19/10/2011: Growth now! If only it were so easy…

There is a new fad idea espoused by many economists, analysts, pundits and other editorial scribblers today: that debt is not the problem, at least not the most urgent one; the lack of growth is. If growth would return, the thinking goes, all our problems would be solved. Unfortunately, bringing growth back in the current environment is a rather daunting task.

Austerity measures are counterproductive because they weigh on growth. They could even lead to a self-reinforcing deadly spiral such as in the Greek case, where the government is shrinking the economy and thus the tax base, ultimately increasing or at least not reducing the public deficit as it is supposed to be doing. To the faddists, it would be better for governments to boost growth by even more deficit spending and only at a later stage care about the debt.

While at first glance it might bear some logic, this analysis occludes the simple truth that what led us to our current dismal situation in the first place – excessive debt from private households and governments – will certainly not be the solution that would pull us out of our misery. Asking financial intermediaries to lend with abandon conflicts with forcing the same financial intermediaries to repair their still shaky balance sheets. Creating incentives for private households to borrow more through low interest rates can only work if those households are not already overly indebted and trying to reduce their burden.

In the 1930s the great economist John Maynard Keynes advocated large public infrastructure projects to boost demand, but he did so in an environment in which governments were not facing massive debts and the risk of being downgraded by rating agencies.

Keynesianism, according to Keynes – though many self-proclaimed Keynesian economists would oppose this statement – should only be used in times of crisis. This is where we are now, so it seems to make perfect sense to use it. But this is a threadbare policy. Having been used so often, even in good times when Keynes did not mean for them to be used, fiscal stimuli have lost their traction.

So since the demand push cannot come from private households and is currently rather inefficient when coming from the public sector, it leaves only one possible growth booster: demand from abroad. Blaming the Chinese, the Germans, the Swiss and all other countries that were exporting instead of incurring debt over the last ten years for acting stingy now has become one of the most popular acts of political posturing in the deleveraging countries. But leaving aside possible cultural differences, is it any wonder why a country would choose not to follow the same debt-ridden path taken by the US, the UK and many countries in the European periphery?

Starting a trade war now in the hope that the winner would be able to boost growth might worsen the current slump. Even without retaliation from the trading partner, protectionist measures usually increase consumer prices, which further depresses real incomes. Patience coupled with ongoing efforts to slowly but surely bring down debt and repair balance sheets – in other words, to keep calm and carry on in the face of austerity – is the only sound advice an economist can give. Unfortunately, this is not what politicians facing elections want to hear and, even more importantly, want to tell their constituents.