March 09, 2020 05:38:06
If you believe the economics profession, human beings are rational creatures.
According to the theory, we always act in our own best interests, dedicating our lives to maximising utility, which is a fancy way of saying our own personal satisfaction.
That healthy competition between individuals drives behaviour which ultimately leads to the efficient allocation of resources and supply meeting demand, thereby benefiting us all.
It all sounds so civilised, so perfectly reasonable.
Except, looked at another way, you could argue the theory really means we’re all a bunch of greedy, conniving hedonists, scrambling to get one up on the bloke next door or the woman across the road, just to prove we’re better than them.
And occasionally, we’ll do almost anything to achieve it, rational or otherwise.
If we’re all so rational, how come we succumb to greed and buy things when prices are soaring, even when it’s obvious we’re paying way too much, and then end up selling when prices are crashing?
The toilet paper shortage is crap (pardon the pun)
Not sure if you’ve checked the supermarket shelves lately but if ever there was a graphic example of irrational behaviour, it’s the current run on toilet paper.
Australians are fighting in the aisles to snare what they believe to be the last of the dwindling supplies of bog roll.
Except, it’s all crap — if you’ll pardon the pun. We make most of the stuff here and if everyone would just calm down, it would take just two days before suppliers could restock the shelves and everything would return to normal.
But there are lessons to be learned from the mass hysteria now gripping consumers.
We’re not rational, at least not all the time — and especially during times of crisis.
That’s something Prime Minister Scott Morrison and Treasurer Josh Frydenberg need to come to grips with when they unveil the Federal Government’s emergency response this week to the COVID-19 crisis which now threatens to cripple the economy.
What have we learned from the GFC?
Crises, by their very nature, demand urgent responses.
In 2008, the Rudd government when faced with a potentially catastrophic meltdown of the global financial system was urged by then-treasury secretary Ken Henry to “go early, go hard and go household”.
With the luxury of a massive surplus, courtesy of years of surging commodity prices and an unrelenting resources boom, the government splashed out with several programs, firstly of cash handouts designed to keep households spending and small business ticking over.
It later embarked upon two programs — the pink batts home insulation installation and the school halls program — designed to flush cash through the economy, boost construction activity, halt a rise in unemployment, and provide something solid.
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In addition to this, a range of measures were instituted to stabilise our banking and financial systems.
Bank deposits up to $1 million were guaranteed, investors were banned from short-selling financial stocks and our banks were given access to the Commonwealth balance sheet so they could refinance their offshore loans.
Without this last measure, all our banks would have folded as global credit markets seized.
Did these measures work?
The short answer is that we didn’t go into recession.
A huge stimulus program from China that supercharged the resources boom played a major part.
But without the spending, unemployment certainly would have been higher and the resulting social problems far greater.
Our financial system survived the onslaught in reasonable shape, although with a reduction in competition.
Smaller banks, like St George and BankWest, that may have collapsed, were waved through to Westpac and the Commonwealth Bank.
What we could have learnt through that tumultuous time unfortunately has been lost as the entire episode became politicised.
The resulting deficit became a noose around then-treasurer Wayne Swan’s neck, although despite all its criticism the Coalition — now in its third term in office — has continued racking up deficits and adding to the national debt.
An uphill battle
Late last month, the number of new coronavirus cases reported outside of China overtook those within the Middle Kingdom.
With much of China’s economy in lockdown, we’ve experienced a supply shock, with shortages of goods, components and materials. But we are now facing a sustained global downturn which will spark a demand shock.
The looming crisis is different in so many ways from the global financial crisis.
It is a health crisis that is spilling over into an economic meltdown rather than a financial crisis, although it has the potential to develop into a financial crisis.
This time, however, we are starting from a very weak position.
In 2007, the Reserve Bank was raising interest rates to cool an overheating economy so that when the crunch came it had ample room to slash interest rates as the Commonwealth unleashed the fiscal stimulus.
Right now, our economy is barely limping along.
The Reserve Bank cut rates twice last year before last week’s emergency cut to an historic 0.5 per cent low, the economy grew at a sub-par 0.5 per cent in the December quarter, and the bushfire crisis, coupled with the impact of the coronavirus, is likely to put us into reverse.
Last week’s GDP numbers showed, once again, that government spending and resource exports were the only things keeping us afloat.
Domestic demand — the bit you and I are responsible for — is hovering near recession levels.
As this graph from UBS shows, while consumption improved, business investment and dwelling investment have been in serious decline.
While we are yet to see details of the Morrison Government’s rescue package, its previous criticism about the Rudd government’s GFC response is likely to see it shy away from direct payments to households and be reticent to “go hard”.
There have, instead, been repeated reference to tax breaks for business.
But if business hasn’t been prepared to invest with interest rates at record lows, it’s unlikely a tax incentive will get it across the line.
Perhaps the biggest problem with our economy is household debt.
It is hovering at around world-record levels when compared with income at a time when wages growth is barely registering a heartbeat.
Despite this, as you can see from the graph above, consumption lifted in the lead up to Christmas, possibly as a result of the tax rebate and last year’s two rate cuts.
A boost to household spending power — whether it’s delivered through a lift in Newstart, income tax relief, or a direct payment — should deliver a boost to consumption, helping keep businesses afloat and workers employed.
Another possible measure could be a loan facility, not unlike drought relief to farmers, that would deliver a debt moratorium to small and medium sized businesses hit by the virus-induced downturn.
When even the base case looks ugly
A study late last week by McKinsey and Co, distributed to its clients, concluded that with the disease now established in four separate geographies — China, East Asia, the Middle East and Western Europe — we are facing a global slowdown, with consumer activity impacted until the end of September.
But it warned that a generalised global spread of the virus — including America and Africa — would tip the world economy into recession, with a demand shock that would continue through until the end of the year.
Even on its base case, McKinsey reckons tourism and hospitality — which employs just under a million Australians — will still be feeling the effects at the end of this year.
That’s worrying news for us because education and tourism are our third biggest exports.
Even on McKinsey’s more conservative base case, it’s likely large numbers of people will find themselves either out of work or not working enough, with many small businesses likely to hit the wall.
That in turn would hit our banking system, geared as it is towards overpriced real estate, with a rise in bad debts.
Let’s hope they’re wrong, for that’s when irrational behaviour takes hold.
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