Doing Good By Doing Nothing?
By Dr. Tim H. Stuchtey

At the beginning of a new year, people look to the future with some skepticism or even angst. What started as a crisis in the U.S. housing market in 2007 that hurt U.S. homeowners and mortgage banks became a capital market crisis in 2008 that hurt bankers and investors across the globe, resulting in a recession of the real economy late last year in the three biggest world economies (the U.S., Japan, Germany) at the same time. Recessions hurt almost everyone, so there is good reason to have some mixed feelings about 2009, but history tells us that recessions are limited in time and at some point the economy will return to its long-term growth path. The question is how long will it take and how bad will it get in the meantime?

A thought that inspires hope is that over the last few decades progress was not only made in knowledge of the natural and life sciences but also of economics, economic cycles, and the effectiveness of economic policies. Therefore one would assume that this recession cannot get too bad because we have ways to smooth it. But since the knowledge about economics is pretty much the same around the world many people in politics, academia, and the media are wondering why the reactions of governments to this economic crisis have been so different. In particular they wonder about Germany and its fiscal policy. Chancellor Merkel (CDU) and her Finance Minister Steinbrück (SPD) are reticent to follow many of their colleagues with huge deficit spending programs. And that remains true even though they are expected to come up with a second stimulus package in mid-January which again will be comparatively small. Monetary policy is beyond the German government's control anyhow since this is done by the independent European Central Bank (ECB).

It will be a few years before economic historians will be able to tell us whose policy approach was right. Does one fight a recession that was caused by loose monetary policy, low saving rates and little regulated credit markets in the U.S., and huge current account surpluses in particular in China (to a lesser degree also in Germany) with loose monetary policy and a stimulus for consumption? Or do we need to go through a certain time and degree of adjustment until things can get back to normal again? If the former is right, countries that aggressively lowered interest rates and that swiftly decided sizable fiscal stimulus packages will not only come out of the recession faster but will also benefit from the growth potential of the hopefully wise investments that were taken to stimulate the economy. If the latter are right, then those countries that refrain from excessive deficit spending will be much better off since their future generations will not be burdened with the interest payments for the deficit spending. But is doing nothing in these times of crisis really a political option?

There is little doubt that in order to keep the economy from a complete meltdown the credit cycle needs to work. Some sort of help for the banking industries therefore seems unavoidable. However, does it really make sense that huge subsidies are paid by the taxpayer to help specific industries and companies in the goods and service sector? All of a sudden the recession becomes an excuse to demand taxpayer money from the government. Of course it follows that foreign competitors will then turn to their governments and demand an even playing field and subsidies that protect them from the "rescued" companies abroad. The group that is certain to lose in this game are the future taxpayers around the world. But electorates demand swift action from their elected officials to demonstrate that they are ahead of the curve, so it is easier for politicians to distract the public debate with rescue and stimulus packages because otherwise people might start to discuss the reasons that brought them into this mess. As a result, people could question the role of the politicians in all of this. Maybe it is not only the fault of greedy investment bankers but also a lack of serious oversight or wrong or inapt regulations?

Times of crisis such as a recession are not only a threat to society and businesses in particular; they also offer an opportunity. The opportunity for governments lies in the fact that in these times policies that increase the welfare of most people - but might hurt a few - are easier passed by parliaments and party groups that, under more stable circumstances, would be subject to strong resistance from well-organized lobby groups. By adopting such policies one would also trigger economic growth in a more sustainable way than with short-lived spending bills.

AICGS' recommendations to the new U.S. president are therefore today more current than they were last October when the Memo to the President was first published. Instead of entering into a race for more subsidies, the U.S. and the EU should quickly sit down and negotiate within the framework of the Transatlantic Economic Council (TEC) the mutual recognition of standards for certain industries, the joint regulation of financial markets, and measures that help to reduce the global macroeconomic imbalances. Success in these fields will certainly shorten the current recession and will also help to avoid new bubbles that are created with the trillions of dollars that are now being used for questionable fiscal programs.

Dr. Tim Stuchtey is Senior Fellow in Residence and director of the Business and Economics program at AICGS.

This article appeared in the January 9, 2009, AICGS Advisor.