“This week the socialist government in France went berserk with austerity and tightening measures. This could put the country’s recovery at serious risk and perhaps President François Hollande may need to re-read the economic page on ‘fiscal multipliers’ – if no book is available the S&P Rating Services offers a sanguine view on page 5. The study proves how the fiscal multiplier in Spain has been closer to 6 to 1, rather than 1 to 0.5% rule which IMF applies. In the case of France we have an economy with low rates, an expensive labour market and now a new marginal tax of 75% - everything being equal will that lead to lower or higher growth? I think you know the answer, even without 5 years wasted at a university becoming an economist.” Steen Jakobsen, Chief Economist at SaxoThere is a link in the quote to an a report from S&P, which gives a breakdown of fiscal multipliers; 'For instance, in the UK, a fiscal contraction equivalent to about 4% of GDP between 2009 and 2011 had a negative effect on GDP growth about twice as high as the typical fiscal multiplier implies.' (p.5) The reason given in the S&P report for the higher multiplier is that there has been a simultaneous fiscal tightening over the developed world, and that the effects of reflationary policies in countries like China are fading.
There are two interesting points that emerge from the S&P report. The first point is that they are actually identifying how critical government borrow and spend is in supporting many developed world economies. The ever well-informed but ever more dubious analysis of Ambrose Evans-Pritchard leads to this conclusion being drawn from the report:
Europe's manic determination to tighten further into recession to meet its bureaucratic targets is nothing less than suicidal.However, the real point that can be understood from the report is that it reveals something of the depth of the economic structure that is being supported by government borrow and spend policy. Regular readers will know that I have often expressed concern about the way in which many countries have structures that have developed to service debt driven consumption. The interesting thing about this report is that it starts to hint at the degree to which economies are now reliant on ongoing government borrowing to maintain current standards of living. In my first ever post, I argued that, for example, the UK is poorer than it thinks, and this is the case in all of the countries that are following the borrow and spend path through the economic crisis.
It is not at all complicated. Current standards of living are to a very large degree contingent on borrowing and consuming. Economies that do so are simply entrenching the structure to service consumption based upon growing debt. As soon, as a government cuts back on debt growth, the structure that is supported by debt growth starts to collapse, and the real wealth generating economy underneath the unsustainable structure becomes exposed. Quite simply, there is no way out of the pain of restructuring, unless there is major economic upturn around the world. The problem is that, as the situation stands, this is not going to happen.
The Keynesians argue that the answer is more fiscal stimulus, and that this will regenerate demand, and all boats will rise with the fiscal stimuli. If only everyone borrowed and spent, all would be well. However, there is a fundamental problem with this idea. The more countries borrow, the more they restructure their economies around the borrowing. If, as they Keynesians had their way, all the countries of Europe were to raise their borrow and spend, this would (assuming that creditors would go along with it; a big assumption) lift Europe out of its current funk. The problem is that the restructuring of all economies to servicing debt based consumption would simply be greater. As country A borrows more, it would not only lift country A, but also countries B and C, which would help service the new demands in country A. The new activity in country B would also lift demand in country A amd B, and so forth.
The problem with this solution is that it is simply spreading the underlying structure of debt based consumption more broadly. Instead of just being reliant on your own borrowing to support your current standard of living, you become reliant upon country A, C, D, E etc. also continuing to borrow and consume. It merely extends the reliance of borrow and spend into an ever more entrenched network. As soon as any country in the network stops borrowing and spending, it impacts upon other countries within the network. Just as the upwards multiplier in the above paragraph lifted all boat, the same can be said of the downwards multiplier. It is this downwards multiplier that the Keynesians fear, and they are right to fear it.
The Keynesian's problem is that they simply do not accept that the more governments borrow and spend, the more entrenched the underlying problem becomes. The greater the coordination in borrow and spend, the greater the network effect of the multiplier, and the greater the negative impact when any single borrower cuts back. In the case of Europe, the fate of each economy is closely entwined with the European economy as a whole due to dense trade links. Any increase in borrowing of any country will improve the economy of its neighbours, and thus make those neighbours more reliant upon continued borrowing. The problem is that borrowing must have a limit. And as each borrow and spend domino falls, the others start to wobble as the effects of the falling domino moves through the network, multiplying the effects beyond the original domino. Coordinated borrow and spend is metaphorically moving the dominoes ever closer together.
