On downturns


I am not sure why we get so worried about economic slowdowns, and indeed economic crises. I always say the economy is a bit like navigating your way onto the furthest platform in a busy station at rush hour. You can see your goal, but the path you take to it is anything but a straight line. With large groups of people coming towards you, others cutting across you, others coming diagonally from behind, you have to weave and dodge to stay on target. Likewise in the economy: you are competing for scarce resources, the workers and skills and talent and office space and machinery and consumables that you need to create your product. And the people who are bidding for these same things have yet others bidding for things that they employ, so they too have to duck and weave.

Or as F A Hayek might have put it, the market economy is a highly complex co-ordination problem. You are trying to anticipate where people will go, even though they don't exactly know themselves, because they too are trying to reach their target destination while other people are unexpectedly getting in the way. In fact, like getting across the station, this economic co-ordination problem sorts itself out pretty well. But occasionally, people do not see someone else's change of course coming: in the station, that might mean getting held up in a knot of people; in the economy, it means firms suffering losses because their guesses about the future prove wrong. If enough travellers miscalculate, they get stuck in a bottleneck; if enough firms do, it's an economic downturn. Sometimes that just happens.

On the station, when you are jammed tight in to a crowd, all you can do is wait until the press eases a bit and then head for the nearest way out, even if it means a long detour on your route to the platform. In the economy, likewise, you have to let the downturn pass and then make the most of the new situation you find yourself in. You might also hope that the station authorities don't make the crush worse by closing some of the exits; and that the monetary authorities don't make the downturn worse by raising interest rates and leaving banks and businesses short of cash. Yet, as John Redwood shows in his ASI report on the crash, this is exactly what the Bank of England did after the first financial crunch – so precipitating an even worse crisis.

Keynsian economists used to boast that they had made modern economies depression proof. They reckoned that the answer to a looming downturn was to throw money at the problem, to spend your way out. What they forgot is that this simply fuels an unsustainable, accumulating boom, an economy on the drug of cheap money. When banks and businesses then start to suffer headaches, the authorities panic and rein back too fast, triggering a real crisis.

The odd downturn may be unpleasant, particularly for politicians and central bankers who like to promise us constant growth. But it has a theraputic function. Tougher conditions eliminate all those forms who were taking too many risks, and succeeding only because, on the rising tide of cheap money, everything succeeded. It forces closure or mergers upon those who entered with questionable business models, while clearing the ground for those who have entered with much better approaches, or who are able to make better predictions about the future economic environment. Far from trying to eliminate all downturns, we should welcome them – thus saving ourselves from stoking up a truly awful mega-crisis like the one we are in.