Budget 2010: How to thaw the economy

March 16, 2010

Anthony_Evans- Anthony J. Evans is assistant professor at ESCP Europe Business School. He will participate in a Reuters Budget live blog at noon GMT on Wednesday, March 24, 2010. Please tune in and join the discussion.-

We’re used to hearing how credit markets “froze” in the summer of 2008, and how the subsequent policy responses have been aimed at economic recovery. Indeed politicians often use terms such as “stimulate” or “kick start” to give the impression that intervention is a necessary prelude to growth.

An alternative view is that fiscal spending has sought to freeze economic activity, by preserving jobs and preventing the structural adjustments that have to take place.

What the economy needs is a widespread recalculation, where unprofitable businesses relinquish their scarce resources, and investors get back to investing. Evidence from the Great Depression in the 1930s shows that vast and arbitrary policy changes backfired, because they destabilised the investment climate.

It was only when government gave up that confidence returned. We now need to see a similar realisation that an economy’s strength rests on private investment, and that policy changes create regime uncertainty.

It is unlikely that an unpopular incumbent government would take the short-term pain that is necessary just before an election. However there are several reasons why the costs of recalculation are exaggerated. Recessions do not affect the economy uniformly, and the disruption they cause present massive opportunities for well-run businesses.

We are seeing high profits for companies that can navigate these difficult waters, with great rewards for acquisitions and foreign expansion. It is also possible for a majority of consumers to leave a recession with higher incomes than before it, challenging the notion that times are necessarily gloomy.

Therefore the debate about when to start paying off the debt is misleading – there’s no danger of endangering the “recovery” when we’re merely witnessing another artificial boom. Attempts to return to the high house prices, high consumer spending and high debt of 2006 completely misunderstand the structure of the economy.

I’d like to see serious attempts to deal with the debt crisis with significant cuts in government spending and innovative ways of raising money through the sale of government assets. But most importantly I’ll be looking for policies that reduce barriers to entrepreneurship – making it easier to hire employees, cutting red tape, and simplifying the tax code.

Politicians are trying to have a recovery without recalculation. What I’m looking for in the budget is the realisation that the economy has been made structurally weaker, and things are set to get much worse.

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