Spend Now, Pay Later?

The latest row between Germany and England about crisis response contains a number of interesting elements. Germany’s Steinbrück complains about the rapid turn-about by Gordon Brown from “supply side” economics to “crass Keynesianism” – and he casts doubts on the effectiveness of especially the VAT reduction as crisis response.

While Anglo-Saxon economic policies have, at the latest since Reagan and Thatcher, preached the evils of state involvement in the economy, urged budget consolidation, tax reductions and public expenditure restraints, and praised the “private market” as the alpha and omega of world happiness, continental Europe maintained higher taxes, higher spending, more government involvement in the economy. The latter has changed with the creation of the Eurozone, when Germany – and here especially the Bundesbank, followed by the treasury, managed to impose politically savvy, but economically questionable budget rules on member states. While Eurozone countries have – to various degrees – followed these budget rules and simultaneously reduced tax shares in GDP, and while the ECB has run a relatively tight monetary policy, the US – and in its wake the UK – have relaxed their previous tenets and adopted “pragmatic” practices, especially with respect to a very accommodating monetary policy. This, together with the deregulation of financial markets, became one of the founding fathers of the present crisis.

Thus, it is understandable to some extent, that the diligent student of  “neo-liberalism” Germany is upset that his teacher has abandoned his hard-hitting doctrine just when he himself has mastered it. This is also a lesson in the flexibility of rules-based versus discretionary policies. It is understandable from an institutional point-of-view that in order to run a common monetary policy for (initially) 12 countries far away from forming an optimal currency area, binding rules need to be introduced for effectiveness. But recent experience shows that such rules are too inflexible to deal with not-business-as-usual situations. As a result, the European Stability and Growth Pact had to be adjusted in 2006, in order to take account of changed circumstances.

While I can understand (if not share) Steinbrück’s dismay at the rapid and massive turn-around of  UK’s economic paradigm, which is reinforced by the fact that the former British Chancellor of the Exchequer used to lecture his European colleagues about the benefits of New Labor’s economic policies as role models for “Europe”, and while there is a strong case of validity in doubting the effectiveness of lowering VAT rates as “jump-starting” the British economy, I do not share his criticism of a large and joint European rescue package.

Of course, England with its high current account deficit must fear a high degree of leakage if other countries do not also stimulate their economies; but for Europe as a whole, gripped by the crisis, it is also true that a joint package (even if each country uses different instruments) will make everybody’s efforts more effective. And this must be Europe’s responsibility: to create measures which help everybody’s economy as fast as possible. Thus also Germany, as the largest EU economy, has the responsibility to act decisively. I fully understand Germany’s reluctance to e.g. pay its EU share into a general rescue fund, whose proceeds would primarily go to other countries; but also the German economy has been hit by the crisis, its export markets are in trouble, its automobile industry also suffers from over-capacity, etc. To implore the rigid rules of the SGP at this time is not very helpful.

Steinbrück, however, hits a very important point: many of the rescue packages, those for banks and those for the “real” sector, ignore the problem of who will pay for them. While rapid help is necessary, while it is extremely important to get the banks to lend to each other and especially to their customers, mechanisms need to be built into the packages to pay back the taxpayers, whose money is used for the rescue.

In the future, taxpayers will likely ask more pertinent questions when banks and businesses reap very high profits, CEOs grant themselves and each other obscene levels of compensation, when mergers create business units “too large to fail”, such that in a downturn they need to be rescued by taxpayers. The model of “privatization of profits and socialisation of losses” is no longer viable. It is, however, the failure of governments and their regulatory authorities, which made these excesses possible in the past. The individual taxpayer may be able to express his choice at a general election, but “the state” acts on his and her behalf. This fiduciary trust has been sorely shaken. It does look now as if governments world-wide were trying to show taxpayers that by throwing money around in previously unimaginable quantities they are acting on taxpayers’ behalf. Taxpayers and voters should beware and ask the relevant question of how and who will pay. These questions need to be asked now.


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