Interesting things happened this morning. I assisted to one of the presentations of the OECD interim assessment. There is nothing very new in the assessment, that concerning the eurozone, can be summarized as follows
- The outlook remains negative (while the rest of the OECD countries are doing better)
- There is still room for monetary accommodation
- This monetary accommodation may not benefit the countries that need it more, because the transmission mechanism of monetary policy is still not fully working
- The Cyprus incident shows that there is a desperate (this I added) need of a fully fledged banking union
- EMU countries need to continue on the path of fiscal stabilization, even if automatic stabilizers should be allowed to fully play their role, even at the price of missing nominal targets Read more
Well, not him, actually (I wish I could); I need to content myself with his latest post on austerity. Krugman argues that austerity is happening (it is trivial, but he needs repeating over and over again), showing that in the US expenditure as a share of potential GDP is back to its pre-crisis level (while unemployment remains too high, and growth stagnates).
I replicated his figure including some European countries, and with slightly different data. I took OECD series on cyclically adjusted public expenditure, net of interest payment. This is commonly taken as a rough measure of discretionary government expenditure. I also re-based it to 2008, as most stimulus plans were voted and implemented in 2009. Here is what it gives: Read more
Wolfgang Munchau has another interesting editorial on austerity, in yesterday’s Financial Times. He argues that the US may become the next paying member of the austerity club, thus making the perspective of another lost decade certain.
Munchau’s article could be the n-th plea against austerity, as one can by now read everywhere (except in Berlin or in Brussels; but this is another story). What caught my attention are two paragraphs in particular.
Update: An edited version of this piece appeared as a Project Syndicate commentary
A few weeks ago on Project Syndicate Raghuram Rajan offered his view on inequality and growth, thought provoking as usual. His argument can be summarized as follows:
- Inequality increased starting from the 1970s, across the board
- Two different explanations of this increase can be offered: a progressive one, that blames pro-rich policies, and an “alternative” one, that focuses on skill biased technical progress. I do not understand Rajan’s restraint, and as I like symmetry, I will label this alternative view “conservative”.
- Both views agree that inequality led to excessive debt and hence to the crisis.
- According to Rajan, nevertheless, the alternative/conservative view is more apt at explaining what happened to Europe, that remained more egalitarian, but was able to hide the ensuing low growth and competitiveness through the euro and increased debt.
- The exception is Germany where, following the reunification, structural reforms had to be implemented to reduce workers’ protection. This explains why Germany today is so strong in Europe.
- Thus the solution is for Southern Europe to implement structural reforms and accept increased inequality through lower workers’ protection; the alternative is sliding into an “egalitarian decline” like Japan.
The way I see it, there are a number of problems with Rajan’s analysis, and more importantly a fundamental (and unproven) assumption that underlies his argument. Let me start with the problems in his analysis, and then I’ll turn to the core of this piece, i.e. challenging the underlying assumption.
Give a look at Dani Rodrick on Project Syndicate (in a number of languages). The scary thing is that it is not completely implausible…
Larry Summers has a very interesting piece on yesterday’s Financial Times.
He argues that a few countries (the US, Germany, Japan, the UK; I would also add France) enjoy extremely low borrowing rates, both short and long run. In particular, real rates (nominal rate minus inflation) are negative or zero for maturities up to 5 years, and extremely low for longer ones. Summers’ conclusions are then straightforward:
- Focusing on further quantitative easing is not particularly useful; given the already very low rates, further reductions are unlikely to trigger private spending (it has a name: liquidity trap. And Paul Krugman has been insisting a lot on this, for example here)
- More importantly, government should borrow now, like crazy, taking advantage of the favorable conditions to reinforce their long term fiscal sustainability. This is what any reasonable CEO would do, and there is no reason why governments should act differently.
Summers makes a point that is almost obvious: Any project that has positive expected return would improve the country’s fiscal position, if financed with debt at negative real rates: This is the time for example to borrow to buy government buildings that are currently leased. Or to accelerate the rate of replacement of aging capital; or again, to engage in long term infrastructure building/renovation. Makes sense, right? It makes so much sense, that chances are that it will not be done…
I would like to add two considerations. The first is to stress that to get private demand started, it is important that growth perspectives are stronger. Firms today do not invest, not because of borrowing costs, but because even at very low interest rates, expected demand is so low that investment is not profitable. The second is that, for Europe, increased borrowing in Germany, France and the UK would be crucial. Countries enjoying low rates could not only significantly improve their long term prospects, as Summers argues. They could also sustain demand in countries that are consolidating, thus favoring the rebalancing I have repeatedly argued for.
The latest IMF World Economic Outlook came out last week. It has lots of interesting remarks on the European austerity. Remarkably enough, it poses the problem of timing: fiscal consolidation, if too hasty, may end up being counterproductive. I played a little with the data accompanying the report, including the forecasts.
I just published an editorial on the Italian daily il Corriere Della Sera (in Italian), that summarizes my views on the causes of the crisis and of global imbalances. It is a reprise of one of my first posts, written with Jean-Paul Fitoussi. It is useful to summarize and refresh the argument:
Martin Wolf has a very interesting piece on China’s attempt to rebalance its growth model from exports to domestic demand. Wolf remarkably shows how this attempt has been going on for at least a decade, with unequal pace, and several stop-and-go. I’d add that the crisis itself played a contradictory role. China on one side was one of the first countries in 2009 to implement a robust stimulus plan amounting to more than 10% of GDP; on the other, it did not resist (as most countries) more or less hidden protectionist measures and currency manipulation. Wolf concludes that, while successful, the rebalancing from external to domestic demand led to excessive (and not necessarily productive) investment. The new rebalancing challenge of China lies in increasing income and consumption of its population.
What I take from this is that China fully grasps its new role in the world economy. Its leadership understood long ago that the transition from developing/emerging economy to fully developed economy needed to pass among other things through less dependence on exports. A large dynamic economy cannot rely on growth in the rest of the world for its prosperity. Even the debate on reforming the welfare state and on health care had as one of his reasons the necessity to reduce precautionary savings. The rebalancing act is long and unsteady, but definitively under way.
It is also worth noticing that a better balance between domestic and external demand in the large economies is crucial element in reducing the macroeconomic fragility of the world economy through decreasing trade imbalances.
It is striking, in contrast, how Europe remains trapped in a sort of small country syndrome. The “Berlin View” permeating the Fiscal Compact advocates fiscal discipline and domestic demand compression, in order to improve competitiveness and to foster export-led growth. Besides the fact that it is not working, this is equivalent to tying Europe’s fate to the performance of the rest of the world, giving up the ambition of being a major player in the world economic arena. What a difference with the ambition and the forward looking attitude of China…
Yesterday I gave a short interview (in French) on the crisis. In particular, my take on the Italian crisis is that the fundamentals are not dramatic, and certainly not worse than they were before the summer. The new element is the increasing political weakness of the Italian government. The absence of political leadership leaves the path open to speculation. Tito Boeri links the spreads to political mismanagement. Without going that far, it is plain that Italy has a political problem far bigger than an economic one.
The EU situation is the same, on a bigger scale. There is a striking difference with the United States where the political system, even in a situation of divided government and economic crisis, can stand in front of speculation. In Europe, the political void leaves the field wide open for market primacy over governments.