The other problem is also distantly related to game theory. If country A tightens whilst all other countries increase borrow and spend, country A will start to restructure its own economy to be less reliant on borrowing. The stimuli from other countries will help it through the adjustment, and it will be left in a position of relatively less debt. It will still be reliant upon the network effect of the debt accumulation of the other countries in the network, which still means further pain at some point in the future, but the pain will be less than those who borrowed most profligately. By contrast, the country that borrows the most will undergo the greatest restructuring to service debt, and will contribute most to the network, at a cost of being in a weaker position in the future. Whilst this debt accumulation will maintain (or even enhance) their own standard of living in the near term, they are also disproportionately contributing to the network at a cost of increasing their debt and greater cost in the medium to long term. In other words, the smart policy now is to restructure whilst encouraging others to borrow and spend; as long as you are not the lender to those borrowing and spending, as these countries are going to have the greatest problems in repaying the debt later.
When looking at the fiscal multipliers, it is possible to see something of quite how large the debt consumption structure actually is for each country, but what is does not show is how those multipliers might effect a dense network. The problem is that we know that individual country multipliers will certainly have network multipliers, but nobody can calculate the network multipliers, which would require understanding of a dense network of interlinking relationships and layer upon layer of feedback between actors in the network. The real complexity in the European network is the different starting points of different countries, and that apparently less debt structured countries have already been lending heavily to those that have been net contributors to the system, not realising how dependent they themselves were becoming upon debt based consumption. Without this, we would see a very different response to the crisis.
What this finally comes to is that government borrowing to support consumption cannot be sustained. Borrowing must have a limit. Although cut backs in borrowing will result in a downward spiral, and the downward spiral will be large if there is simultaneous cuts in borrowing, this does not alter the fact that, at some point, economies must restructure. Coordinated borrow and spend can only make the problems even larger in the future. Acting as a net contributor in the network is foolhardy. Lending to a net contributor is foolhardy. Notwithstanding the complexity engendered by past lending, it leaves Europe in a position where the only real solution is to accept that the restructuring will lead to a downwards spiral. Better now than later.
Notes on Comments on the Last Post:
Lord Sidcup: I agree that, in some respects, the dichotomy between real and unreal becomes ever harder to see. I am very sympathetic to the creditism argument, and the original version of this post was going to address what is 'real' to some degree. For the moment, I will just say that what we are seeing is not that there is not a real underlying economic reality, it is just getting harder and harder to see. In some respects, it is a flight of fancy to use the world 'real', but what I mean by this is the idea that economies, in the long run, are comprised of individual actors who buy and consume 'stuff' and create 'stuff'. The global economy still comprises this fundamental structure. The relationships between these actors are the fundamental drivers of economics in the long run.
These actors operate in a global system comprised of the other actors, and there are subsystems in which these actors participate, which is individual country economies, and these operate more or less efficiently. These in turn have economic entities which operate more or less efficiently. Beneath this is the layer of individual actors, who also are more or less efficient. Obscuring this is money and debt (I will not argue about the distinction between these here), which is a layer over the top of a system in which each individual actor is a consumer of resources and/or adding value to resources (not all actors are both consumers and 'value adders') within a system.
The fundamental of 'real' wealth creation is the efficiency with which value is added to any given resource, relative to other actors. If you can take an input and add more value to it than another actor, then in the long run you will be more wealthy. The obscuring layers hide where the real value is being created. I know this is an incomplete answer, but I hope it helps to clarify a little about what I mean by real. However, in some respects I accept what you say about a false dichotomy, as the unreal and the real are ever less separable.
Lemming: An interesting point about throwing the dice on infrastructure:
He doesn't say it as such, but I think there's a suggestion that if we borrow lots of money to build infrastructure and then default, at least we'll have the infrastructure; if we don't do that, we'll still default because we won't be able to grow, and we won't have the infrastructure for the future either.I did not see Evan Davies, but note your mention of 'investment' in infrastructure for new rail lines. These were no doubt called an investment, but rail requires subsidy. As such, it is an investment almost guaranteed to create a negative return in financial terms. However, it might have a positive return in improving 'quality of life', but that is achieved at a cost that needs to be considered against other priorities for government spending.
However, the problem runs deeper than this example. If it is accepted that government should provide and invest in infratructure such as roads (which is another topic), then it is quite right that investing in infrastructure might be viewed as a positive, provided that there is a real need (and in the case of roads I would think that this is probably the case). However, the problem of the UK is not one caused by investment in infrastructure, but rather that there is overall consumption that exceeds the wealth generating capacity of the country. The question then becomes one in which it is necessary to ask what can be afforded. Provided that there is a real need for x infrastructure project, it absolutely should be at the top of the priorities. The problem is that nobody is willing to really accept that there must be much tougher priorities or the resources available to goverment must be used more efficiently.
