While the only real problem is to produce more and to consume less in order to increase the stock of capital goods available, the interventionists want to increase both consumption and investment. They want the government to embark upon projects which are unprofitable precisely because the factors of production needed for their execution must be withdrawn from other lines of employment in which they would fulfill wants the satisfaction of which the consumers consider more urgent. They do not realize that such public works must considerably intensify the real evil, the shortage of capital goods—Ludwig von Mises
Robust Recovery or Depression? Capital Consumption, Impairment of Demand, Production Imbalances, Economic Cost of Bailouts and More!
I. Robust Recovery or Depression? Five Reasons For Depression
II. The Escalation of Capital Consumption Means Economic Stagnation or Depression
III. Say’s Law: Production Stoppage Will Depress Consumption
IV. More Say’s Law: Interventions on the Production Chain Will Likely Have Lasting Effects
V. The Economic Costs of Bailouts
VI. See? The FIST Act: The BSP Proposed a Taxpayer-Consumer Bailout of the Banking System!
VII. Bailouts: The Political Rationing of Scarce Resources
VIII. Will Fascism, Regime Uncertainty, and the Ratchet Effect Fuel a Boom or Extend the Recession?
I. Robust Recovery or Depression? Five Reasons For Depression
Of course, there will be a rebound. But this bounce needs to be seen in its proper context.
A reopening from a forced shutdown is completely a different picture from an economy responding to the natural readjustments from the unwinding of existing imbalances.
If the politically imposed lockdown sent the economy spiraling down to a 20% level, from the previous 85% operating capacity, a push to 40% due to the reopening would indeed signify a bounce. But that’s far from the norm and is hardly representative of a recovery.
Yet, after failing to see this recession coming, public officials and experts have been lining up to assuage the public, by suggesting that from a statistical point of view, the economy would recover strongly next year. The Department of Budget and Management sees a 7 to 8% GDP next year! What a pipe dream!
And how is this powerful recovery supposed to happen?
The simplified answer: As popularly embraced, just throw an immense amount of money into the economy! Massive amounts of fiscal spending backed by a credit boom from the BSP's record easing of the financial conditions, and secondly, by the unprecedented scale of liquidity injections should prompt the economy to magically "heal as one"!
And throw in the Keynesian elixir mix of tax-cutting even as the nation register historic deficits! To further spice up the “recovery”, they also plan to expand bailouts and extend price controls! In short, the government's golden touch will do the trick!
Well, the market economy is not a homogenous blob that churns out a single product from non-specialized labor. It isn’t a knob to be opened or closed through political directive as popularly perceived. Instead, despite increasing political interferences, the market economy still represents a complex system operating under spontaneous order. For instance, does the government tell most entrepreneurs or firms whom to sell to?
Outside this halo effect, the economy will be reacting to two forces once the shutdown has been eased or lifted: One, the direct and indirect effects of the Enhanced Community Quarantine (ECQ) or the lockdown, and second, the state of the economy before the imposition of such repressive lockdown policy.
And let me enumerate 5 reasons why a robust recovery is unlikely to occur:
1. The ECQ intensified the process of capital consumption that existed before COVID19
2. The production stoppage translates to a structural impairment of demand.
3. Disruptions of the production process hinder output and raise the risk of imbalances.
4. Bailouts ain’t free! The BSP proposed a taxpayer/consumer bailout (FIST) of the banking industry.
5. The ECQ secured the shift towards a centralized economy, which should be reinforced by the ‘ratchet effects’. ‘Regime Uncertainty’ should plague investments.
II. The Escalation of Capital Consumption Means Economic Stagnation or Depression
The politically mandated economic paralysis forced not only a cessation of production, but it also imposed losses and joblessness into the system. Such massive losses translate into capital consumption or capital decumulation. It reduced the availability of capital goods necessary for investments, undermining the very foundations for a meaningful economic recovery.
And the accumulation of capital goods through savings expansion represents the most important ingredient of economic development.
In fact, we may say, and nobody can deny it, that all material progress, everything that distinguishes our conditions from those of earlier ages, is that more has been saved and accumulated as capital goods.
And it has not just been losses.
People's survival under the ECQ, importantly, depended upon the drawing from their limited pool of savings or borrowed from others. This financial drawdown exacerbated this process of savings depletion required for capital investments. Let us put aside the government lifeline for the meantime.
Capital goods come into existence by saving. A part of the goods produced is withheld from immediate consumption and employed for processes the fruits of which will only mature at a later date. All material civilization is based upon this "capitalistic" approach to the problems of production.
