Recession

Is the headlines in today’s newspapers all around the world show, there is a global economic slowdown.  Economies all over the world are being plunged into what is tentatively being called “Recession.”  While there are those who believe that this is simply an expected trend given the rapid growth of the global economy, it still does not detract from the fact that it is an urgent and pressing problem.  In order to address this problem, several governments have issued massive bail-outs and laws designed to manage the system.  In line with the principles of Keynesian Economics, it seems that the government is the only player capable of solving this problem.  It is this government intervention through the Federal Reserve, led by Ben Bernanke, that is touted as the solution to the country’s, if not the world’s, economic problems.

According to most economists, the current bailout scenarios that have been presented are nothing more than prime examples of throwing good money after bad.  Instead of tackling the problem head on by implementing sound fiscal and monetary policies, the United States government is bent on revitalizing the economy by allowing massive losers such as the AIG group to continue accumulating losses and patronizing its already proven bad habits.  The main strategy here, as employed by Chairman Bernanke, is to pump prime the economy through a mixed strategy of monetary and fiscal policies.  It is posited that increasing funding to these “black hole institutions” will be the key to ending this financial crisis.

As such this brief discourse will seek to address the question, While facing the economic downturn, should U.S. continue to remove restrictions on free trade or should it pass protectionist trade policies?, in light of the current causes for the economic crisis and the impact that a protectionist policy would have vis-à-vis a free trade market similar to laissez faire economic theory.  It will briefly discusses the different approaches to market and free trade in line with the model of David Ricardo and comparative advantaged, juxtaposed against more contemporary thinking as that of Joseph Stiglitz and John Maynard Keynes.

Approaches to Market:

In order to arrive at a better understanding of this problem, the main reasons for the collapse of the American Economy must first be examined because any solution that is provided must deal with the foundations of the problem.  The fundamental flaws and structural weaknesses of the American economy are not only more visible now but also more potentially damaging.  The much touted and highly publicized US $700 billion bailout plan is argued to be good for the economy as a “quick fix” to the problem yet there are a number of economists who feel that the real solution to the problem lies in establishing more solid fiscal and monetary market fundamentals.

In order to effectively argue which type of economic policy would be more effective, it is important to first understand the current market situation.  As the headlines in today’s newspapers all around the world show, there is a global economic slowdown.  Economies all over the world are being plunged into what is tentatively being called “Recession.”  While there are those who believe that this is simply an expected trend given the rapid growth of the global economy, it still does not detract from the fact that it is an urgent and pressing problem.

There are two ways by which the problem can be addressed.  The first method is through the application of the Laissez Faire method, which basically dictates that the market should be left alone to resolve the problem, and the Government Regulation, which is the policy that the governments around the world have taken.  The first part of this discussion will outline the reason why a free market system should not be adopted while the second part and the conclusion will show the necessity of reducing government intervention.

As the current economic meltdown shows, it is argued by many that there is indeed a dire need for government intervention.  At the peak of the Great Depression, John Maynard Keynes advocated for government intervention so solve the problem.  Similarly, the US $700 Billion bailout plan mirrors the type of government intervention that stopped the Great Depression.  The reason this policy was effective was because it negated the effect that other negative forces had upon the economy.  Without the ease by which goods could travel, such as in the present, the economy had to be resuscitated by the government.  As history shows, the solution lies not in letting the market forces dictate the flow of the economy alone but by allowing the government to regulate such flow.

The great danger in allowing a free market economy is that it does not allow for regulations.  We exist in a global market.  An action in one end of the world invariably affects the other side.  As such, care must be exercises, especially with regard to economics because of the repercussions that it might have.  The more complex markets of today have shown that the pursuit of self-interests, while natural of human behavior, must be regulated by external systems in order to ensure a more equitable and efficient allocation of resources.

