What Recession?

I’m feeling the recession.  I’m sure you’re feeling the recession.  I know those 500,000 people who lost their jobs between July and October are feeling the recession.  But if you’re government its a case of, “what recession?”

I’m serious about this.  What’s going on is nothing short of a travesty.  The economy is contracting because an unsustainable credit boom (2003-2008) generated mal-investments in the economy.  The credit driven demand growth was false and sent incorrect signals to producers about the underlying real conditions.  When eventually those unsustainable conditions came to an end, as they always do, real conditions were exposed and investments were discovered to be redundant.  The mal-investments have to be liquidated to free up capital that needs to be invested in sectors/areas where real demand and return on capital is strong. 

That liquidation process generates a fire-sale of assets, hence we get asset price deflation in a recession.  The liquid assets get liquidated quickly so their price falls quite quickly and usually bottoms out before the recession is over.  The more illiquid capital takes longer to liquidate so those asset prices take longer to fall and can bottom out after the overall economic recovery starts.

The capital liquidation process can be a painful process for the sellers (but better than their next best alternative), but is a wonderful thing for buyers with cash as they can now snap up assets at realistic and affordable prices.

This whole process, along with the job losses that must necessarily accompany it, is part of what it means to ‘right-size’ for the real environment.  Households also right-size when they realise they’ve taken on too much debt and lived beyond their means.

Right-size.  What a great phrase.  Wish I had coined it.  Households and companies right-sizing during a recession is pure economic poetry.  Cutting away that which is inefficient, unsustainable and unproductive.  It’s not an option, it’s a fact of economic life.

But for government the rules seem strangely different.

I spent some time speaking to SA government officials this week about the recent budget announcement.  No, I’m not a very connected high-ranking member of the illuminati, but let’s just say I occasionally get access within certain open forums to engage with ‘lower high-level’ government ‘people’.  Something like that.  You get what I mean.

To say the least the encounter left me dejected, more disappointed about the state of public finances than I was immediately after the medium term budget announcement on Tuesday.  But I’m not here to tell you about my psychological state like an irritating over-Facebooked housewife.  I’m here to tell you about what the South African government is doing during the recession while all of us are right-sizing.

While we’re getting leaner and meaner, government is getting fatter and… couldn’t think of a good rhyming word with fatter.  Point is, government is not playing by the recession rules of right-sizing. 

Instead it’s super-sizing.

The graph below shows goverment spending as a % of GDP.  The graph doesn’t go too far back but if we took it back into the 1990’s it would sit somewhere around 22-24%.  The inexorable march of more government continues…

South Africa govt spending as a % of GDP - the inexorable climb...

Some quick rough numbers: SA’s total stock of government debt is currently about 23% of GDP, but with the current budget deficit, and the projections for 2010/11-2012/13 fiscal years it will climb to around 43-45% of GDP (note these figures do not refer to the above graph).  This projection is pretty worrying.  It got even more concerning when I discovered that this projection is based not on a conservative revenue projection by Treasury, but actually on an very bullish revenue forecast.

How bullish?  Well, Treasury is projecting a 28% compound annual growth in revenue collection every year for the next 3-4 years.  Let’s take off inflation and some real growth and it follows that Treasury will be hoping for considerable broadening of the tax net.  Officials admit this is a very optimistic ‘target’. (by the way, just as an aside, I get very nervous when government starts talking about ‘targets’ rather than ’forecasts’ when it comes to revenue but let’s leave that rant for another day).

But beyond the next 3-4 years government plans to increase the national debt to 50% of GDP.  After that their model gets “fuzzy”.  So who knows, if the president of the day decides he/she is comfortable with a 50% debt, maybe SA heads toward 60%, 70%, 80%?  Hey, why not just follow in the footsteps of the US and UK?

When challenging mainstream economists (who by the way are generally ga-ga over this latest budget) that government should be cutting spending to right-size and live within its means as we all must, I often get the stern response, “well where would you cut spending if it’s just so easy to do?”

Gee, let me think.  How does any organisation cut costs?  Take salary cuts or lose your job.  Cut back staff.  Streamline processes.  Source cheaper suppliers.  Lower incentive bonuses.  No vehicle allowances. No team building exercises.  Did I mention cut back staff. No entertainment expenses. No business class travel.  Cut back staff.  Require longer hours from staff.  Up performance targets. Drive VW Polos instead of expensive luxury sedans…the list is endless.

The point is simple:  There is simply no excuse for why government can’t live within its means like everyone else.  But there are at least two key reasons why it doesn’t. 1) Because it can (in the short term), and 2) because of Keynesian fallacies (also short-termism).

Government should try experiencing this recession along with the rest of us instead bloating out from seal to elephant-seal.  It might find the process wonderfully cleansing.