Like a deus ex machina, growth has mutated into the great hope of 2012. Inspired by the election promises of the new French president, increasing support is being garnered by voices of opposition to German-led austerity who would put an end to ostensibly destructive belt-tightening and return us to the easy days of larger deficits. In this connection, past experience and insights concerning effective growth policies are being largely ignored – and not just at the EU level, where misinformation abounds, from the unsuccessful Lisbon Strategy of 2000 to more recent discussions concerning ‘project bonds’ that would be granted by the European Investment Bank. One cause for consternation is the frequent confusion between business cycles and growth.
Growth, as we know, is trend development of real gross domestic product under normal capacity utilisation – in other words, it is a measure of expanding output potential. The factors that contribute to growth are well known: human capital, physical capital (including infrastructure), technological innovation, and effective regulation with a view to flexible and open labour and product markets, sound public finances, and efficient social systems. As achieving growth at a national or European level necessitates policy measures that take these growth factors into account, it is contradictory to advocate growth while at the same time ignoring public debt problems.
Business cycles, on the other hand, are fluctuations in capacity utilisation triggered by swings in macroeconomic demand. In times of recession, countercyclical policies (such as economic stimulus plans) can help to counteract slowdown, although such measures have their limits. Indeed, we can be sort of glad if stimulus spending leads merely to a proportionate increase in GDP – i.e. if the 'fiscal multiplier' is one. Yet as policymakers typically ignore the flipside of Keynes's prescriptions – that is, to run budget surpluses and pay down debt during times of expansion – countercyclical spending leads to ever increasing public debt, the repayment of which is postponed in perpetuity. The excuses are always the same: When times are good, we shouldn't undermine the recovery. And when times are bad, we can’t risk intensifying the recession. So when is time to pay down debt?
Many European countries proclaim that current deficit spending is directed at preventing a collapse in output, and that fiscal consolidation is still on the agenda, yet must be delayed due to current headwinds. This argument is not without its merits, and would be acceptable if the problem countries within the eurozone made credible promises to reduce deficits and debt. Yet I am reminded of a line from Goethe's Faust: 'I hear the message well, but lack faith's constant trust'. The problem countries within the eurozone must rapidly and comprehensively reform their regulatory and social systems if fiscal consolidation is to be slightly postponed. Reforms are needed to flexibilise labour and product markets, including the elimination of barriers to entry, excessive bureaucracy, and other hurdles to competition. Furthermore, amendments are needed to restrictive social protection policies that discourage entrepreneurial initiative. Beyond such reforms, in Spain efforts must focus on recapitalising key parts of the financial sector. If the Spanish government provides for this recapitalisation (and not the EFSF), then the country's public debt levels will of course increase. But this recapitalisation, in conjunction with other reform measures, would have a positive signalling effect for financial markets, and could win acceptance for a prolonged timetable for fiscal consolidation.
Pro-growth policies and fiscal consolidation don't have to contradict each other; in fact, they are symbiotic. As a complement to the European Fiscal Compact, a growth pact could transform existing subsidies, such as those for agriculture (without – horribile dictu – sparing the French), at least partially into pro-growth investment. In Germany it is difficult to understand why parts of the opposition in the Deutscher Bundestag call for the ruling coalition to adhere more closely to the country's 'debt brake' regulations, yet at the same time claim that restrictions to deficit spending represent 'ruinous cutbacks' in the problem countries of the eurozone.