Based on the evidence gathered over the centuries with regard to the way that business and commerce have been conducted, all indications are to the effect that the business cycle is here to stay. And the conclusion we must draw is that we should learn to live with it because the best that we can do is tame it a little but not repeal it altogether. And so, I begin this discussion by accepting that postulate and I try to develop an understanding as to why the business cycle exists at all and how it repeats itself. To do this, I think of the economy as a machine made of two parts. The first part produces and supplies goods ranging from the tomato to the jumbo jet and produces services that range from the haircut to the billion dollar insurance coverage. The second part of the economy is a massive consumer that takes in all these goods and services. It is composed of private citizens going about their daily lives, of the procurement arms that buy goods and services for government agencies, of the purchasing departments that buy for private business and of everyone else that buys goods or services and pays for them with money or barters them against other goods and services.
Having outlined an economy with this simplified sketch, I see it as existing in one of three possible states. First, the economy is shrinking which means it is becoming smaller or (to use the jargon of the trade) it is registering a negative rate of growth. Second, the economy is stagnating which means it is registering a near zero rate of growth. The reason why this would happen is that the production side can sometimes match the demand side and not cause a detectable change in the size of the economy. Third, the economy is registering a steady and positive rate of growth year after year which is a healthy state for it to be in. Unfortunately, however, this is a situation that no country has been able to maintain for an indefinite period. The more likely thing to happen is that the economy registers the kind of positive growth which leads to cycles of booms and busts. There are numerous reasons why this can happen but more often than not, the cycles result from a mismatch created when the supply side of the machine fails to produce what the consuming side demands whereby the economy attempts to restore balance but overshoots in one direction or the other.
More precisely, the mismatch can happen because the economic machine does not produce enough of what the consumer demands or because it produces the sort of goods and services that the user no longer needs or perhaps did not need all along. A situation like this throws the supply-demand equation out of whack and opens a gap between the two parts of the machine. If the phenomenon persists, the gap keeps widening till it undermines the value of the currency underlying the economy. The price of goods and services begins to inflate and reaches a level called a bubble which then bursts and threatens to collapse the entire economy. The authorities in charge intervene and try to bring the economy to a landing. Their aim will be to soft-land it which means make it register normal growth again. But it often happens that the economy will land into a recession meaning that it will register a rate of growth that is below normal or worse, it will crash land and register a rate of growth that is negative and that is large. In either case, the economy will take a breather for a period of time after that and restart the cycle only to go through it all over again.
To understand why the economy goes out of whack in the first place at the macro level, we need to look at the small parts that make up the producing side of the machine as well as the small parts that make up the consuming side. These would be the parts that undergo changes at the micro level which are so small they can barely be detected or not at all. Their cumulative effect, however, is sufficient to cause a big change at the level of the overall economy. What are these parts? Well, the parts that make up the producing side of the machine are things like ideas, concepts, scientific discoveries and technological developments. They do not stand still because new ones appear all the time and replace the old. As for the parts that make up the consuming side, they are things like taste, fads, styles, preferences and so on. They change because they respond (but not always) to the changes that occur at the producing side given that the consumers are affected by the appeal that is generated when new products hit the shelves. And they change because the demography of the users keeps changing given that human beings grow old and cede their places to the younger generation.
So then, what we have in a modern economy are two sides of an equation whose parts are made of variables that constantly change. The variables cannot be controlled for any length of time because they transform into something else faster than a response can be formulated to address them. For this reason, the supply side of the economy fails at times to adequately respond to the changing needs of the consumer. The consequence is that the supply-demand equation goes out of whack and causes the familiar economic cycle. However, we must keep in mind that change in itself is not a bad thing because it is the product of an innovative spirit that keeps renewing the economy by incorporating into it new ideas we consider to be an improvement on the old until proven otherwise.
But where the real trouble begins is when the volatility in the economy becomes so large that it causes a swing in the economy which may range from the creation of a small bubble that quickly dissipates to causing a crash that lingers long enough to become a prolonged slump in the economy. This is the dreaded event that sends the rate of unemployment to levels that test the social safety net put in place to help people transition into a new economy. And this is the time when the quality of the net becomes the indicator that tells how advanced a given economy is and how well it has performed lately.
The nations of the world have, in fact, gone through a few of these cycles during the past decades, and several approaches were employed to mitigate the problems that crept up, especially those of unemployment. These approaches met with various degrees of success but they now seem to have become obsolete in the face of a global economy that does not respond to them the way it used to. The challenge, therefore, is to understand why this is so and to find ways to respond to a situation that has materialized when doing business in the global village became the norm. To this end, the first thing we do is notice that we have a problem of a sort we never encountered before. It is one that has become starkly visible after the near financial meltdown of 2008. It is the phenomenon of big business in the developed economies hoarding cash instead of using it to hire people, reduce unemployment and help the economy grow. Why is this happening?
To answer this question we need to understand what approaches were used in the past to solve the problem of a slumping economy. I begin with the story of the economist John Maynard Keynes who lived at a time when cycles of boom and bust were frequent. This was a time of great technological innovations, a time when transportation vehicles of all sorts and household products of every description were regularly invented and put on the market. The consumers rushed to buy these products and they quickly depleted their savings as well as the ability to obtain new credit. This caused a sudden reduction in demand and resulted in the considerable slowing down of the economy. Keynes responded by having the government supplant the consumer to create demand in the economy. This was done by launching public works such as updating the infrastructure of the country. The approach worked but, like everything else, the theory behind it was not without drawbacks. To begin with, the infrastructure of a country may not always need updating. Also, there is the fact that when you spend on the infrastructure, you inject money into the economy without producing the sort of goods and services that the consumers usually buy. Thus, you create a situation where more money is chasing the same amount of goods and services, an effect that creates inflation down the road and sets the economy for a period of boom which, if unchecked, can turn into a bubble.
