If governments want to survive the global financial downturn, the last thing they should do is batten down the hatches
What lessons can governments learn from the global financial crisis and the way in which companies responded?
Our research into corporate reactions to the global downturn that hit its nadir in September 2008 with the collapse of Lehman Brothers overturns received wisdom on how companies should handle recessions and provides some salient lessons for governments. In particular, we believe that many European governments have adopted courses of action that in the corporate world turned out to be a losing strategy: they have been too slow, too cost-focused and too passive.
The cost of the financial crisis was enormous; GDP ratios rose by about 25% in many countries. As a result, the focus of many governments started to swing towards debt reduction, and away from supporting economic growth. Many of these economies are now seeing a double-dip recession, casting doubt on their governments' diagnosis and treatment of the problem.
Conventional wisdom on how companies should handle recessions says they should batten down the hatches and ride out the storm.
But in this downturn, the winners adopted a different mindset, which resulted in a faster response, a more intelligent approach to cost reduction, and a determined focus on coming out of the crisis stronger than they went in.
We believe governments can learn from all three elements of this corporate experience.
The first element is speed of response. Conventional battening-down amounts to saying "we will wait until we see that a recession is real, then cut costs and hold firm until we see a return to business as usual". In the financial crisis, this cost many companies 18 months of reaction time from the collapse of Northern Rock until six months after the fall of Lehman Brothers.
A more successful approach borrows from the military. Observe, orient, decide, act (OODA) was invented by US airforce pilot and Pentagon consultant Colonel John Boyd.
Our survey showed that too many companies failed to interpret the facts ($1tn in losses in US sub-prime mortgages, the first run on a UK bank for over 140 years, and numerous worldwide failures) as indicating either that a recession was coming at all or that it would be more profound than others they had lived through. The winners won through superior orientation, which enabled them to plan better and carry through their plans.
Similarly, many governments are still struggling to adjust in a post-financial crisis world. Many continue to ascribe high levels of debt to government profligacy when, with the exception of Greece, most of the highly indebted countries had relatively low levels of government debt before the crisis, compared with Germany.
They are struggling to ask the right questions, let alone identify the right answers.
The second element is an intelligent approach to costs. In a recession, cost-cutting tends to be reactive, and indiscriminate. The softest targets are cut, regardless of their contribution to business sustainability: travel and client entertainment go first, followed by marketing, training, IT investment and new projects. These cuts may preserve short-term profits, but they often need to be reversed and compensated for later, when the pressure is reduced.
Governments' approach to cost cutting stems from the received wisdom that fiscal contraction has no side effects. The UK led the way, talking of 'expansionary contraction', but we were not alone: Jean-Claude Trichet, former head of the European Central Bank said austerity measures would not trigger stagnation. In fact, the degree of austerity turned out to be strongly correlated with decline. The US took a less austere approach, which resulted in a major political debate, and a ratings downgrade, but the US has grown faster than the EU and UK, and its interest rates remain lower.
The final element is mindset. The conventional approach to a recession is defensive, focused on protecting profit. The winners understood, however, that the great recession was deeper, would last longer and would have more structural impact than a normal recession, bringing major shifts in market power. They understood that flux equals opportunity and planned to emerge stronger from the crisis.
One large consumer goods company, for example, recognising that its competitors would slash marketing expenditure, held spend constant, and took advantage of the crisis to renegotiate its media contracts. This helped it to secure double the advertising space, double the air time and double the web-presence. As a result, it more than doubled its 'share of voice' and increased market share followed.
A defensive approach is insufficient for governments. With declining GDP, any level of debt eventually becomes unsustainable, so a successful strategy needs to generate growth and, in particular, private sector growth.
With little confidence in domestic demand as consumers and governments reduce spending, large companies are investing abroad or in risk-free assets rather than making capital investment at home. But latent demand exists in many areas of infrastructure and energy; and where returns can be reasonably expected, investment is attractive. Investment in sound projects makes the country richer, not poorer.
Mark Thomas is a business strategy expert at PA Consulting Group.
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