Government intervention has been heralded as the solution to the inefficiency of markets because of the fact that it allows for a more efficient and effective distribution of resources among the players in the market.  As the government is but a tool, a conduit, for the movement of resources, it is, therefore, but logical to argue that in order to achieve optimal efficiency in the economy, there must be government intervention.  Without this, markets will collapse, as the recent economic meltdown has revealed.

This view is similar to that of classic economists who have always held that the ideal and optimal economic performance is determined by the degree of involvement of market forces.  Recent economic models however have shown that when the interests involved are public goods, there is a need for a certain level of government intervention.  This study therefore seeks to examine the situation in a welfare state and allowable state intervention to produce a successful and progressive economy.

Mainstream neo-classical economic theories, however, discourage too much state intervention.  It is the belief of these economists that too much state intervention unduly restricts the possibility of conducting free trade.  It is the theory that the perfect economic model can only be achieved in a laissez faire model (Brebner, 1948).   Later economic theories however take a different stand from the neo-classicists in that they postulate that there is a need for government intervention up to a certain extent.

Russell Roberts, however, in his article entitled, A Marvel of Cooperation: How Order Emerges without a Conscious Planner, argues that there is no such need for massive government intervention because economics has a way or bringing about order in life.  Citing the teachings of Hayek and Frederic Bastiat, he effectively argues that the workings of the markets do not need government intervention or guidance for it to flow.  He essentially argues that the time for Keynesian Economics has passed.  The application of government regulation and intervention techniques are no longer as effective as they used to be.

The previous arguments on the matter have taken the side of government intervention in order to mitigate the perceived “harmful” effects of a regulated market.  Classic economists have always held that the ideal and optimal economic performance is determined by the degree of involvement of market forces.  Recent economic models however have shown that when the interests involved are public goods, there is a need for a certain level of government intervention.  Mainstream neo-classical economic theories, however, discourage too much state intervention.  It is the belief of these economists that too much state intervention unduly restricts the possibility of conducting free trade.  It is the theory that the perfect economic model can only be achieved in a laissez faire model.   Later economic theories however take a different stand from the neo-classicists in that they postulate that there is a need for government intervention up to a certain extent.

Perhaps the wisdom of the words of Russell Roberts is more evident in the manner by which governments all over the world have reacted to the recent economic crisis.  The current economic crisis that has rocked the global economy has prompted many countries to take drastic measures in order to deal with the situation.  The Federal Reserve and the National Treasury have also teamed up to deal with this global economic crisis by instituting several reforms and policy changes.  With the goal of providing an immediate and permanent solution to the problem, the Treasury, with the help of the Federal Reserve, has instituted these fiscal policies to alleviate the situation.

Fundamental Issues:

The issue on implementing a protectionist stand as opposed to a free trade policy can be seen more clearly by analyzing the root cause of the problem.  The problems have long been detected are can be clearly seen in the reasons why the United States economy is currently entering a recession.  Problems such as mounting public debt and pension underfunding have been caused by the poor monetary and financial policies that the Federal Reserve and the National government have planned.  The first problem, Pension Underfunding is a very large problem for the American Economy.  According to certain independent studies, the underfunding that large companies have done for the pension plans will result in a very large public deficit in the future especially if the Pension Benefit Guaranty needs to bail out these companies.  The problem here is that the present workers and future pensioners are working without any future security.  There is no guarantee that upon retirement they will be able to receive anything.  This could spur an attitude of non-spending and result in an economic slowdown.

Another effect that this problem could have is on the healthcare system.  Without the financial security that the pension provides, the American healthcare system could bear the burden of millions of pensioners all seeking aid.  The healthcare cost in the United States is becoming excessive and people are unable to afford or obtain any type of healthcare. It cannot be denied that there is something wrong with the system today. The rate of the uninsured and underinsured is rising every year. Not having health coverage leads to 18,000 deaths a year (Davis 23).  A Universal Health Care system is to ensure that all residents, regardless of their position in life, maintain coverage in the event of injury or the need to pursue a general practitioner.  This type of system would increase taxpayer dollars, burden the government when funding is not available, cut funds from certain programs, and increase the number of patients to each nurse.  Thus, by having a weak pension fund the healthcare system of the United States could be affected thus increasing the financial burden upon the American government.