Nevertheless, the Keynesian approach reigned supreme as a practical economic remedy for a number of decades when something happened to challenge all that. The approach was transformed into a political ideology by people who attacked it on political grounds while advocating an economic approach that was better suited to their vision. They called the Keynesian solution a remedy of the Left that does not work, and they proposed an approach of the Right that they promised will work. To make their point and to give it the aura of respectability, they adopted the economist Milton Friedman as their patron saint whose theory of economics is based on the principle that when people are free to choose they make the best choices, and this leads to good things happening to the economy. This idea was interpreted to mean that everyone should be allowed to do what they want. And the “laissez-faire” approach became the mantra of the Right.
While the bickering between the Left and the Right started on economic grounds, it quickly degenerated into a battle among political ideologues. The Keynesian theory was described as a leftist conspiracy to make the government intervene more massively in the economy by favoring the demand side of the equation and by kissing up to the labor unions. This was countered with the charge that the laissez-faire approach was a rightist conspiracy designed to get the government out of the economy by favoring the supply side of the equation and kissing up to big business that seeks to abolish all business taxes. Whether this charge is true or false, the approach of the Right also has its drawbacks because there comes a time when business is flush with money and needs no preferential treatment while the government may need money and cannot afford to lower the taxes or reduce service to the public.
The conclusion we must draw from all this is that neither side has the perfect solution to a slumping economy. In theory, a good solution would be to have unlimited amounts of money and new ideas at your finger tips such that you can come up with new products and new services at the snap of your fingers. You will need to constantly create the products and the services that will please the consumer, and you will need to produce them at an ever cheaper price which means you will need to constantly raise the productivity of the workers. This done, you will have to pay the workers higher and higher wages because they are, after all, the consumers who will buy all those goods and services. Can this be done? No. This is a fantasy cited here only to show what an ideal – but impossible to attain -- solution would look like.
However, the truth is that at this moment in time patented ideas and more ideas waiting to be patented exist by the tens of thousands and they beg to be used. Moreover, there is the reality that big corporations in the advanced economies are flush with hoarded money which they are not investing in old ideas or new ideas. It is as if these corporations have gone on strike at a time when they have it within their power to alleviate the current slump, something they can do by using the money in their vaults to develop those ideas and turn them into new products and new services. But the corporations are not doing it and the question is: Why not?
The reality is that since everything was politicized, big business has wanted to play ball by participating in the political game and playing it the business way which is oriented toward the principle of competition more than the principle of compromise. However, the trouble has always been that people in business are a cautious lot who would not activate plan A unless they had plan B safely tucked in their drawer. Thus, aside from doling out monetary contributions to the political class, the people in business did little else to participate in the political game until the globalization of the world economies happened and new opportunities opened up to them. They got into the arena, and the way they played the game was to play one jurisdiction against the other. They got the jurisdictions to compete at giving them better tax breaks and more favorable regulatory regimes. This is how they succeeded at making good things happen for their business and for the shareholders.
One thing they did effectively was to shift their investment strategy from the mature economies to the emerging ones. The strategy worked so well that they were able to make their balance sheets look good by relying almost exclusively on the growth generated in the emerging economies. And this happened at a time when the mature economies were in a slump and going nowhere. In the meantime, the big multinationals began to demand concessions from the governments of the mature economies as they sat pretty on their cash and waited for the right response to be whispered in their ear. This is where things stand now; and the one thing we can be certain about is that the way this standoff will be resolved will set the tone for the relationship that will exist in the future between the governments and the big businesses not just in the mature economies but everywhere on the planet.
So then, what to do? The short answer is that all governments must develop the means by which to break the investment strikes which are now in effect and those that big business will want to initiate in the future. To do this, the central bank and the treasury in every country should be allowed to work together and they should be given the right to deny the first tier of big business access to the bank's window. Moreover, the central bank and the treasury should be allowed to engage “scab” businesses of the second tier level. They will nurture and ready these businesses to supplant the first tier if and when the latter go on strike. In effect, these businesses will be told that if they strike they will be locked out. The political Left will not mind seeing a policy like this in place because it will check the power of big business. And the political Right will not mind it because according to the theory of Friedman, the policy will encourage more competition. And both sides will love it even more because it will mean no more bailouts.
The way to start the ball rolling is to put the squeeze on the big financial institutions that must never be allowed to attain the size of “too big to fail” anyway. Then there are the manufacturing industries that receive massive contracts from the defense department and from the various scientific programs, some of which are subsidized to the hilt. And you can go through the list of companies and implement this policy at lower and lower tiers until everyone that runs a business understands they cannot hold the gun to the head of the nation and demand concessions they have not earned the old fashioned way.
This is the way that governments will have to do business in the global village from here on if they want to maintain some level of influence over their respective jurisdictions. And this suggests that some sort of agreement will have to be forged among all governments to the effect that they will not allow the multinationals to play one country against the other and so usurp their economic powers. As I see it, this is the way that governments will be able to prevent business from blackmailing big and small nations into submission.
P.S. I normally take a vacation in July but will not this year. I am scheduled to undergo a cataract operation in a few weeks. I shall remain in touch whenever I can till the day of the operation. I don't know how long it will take me to recuperate after that.