How do we tackle economic problems and foster economic growth?

Australia – austerity or growth? It’s a global question!

There are usually a range of options to tackle any economic problem or condition, ranging from increasing government spending to reducing taxes to printing money or even starting a war to divert the attention of a worried populace. What has struck me most about global approaches to tackling the post-Global Financial Crisis economic problems is the stark bipolar nature of the debate. If you listen to political commentary, all of those many policy options seem to boil down to one of two options – increase the role of government in the economy or decrease the role of government in the economy. This may be nothing more than a failure to understand more complex economic issues on my part, so i am open to that possibility – but my impression of policy debate throughout the world is one where there are only two possible approaches. The end result is a “Morton’s Fork” misrepresentation of a far more complex range of alternatives.

An interesting twist is that proponents of the opposing views have hijacked prominent historical economists to back their specific approaches to economic management. And when that happens, you just know that there’s someone out there somewhere, ready to parody the whole concept.

Keynes versus Hayek

[These videos were put together by EconStories, whose website can be found here at www.econstories.tv]

In the real world, you’ve got to ask whether the academic debate has any validity? For an in-depth look at the economic theory side of this argument, see this site http://reason.com/archives/2012/02/16/keynes-vs-hayek-oversimplified

It is really as simple as austerity or growth?

The idea that complex problems have only two possible solutions seems strange to me, as it assumes that one “version” of economic theory is correct, and another “version” is incorrect – whereas the truth is more likely to be found somewhere in a mix of the two. In just two examples, we can see this dichotomy very clearly:

The European Union and different economic growth rates and conditions among its member states
1.   Germany, is seen as wanting “austerity measures” whereby governments reduce costs to keep debt under control.

2.   France, Italy, the UK and others are looking for latitude on debt and more action to stimulate growth – even at the cost of debt control.

The United States arguments over debt ceilings and government spending levels.
1.   Republicans, and most especially the Tea Party faction, want to see less government spending and lower taxes, even if it means less government services, including those for the poor and disadvantaged.

2.   Democrats broadly seeking to cushion the impact of post-GFC financial impacts and provide greater support for disadvantaged and to address “income inequality”.

In each case, there are valid arguments for reaching a compromise based on a a mix of policies but minority governments and “hung parliaments” have reduced the ability of politicians to find a middle ground. The result is a world where compromise and agreement are pushed aside in favour of short term delays and token band-aid solutions. Sticking to our two global hotspots, we can examine their respective approaches further:

1. In the Eurozone, Greece has a level of debt that most economists would agree to be unsustainable, and will most likely lead to some form of default or a perpetual state of economic recession or depression. Greece has endured the largest economic depression of any developed country in the last 80 years – so if there was economic mismanagement in the past then there is an argument to say that a penalty has been paid. Greece is currently running at a budget surplus – but only if you ignore the debt and its repayments. As the largest creditor within the Euro zone, Germany is unwilling to see Greece avoid any of that debt, and continues to push for rollover of debt to what has been or may still be, a bankrupted nation. It’s as though the elephant in the room – that is, the impossibility of repaying that debt – just doesn’t exist. It would make more sense to bring the debt to a sustainable level in return for structural changes to the Greek economy and stimulatory policies to foster growth and boost the nation’s ability to deal with its debt “normally”. But in a polarised world where no-one wants to be seen to give way on ideology, that is simply not going to happen. Not without a fight, anyway.
2. In the United States, budget constraints and an aversion to “big government” have resulted in a Quantitative Easing policy that fosters income inequality by boosting the value of investment assets that have traditionally only been owned by those in higher income and wealth brackets. The economy has returned to robust growth and strong employment growth but there remains a large chunk of the population that has failed to re-enter the workforce, and the gains have predominantly flowed to higher earners and the wealthy. This is a simplified interpretation but the broad thrust is arguably more correct than not.

Paradoxically, the society that least likes “big government” – the United States – has willfully engaged in one of the largest transfers of wealth from taxpayers to the corporate sector that the world has ever seen, incurring huge taxpayer debt in the process.

Sometimes the best way of considering an argument is to look somewhere in the middle.

Scandinavian countries – Sweden, Denmark, Finland and Norway are arguments for austerity but subject to conditions. Their “model” differs from Germany’s, and is covered in this article from the American Institute for Contemporary German Studies at John Hopkins University, “Growth in a time of austerity: Looking beyond Germany at the Nordic model“. Here’s an extract that shows how a mix of ‘standard’ austerity and growth policies can potentially offer better outcomes that either could by itself…

The old model depended on the idea that the state could keep on getting bigger. The answer to every problem was more state—and more state inevitably meant more taxes and more regulation. But in the 1990s the Nordic countries realized that they had reached the limits of big government. The new model focused on restraining the growth of the state and getting more productivity from taxes. It also focused on putting long-term finances on a sound footing.

Sweden reduced public spending as a proportion of GDP from 67% in 1993 to 49% today. It could soon have a smaller state than Britain. It also cut the top marginal tax rate by 27 percentage points since 1983, to 57%, and scrapped a mare’s nest of taxes on property, gifts, wealth, and inheritance. In 2013 it cut the corporate-tax rate from 26.3% to 22%. Sweden also donned the golden straitjacket of fiscal orthodoxy with its pledge to produce a fiscal surplus over the economic cycle. Its public debt fell from 70% of GDP in 1993 to 37% in 2010, and its budget moved from an 11% deficit to a surplus of 0.3% over the same period. Sweden also put its pension system on a sound foundation, replacing a defined-benefit system with a defined-contribution one and making automatic adjustments for longer life expectancy.

Which pathway should Australia take?

Personally, i have no idea. We’re a wealthy country with a very small population holding a disproportionately large chunk of the the habitable land on this planet, yet there are questions of sustainability, water scarcity, environmental degradation, social diversity and then there’s the state of our national accounts. It would seem that there are a lot of lessons that Australia’s leaders could take from the recent global posturing and policy initiatives – but how to avoid the simple this/that approach to highly complex problems?

There’s no particular outcome being sought in my musings on this point. It’s more a case of looking at the situations where polarised opinion and policy have failed to bring about better outcomes, and enjoying a little rap economics along the way.

I’d be fascinated in any thoughts or opinions this may bring out from those who read this blog – i know that you are, on average, a very capable and erudite bunch, so your opinions are most likely going to be helpful to the casual reader who stumbles across this post.

Great Disclaimer

As usual, please remember that nothing on this site is to be taken as personal financial advice. It is simply the outpourings of thoughts and musings of Michael O’Hara, a financial planner who lives in Perth, Western Australia. Please feel free to comment, criticise, correct or compliment.