Thursday, November 27, 2014

Austere Growth?

WASHINGTON, DC – The German government’s reaction to newly elected French President François Hollande’s call for more growth-oriented policies was to say that there should be no change in the eurozone’s austerity programs. Rather, growth-supporting measures, such as more lending by the European Investment Bank or issuance of jointly guaranteed project bonds to finance specific investments, could be “added” to these programs.

Many inside and outside of Germany declare that both austerity and more growth are needed, and that more emphasis on growth does not mean any decrease in austerity. The drama of the ongoing eurozone crisis has focused attention on Europe, but how the austerity-growth debate plays out there is more broadly relevant, including for the United States.

Three essential points need to be established. First, in a situation of widespread unemployment and excess capacity, short-run output is determined primarily by demand, not supply. In the eurozone’s member countries, only fiscal policy is possible at the national level, because the European Central Bank controls monetary policy. So, yes, more immediate growth does require slower reduction in fiscal deficits.

The only counterargument is that slower fiscal adjustment would further reduce confidence and thereby defeat the purpose by resulting in lower private spending. This might be true if a country were to declare that it was basically giving up on fiscal consolidation plans and the international support associated with it, but it is highly unlikely if a country decides to lengthen the period of fiscal adjustment in consultation with supporting institutions such as the International Monetary Fund. Indeed, the IMF explicitly recommended slower fiscal consolidation for Spain in its 2012 World Economic Outlook.

Without greater short-term support for effective demand, many countries in crisis could face a downward spiral of spending cuts, reduced output, higher unemployment, and even greater deficits, owing to an increase in safety-net expenditures and a decline in tax revenues associated with falling output and employment.

Second, it is possible, though not easy, to choose fiscal-consolidation packages that are more growth-friendly than others. There is the obvious distinction between investment spending and current expenditure, which Italian Prime Minister Mario Monti has emphasized. The former, if well designed, can lay the foundations for longer-term growth.

There is also the distinction between government spending with high multiplier effects, such as support to lower-income groups with a high propensity to spend, and tax reductions for the rich, a substantial portion of which would likely be saved.

Last but not least, there are longer-term structural reforms, such as labor-market reforms that increase flexibility without leading to large-scale lay-offs (a model rather successfully implemented by Germany). Similarly, retirement and pension reforms can increase long-term fiscal sustainability without generating social conflict. A healthy older person may well appreciate part-time work if it comes with flexibility. The task is to integrate such work into the overall functioning of the labor market with the help of appropriate regulation and incentives. 

Finally, particularly in Europe, where countries are closely linked by trade, a coordinated strategy that allows more time for fiscal consolidation and formulates growth-friendly policies would yield substantial benefits compared to individual countries’ strategies, owing to positive spillovers (and avoidance of stigmatization of particular countries). There should be a European growth strategy, rather than Spanish, Italian, or Irish strategies. Countries like Germany that are running a current-account surplus would also help themselves by helping to stimulate the European economy as a whole.

Slower fiscal retrenchment, space for investment in government budgets, growth-friendly fiscal packages, and coordination of national policies with critical contributions from surplus countries can go a long way in helping Europe to overcome its crisis in the medium term. Unfortunately, Greece has become a special case, one that requires focused and specific treatment, most probably involving another round of public-debt forgiveness.

But insufficient and sometimes counterproductive actions, coupled with panic and overreaction in financial markets, have brought some countries, such as Spain, which is a fundamentally solvent and strong economy, to the edge of the precipice, and with it the whole eurozone. In the immediate short run, nothing makes sense, not even a perfectly good public-investment project, or recapitalization of a bank, if the government has to borrow at interest rates of 6% or more to finance it.

These interest rates must be brought down through ECB purchases of government bonds on the secondary market until low-enough announced target levels for borrowing costs are reached, and/or by the use of European Stability Mechanism resources. The best solution would be to reinforce the effectiveness of both channels by using both – and by doing so immediately.

Such an approach would provide the breathing space needed to restore confidence and implement reforms in an atmosphere of moderate optimism rather than despair. The risk of inaction or inappropriate action has reached enormous proportions.

No catastrophic earthquake or tsunami has destroyed southern Europe’s productive capacity. What we are witnessing – and what is now affecting the whole world – is a man-made disaster that can be stopped and reversed by a coordinated policy response.

