08 February 2009

Institutional Instincts Deepen Crises

As we move deeper into the current economic crisis, it is becoming increasingly clear how instinctive responses to the crisis can be counterproductive, both at the national and institutional levels.

At the national level, officials move towards protectionism when their intent is to expand trade and economic activity. Protectionism, including "buy American" policies, reduces trade and production by inducing trading partners to restrict our goods from entering their markets.

Governments also try to encourage easy credit and aggressive consumer spending when those are precisely the reasons for the economic crisis in the first place. The cure for excessive borrowing and spending is saving, but while savings help long term economic growth, they discourage near term consumption.

Individuals and families naturally save more and spend less when they feel that their assets are declining in value or that their sources of income are at risk of decline. The governments are actively discouraging this natural instinct because it means a decline in consumption in the near term which causes declines in perceived economic strength and hence government popularity. Without savings, however, there is less capital available for creating new companies and providing productivity-enhancing capital to workers in the medium to long term.

Because individuals cannot be easily discouraged from saving when they sense economic troubles, governments resort to taking the money individuals invest in government bonds and spending it for them. Instead of these savings going into the most productive industries and investments, it is turned into government make-work projects like bailing out poorly run companies and inefficiently building unneeded infrastructure projects. In short, these savings are diverted from achieving their natural role of encouraging long-term economic growth into short-term make-work projects.

The same short-sighted mistakes are made at the institutional level. Rather than simply reducing spending and production, organizations often choose to provide a lower quality product, thus diminishing their reputation and hurting their long-term growth. This is especially true of service organizations like private schools and colleges where it can seem more attractive to accept lower quality applicants who can pay full tuition than it is to offer scholarships or simply lower tuition so as to enable more high quality students to be able to attend. This latter requires some belt tightening, but it ensures that the quality of the product is maintained or even raised. Above all, customers demand value for their investment during crises. Schools and similar service-based organizations need to both reduce their prices and raise their quality.

Whereas the individual instincts to save money and look for better value during crises are very healthy, institutions and governments with short term economic objectives tend to make decisions which seem to be compelling in the short term, but which ultimately diminish the health of the country or organization. The role of crises is to improve value and savings, and resistance these ends will only protract and deepen the economic suffering.

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