world economy during the first 12 months of the Great Depression.
Comparing behaviour of world industrial output in the months following the two peaks, which occurred in June 1929 and April 2008 we can see world industrial output tracked the decline experienced during the Great Depression, although the rate of decline slowed in February and March 2009. This slowdown in the rate of collapse is even more marked when comparing world trade volumes during the two crises, but what stands out even more in that picture is the fact that world trade has been falling much, much faster this time around.
Since those who work in financial markets are an excitable lot, the slowdown in the rate of collapse of the real economy translated into a substantial rise in world stock markets in February and March – but once again the broader picture is of a one-year performance substantially worse than that experienced eight decades ago.
What is clear is that the depression of 2008 represents a shock to the world economic system comparable to that of 1929.
What is also clear is that the world economy would need to keep contracting at its current rate for another two or three years for our depression to be considered “great”. The task for policy-makers is to prevent this, and here the news is better.
Interest rates have been cut much more aggressively, and from a lower initial level, than 80 years ago. Modern social welfare systems and – in some cases – deliberate decisions to stimulate the economy have ensured that government fiscal policy has been more expansionary as well, at least in larger countries such as China, the US and Germany. The hope is that this will prove more important in a global context than the enforced contractionary policies of smaller economies such as Ireland, Latvia or individual US states.
Does recent evidence of “green shoots” indicate that the world is bottoming out or is this merely a lull between storms?
It is surely too early to tell. The data are still contradictory, with reports of rising business confidence alternating with yet more evidence of falling output and trade.
More fundamentally, the IMF has pointed out that this downturn is particularly dangerous in two key respects.
First, it originated in the financial sector, implying a potential for destabilising two-way feedback from the financial sector to the real sector, and back again. Second, the downturn is global, implying that economies cannot simply export their way to recovery. The world as a whole has nowhere to export to; the major economies of the world need to take responsibility for stimulating demand themselves.
There are several reasons not to assume yet that the worst is over.
First, the world economic landscape is littered with unexploded landmines such as Latvia. If they do go off, as seems likely, there will be a clear potential for contagion with unknowable consequences.
Second, small businesses everywhere have already felt the feedback running from a distressed financial sector to a weakening real economy via the credit crunch. It is only a matter of time before the arrow of causation reverses, and rising unemployment and corporate distress create new holes in the financial sector. In the Irish context, the potential for large-scale default on residential mortgages and other loans as unemployment rises is an obvious worry.
Third, some analysts are beginning to fret that rising fuel prices may damage the economy later this year or next.
And finally, there are grounds to be concerned about whether policy-makers in large countries will continue to fight the depression, or will instead cut spending and increase interest rates too early, thus making matters worse.
All this has come at the worst possible time for Ireland. As it was we were facing the prospect of a major economic crisis due to the collapse of our housing and construction bubble, the structural budget deficit that was run up during that bubble, and our excessively high costs. The global downturn has made things a lot worse despite the falling interest rates it has brought us. As such, we have a vital interest in the right economic decisions being taken at the European and global levels.
The inspired decision to appoint Adam Posen (one of the world’s leading experts on Japan’s lost decade) to the Bank of England’s monetary policy committee suggests that the British are still focused on the real deflationary risks facing the economy, and the same can be said of key US policy-makers. If the focus of euro zone policy turns to combating inflation the resultant slowdown and appreciation of the euro will be catastrophic for us.
For reasons that have been well rehearsed at this stage, Ireland is too small and too fiscally fragile to be able to engage in expansionary fiscal policies. However, our inability to influence the overall macro-economic climate, and our reliance on policy-makers elsewhere, does not mean that domestic policy choices are irrelevant.
Reducing wages, commercial rents and other costs is obviously important, as is shifting the relative burden of taxation away from labour. As many commentators have pointed out, there is no sense in the Government cutting expenditure and raising taxes on the one hand, while bailing out private investors in banks on the other.
Nor can it afford the salaries paid to top public servants, which should be capped at €150,000 or less.
And can one really justify cutting primary school funding while spending hundreds of millions of euro on a “research corridor” of unproven merit linking TCD with UCD?
By worrying less about what the country’s elites want, and embracing the basic republican values of fairness and justice, the State may yet salvage something from the wreckage which surrounds us.
Kevin O’Rourke is professor of economics at Trinity College, Dublin