Demand Creates Supply: How to Stimulate the Economy in a Crisis

Recently, my colleagues and friends (Zharas Akhmetov and Anuar D. Ushbayev) and I wrote up our outline of a possible way out of the current economic situation.

Today the short-term economic indicators for January 2016 were released. To put it mildly, they are not very encouraging, and they confirm our proposals.

The short-term economic indicator came in at 98.5%, which points to a recession in the country.

Many sectors have contracted, above all industry, mainly because of the mining sector.

But that is not the worst of it. Worse, trade in real terms fell by 7.3%, and wholesale trade by 9%!

What does this tell us? It tells us that economic agents simply do not have the money to buy.

In other words, without money we cannot buy anything unless demand is stimulated. Before long this will hit manufacturing, which will either produce for the warehouse or also fall into recession. Trade is the first indicator of a possible downturn.

In effect, our entire economic policy is built on stimulating supply. Money is given to national companies, banks, national champions and development institutions, and all of it either stimulates supply or goes to settle the obligations of existing companies. Distributing funds this way merely encourages inefficiency, and it entirely lacks a multiplier that would stimulate production.

I will try to explain briefly why this happens.

There are three types of demand:

1. Private-sector demand

2. Government demand

3. Exports

There are no other options. In a crisis, it is vital to stimulate consumption, and specifically basic consumption. In Kazakhstan it is easier to launch production in basic sectors (food, basic services, essential goods and so on); otherwise, we will end up stimulating imports.

If consumers have no money, they cut their consumption, and the economy suffers. If money is given directly to the population, who have room to increase their consumption, it will go straight into consumption and reach the most efficient producers (sellers), those making the best and cheapest goods. In this way, the money reaches quality producers.

If, on the other hand, money is given to banks and national companies, it will be spent on resolving their current financial problems and on producing goods that will end up in the warehouse. Such money is thrown to the wind, because the population simply has no money to buy low-quality goods.

Even if money does reach an entrepreneur through a government contract, it will either settle in intermediary organizations and pockets along the way, or go into savings or consumer-type investment (houses and cars, which is essentially imports), or leave the country. The effect of such support will be zero. That is why in a crisis it is more effective to distribute money to demand rather than to production.

Everyone knows that demand creates supply, and not the other way around. Yet for some reason we have decided that if KTZ is given money, people will rush out to buy Kazakhstani sausage. That is roughly the logic.

Increased government spending should be directed at creating labor-intensive production that may not turn a profit but would put the poor to work, thereby giving them money to spend. A labor army would earn extra income and would not lose its work skills, and the wages earned would flow to producers through consumption.

A simple example: if some well-connected operator receives $1 million from a government distribution of funds, he will move it abroad or buy a house or a couple of cars. But if 10,000 people receive that $1 million, they will, without any doubt, spend it, and the money will stay in the economy.

I have set out one of the points of our report in very simple language. In my next post, I will try to write about Kazakhstan's exports.