Image via Wikipedia(for part 1 see here)
This financial disaster requires some extra innovations in stimulus. Stimulus is needed from the governments simply because the massive reduction in demand brought about by job loss, credit freeze and re-balancing of household budgets. Tax cuts versus cash handouts are a red herring. The sheer amount of demand lost cannot be replaced by increasing discretionary income. Most of the consumer demand was credit based that 140 to 160% leverage of households. Trying to replace that with tax cuts or cash handouts is like trying to refill a reservoir with a bucket after the dam as broken. It’s not going to even touch the sides.
Nor can businesses replace the demand. They are inextricably tied to the crisis as businesses have been just as profligate as consumers over leveraging and not building up capital reserves. Few companies have built up cash reserves that they can use to invest during the down turn. Government handouts or tax cuts to businesses aren't going to do much to create the necessary investment in growth. Too many companies need to repair balance sheets (just like households).
The only point is for governments to step with their own demand. The idea isn't to replace all the demand lost (that will never happen) rather to break the cycle of lost demand causing further lost demand. Government stimulus initiatives need to be more direct than perhaps they have been in previous recessions. For the demand replacement to work it can't focus on make work like ditch digging. Stimulus programs need to consist of short, medium and long term that focus on energy, transport, communications and maintenance in order to produce a trajectory that gets us out of the spiral.
Short term initiatives are programmes that can be started in a very short space in time. Short term projects that would work are:
- Insulation or wheatherisation of homes (in particular low income households),
- Rebates, low interest loans or direct funding for households to install renewable energy systems and general energy efficiency for both households, schools, hospitals and government buildings,
- Maintenance of roads, bridges, culverts and buildings will improve infrastructure are usually ready to go and can easily verified.
- Re-opening existing funding programs for example, in Australia there was a solar-rebate program that was shut due to over-subscription. Adding money into this and re-opening would be a quick win as the bureaucracy already exists and nothing new has to be done.
Medium term require more time to get off the ground. The idea is these projects take over creating demand as the demand from the short term projects peters out. Examples of projects are:
- National conduit system for communications (fibre). The idea is that the conduits are all built to the same design and can be undertaken by a multitude of companies across the country at the same time.
- Installing Electrical re-charge stations would overcome the chicken and egg problem of getting plugin cars main stream. They would also reduce bills spent on petrol (gas), while stimulating demand to replace existing cars with plugin’s.
- Replacing old bogies and busses and expanding the fleet will generate demand for manufacturing while improving the energy consumption of the economy. As per unit energy of transport falls productivity rises and frees up resources to be spent elsewhere. London Transport could certainly do with more upgrading the overground trains and increasing the size of the fleet. To say nothing of the underground.
- Fund mass transit systems in cities.
- Fund fast rail projects linking up major cities. In Europe this would involve funding cross boarder connections and city bypasses.
- Provide loans for large scale renewable energy projects. The loans provide the initial liquidity that is lacking at the moment and address the need to create green jobs.
- Fund the extension of the power grid from sources to demand. This overcomes the chicken and egg problem that make a lot of large scale renewable energy projects dicey.
Development projects are only one part of the stimulus package. Additionally, help to start new and existing businesses is needed (many of the old businesses need to die as we progress from centralised to edge economy). For small business the hardest part is getting the capital/resources together to get the business to a point of being cashflow positive. Venture funding is not the answer. Most small businesses are not venture businesses but rather businesses that will turn a tidy profit but never exit.
For many (if not most) small businesses labour is the largest cost in the early years. To help new businesses start, governments need to provide income-contingent loans that pay salaries for up to 5 employees for the first year with an option to extend for a 2nd year. The income-contingent loans would be on the employee and not the business (reduces gaming of the system and also means the employees are invested in getting the business to succeed). Large numbers of new small business will go a long way to address demand destruction.
The government also needs to reduce the costs they impose on business through the amount they charge for services and cost of complying with regulation and legislation. This will free resources leading to increased investment and lower prices which benefit the economy overall.
Why energy, communications, transport and maintenance? Energy has two effects it addresses the simmering problem of peak oil and energy security (that hasn't gone away only been pushed to the background and will come roaring back soon). Additionally, by increasing energy efficiency cash is freed up (households, business and government) that can be used elsewhere whether repairing balance sheets faster or for consumption. Communications and transport projects also go to increasing energy security but primary reason is that improved communications and transport increase the productivity of the economy. Maintenance improves the performance of assets while also extending their life.
Moral hazard will be raised along with the supposed unfairness to people who where sensible. This is a concern but one that shouldn't, mustn't, hold up initiatives to break the spiral. The market can only work if there is a market and we are all part of a system. Just like destruction of one part of an ecosystem flows on to destroy other parts, so too will the spiral flow on to effect even the sensible. Within the three pronged approach you can put in place methods to address moral hazard and poor behaviour. For example, with the mortgage principal reduction the government can take a majority of any future realised capital gains. People who have the mortgage reset can also face additional credit restrictions in the future.
All of this is further complicated by the need for Western countries (particular the Anglo-Celtic countries) to coordinate the implementation of such a sweeping initiative. If the countries go it alone they will only make the whole job harder.
These are unusual times and call for unusual measures. The aim here is to reduce the crushing debt and cushion the economy from the plunge in demand by making it easier for new businesses to start and creating demand to replace some of what was lost. Make no mistake; the world will not return to levels of demand seen previously and the point of stimulus packages is to make the shift in the economy orderly rather than chaotic. Now is not the time for ideological battles or programs. The world needs pragmatism and the leadership to break the spiral and begin the path to recovery.