Structural reforms are what we need

At the beginning of this century the so called ‘new economy’ promised us a never ending period of economic prosperity. Economies had changed so much that recessions were something of the past and otherwise we could rely on the capabilities of (monetary) authorities to manage the economy in the right direction. Now, some say that a long period of stagnation has started. Only the government can save us, by spending lots of money. Both thoughts show that economic forecasts are often no more than extrapolations of present circumstances. Turnings are often overlooked. Another peculiar feature is to say that economic regularities from the past do not longer apply. Special circumstances require, so to say, special measures. The question is, however, what is wise economic policy?

First here is what we must not do:
· Increase government spending. This results into huge deficits and further increases the already enormous grip that governments have on economies in Western Europe. Eventually, the higher spending of today has to be covered by future taxation. According to an advice by the Dutch Council of Economic Advisors in 2005, lowering adverse taxes by 1 percent GDP will lead to an increase of economic growth by 0.1 to 0.2 percent per year. This doesn’t seem much, but accumulated over a long period of time it is enough to explain differences in economic growth outcomes in the western world between frontrunners and laggards. It’s rather odd to hear that some of these advisors are now recommending higher government spending and higher deficits. High taxes choke economic growth and hinder entrepreneurship and innovation. Every increase in government spending should be valued separately on its own merits. No extra money must be spend if there’s no economic return. Even if more spending would be a good idea, then it still takes time for the government to put together a sound investment programme. In the mean, time economic circumstances can be totally different. These stimulus packages have been called ‘straw fires’ by the German economist Sinn. They burn vigorously but after a short time extinguish quickly. Spending an extra 5 billion euro corresponds to 1 percent of Dutch GDP. This hardly makes a difference in stopping the economic downturn, but makes a significant contribution in derailing the government budget. This is because such a stimulus comes on top of an autonomous increase in spending, due to the working of ‘economic stabilisers’, such as extra unemployment benefits.
· Nationalisation of financial institutions. Governments should not buy financial institutions and should not intervene in the daily management of these companies. Extra funding by governments has by and large vanished due to the enormous depreciations on bad loans. Government ownership is no guarantee for good management, as state companies like the Dutch railways prove every day. The lack of markets explains recent failures of semi-public organisations in healthcare and public housing in the Netherlands (Orbis, Philadelphia, Meavita, Woonbron, IJsselmeerziekenhuizen). Often well-known politicians were on the governing boards of these organisations and unable to prevent bankruptcy and misuse of public funds.
· Interfere in remuneration policies in private companies. Remuneration is a matter of (individual) employers and employees or their representatives. Performance pay and bonuses have proved to be useful incentives for generating extra effort and therefore better outcomes. Excesses in the past have especially been caused by a distorted balance of power between shareholders and the board of directors. Introducing legislation based on jealousy is just as short sighted as some remunerations packages are.

What is it that we should do:
· Make better rules, that are enforced adequately, and restore norms and values. The present crisis has especially monetary causes, just as most economic downturns in the past. Expansionary monetary policies, especially in the US, has caused bubbles on asset markets that were not sustainable. Inadequate legislation and lax enforcement of these rules in combination with behaviour that rewarded an aggressive focus on making short term profits, gave the decisive and fatal push. On the one hand this shows the strength of the market mechanism, on the other hand it makes clear the necessity to control it in some way. New rules of the game, as agreed upon by the G20, are necessary as well as reforming the IMF and Worldbank.
· Focus on restructuring the financial sector. Government policies that try to maintain effective demand focus is fighting symptoms. How negative it is from a moral point of view, right now we need to free banks from their worthless assets. Let them go bankrupt is unfortunately no feasible solution. Authorities have forsaken their duties for many years and now can not afford not to interfere. The foregoing also means that authorities should restrict their interventions to the financial sector. The recession must do its healing work in the rest of the economy through a process of (creative) destruction. Car makers should be left alone by the government.
· Stimulate capabilities to adapt. The earlier the financial sector is restructured, the sooner the economy can recover. Measures that can increase the ability to adapt are therefore more than welcome. In the Netherlands firing costs should be lowered, combat the poverty trap that makes having a benefit financially more attractive than a low paid job, do not introduce part time unemployment benefits that lock workers in unproductive jobs etc. Internationally this means that world trade flows should go on. If the volume of world trade further decreases this will mean an enormous threat and will lead to a further deepening and widening of the recession by also lengthening it. Politicians and other authorities that are right now stumbling over each other to show how good they are in stimulating the economy by extra government spending, could much better have spent their time in finishing the Doha-round and concluding an agreement to further decrease obstacles for world trade. The decision by the EU to reinstall export subsidies for agriculture products is very damaging and shifts on the recession towards developing countries.

In the past, recessions have been used in the Netherlands for implementing structural reforms. This has made that our starting position is now much better than it was in previous recessions. Recessions are inevitable, good policy is a matter of choice.