This scarcity of savings, a condition that persisted even before the ECQ, and which had been brought about by the BSP’s easy money policies magnified the lockdown’s financial damage to the households and the economy.
Figure 1
The lockdown simply exposed the fragility brought about by heavy dependence on credit than from savings to fund economic activities.
As a proxy, I used the ratio of the BSP’s total bank loans issued against savings to demonstrate malinvestments. The excesses of "forced" investments signified by bank loans relative to available savings exhibit the degree of misallocated capital.
As the great German and American economist Hans Sennholz explained[3]
As economic improvements may accelerate through ever higher rates of saving and investing, so may we see an accelerating process of capital consumption and economic decline. No matter what our incomes may be, if we consume more than we produce we are eating into our productive substance. And once we consume capital while stubbornly clinging to old levels of consumption to which we have grown accustomed, we descend at ever faster rates.
If the seeds have been consumed, then what is to be harvested when no planting ever took place?
Even this striking advice from an elite businessman and staunch ally of the administration to entrepreneurs recognize the importance of savings.
From GMA news (May 21): Presidential adviser on entrepreneurship Jose Ma. “Joey” Concepcion on Thursday advised small entrepreneurs not to tap their family savings to keep their COVID-19-hit businesses up and running once the lockdown measures are eased. In an interview on Dobol B sa News TV, Concepcion said the working capital of micro, small, and medium enterprises were already depleted and it will be a challenge for them to replenish funding since many banks may reduce their risk exposure amid the crisis. However, he said, that it may be best for small businesses to let go of their employees and close shop instead of using their own or their family’s hard-earned savings. [bold mine]
Though the advice seems sensible, it also incomplete, thus seemingly insensitive. Sadly, no alternative was provided for the option of PERMANENTLY laying off employees and the closing of small businesses! And without sources of income, the consumption of savings will remain the recourse of these countless number of hapless entrepreneurs and the unemployed. It’s like being caught between a rock and a hard place!
And does this advice, from a political stalwart, sound like a coming boom in the economy? Or is this portentous of an economic depression?
And here is another disheartening insight, the small-and-medium scale enterprises, the biggest providers of jobs to the economy, are the largest victims of the COVID-19 policies! This policy-induced erosion of competition only reinforces the interests of establishment elites by entrenching the monopolistic character of their enterprises!
And the distribution of the residual capital goods will further entrench this inequality.
Specific entrepreneurial activities determine the existence of diverse capital goods, which are subject to wear and tear, and importantly to changes in consumer preferences. As Professor Mueller wrote[4],
Austrian capital theory in the tradition of Menger, Hayek, and Mises reminds us that monetary saving is not necessarily investment, and investment is not necessarily capital formation which renders yields and could bring forth appreciation by some compound interest formula. Real capital does not exist as a homogenous lump in the sense that there is a capital stock that enters the production function to produce the national income. Real capital exists in the forms of diverse capital goods, and as such, they do not represent a source of a permanent income. In a nonstationary economy, capital goods render an income stream only insofar as they are constantly rearranged and renewed according to the changing market conditions. Capital without entrepreneurial activity is an empty concept.
This means the drastic changes in the economy, as a consequence of COVID-19 and the political response to it, would require more than the maintenance and replacement of the existing base of capital goods, it would necessitate the generation of new ones: capital goods catering to the new normal.
But even from the perspective of the elite enterprises, many of whom have wallowed on debt and have limited cash reserves, partly due to the losses imposed by the ECQ and mainly from the race to build supply bubble, how will new capital goods be financed, especially when banks retreat from extending credit?
And with limited access to credit, how much more for the SMEs?
The crux of the matter is: Before any boom will take place, savings will have to be rebuilt, and balance sheets will have to heal.
III. Say’s Law: Production Stoppage Will Depress Consumption
Widely underappreciated by the establishment is the impact of the sudden stop of production.
Aside from the financial losses leading to capital consumption, its effect on consumption is the other essential aspect.
Or, barely has been recognized by an establishment fixated on consumption as the be-all, end-all of the economy is that the production is the source of consumption!
Simply put, there can be no consumption without production.
Let me layout some examples.
While some technology may exist to support human life in space, it is not enough to generate commercial viability for people to enjoy space tourism and or tap natural resources through asteroid mining. Hence, while capital may have been invested for its development, these projects have not reached the stage for its commercialization. So even with so much money floated today by central banks, space tourism and asteroid mining have yet to come into existence!
