November 19, 2008

Spend or Suffer

To stop the current global economic slide, governments-and you and me-need to pump more money into the economy, says an expert

By Marjorie Howard

“We must control our impulses and not change our habits. We must continue with business as usual,” says Yannis Ioannides, the Max and Herta Neubauer Professor of Economics. Photo: Joanie Tobin

Yannis Ioannides’ hairdresser had a question. She had been hearing that the government might bail out people whose homes were in foreclosure, and that bothered her. “I’m paying my bills,” she said, as she continued snipping his hair. “Why should people who haven’t paid their bills get help?”

“That,” Ioannides told her, “is exactly the point.”

If it wasn’t for her, and people like her who are meeting their mortgage payments and paying their bills, the economy might be worse off than it already is, says Ioannides, the Max and Herta Neubauer Professor of Economics. Just as important, he says, if there is a way to help those who are struggling, so much the better for all of us.

Unfair as it may seem, he notes, the U.S. “is better off if the people who did dumb things are allowed to continue with their present spending until we get out of this.” Whether people were foolish or were fooled, he says, we all benefit when people can pay their bills and meet their expenses.

It’s clear that we’re all inextricably connected through the economy, Ioannides says. “My hairdresser said she understood that if customers have less money, they’ll put off getting a haircut or a perm. My wife and I might decide to put off repairs to our home for a year,” he says. “You can keep your car another year. The refrigerator that is 25 years old can go another year. People will even start asking, Do I need a new pair of boots this winter or can I make do?”

All these postponed purchases add up, and are magnified throughout the economy. “Fewer snow blowers are ordered, so the company that manufactures them lays off workers, and they don’t spend money and it ripples throughout the economy,” Ioannides says. “We must control our impulses and not change our habits. We must continue with business as usual.”

It comes back to the question Ioannides’ hairdresser raised. Should people who took on too much debt be made to pay for their folly? If they are, he suggests, we are all going to pay an even greater price.

“We have to do whatever we can to let people spend and worry later about who owes what to whom. A lot of people right now are technically insolvent, because they own houses whose values are lower than their mortgage balances,” he says. “People have to be able to continue their economic lives. Ninety percent or more of what we do with our income is spent, and if we can’t spend, less is produced by industry and services, and incomes are lost, and neighborhoods are adversely affected.”

What could stop this downward spiral? Ioannides places some hope in the election of a new president and hopes for early signals from Barack Obama about his economic plans.

In particular, Ioannides says, the federal government needs to take an active role to ensure the economy turns around. “It must engineer social spending in all possible areas and on a vast scale, including providing help to large firms like the auto industry,” he says. “It is true that the U.S. government will be become co-owner of many firms. That would be fine. It can sell off its holdings when the time is ripe.”

He notes that spending on physical infrastructure will also help the construction industry, because it too provides employment and generates incomes, and helps the U.S. economy stay competitive internationally.

The origins of the current financial crisis highlight the ways in which the world is more economically tied together than ever before, Ioannides says.

“Our financial institutions sold the rest of the world poor assets and did unwise and awful things,” he says. “And people around the world bought those assets. We’re not talking about street-corner pawn shops, but about institutions like UBS, the largest bank in Switzerland, which had to be rescued by the Swiss government. The largest bank in Saxony went bankrupt, but it’s owned by the state of Saxony [in Germany]. Suddenly the state had to bail out the bank, and the result has been layoffs.”

Why did countries and institutions make poor choices? Ioannides says it’s simple: they needed places to invest their enormous assets.

China, for example, has a huge trade surplus, as do other countries in Asia, and oil-producing nations have vast quantities of petrodollars. “All these organizations and institutions have to keep their money somewhere, so they invest it and put it in banks and financial institutions.” The United States is the single largest economy in the world, making it logical for other countries and institutions to invest here.

Much of the money people borrowed to buy homes in the United States ultimately came from overseas. And because most people now have stock-based 401k retirement plans, instead of company-sponsored pensions, a large portion of the population has a direct connection to the global financial crisis. “So we are all players in the international financial world,” Ioannides says.

Marjorie Howard can be reached at

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