In other words, asking for greater investment in infrastructure may be reasonable, but still leaves the problem that the current undertakings of the government cannot be afforded in their current form. The assumption is that the spending on infrastructure must be undertaken on top of the current undertakings. Where does the assumption come from? It is quite possible to cut undertaking x and y, and at the same time put resource into infrastructure. They are not mutually exclusive. And if, and it is a big if, the infrastructure improves the economy, this will allow for greater resource for the government in the future. My real worry in all of this was that, in particular during the build up to the crisis, was that the words spend and investment became interchangeable. However, that again is another topic. The main point here is to point out the problematic assumption. There is no reason that spending on infrastructure should mean incresing borrowing. It is just a question of priorities.
General Comments: Thanks for the positive feedback. Also, some challenges and interesting contributions. I would love to answer all the comments, but as you can see, this is already a long post with some long answers to a couple of the comments already. Quite simply, I have run out of time.
Final Note: For some reason, the Blogger service keeps changing 'S&P' to gobbledygook - apologies if this takes place when I hit the publish button, but I am unsure how to fix it (and it may happen in this note as well).
A reply to a comment on this post (same day as post, the reply was too many characters for the comments so added here):
Nice to see you commenting again Chaingangcharlie. I agree that the lead up to the crisis was not a very positive picture for the invisible hand but..... but the sudden dropping of massive surplus of labour into the world economy was not the work of the invisible hand, but very visible hands. China and India kept their workforce out of the global supply, and then 'dropped' their workforce into the supply. The invisible hand was not the cause here. As a regular reader, I am sure that you will know my argument that this labour shock was the underlying cause of the financial crisis (aided by regulation), the boom in credit etc. I cannot detail this here. However, the point is that it is not the visible hand.
As for bankrupt, you are right that printing money is not going bankrupt in the strictest terms. However, if you hold a devalued GBP that has taken a 'haircut' as a result of devaluation, how is this different from taking a haircut more directly from a failure to pay and renegotiation?
In both cases, the value of your bond holding has fallen, and the issuer has failed to pay what they implicitly promised; returning to you x% of greater value that you lent. A country cannot be legally bankrupt, but being unable to pay your debts is, from a pragmatic point of view the same thing.
As for the market knows best, as I have detailed in other posts, the global economy is no longer about market signals, but about government and central bank actions. Again, there are very visible hands at work, and how is that working out for us? You say we will head into a long period of pain, and suggest this is not the answer. However, we can see what has happened when the other answer has been pursued to a conclusion; Greece and Spain. When it comes to other borrow and spend countries, they may have a while yet, but......what must finally happen unless they eventually accept that they cannot consume more than they produce....?
You have confidence, it seems in the policy makers who failed to see the crisis coming, who have not resolved the crisis since it became apparent in 2008, and who have in the meantime printed and borrowed to no effect. And despite this policy action, as I have discussed before, people are still getting poorer, and doing so whilst racking up future commitments that will make people even poorer.
In the meantime they have obliterated any functioning of the market, created monetary time-bombs, and borrowed to the point where any prospect of repaying the debt grows ever more dim. In so doing, what have they created; an economic system that is now policy driven. But driving where? Do you see this policy action working on any level at all, except for building and ever less sustainable and distorted structure?
You have faith in policy makers to make things right. I have no faith in them whatsoever, as their record is dismal. They have failed on every level, and even the most casual reading of the news shows that this is the case. Even when the news is positive, the situation always reverses. The overused phrase of 'green shoots' appears, only to see that there were no real green shoots, or that the shoots whither as soon as they emerge. How much failed policy would it take to convince you? What would it take to dissuade you of the necessity to change course?
Unlike those who proposed exansionary austerity, I never bought this idea. I always recognised that you cannot restructure away from debt fuelled and unsustainable consumption without a painful adjustment. And this is why I emphasise that the problems are that economies are structured around debt based consumption. If that is accepted, then more debt just deepens the problem. More countries simultaneously increasing debt just raises the problem to a new level and deepens the structural problems. I understand your concern, but surely leaving the current system in place can only eventually make things worse.
And then what will the final mess look like? I do not like the choice I propose but it is the same point I have made for a long time; pain now or more pain later. I go for pain now. It is not good, it should never have got to this situation etc. etc. but the situation as it stands is still the situation.