Another instance, if one is stranded in a far-flung island detached from modern-day civilization inhabited by primitives, who depend on hunting and gathering, no amount of money will enable that person to purchase a Mercedes, and or, a Rolex, and or, other luxuries of modern-day society. Reason? Because these items do NOT exist on the island!
And coexistence by interacting with its denizens won’t come easy. First of all, these inhabitants don’t recognize money. Next, if one can convince them to trade, one would have to have products to offer in exchange for their products.
Or, for a trade to take place, to gain access to consume their products, one has to offer something of value to them. Trade will then take place in the form of barter: exchanging of goods without money.
The concept is similar even in this modern era. The difference is that exchange through barter has been substituted with money, functioning as a medium for such interactions.
That supply must precede consumption represents Jean Baptiste Say’s Law of Markets or the eponymous “Say’s Law” in action.
People work for producers and for service providers to generate income (purchasing power) for consumption.
So when politicians decree the cessation of producers and service providers to do business, the equivalent destruction of supply translates to the devastation of income for the producers or service providers (capitalist and or entrepreneur), their workers, and suppliers.
And since such repression will likely put many producers and providers out of commission for good, this should redound to a lasting shrinkage of demand!
But there is more than meets the eye.
IV. More Say’s Law: Interventions on the Production Chain Will Likely Have Lasting Effects
And like the economy, production can hardly be opened or closed like a knob or a faucet lever.
That’s because production entails entrepreneurial and corporate activities of anticipation of demand, estimation of costs, all guided by pricing signals, the planning, organizing, mobilization, and coordination of inputs and workers with the production, post-production, and the distribution process.
Furthermore, many other firms are associated with a production outfit by providing different inputs or services necessary for the completion of its operations.
The thing is, production is interrelated with and interdependent on the market economy.
Hence, “any stoppage or disruption in manufacturing processes and employments in any one or more of these production stages”, writes Professor Richard Ebeling[5], “threatens, in principle, the ability for production to continue smoothly through time so the final good is available in particular amounts to the consumers wishing to demand it, period-after-period.”
More importantly, government interventions not only disrupt the process but also prevent producers from undertaking the necessary adjustments to cope with the changing environment.
Again Professor Ebeling, “Market relationships are too complex and overlapping for any but those in the production processes themselves at each of the respective stages of production to fully and effectively know and understand what needs to be done in changing market conditions to substitute particular resources and types of capital and labor from some parts of the structures of production to others as communicated and discovered through the relative patterns of prices and wages that convey the needed knowledge to make informed decisions so to keep productions moving forward with minimal breaks and disruptions in and across markets”
That said, the massive interventions into the economy through the “loosening the lockdowns in “steps” over time misses the central point that all markets and the actions of the people in them are interconnected in ways that releasing some while delaying opening others threatens a successful restoring of productions and employments as soon as possible to rapidly escape from the government-created economic chaos in the shortest possible period of time without introducing other imbalances and shortages that need not happen, if not for continuing government involvement”, concludes Mr. Ebeling.
So temporary disruptions on the production chain would likely have lasting effects.
Hence, the formation of imbalances, possibly vented as shortages, will impede any material recovery from taking hold.
Therefore, the longer these interventions take hold to disrupt the production side of the economy, the larger its adversarial effect on demand, and output over the longer term.
V. The Economic Costs of Bailouts
Work stoppages constitute only part of the political program of the general policy of a large-scale community lockdown.
Many other interventions, to supposedly mitigate its harmful direct effects, had likewise been implemented.
Indemnification of targeted sectors with cash transfers (called cash subsidy), a declaration of holiday on payments of interests, penalties, fees or other charges on loans issued by formal financial institutions, deferment of payments on loan principal and rents, injections and easing measures, as well as enforce price control and related anti-hoarding or profiteering, and more, are among the economic measures instituted.
Figure 2
Various stimulus programs have been submitted, centering mainly on a surge of public spending on targeted sectors. Aside from its stimulus plan, the DOF proposed a massive tax cut (CREATE bill), which ironically comes in the face of massive deficits! The Department of Budget and Management’s latest deficit-to-GDP projections signify a staggering 8.1% in 2020 (!), 6.7% in 2021 (!), and 5% in 2020(!). Yet, the DBM’s GDP and revenue projections seem overly optimistic.
While tax cuts should be welcomed, surging deficits are incompatible with it. That’s because deficits, as a result of BIGGER spending, ensure HIGHER tax rates over time.
The key focus should not be on the budget deficit as such but rather on government outlays: it is not possible to effectively lower taxes without a reduction in government outlays.
