All European countries are engaged in a very determined effort to reduce their unsustainable budget deficits. Politicians see this as their pre-eminent policy task. Observing the size of the increase in public debt since before the crisis began, they might have a point: in the EU countries, public debt has grown on average from 58.8% of GDP in 2007 to (forecast) 79.6% in 2010. The largest part of this increase comes from the bailouts of the financial sectors in the EU countries. Now, the responsible politicians argue – jointly with the European Commission and the European Central Bank, in unison with financial markets actors – that deficits and thus debt levels must be reduced quickly, in order to keep financial markets happy and interest rates for the public debt low. Frequently, the more altruistic reasoning that “we cannot burden future generations with our high debts” can also be heard. So far, so plausible – but is this really the right way to go? Does this take into consideration empirical knowhow about the aftermath of crises, does it take account of medium-term growth prospects, and – above all – does it take account of the global dimension of the present crisis?
The answer to all three of these questions must be: no!
It is wrong for policymakers to ignore the global dimension, it is wrong to ignore the weaknesses in Western economies’ demand and it is at least doubtful whether for the future generations (one of them is already with us, looking for education, looking for jobs) rapid deficit reduction is preferable to better growth prospects.
The present austerity policies assume (without empirical proof) that to cut public expenditures here and now and to raise some taxes (on average, EU countries’ consolidation packages consist of 2/3 expenditure cuts and 1/3 tax increases) will improve growth chances. This is the rating agencies’ and the financial market actors’ credo. But, if enterprises do not invest (because of spare capacity and bringing their balance sheets in order), if consumers do not spend (because they are afraid to lose their jobs or not being able to pay back their debts), and if governments save more than they spend, growth could only come from exports. But – and this is the global dimension – if all potential importers (at least in Europe and the US) pursue the same policies, there will not be demand for such imports, because everybody wants to become a net exporter, exporting more than he imports. And if the fast-growing emerging economies in Asia and Latin America also base their growth strategy on exports, i.e. if the whole world wants to become a net exporter, the globe would have to be extended by another large planet which purchases – against good money – all our world’s exports. Obviously, this is not a viable strategy.
The crisis was – among other reasons – caused by the cumulating world imbalances which find their clearest expression in the imbalance between the USA ( a heavy net importer) and China (a heavy net exporter). These two, the largest national economies in the world, are only the most important manifestations of such imbalances which occurred also between other countries. China has become the manufacturing center of the world, supplying it with cheap goods and – as a result – building up the highest foreign currency reserves seen in history (at last count 2.6 trillion $ in a 4 trillion $ economy). These reserves were mainly invested in US treasury bonds, thus financing a large US consumption, securities and housing boom and keeping interest rates low. This was le helped by a very loose US monetary policy under Alan Greenspan (followed by his successor Ben Bernanke) and a financial sector deregulation drive with the purpose to enable banking risks to be spread around the world. At present, both countries pursue policies attempting to promote their export industries: China by intervening to keep its exchange rate from appreciating (faster), the US by “quantitative easing” keeping the dollar low and swamping the world with US dollars. (By the way, does this not remind us of the Euro-Dollar policy of President Johnson who wanted to finance both the expensive Vietnam War and social programs?).
Unfortunately, the effects of this economic “war” (the media speak of “exchange rate wars”) are not restricted to these two countries, but affect the whole world. The solution is clear on paper: In such a situation we need international cooperation and compromise, in order not to drag the world economy into another Great Depression, like at the beginning of the 1930’s. What two years ago started hopefully with the elevation of the G-20 Group to Global Economic Policy Coordinator (my term, KB) when a significant start was made at the impetus of the domestically unfortunate Gordon Brown, seems to have lost its impetus for policy coordination. The upcoming meeting in Seoul will have an important task ahead, if it is to take up this baton and move it forward.
In many countries, the economic policy controversy revolves – simplistically – around whether to cut the deficit faster or slower and whether consolidation should rely more on expenditure cuts or tax increases. This is an important debate, because economic effects are quite different, but it does not reach far enough. It is not just the short run with which policy makers should concern themselves, but also the medium and long run. While it is clear that deficits must be cut in order to get government debt down to acceptable levels and in order to lower the interest burden on government debt which – at around 10% of total expenditures – crowds out productive investments, consolidation must be timed to address pressing economic problems. In other words, right now government budgets need to support total effective demand in order to achieve reasonable rates of growth and employment. But at the same time, while significant consolidation should be postponed, supply-side reforms must be undertaken, in order to support and enable future growth. Europe’s demographics point to falling populations and labor force, thus productivity-enhancing investments are necessary (abstracrting from the possible solution of increased immigration). Support for education – from cradle to grave – should not remain lipservice, but become reality. Training and retraining, making people fit for work, creating opportunities for work and jobs, language training for cross-border work – all these need to be implemented here and now. This also, and even more so, pertains to persons with other mother tongues in our countries. Our human capacity are the resources for future growth, more even than construction-heavy infrastructure projects.
Many impediments for enterprises to work, especially in the services sector, like restrictions on liberal professions which go beyond quality assurance need to go, because it is in services where European countries will have a large part of their future, together with a medium- to high-tech manufacturing sector. Competition rules need to be applied, but they must also be extended to preventing the competition-impeding mergers and acquisition activities which were rampant before the crisis. Government expenditures must be scrutinized carefully for their growth-enhancing quality, in addition to those serving solidarity and social-cohesion purposes. Subsidies must be scrutinized, whether they enhance growth potential and not whether they please a special interest group.
It cannot be an economic policy aim of the EU to force all its members to have an exactly balanced external account: there will always be net exporters and net importers, depending on division of labor, on catching-up, on absolute or comparative advantage. But the ideology and idolatry of net exporting must go. It belongs to the long-gone age of mercantilism. It also leads to holding wages down. Germany and Austria, among others, pride themselves – and are praised by the European Commission – for their falling (relative to their trading partners) unit labor costs. While being a successful exporter obviously is a (positive) sign of competitiveness, it must not come at the expense of domestic demand. The European Union together is the world’s largest internal economic space. Its policy recommendations must balance this potential strength with export prowess. The Commission must not recommend wage restrictions as being contrary to growth. For the EU as a whole wages must rise with the growth rate of productivity, as the Lisbon Agenda proposed. Productivity must be enhanced by medium-term investments in infrastructure and in the people. Domestic demand is at least as important as foreign demand: policy must finally recognize this. Thus, a new balance between domestic and global requirements need to be found in EU economic policy making.