Illusion of Economic Recovery

By Shyam Paliwal

Most economists now believe that we are well on our way to a sound economic recovery. However, we need to look carefully before making any assumptions on the soundness of this recovery.

If we take a look at banking, banks historically have always focused on acquiring, growing and protecting their clients' assets, lending money and making profit out of the assets under management.

Then over the last decade the value relationship between banks and clients abruptly changed; it switched to banks trading their own products at the sacrifice of their own clients and overnight the compensation model for the executives was based upon how much money they could make by the volume of products they could sell, not the number of clients they were managing.

These days the phrases that you hear the most are like ``survived the worst'' or ``turned the corner'' and in this chorus the voice of reason is left unheard.

Asset values are going up and consumer and business confidence levels are high. However, in order to have long-term stability we need the economic system to have strong foundations.

Growth should not merely be the result of government spending and artificially lower interest rates that provide cheap money to the banks.

Under the influence of cheap money, bankers become brave and take imprudent risks which have no rational justification.

However, now that the hangover is gone it's probably high time for bankers to party again. They are resuming their old habits acquired in the days of the credit boom.

They have commenced lending to private equity investors and loosened the conditions to such an extent that borrowers can pay the annual interest by simply borrowing more. When the private sector was over-borrowing, it was absorbing resources it couldn't really afford.

Plus, it was sending the wrong signal to producers, leading them to believe that they had real customers on the other end of the line, who could afford what they were buying.

What they had were people pretending to have more purchasing power than they really had. And when the credit got turned off, these customers disappeared, leaving the manufacturing sector with too much capacity and the retail sector with too much floor space to sell those goods.

Now, the American government is doing the same thing, taking up resources by borrowing money it really cannot afford and redirecting them to unsustainable projects.

But is it really productive work to build expensive equipment for airport security or state of the art warfare for Afghanistan and then shipping it there to pound bombs that mostly fall on barren land?

Another way to boost the GDP figures is to hire thousands of bureaucrats to process healthcare paperwork. This will certainly generate employment, assist with consumer spending and increase the size of the government.

Consider, an economy where the number of regulators outnumber people working in manufacturing units.

In the free market oriented economy, people are always making mistakes.

People buy things they really don't need with money they really don't have. Then, they pay the price. However, in the government controlled economy, people are always making mistakes too.

But since the person who makes the mistake is not the one who pays the price there is little incentive to ever recognize the mistake or to stop it.

Also, there is little incentive to get out of an unsustainable program just because too many jobs will be lost or to spend endlessly on wars that go on forever.

The government here in South Korea has taken a step in the right direction by deciding to turn the Sejong city complex into a science and education hub rather than offices for bureaucrats.

This revised plan will not only spur development and provide real jobs but will also lead to production of real goods rather than bureaucratic jargon.

Certain responsibilities are required to be turned over to private sector, which can carry out work with less cost and more efficiency.

A frequently cited example in India is the comparison between DHL and Indian Postal Service. The government should reduce its role and allow greater freedom for the private sector.

Most agencies need downsizing and reorganizing to reduce costs. A real recovery will not take place until we purge the excess debt from the system, and the longer we take to do that, the longer the pain will last and the worse it will be.

It is like a bitter pill that has to be taken to cure a disease. Just because Seoul had a record snowfall in 70 years and its coldest winter in six years we cannot brush the fact of global warming under the carpet, and start predicting an end to global warming based on unusually high snowfall.

Shyam Paliwal is an international investor and an economic advisor. He now resides in Busan. He can be reached at shyampali@gmail.com.