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    1. CommentedNathan Coppedge

      Governments always seem to be caught on that problem of needing to spend a little more money to compensate for a situation that is entirely problematic.

      Perhaps a government should be more 'coup d' etat' and accept a radical policy switch such as conceptualizing money. Money should be like the ground we walk on, or the computers we use, not some concept that flits in and out the window.

      But, paradoxically, and paradigmatically, a radical policy does not need to have a radical agenda---here again I'm sensing the general trend of being unthinking in the face of shock and disaster---

      Radical creative conservatism could take the form of conceptualizing money in such a way that one expenditure counts towards another pool of resources. But to genuinely do this is very ingenious.

      Consider a quadra of equally-weighed money properties in a Cartesian coordinate system. Say that they oppose one another along a diagonal. When one resource is spent, it results in an automatic investment in another category, because the properties of the second category are utterly opposite. This seems feasible for example, in a future capital-virtual economy (with inklings of this in coupon culture), or in some uses of free versus industry resources, such as investment in arbitrary amounts of computer resources.

      At any rate, the focus should be on a generative economy, even if such an economy has some virtual aspects. Some would say in the U.S. its gone way beyond that, and not by being respectful or necessarily conservative.

    2. CommentedCole Skinner

      Zsolt -

      People have been claiming that we're running out of resources for centuries (depletion of nitrogen for farms was a panic button issue until somebody figured out a way to pull it from the atmosphere).

      There has been a doomsayer about population for every generation since Malthus 350 or so years ago. Consider how terribly inaccurate all the predictions in The Population Bomb book of the 1970's were.

      Populations have a tendency to self-adjust, and we are feeding, clothing, and housing *more* of the planet and more efficiently and at a higher standard than ever before.

      The standard of living only really began to increase measurably when we had enough people (and better transportation, free trade, property rights, etc) for specialization and division of labor. More people improve the planet, they don't diminish it. Their contributions increase the yield from the resources exponentially, rather than reduce the size of the whole pie.

      One of the beauties of free markets is that resources and innovation flow to where the line is the thinnest - help the cause of liberty - civil liberty and economic liberty - and you will see many of these problems you fear decrease.

    3. CommentedCole Skinner

      "So, yes, more immediate growth does require slower reduction in fiscal deficits.

      The only counterargument is that slower fiscal adjustment would further reduce confidence and thereby defeat the purpose by resulting in lower private spending."

      I believe this is incorrect. Real growth occurs in the private sector. Most govt spending produces less growth, dollar for dollar, than private sector spending, so by reducing deficits you are immediately freeing up / returning money for a more productive spender, ie, the market rather than the govt.

      This has been well-documented in the phenomena of "crowding out" - where govt sucks up resources better used by private handlers.

      Why else, then, would the market react unfavorably to news that the govt was not attacking deficits, as you point out? Because, as you correctly point out, it is a signal that future taxes will be higher and they should save money to pay those future taxes; but it is also a signal that the govt is not serious about debt reduction.

      Regardless of politician promises to the contrary, "govt spending to stimulate growth" and (presumably generate revenue to pay down debt) is just as likely to be more squandered money parcelled out as political treats with no ROI, which means the citizens will have to be taxed twice to pay for the same deficit dollar.

      The private sector needs no stimulus from the government to jump start that which it does so well naturally. The only thing the markets need to function is their money back.

    4. CommentedGary Marshall

      Here is a solution to the Greek problem. If anyone can find the flaw, I shall be more than happy to give him or her $50,000. I am just tired of doing this.


      The costs of borrowing for a nation to fund public expenditures, if it borrows solely from its resident citizens and in the nation's currency, is nil.

      Why? Because if, in adding a financial debt to a community, one adds an equivalent financial asset, the aggregate finances of the community will not in any way be altered. This is simple reasoning confirmed by
      simple arithmetic.

      The community is the source of the government's funds. The government taxes the community to pay for public services provided by the government.

      Cost of public services is $10 million.

      Scenario 1: The government taxes $10 million.

      Community finances: minus $10 million from community bank accounts for government expenditures.
      No community government debt, no community
      government IOU.

      Scenario 2: The government borrows $10 million from solely community lenders at a certain interest rate.

      Community finances: minus $10 million from community bank accounts for government expenditures.
      Community government debt: $10 million;
      Community government bond: $10 million.

