Wall Street Journal, december 18, 2008
There's a telling difference between the Big Three auto makers and the average American household today. It's the difference in their appetite for debt.
The auto makers want to borrow a huge amount of money from the only source that might be willing to extend additional credit to them: the federal government. They have nothing to lose because they are, in effect, already bankrupt.
By contrast, millions of gainfully employed but frightened people are fighting to stay out of bankruptcy. Without suffering any loss of current income, over the past year they have seen a third or more of their savings and personal wealth disappear into thin air. The last thing they want to do now is to borrow and spend.
Consider the simplified balance sheet of someone in his 40s or 50s who earns $100,000 a year and has two principal assets -- the equity in his house and the money in his retirement account.
Let's assume that his only debt is the $300,000 mortgage on his house, which was appraised at $500,000 a year ago but is now worth just $400,000. Let's assume too that his retirement account -- in line with the decline in stock prices -- has taken a 37% hit over the past year, falling from $200,000 to $126,000.
So how is this seemingly affluent individual feeling about his personal finances?
He is, to put it mildly, in a state of shock. Even though his income has remained the same, in just 12 months he has lost a staggering 43% of his net worth, or personal wealth. His entire nest egg (the retirement account plus the real value of his house) has dropped from four times his annual income to just double.
The Federal Reserve can pump up the money supply, drive down interest rates, and pressure banks to restart lending. But this person only wants to replenish his savings and repair his badly damaged balance sheet. Despite the reports of a credit squeeze, local real estate agents and car salesmen will tell you that there is little demand.
The incoming administration is talking about spending hundreds of billions on public works with the hope of creating some jobs, but remember: 93.3% of Americans, though shaken, already have jobs.
So what to do?
The government must do something, and something fairly big, to jump-start the economy, an economist friend told me. His point was that the private sector is too shell-shocked to climb out of the hole it is now in, and government needs to take the lead. He also quoted the old shibboleth among economists -- the "fallacy of composition" -- which argues that what might be a good course of action for an individual can lead to disaster if widely adopted by members of the larger group. In this case, disaster could be the result if there was too strong a preference for savings over consumption.
I disagree with this whole line of thought. It reminds me of the open letter that 364 economists addressed to British Prime Minister Margaret Thatcher in 1981, condemning her for daring to cut public borrowing in the midst of a recession, which was contrary to the Keynesian orthodoxy at the time. They did not accept Mrs. Thatcher's reasoning that too much public-sector borrowing and government-directed investment could only crowd out private-sector borrowing and risk-taking.
They also implicitly rejected Mrs. Thatcher's strongly held belief that both governments and individuals must be guided by fundamental rules of common sense and frugality, in good times and bad. The economists described her thinking on this score as naive.
Mrs. Thatcher spurned the collective wisdom of the 364 economists, seeing their advice as just more of the same failed interventionist policy prescriptions which the country had followed for over three decades.
When she came to power in May 1979, the British economy, by every measure, was in worse shape than the U.S. economy is today. Inflation was out of control. Unemployment was high and rising rapidly. Job creation had been at a total standstill for almost a decade and a half.
No one has captured the Keystone Cop-like futility of government intervention to fix this or that problem any better than Mrs. Thatcher's long-time sparring partner and rival, Denis Healey, the Chancellor of the Exchequer in the Labour government that preceded her administration. Speaking of Britain's periodic bouts of wage-and-price controls to counteract inflation, he wrote: "Adopting a pay policy (i.e. limiting wage increases to a set percent) is rather like jumping out a second-story window: no one in his senses would do it unless the stairs were on fire. But in postwar Britain the stairs have always been on fire."
Clearly, some things have changed since Mrs. Thatcher's time. Inflation is more easily controlled today, due to intense global competition. But Thatcherite principles remain as valid as ever. The freedom of the marketplace is still the only effective mechanism for eliminating poor business practices, identifying productive investment, and providing long-term growth.
President-elect Barack Obama has said that he expects things to get worse before they get better. If the experience of the first Thatcher administration is anything to go by, that will certainly be the case. For one thing, some "hidden unemployment," as Mrs. Thatcher called it, will be flushed out into the open. This will be the case with the expected closure of the Big Three's "job banks," which pay almost full wages and benefits to several thousand auto workers for doing nothing.
With the elimination of much higher levels of "over-manning" in parts of British industry that were heavily unionized and subsidized, unemployment doubled to 12% in Mrs. Thatcher's first three years in office.
Yet by sticking to her policies of lightened regulation, reduced trade barriers, privatization of a raft of publicly owned companies, reduced taxation, and the adoption of laws to prevent abuses of union power, Mrs. Thatcher achieved something few if any of today's economists have begun to consider. She achieved a genuine, productivity-led recovery that transformed Britain from perennial basket case into the Europe's most improved and vibrant economy.
U.S. policy makers and professional economists should study her example in order to turn this time of crisis into useful and enduring change. As she herself said, "Economics is too important just to be left to the economists."
Mr. Wilson, a St. Louis-based writer, was Business Week's London bureau chief from 1981 to 1985.