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History and the Financial Crisis

Reading Time: 3 mins
  • Gary Hawke

    New Zealand Institute of Economic Research

In Brief

Most economic historians attribute the severity of the Great Depression of the 1930s more to mistaken policy responses than to the initiating behaviour of market participants.

An even stronger consensus among economic historians is that absence of international co-operation exacerbated the Great Depression.

What are the implications for our current circumstance?

Current discussion of fiscal stimulus assumes implicitly that government spending will be financed by borrowing. That is a welcome endorsement of the lessons of recent decades – we do not want another general inflation. But we should also note it means that people must be willing to hold government bonds.


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We are seeing an immediate lowering of interest rates as central banks judge that inflationary pressures will be restrained by fear of inadequate demand, and as central banks support government decisions to exert a stimulus. But borrowing programmes will put upward pressure on interest rates. We can be sure of short-term volatility, and we should expect that in the medium-term and longer-term interest rates will rise. Our challenges include slowing growth rates, not only for reasons such as global warming or the difficulty of achieving agricultural productivity increases, but also because of the impact of policy decisions being taken now. We should not lose sight of the role of policy in the severity of the Great Depression.

Fiscal stimulus is different from additional public spending. If spending were the road to prosperity, we would not wait for a crisis before embarking on it with enthusiasm. Much current discussion also implicitly assumes that resources are going to become unemployed, but we await real assessment of to what extent. As resources are not perfectly substitutable, we also need assessment off what resources are to be used for. It is obvious that opportunists are lining up to secure government subsidies for initiatives that are only loosely related to the global crisis. We should not forget what Asian economies taught us from the 1960s to the 1980s: that government should always facilitate adjustment and not protect declining activities.

Even interventions which are well-designed will impact differently on existing activities, benefiting some and disadvantaging others. Some unintended adverse consequences will fall on foreign interests. We will need to distinguish incidental effects from disguised protectionism. And we need to do so with sufficient credibility to dissuade knee-jerk responses. We will otherwise see a retreat from international co-operation, which characterised the 1930s.

There is a close connection between the requirements of sound domestic economic policy and avoidance of adverse international reactions. A key requirement is a credible surveillance mechanism to track any additional protection. This is essentially a proposal for transparency. It should include even ‘WTO-consistent’ increases in protection, not only because the well-known gap between actual tariffs and WTO-bound tariff rates creates a clear opportunity for ‘WTO consistent’ protectionism, but also because there will be genuine uncertainty over whether incidental protective effects of assistance measures adopted for other reasons should be tolerated. Individual government leaders may be uncertain, and tensions between government agencies will enhance or even create uncertainty. Two major implications follow from this:

  1. Compilation of the surveillance record should be entrusted to an independent economic institution. We cannot expect governments, with their need to retain political support, to be scrupulous in assessing what is unintended and reasonable from what is protectionist; and
  2. The mechanism should be regarded as a basis for dialogue, and not a list of transgressions. It is unlikely that governments would agree to the mechanism on any other basis, but more important, there will be room for genuine disagreement on whether a particular measure is justified adjustment assistance or additional protectionism, and constructive dialogue offers the best prospects for mutual agreement. Asian processes of agreed objectives and peer review of progress offers better prospects than Anglo-Saxon notions of accountability and monitoring.

This is an extract from an article which appeared in the EABER newsletter series

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