      At x years in the future: the asset held by the community (lenders) will be $10 million + y interest. The deferred liability claimed against the community (taxpayers) will be $10 million + y interest.

      The value of all community government debts when combined with all community government IOUs or bonds is zero for the community. It is the same $0 combined worth whether the community pays its taxes immediately or never pays them at all.

      So if a community borrows from its own citizens to fund worthy public expenditures rather than taxes those citizens, it will not alter the aggregate finances of the community or the wealth of the community any
      more than taxation would have. Adding a financial debt and an equivalent financial asset to a community will cause the elimination of both when summed.

      Whatever financial benefit taxation possesses is nullified by the fact that borrowing instead of taxation places no greater financial burden on the community.

      However, the costs of Taxation are immense. By ridding the nation of Taxation and instituting borrowing to fund public expenditures, the nation will shed all those costs of Taxation for the negligible fee of borrowing in the financial markets and the administration of public

      Gary Marshall

        CommentedManish Singh

        @Eduard Lungu - I don't consider this a savings problem - "in the case of the developing countries, the citizens are more likely to use their money for consumption than to save" - Developing countries like India/China have the highest saving rate and is pretty stable in the long run.

        CommentedGary Marshall

        Hello Eduard,

        I read through your comments. I hope the following helps.

        The nation need not repay the debt as long as the lenders are certain of the security of the loan. Would one lend to an organization that created $1 in assets for every $1 borrowed? Probably not. How about $2 in assets for every $1 borrowed? Certainly.

        It only becomes a matter of settling on an aggreeable interest rate for both borrower and lender.

        There are few entities on this earth that do not count liabilities among their assets. Most of us carry debts and many other liabilities. That is not the worrying part. The part for concern is the value of our assets. Does one possess assets exceeding those aggregate liabilities. Most will say yes. Some no unfortunately.

        Does a government possess financial and material resources? Certainly. With Taxation, the combined financial and material resources of every entity within the nation. Without Taxation and with borrowing, the same. This is what backs the nation's financial debts.

        Now if an entity can borrow and invest, creating assets that exceed liabilities, should it do so? The answer is obvious, and just as obvious if it cannot.

        So if a nation can borrow from itself, its citizens, and create assets that exceed the acquired liabilities, should it do so? Yes.

        Banks do it all the time. They borrow from one and invest or loan money to another, living on the margins. They never pay off their lenders. They just borrow more money for supplying more loans, creating assets that exceed liabilities.

        And it will be the same for a nation. Borrow from one and invest in some project, creating assets that exceed liabilities and enriching the nation and its people. An investment in clean drinking water will take out many water borne diseases that drive up medical costs and reduce the working days of a labourer.

        The first post above merely shows that the cost of borrowing for a nation is in effect nil. The debt obligations issued by a nation create a liability that is equally matched with a created asset, held by a resident US lender.

        Its like a bank adding to both sides of its balance sheet. The addition of an asset offsets or nullifies the addition of equal extent of a liability. Or in other words, are you better off if you borrow $1 from your mother? You owe what you now possess, so your circumstances are unchanged.

        The question for the Government now centers on what we get for our money expended in public projects? With Taxation, there is no justification because government can take your money and do pretty much as it pleases. With borrowing, the government will have to approach the citizen and provide a proper analysis.

        The government, any government, is currently taking large fractions of the financial resources of a nation by force. So with the abolition of Taxation, this will free up all the money currently being paid in taxes of all forms in any nation, in Spain and throughout the world.

        By revoking the right to tax, the government will have to wade into the financial markets like any other lender. As funds will thence come with a capital charge, the government will be forced to justify its expenditures through novel cost/benefit analysis. Otherwise many will not lend.

        With a people's direct control over government expenditures, can you imagine a government actually having to justify its expenditures, having to prove worthiness?

        Government expenditure should contract drastically as all those politically enriching, but practically worthless and corrupt expenditures cease to be, especially in those very poor or developing countries you mention.

        There will also be the benefit of a nation not having to factor in Taxation into every economically worthy activity. There will be no constraint upon worthwhile economic activity. People and corporations will earn, save, invest, retire debt, expend without having to hand large fractions of that money to the ubiquitous tax man.

        There is also the interest rate to consider. The rates are currently very high given all the uncertainty about stability and the Euro. If there are few borrowers, the interest rate must rise to reflect the forces of risk and reward.