The Second problem is the ever growing public debt.  The recent economic slowdown as caused by the collapse of the Housing market has shown that there is no solid economic backing for many financial institutions.  In an economy where the public debt has amounted to over seven trillion dollars (US$ 7 trillion), it becomes clear that this problem is something that the future generations will have to deal with.

The problem with having a huge amount of public debt is that it could affect the debt servicing of the country.  At present, the United States spends nearly 10% of its Gross Domestic Product on debt servicing, with the increasing public debt and the maturity of these loans, the United States could have to increase the amount that it spends on paying back these loans.  The end result of this is that there could be a slowdown in the development of public services and also in the construction of public works.

In order to meet these payments, the United States government could be forced to increase taxes and cut back on public spending.  The net effect of this policy will be to make the economic struggle even worse.  Without the necessary government spending, the public would be wary about spending and would instead focus more on saving in order to anticipate future economic reverses.  This would result in a general economic stagnation.

Analogous to the collapse of the Housing sector is the collapse of the very houses that are erected.  It may be unfortunate to state that the woes of the Housing sector have only just begun but that is the case at the present.  The overbuilding that has happened in coastal areas and earthquake territories can result in massive property damages.  As the aftermath of Hurricane Katrina has shown, a single powerful hurricane could instantly wipe out billions of dollars worth of infrastructure.

The reason that this is a problem can be explained through this simple GDP explanation.  The basic GDP equation includes the amount that the government spends on infrastructure and the rechanneling of funds into the private sector.  In this model, the investment that a government makes in preschool programs creates more jobs and better opportunities for young students.  This directly affects the productivity curve of the populace therefore making it into an economic activity.  On the other hand, the new military weapon system is also another way of increasing the GDP because it creates more jobs and increases government spending in that economic sector.  The spending on healthcare and the controls that are placed on the internet can also be considered as economic issues because they directly and indirectly affect the amount of money that people will spend on these activities.  Stringent government regulations on the internet could stifle its economic growth.  Alternatively, by subsidizing the cost of healthcare, the government could make it more available and increase human capital investment.

Since the GDP of the government will be used to deal with the potential property damage should a single calamity occur in any one of these areas, the rest of the economy will suffer because the funds that are needed will be diverted to relief efforts.  The government is currently offering a number of subsidies to these companies and is therefore encouraging people to allow the government to bear the burden.  This is a serious economic flaw that must be addressed.

One of the problems, which are related to the first item, is the low savings rate which results in the reduction of social security.  The lower savings rate means that there could be a shortfall of nearly four trillion dollars (US$ 4 trillion) by the year 2017.  People are not inclined to place their savings in what they consider low return policies and instead have shifted to greater consumer spending.  While in theory this could be good for the economy, in the long run, this could result in more trouble.

With people less inclined to invest their funds or to save their earnings, there is a decrease in the amount of capital funds that are available in the market.  This in turn results in a slowdown of new comers into the market due to the scarcity of capital funds.  Greed as a regulator in a capitalist market functions in a similar way.  In what is termed as the “balancing mechanism” of greed, the capital that is infused into any industry or business will always look for the cheapest source.  Given this behavior, it is logical to assume that this capital will go to places where labor and materials are cheap.  This low cost will not remain forever and will eventually force the prices of the factors of production up and by doing so removing the advantage that was sought after in the first place.  This in effect levels the playing field and regulates the market.  The recent decrease in savings, however, will not create this scenario and will instead force the capital elsewhere and adversely impact the American economy.

Finally, the most serious problem is the large dependence that the United States has on oil.  The recent economic situation of the United States could arguably be better were it not for the exponential increase of oil prices.  As the world’s largest importer of oil, the United States spends a large amount of its funds on energy and energy alternatives.  It can even be argued that the total cost of most goods produced is attributed to oil costs.  The problem here therefore is the reliance that the United States economy has upon oil imports.  Any slight increase can drastically affect the American economy as we can see at present.