This is because the government as such is not a wealth generating entity. In order to fund its activities it has to take resources from the wealth-generating private sector. Various individuals employed by the government expect compensation for their work. The government can pay these individuals by taxing others who are still generating real wealth. By doing this, the government weakens the wealth-generating process and undermines prospects for genuine economic growth. (We ignore here borrowings from foreigners).
In other words, all the proposed shebang of “stimulus” via throwing money to the economy will likely benefit some groups at the expense of the larger segments of the population, who will have to bear the significant share of redistribution.
Furthermore, the bigger the public spending, the larger the likelihood of misallocation of capital that leads to more capital consumption. (see Mises heading quote)
Moreover, since debt will have to finance such outsized deficits in the interim, this raises the risk profile of both the government and the financial system. Even the National Government have come to realize of the magnified risks from these.
According to the Inquirer (May 23), “To finance these huge budget deficits, the government will have to borrow from multilateral lenders as well as issue bonds onshore and offshore, although the report warned that “increased risk aversion of investors can lead to an increase in borrowing costs” in the near term.”
And if the BSP’s digital printing press will be used to finance this public spending spree, imbalances and dislocations brought about by inflationary policies will ultimately lead to a greater economic breakdown.
Printing of money won’t magically produce rice, capital goods or restore business solvency.
Yet, that is where we’re likely headed.
VI. See? The FIST Act: The BSP Proposed a Taxpayer-Consumer Bailout of the Banking System!
This week, the BSP proposed to Congress to enact a law, the Financial Institutions Strategic Transfer (FIST) Act, which would transfer the banking system's bad loans, to the newly established Special Purpose Asset Vehicle platform.
The FIST essentially represents a taxpayer bailout of the banking system!
So haven’t this author been right about the banking system?
And here’s the thing.
Supposedly to help consumers, the Bayanihan Act institutionalized a holiday on interests, penalties, fees, or other charges plus a grace period on the principal of all loans issued by private and public banks, quasi-banks, financing companies, lending companies, and other financial institutions. The BSP declared its extension this May.
The odd part is that these lending institutions took the brunt of these government-imposed losses, which has worsened the imbalances of their balance sheets even during the pre-COVID period.
And to save the same institutions, consumers are being asked, by the BSP, to bear the costs of the bailout! That is, higher taxes and or the inflation tax reduce consumer spending*. Hence, the BSP is seemingly engaged in a bait and switch. It proposes to save consumers today but will tax them hard tomorrow.
But there’s more.
Figure 3
The BSP’s FIST highlights the arbitrariness or inequity of bailouts by socializing losses while privatizing profits! Or, in a crisis, taxpayers are forced to pay for the sins of banks, while in good times, banks pocket huge profits(2009-2013).
Hence, because of the implicit guarantees provided by the BSP, bankers engage in reckless risk-taking behavior.
Think of this, if the foundations of the Philippine banking system have been solid, or "robust" as popularly advertised, why the avalanche of bailout measures? Why should a doubling of NPLs even bother the BSP?
Why can’t the industry’s supposedly "sound" capital base absorb such losses? Why should the banks be relieved of their accountabilities, or for the rampant engagement of carefree lending and investing? After all, won’t transferring losses to the taxpayers promote more moral hazard, as above? How will this be beneficial to the economy?
VII. Bailouts: The Political Rationing of Scarce Resources
And it tell us of the nature of bailouts.
Who is to tell which companies are deserving life or death?
Since the popular industries have business models built on the premise of high pedestrian traffic, which fundamentally goes against the predicate of COVID-19’s physical distancing, who is to tell where support must go to?
Here is an example. From the Inquirer (May 15): “Acting Socioeconomic Planning Secretary Karl Kendrick T. Chua said the proposed Philippine Program for Recovery with Equity and Solidarity, or PH Progreso, being pitched by the Duterte economic team to Congress seeks to grant large companies “equity support to match bank lending with conditions.” “I remind everyone and the industries who are asking for help the two economic principles—number one, nothing is free from heaven; number two, there’s a trade-off—and we will apply them,” Chua told members of the Financial Executives Institute of the Philippines (Finex) during its general membership meeting.” (bold mine)
While it is delightful to see that the acting NEDA chief seems to be on the same page with us when he asserts from the premises of “no free lunch” and “tradeoffs”, what are his opportunity costs in proposing to save specific “large” firms? Why should large firm A be better than another large firm B or C or D? Shouldn’t the consumers decide on this?
