• Time for A Step Change

    Europe’s leaders are being taught lessons that they refuse to learn. The Greek economy was always too weak to join the euro zone; now that it is – as a consequence – flat on its back and weighed down by debt, the “remedy” imposed on them by their European partners is an enforced dose of yet more austerity that will make it quite impossible for them ever to pay off their increased debts.

    The consequences for the European – and ultimately the world – economy will be dire. Greece is only the beginning; a recession-infected Europe now looks inevitable. Already, even in remote New Zealand, we are being warned that the euro zone’s difficulties will mean a worse economic outlook for us in future years.

    But before we put the entire blame for our woes on the Europeans, let us recognise that the bizarre European determination to treat austerity as the remedy for recession is shared by our own leaders. We seem to be locked into the same ideological deep-freeze.

    We are, after all, now entering our fifth year of either negative or minimal growth. We, too, have insisted that the key to securing a recovery that seems constantly to disappear further over the horizon is to close part of our economy down.

    Our principal goal, it seems, is not to reduce unemployment and get the economy moving, but to cut the level of government economic activity. The result? The economy continues to stultify and the government deficit proves increasingly stubborn and difficult to manage.

    But our economic problems are not defined by the recession alone; they are more deep-seated than that. The simple truth is that, despite the great advantages of buoyant export markets and record commodity prices, we continue to live well beyond our means.

    We make up the gap between what we earn and what we spend by borrowing from overseas and by selling off our assets to foreign owners. We have been doing this for decades, but the price we pay for this indulgence is getting increasingly steep. We have to pay an interest rate premium to foreign lenders, if they are to continue to lend to us, and we also have to pay to foreign owners – across the exchanges – the profits on the assets we no longer own, with the result that our perennial trade imbalance gets even harder to manage.

    More and more of our national wealth goes overseas. We have less and less control over our own economy, as the proportion we actually own diminishes. High interest rates not only inhibit domestic investment but produce an overvalued dollar that prices our goods out of international markets, including our own, and reduces our return on those goods that we do sell.

    We have been travelling down this no-exit road now for nearly thirty years. Yet our policy-makers still set their faces against any change of policy. We continue to assert that the only focus of macro-economic policy must be to control inflation, even though the measures we use to do so are poorly focused and slow-acting, and actually make our real problem much worse.

    What is our real problem? It is certainly not inflation. It is that we are basically uncompetitive. We have steadfastly ignored the fact that the world has changed and that rapidly developing economies like China, India, Korea, Taiwan and Singapore are now super-competitive economic powers, determined to build on that huge advantage by holding down their exchange rates and becoming ever more competitive.

    They have rapidly built the strength of their productive sectors and have earned huge trade surpluses which have allowed them to buy up the assets (including our own) that they will need for further development. Many of them already enjoy living standards better than ours and pay wages and salaries that are higher.

    We, on the other hand, are arrogant (and stupid) enough to believe that competitiveness does not matter, and that we can – in defiance of economic rationality – continue to push up our exchange rate with impunity. By focusing on inflation, to the exclusion of other objectives, and using interest rates and an overvalued dollar in the attempt to control it, we make it inevitable that our lack of competitiveness gets worse.

    The result is that we dare not grow – even in a recession – for fear of balance of trade constraints, and are reduced – for as long as we can find willing lenders and buyers – to financing our unsustainable consumption by overseas borrowing and selling off what little remains of our assets.

    It is time that we realised that competitiveness produces improved productivity, and not the other way round. We cannot hope to innovate and develop if we are constantly fighting the headwind of being uncompetitive. We should no longer be tinkering at the margins, with largely ineffectual tax changes and constant but ineffectual exhortations to improve productivity; it is time to make a step change by making competitiveness the focus of policy.

    But our leaders seem blithely unaware that their out-dated nostrums are destroying our economic future. The exchange rate, and issues of competitiveness, it seems, are no-go areas for discussion. They prefer their own simple certainties to the evidence before our eyes.

    Bryan Gould

    12 February 2012

    This article was published in the NZ Herald on 14 February

  • Europe’s Disaster

    New Zealand observers of the long drawn-out death throes of the euro-zone might be excused for finding it hard to understand what is going on. They will have lost count of the number of times that Europe’s leaders have proclaimed that they have yet again found a permanent solution to the euro-zone’s ills.

