Whether one is a nation, an individual, or a corporation, it does not do to enter a tougher environment without the financial wherewithal and without a plan, writes Kyran Fitzgerald
Sooner or later, a downturn in our economy will come calling. It is the repayment that comes after times of plenty.
Farming families tend to understand instinctively that good times never last forever. Last year’s bumper crop, or price, gives way to this year’s shortage or revenue meltdown.
Those living in cities are perhaps less likely to accept that this is simply a fact of life and more likely to play the blame game when things go wrong.
We are five to six years into an economic recovery which many regard as our due after the big economic freeze of 2008 to 2012.
A variety of events starting with a mishandled Brexit, a conflict and-or financial meltdown could serve as the trigger, but the truth is that the good times do not go on forever, regardless of the circumstances.
Naturally, people focus on the problems that accompany prosperity, in particular, in the area of housing. But we need to take care to curb public and private spending so as to give ourselves room for manoeuvre in a downturn. The recent crash taught us some hard lessons.
We learned about the dangers of over borrowing at personal, household, corporate and national level. We discovered just how quickly borrowing costs can soar as confidence evaporates. It is sound economics to keep back funds for difficult times.
The finance minister has recognised this by allocating €500m a year to a rainy day fund, though €1.5bn is coming from the country’s sovereign wealth fund, a case of robbing Peter to pay Paul. Are we really doing enough to put aside funds for this event?
Governments need to keep decent reserves for priming the pump when finances are tight.
It makes sense from a business point of view. In harder times, you get far more bang for the taxpayers’ buck. Capital projects are less costly. Labour is cheaper.
But could the Government go further by selling off more State assets at a time of buoyancy in the property market and putting the proceeds into an enlarged fund? Total public expenditure in Ireland is now close to €60bn a year.
In this context, an annual €500m down payment is a modest sum indeed.
In the US, there is concern that “only” eight states have rainy day funds equivalent in size to 10% of annual expenditures. We are still way off what in our case would be a €6bn target.
We need to learn the lessons from previous recessions on the best methods of combating downturns. The Hamilton Project at the US Brookings Institute has come up with interesting findings. It examined measures undertaken during the great recession in America 10 years ago.
While the US Fed’s easy money strategy primed the pumps, then President Barack Obama administration’s fiscal stimulus also helped to shorten the downturn. The US emerged from the crash much more quickly than Europe.
And the most effective individual measures? Programmes aimed at lower income people much more inclined to spend those funds quickly and in their local districts.
Economists such as Alan Blinder have concluded that public spending was more efficient than tax cuts in fostering recovery. However, well-targeted tax cuts also helped. The most effective being increases in child tax credits (seen as six times as effective as accelerated depreciation aimed at boosting capital investment by firms). However, economists also concluded that safety net programmes varied greatly in their effectiveness.
In the great recession, employment among males without a high school qualification fell 13%. The already poor and the young were hit hardest and have been slowest to feel the benefit of recovery, though most of the US is now at full employment. The next downturn could be accompanied by a rapid increase in the use of artificial intelligence leading to a sudden displacement in middle-level jobs.
Policymakers could face different challenges. One piece of advice to households would be to keep levels of debt at modest levels. There are signs that Irish people have learned the lesson of 18 years ago and that debt is still being paid down. But there should be real concern about the Government’s failure to run a surplus at the top of the cycle, given the size of our national debt.
Businesses too should be alert to the experience of firms during recessions across the past few decades. Harvard academics Ranjay Gulati and Nitin Nohria studied 4,700 companies, examining their response to recession. They looked at three American recessions: 1980 to 1982; 1990-1991; and 2000 to 2002.
The periods covered included the three years before the recessions and the three years after the recessions. The picture is not a pretty one. Four in five of those that did not regain pre-recession sales levels.
Interestingly, firms that cut costs faster and deeper did not flourish. Such firms had only a one in five chance of pulling ahead of the competition when things got better. Equally, businesses that boldly invested more than their rivals did not fare particularly well either.
The real winners were those companies that combined defence and offence, cutting costs while investing for the future and when it comes to cutting g costs, securing efficiencies in operations and in supply chain management would appear to be the way to go.
Firms that slashed their workforce ended up with lower staff morale and found that they had lost much of their expertise. When the recovery came, they often had difficulty filling the gaps that had opened up.
They lowered head-counts, preserved cash, shut down businesses, postponed fresh investment in research and development (R&D) or the purchase of assets. Sony is cited as a company that struggled to regain momentum following heavy cutbacks during the 2000 and 2008 recessions.
Hewlett Packard is cited as an example of a company that suffered from an overly aggressive, optimistic strategy. It ramped up spending on R&D by almost 10%, spent billions on acquisitions and on IT.
The authors cited the US retailer, Target which thrived through a clever mix of expansion and contraction. It actually increased its workforce by 10% while also shutting down underperforming facilities. It boosted service and shifted to high-end products. The company was able to take advantage of depressed prices to pick up property, plant, and equipment on the cheap.
It turns out that those who box clever win out during recessions which are often times of deep business transformation. But a good strategy will not suffice without sufficient financial firepower. The best generals can do little without weaponry at their disposal. A good general knows that an army needs decent food, clothing, and shelter.
This is something that cutback merchants tend to neglect as they set out to shred the cost base.
That said, whether one is a nation, an individual, or a corporation, it does not do to enter a tougher environment without the financial wherewithal and without a plan.
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