        If savings' market rates are low, it is because people think better returns are to be had elsewhere. Therefore rates must rise.

        Now with government cost/benefit analysis, returns for certain projects become dubious beyond certain rates, so the government may refuse to fund them. Funny, in a thriving economy when tax revenues are plentiful, government expenditure is at its highest. When the economy wanes and revenues fall, government expenditure retracts.

        With the interest rate as arbiter, government expenditure will be greatest when the economy declines and lowest at its peak. How different it would be!

        The reason that many governments borrow externally is because Taxation has perhaps yielded as much as it can, or a nation fears higher taxes will drive off investment.

        Now you doubt people will lend. I don't. There is a lot of pension fund money in any developed nation looking for investments. Similarly, in many nations.

        The reason that savings are so little in poorer countries is because large amounts of money must go to acquiring the necessities. The cost of living is very high, and much of it has to do with rotten government policies and practices. I have dealt with these above.

        A nation if deprived of internal savings can always turn to outside lenders temporarily to fund a public project. Its the poorer nations where the returns for private investment will be highest. Unfettered by corruption, those nations should see great leaps in industry, wealth, and income. And all that industry will fund the necessary public projects.

        In Greece, the government will see expenditures that do not meet cost/benefit analysis vanish. The cost of government should decline sharply. Without Taxation, there will be an immediate influx of investors from all over the world seeking tax havens and worthy investment. Without constraint upon worthy economic activity, all those projects which taxation or heavy regulation prevented will commence. The economy should pick up.


        CommentedEduard Lungu

        Well, of course that will be easier for a state to borrow from it´s own citizens than to tax, but there are a lot of historically reasons why the states always preferred to tax, like for example:
        -in the case of the developing countries, the citizens are more likely to use their money for consumption than to save. Why do you think that the banks in Greece, Spain or Portugal borrowed large sums of money from Germany, instead of using their own costumers savings? And trust me, I live in Spain so I know about the consumption rage in the last 10 years; no one bothered saving money. Elementary, you can increase the level of Savings with a combination of high interest rates and a high VAT, but that of course will be taxation.
        -in the case of poor countries, what community finances? Of course they need to borrow money from elsewhere.

        But I think that the flaw in your argument is this:
        Even if the state borrow money from the local community, they still need to repay the debt, and where can they get that money if not from taxes? Let´s say that the state builds a highway and that brings more wealth to the community,which is great, but in order to repay the debt the government need to impose a highway tax or just tax the local transportation companies (which presumably have more money now). So even if you can simply borrow the money for public expenditures , taxation is necessary in order to recuperate the money... and so the costs of Taxation that you speak off are inevitable.

        But, what I don´t understand, how is this helping Greece in their CURRENT situation anyway?

    5. CommentedZsolt Hermann

      The end of the article:
      "No catastrophic earthquake or tsunami has destroyed southern Europe’s productive capacity. What we are witnessing – and what is now affecting the whole world – is a man-made disaster that can be stopped and reversed by a coordinated policy response."
      In truth there is neither a disaster, nor can it be stopped.
      We simply kept on developing and the world kept on evolving around us.
      What used to work before, like constant quantitative growth in a relatively "loose" system, with abundant resources, and independent, polarized, self calculating planning and decisions, simply do not work any longer, because today we live in a closed, finite system where humanity has become "round", global and interdependent.
      There are multiple factual and scientific publications predicting significant shortage in basic food and water supplies, energy sources, and other basic raw material supply within very short time, very much within the lifespan of the present generation.
      Our present system is built on inconsiderately excessive, and unnecessary over production of goods we simply do not need for a normal human life. We only "desire" and buy these things because we are programmed to do so by a sophisticated mass media, marketing system brainwashing us 24/7. Even for a second we do not live the life we truly want to live, we live a life others trick us into.
      This whole setup, that is the natural result of our inherently egoistic evolution, drove us into the present global crisis with its economic, financial and political components, but also effecting our life in every other respect as we can see from the woeful education and health systems, family breakdown, spreading depression, suicide, drug and other substance abuse figures, etc.
      Austerity vs. Stimulating growth...we are simply kicking a dead horse here. We need to rise above this cul de sac and start building something new that suits the state of our evolution in the 21st century in order to move on in a sustainable manner.