Given their heft, sophistication, the scale of market share which they cater to, and access to credit, why extend bailouts to them? If the pandemic has changed consumer behavior, wouldn’t such obsolete business models fail? Why should taxpayers carry the burden of their errors?
And wouldn’t political rescues only promote the survival of zombie companies that compounds on the systemic inefficiencies that would diminish economic dynamism and progress?
Yet are bailouts necessary?
Has the NEDA chief’s tradeoff been a matter of choice from a pool of options of categorical political interventions to attain the welfare economy’s Pareto Efficiency?
Has he ever considered the free market as the fundamental premise for balance sheet restoration through savings and capital accumulation as an alternative?
I guess not.
Or, will political connections, and affiliations ultimately determine who gets bailed out?
VIII. Will Fascism, Regime Uncertainty, and the Ratchet Effect Fuel a Boom or Extend the Recession?
The lockdown has cemented the Philippine political economy’s transition towards a socialist state.
Not only have the property rights of individuals and businesses been shred to pieces, but substantial increases in regulations, in the cover of physical distancing, will now determine the existence of enterprises. Goodbye to the 1987 Constitution’s Bill of Rights!
And not only have price and supply controls been expanded, but the state has now a say on how businesses should conduct their operations.
For instance, prohibitive guidelines discouraging crowds await the reopening of shopping malls. Salons and barbershops and other industries including transport groups may be allowed to operate under strict health protocols.
The deluge of restrictive regulations will strangle mostly small businesses out of existence.
From GMA News/MSN (April 29): The Employers Confederation of the Philippines (ECOP) on Wednesday said small and micro businesses may just close their operations altogether than comply with the strict health protocols against the COVID-19. Interviewed on Dobol B sa News TV, ECOP chair Sergio Ortiz-Luis Jr. said these businesses, which makes the 90% of enterprises in the country, do not have enough resources to continue their operations unlike large businesses. (bold mine)
In effect, by weeding out the competition through arbitrary political obstacles, the nation’s economic structure will gravitate into a few big firms, which will operate as pseudo-cartels controlled by the state!
Participatory Fascism, as Professor Robert Higgs, wrote[7], is a system in which nominal private-property rights exist in most resources, but these rights are subject to pervasive state abridgment and restriction. Private markets operate, but only within the extensive constraints imposed by the government. Many producers—now often referred to as “cronies”—enjoy special privileges or protections created by government restraints and penalties imposed on competing producers. Such pervasive government interference also exists in markets for labor, natural resources, intellectual capital, and other inputs in the productive process.
What distinguishing advantage does a fascist political economy have over a market economy in crisis management?
Even from the business perspective, would investors see the diminution of private property, magnified intrusions by the government on business and social life, the political allocation of capital and credit, and financial repression as a fertile ground for private investments? Or, would such policies deter investments due to what Professor Higgs calls as ‘Regime Uncertainty’[8]?
And exactly how would a cloud of regime uncertainty fuel a boom in the economy?
Finally, many would like to believe that the current policy response represents a temporary measure against the pandemic. History and theory tell us otherwise.
First, the public typically embraces government in a crisis.
Again Professor Higgs, “A crisis alters the fundamental conditions of political life. Like a river suddenly swollen by the collapse of an upstream dam, the ideological current becomes bloated by the public’s fear and apprehension of impending dangers and its heightened uncertainty about future developments. Bewildered people turn to the government to resolve the situation, demanding that government officials ‘do something’ to repair the damage already done and prevent further harm.”
Next, bestowed with newfound power, the political regime will likely lock into this power by absorbing such temporary programs (or parts of it) into the system. Professor Higgs calls this the ‘ratchet effect’[9]. That’s because a coalition of special interest and political groups will work to preserve the benefits from these.
Again Professor Higgs: “Attempts to eliminate or diminish emergency programs, run up against a fundamental principle of political action: People will fight harder to keep an established benefit than they will fight to obtain an identical benefit in the first place. This asymmetry assists every effort to hang onto iron triangles created or enlarged during a crisis.”
Let me end this outlook with a germane but powerful quote from former White House Chief of Staff to US President Obama in reference to the bailouts during the Great Financial Crisis in 2007:
You never want a serious crisis to go to waste. And what I mean by that [is] it's an opportunity to do things that you think you could not before.
[1]Ludwig von Mises, The Making of Modern Civilization: Savings, Investment, and Economic Calculation, Mises.org
[8]Robert Higgs, Regime Uncertainty Why the Great Depression Lasted So Long and Why Prosperity Resumed after the War, Independent.org 1997
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