    The difficulty is compounded by the determination of Europe’s leaders – born of either self-delusion or a deliberate intention to deceive – to describe the worsening crisis in deeply misleading terms.

    As Brian Fallow explained in these pages last week, the talk in Berlin and Paris is all about deficits. The crisis is caused, we are told, because euro-zone governments have irresponsibly spent like drunken sailors and have allowed their deficits to spiral out of control. This narrative is of course very congenial to fiscal conservatives.

    The facts, however, tell a quite different story. Virtually all of the euro-zone governments, with the exception of Greece, have maintained a generally prudent stance, either staying in surplus or running deficits well within the 3% limit dictated by the Maastricht Treaty.

    There have been of course occasions when individual governments have, for a short time and for good reason, temporarily run deficits above the 3% limit. And interestingly, these supposed miscreants have included those governments that are now leading the charge to tighten the rules yet further.

    Even the Greek deficit is to be explained in terms that do not correspond with the story told by Merkel and Sarkozy. Greece is as much a victim as a culprit. Greece was never going to live with the monetary regime required by membership of the euro-zone and imposed from Berlin. It was the attempt to do so, without being allowed the usual remedies for lack of competitiveness offered by exchange rate and monetary policy that led directly and predictably to Greece’s current woes.

    What was true of Greece is also true – to varying degrees – of many other euro-zone countries. It is the futility of the attempt to require so many diverse economies, at different stages of development and with such different interests, to subject themselves to a single and largely inappropriate monetary policy, that is the true explanation of the euro-zone’s difficulties. The deficit contagion is the result and not the cause of the crisis.

    Not surprisingly, the mis-diagnosis of the malaise has led to a succession of misplaced remedies and, worse, a failure to grapple with the problem that demands and is susceptible to an immediate solution – the need to ensure that Europe’s banking system does not grind to a halt for lack of liquidity. That failure has placed the global economy in extreme danger of a double-dip recession.

    But it is the longer-term outlook for Europe that is even more depressing. The so-called “solution” agreed in Brussels will simply make matters worse. Far from releasing member countries from an economic straitjacket, Europe’s leaders have decided in their wisdom to give the lock a double turn.

    If the new arrangement holds, which seems doubtful, this would simply condemn Europe to an economic policy that makes it inevitable that half the European economy will, in effect, have to close down. Without access to exchange rate and monetary policies suited to their own circumstances, many euro-zone countries will collapse under the burden of policy dictated from Berlin. And just to make doubly sure, the new arrangement will tighten the rules and impose severe penalties for any breaches.

    Committing Europe’s diverse economies to a one-size-fits-all blueprint would be bad enough. But the dangers are compounded because the blueprint is in fact a recipe for increased austerity across the board, whatever the needs of individual economies. Germany may prosper in conditions decided in Berlin; others will not be so fortunate.

    The remedy for threatened recession is apparently that euro-zone governments must retrench, and achieve a fiscal balance at whatever cost, even if it means running their economies into the ground and thereby making their deficits worse. Such policies applied across Europe will simply drive the European economy into depression.

    Democracy, of course, has played no role in any of this. The people of Europe are required only to bear the burdens of policy failure, not to express an opinion. In implementing the Brussels agreement, no consultation with democratic opinion across Europe is to be countenanced. Elected governments are to be supplanted by a political elite who, pinning their hopes on a political mirage rather than economic reality, are perfectly prepared to defy experience and common sense.

    Does any of this matter to us? A failure of the European banking system, and a renewed financial crisis, would certainly hurt us. Our overseas borrowing, for example, would become much more expensive and difficult – and a prolonged European recession would also depress our major export markets.

    But we should also be aware that the issues being played out in Europe have their echo here, albeit on a much smaller scale. The attempt to outlaw steps that elected governments in future might wish to take, for example, to get people back to work is not limited to Europe. Our own newly elected government has, it seems, signed up in its agreement with Act to do just that.

    Bryan Gould

    11 December 2011

    This article ws published in the NZ Herald on the 13th of December