As such, it is clear that if the Federal Reserve had implemented any real policies in the past three years, there problems could have been averted and the entire crisis could have been avoided.  As it is, however, the reality is that there is a crisis.  The best thing to do right now is wait it out and learn from the lessons of the past to ensure that this does not happen in the near future.

Embracing Globalization:

Globalization is often an impressive word to use during debates concerning terrorism, political policies, economics and even sociology.  Yet more often than not, this term is applied in the wrong context.  Globalization is properly understood as primarily an economic concept; a term for the complex series of economic changes seen as increasing interdependence, integration and interaction between economies in disparate locations. Yet Globalization can also be understood from another perspective.  Globalization is not simply an integration of economies and markets but also the interaction between cultures and people (Giddens 2000).  There is much more to Globalization than just simple economics as the exchange of technology and ideas, while these are generally considered as an economic factor, is facilitated and considerably increased causing the improvement of different parts of the world and bringing them closer to the world standard.  Given that Globalization can mean so many different things, it is important to first analyze and examine the various aspects and contributions of this concept before coming up with a proper characterization of the concept of Globalization and its effect on developing countries.

A proper understanding and appreciation for the concept of Globalization necessitates an examination of the various benefits and effects that it has had on a world scale.  The first and more obvious effect that is attributed to globalization is the market-oriented aspect or quite simply put the economic benefits.  While there have been numerous discussion regarding the true economic impact of globalization on the world economy, it is clear that globalization has united all of the world economies and created a single world market for every country to be able to participate in (Micklethwait 2000).  The increase in trade between countries and the speed by which new technologies can be acquired erases previous advantages that other countries possessed in the manufacture of goods and can be said to have leveled the economic playing field to encourage the entry of new comers.  The overall effect of this is the creation of more jobs and the increase in overall market productivity for the countries involved.  A single country which previously could only trade with its neighboring countries can now market its goods internationally and increase its income and promote economic growth (Friedman 2000).  Globalization can therefore be said to provide a larger market for economies to encourage their growth by providing access to newer markets that were previously inaccessible due to geographical and political restrictions.

The impact, therefore, on developing economies can be two sided.  On one side, globalization can said to be the boon that these countries need to jump start their economy.  By granting access to another market, developing countries can increase production and even gain more access to capital which is essential in the take off stage of any developing economy.  On the other hand, the same access is two way.  It also provides access to the local economy for foreign goods and creates competition that could prove to be unhealthy to fledgling economies.  The answer must therefore lie in the intangibles that globalization brings to developing countries such as the transfer of technology and culture.  By encouraging trade, developing countries are able to learn from others and improve their methods to allow them to compete on a global scale.  This is benefit that globalization brings to a developing country.

 

Conclusion:

The answer, however, clearly lies in the road less travelled.  Laissez Faire should be adopted by the world markets in order to address the current economic woes that global economies are facing.  Laissez Faire has a distinct advantage because it will allow the emerging markets to reach their full potential without government regulations that stifle their growth.  China will be able to emerge as a legitimate economic global power once the trade restrictions are eased.

The time for Keynesian Economics has passed.  The application of government regulation and intervention techniques are no longer as effective as they used to be.  Since the problem was caused by government intervention in the first place, it stands to reason that the solution may not possibly lie in that area.  Laissez Faire can, and will, create an avenue of growth that will solve the global slowdown.  The free market system will be more reactive to the real world scenario and will bring solutions to the current economic problems.

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Kansas, Dave (2009) The Wall Street Journal Guide to the End of Wall Street as We Know It: What You Need to Know About the Greatest Financial Crisis of Our Time–and How to Survive It (Paperback) Collins Business ISBN-10: 0061788406

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Taylor, John (2009) Getting Off Track: How Government Actions and Interventions Caused, Prolonged, and Worsened the Financial Crisis ISBN: 978-08179-4971-6
Pub Date:  February 26, 2009