A shrinking economy

The Real Matter - By Pankaj Jumar


A good stimulus package should restore confidence and reflate a sluggish financial system

IN the 1989 hit movie, Honey, I Shrunk The Kids, Rick Moranis plays a nutty inventor who perfects a machine capable of shrinking objects down to a hundredth of their size.

The plot made a good family comedy and the end result was Moranis was finally able to reverse the machine’s capability and bring his children back to normal size.

Incidentally, there were two sequels to this movie: Honey, I Blew Up The Kids and Honey, We Shrunk Ourselves.

No need to get into the details of these movies as their titles would allow us to imagine what would have happened in the sequels.

Now, how do we relate the “experience” of the above three movies to the predicament that we are all in now? While some readers may not agree with my analogy, I will attempt to relate the movie’s plot to the current crisis of confidence.

While we may not have deliberately shrunk our economy by using a machine, we caused it to shrink due to the housing market bubble, the huge inflated size of the US financial institutions’ balance sheets, as well as the easy lending in both the credit market and derivatives activities.

As troubles mounted in these financial institutions, governments globally had to provide a lifeline to them to ensure that they remain afloat.

Except for Lehman Brothers, which was allowed to fail, companies like AIG, Citigroup and others were deemed to be “too big to fail”, and failure itself could lead to further destruction of wealth of investors.

While the US government, and to a certain extent other governments in Europe, rescued these financial institutions from collapse by recapitalising them, most of these institutions took in new money in the form of capital to de-leverage their balance sheets and not entirely lend again.

Hence, there was a huge hue and cry among corporates and individuals as new borrowings were hard to come by.

In addition, due to the destruction of wealth of US consumers as a result of lower home prices and job losses (which have reached 4.38 million since January 2008), consumers simply halted consumption, resulting in drastic reduction in demand for goods and services.

With financial institutions unwilling to lend, some economists thought that perhaps the government should step in and provide financing to consumers. Hence, the US government instead becomes the lender of last resort as financial institutions have failed to act to stimulate demand.

There is empirical evidence that suggests banks’ willingness to lend to consumers/corporates is indeed instrumental to economic growth, as the lending activity itself has a multiplier effect on the economy.

Recent Bank Negara statistics which show loan applications and approvals in January 2009 fell 21% and 35.6% respectively, compared with 18.8% and 23.7% in December 2008, suggest that not only consumers/corporates are not encouraged by the current low interest rate environment to borrow or invest, banks too have been reluctant to lend.

To re-ignite the global economic engine, countries like the United States, Britain, Australia and Austria have unveiled massive stimulus packages.

Based on available data, the relief programmes now amount to about US$4.5 trillion or RM16.6 trillion. While these programmes are meant to stimulate the economies of the nations, some may not be able to create the multiplier effect because many of the programmes are meant to shore up the balance sheets of financial institutions.

In Malaysia’s case, it is a RM60bil question whether the stimulus package announced last week can have the right impact on the economy, as some have argued that it is not directed at the right target group.

My personal opinion is that the Government should have tackled the epicentre of the current crisis: consumer spending, which makes up half the economy.

Perhaps one way to “force” consumers to spend is to provide them with shopping vouchers to the tune of perhaps up to RM1,000 per household. This would cost the Government not more than RM10bil.

To ensure that the money is spent, perhaps the vouchers can come with an expiry date that says: “This voucher will self-destruct in three months.”

This way, retailers will be able to see their sales rise by the same amount in a shorter period, while creating a direct multiplier impact on the economy as a whole.

Just like the banking sector, where the central bank may end up as the lender of last resort, governments across the globe too need to step up spending, and even turn spender of the last resort, to restore economic activities.

A good stimulus package should be able to restore confidence and reflate a sluggish economy, as a shrinking economy is not going to get us anywhere. As in the movie, we need a good ending to the current sequel, Honey, I Shrunk the Economy.