job creation

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Latvia Is No Success

Anders Aslund of the Peterson Institute is fairly certain that austerity during depressions works:

After five years of financial crisis, the European record is in: Northern Europe is sound, thanks to austerity, while southern Europe is hurting because of half- hearted austerity or, worse, fiscal stimulus. The predominant Keynesian thinking has been tested, and it has failed spectacularly.

The starkest contrasts are Latvia and Greece, two small countries hit the worst by the crisis. They have pursued different policies, Latvia strict austerity, and Greece late and limited austerity. Latvia saw a sharp gross domestic product decline of 24 percent for two years, which was caused by an almost complete liquidity freeze in 2008. This necessitated the austerity that followed.

Yet Latvia’s economy grew by 5.5 percent in 2011, and in 2012 it probably expanded by 5.3 percent, the highest growth in Europe, with a budget deficit of only 1.5 percent of GDP. Meanwhile, Greece will suffer from at least seven meager years, having endured five years of recession already. So far, its GDP has fallen by 18 percent. In 2008 and 2009, the financial crisis actually looked far worse in Latvia than Greece, but then they chose opposite policies. The lessons are clear.

The notion that Latvia is somehow a success story is just absurd.  Latvia has shed some ten percent of its workforce during the economic turmoil — that would be like more than 20 million people emigrating out of the USA, or 4 million people emigrating from Britain. This is why the unemployment rate has fallen somewhat.  And Latvia’s economy is still deeply depressed, far, far below its pre-crisis peak. Would we be calling Britain and America success stories if millions and millions of people were leaving and output was still far, far, far below its pre-crisis peak?

This video from last year shreds the notion of Latvia as some kind of austerity-driven paradise:

The truth is that the binary choice between stimulus and austerity is false. The real decision is how best to produce productivity, creativity, entrepreneurship and growth. It is possible to do this without any debt-fuelled stimulus, and without any immediate fiscal contraction, by (for example) attracting more foreign investment, using bailed-out banks to provide business finance to the unemployed, and deregulating small businesses and entrepreneurs.

The fiscal trick is in learning to cut spending during the boom — something which very few governments have ever mastered, but which is necessary for long-term fiscal sustainability. In the United States during the mid-2000s, tax revenues were high, and growth was moderately strong. This gave the Bush administration a false sense of leeway that allowed them to embark on massive debt-fuelled spending at precisely the wrong time, starting two wars, and creating large-scale domestic spending programs like Medicare Part D and No Child Left Behind. If the Bush administration had cut spending during the boom, not only would it have offset some of the potential for bubbles in housing and stocks, but it would have left the American government in a much stronger financial position come the downturn.

Yesterday’s prosperity didn’t last forever (leaving us with collapsed tax revenues, and massive budget deficits) and today’s depression doesn’t have to last forever either, so long as we have the courage to create the environment for small business and entrepreneurs to thrive, and then to cut, cut, cut during the next boom. Trying to balance the budget in the way Anders Aslund seems to endorse is a road to deeper depression, extreme unemployment, and potentially to millions and millions of people leaving to look for work elsewhere.

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The Economist: “Be Afraid (Unless We Print a Lot More Money)”

While most readers of this blog will be convinced of (or at least open to) the idea that the global financial system is fundamentally broken, and either needs to fail or at the very least needs to undergo a radical transformation, some of us believe that the problem is basically a lack of demand, and that the entire solution lies in printing fuckloads of money, giving it to the people who brought us Solyndra, and hoping for the best.

From today’s issue of the Economist:

Lacking conviction and courage

In the aftermath of the Lehman crisis, policymakers broadly did the right thing. The result was not a rapid return to prosperity in the West, but after such a big balance-sheet recession that was never going to happen. Now, more often than not, policymakers seem to be getting it wrong. Their mistakes vary, but two sorts stand out. One is an overwhelming emphasis on short-term fiscal austerity over growth. Fixing that means different things in different places: Germany could loosen fiscal policy, while in Britain the reins should merely be tightened more slowly. But the collective obsession with short-term austerity across the rich world is hurting.

The second failure is one of honesty. Too many rich-world politicians have failed to tell voters the scale of the problem. In Germany, where the jobless rate is lower than in 2008, people tend to think the crisis is about lazy Greeks and Italians. Mrs Merkel needs to explain clearly that it also includes Germany’s own banks—and that Germany faces a choice between a costly solution and a ruinous one. In America the Republicans are guilty of outrageous obstructionism and misleading simplification, while Mr Obama has favoured class warfare over fiscal leadership. At a time of enormous problems, the politicians seem Lilliputian. That’s the real reason to be afraid.

The alternative view (as I have spelled out many times before) is that no amount of monetary policy without at the same time addressing the underlying real-world problems will solve the problems. Problems will just be kicked down the road, to re-emerge at a later date:

Those troubles are non-monetary — they are systemic and infrastructural: military overspending, political corruption, public indebtedness, withering infrastructure, oil dependence, deindustrialisation, the withered remains of multiple bubbles, bailout culture, the derivatives-industrial complex, and so forth. The real question is when will America tire of the slings and arrows of fortune? When will America take arms against her sea of troubles? And how long will she last on this mortal coil? To die? To sleep? For in that sleep of death what dreams may come…

Until we address the underlying problems, the market — in the long run — will keep crashing. And in the long run, we’re all dead. So that’s twice as bad. Junkiefication leads to junkification.

There was always the hope that kicking the can down the road might give us an opportunity to address those underlying problems. But it doesn’t seem like we have. Risk and leverage are greater than they were in 2008. Moral hazard is ready to rear its ugly head. The global trade structure is as fragile as ever. America is just as dependent on foreign energy and manufacturing. Deleveraging is proving costly and painful. Worst of all, many of the dangers inherent in the financial system have  now been transferred via bank bailouts to the sovereign level — like in Europe.

So no — the real reason to be afraid is not that policy-makers are not showing Bernanke’s famous Rooseveltian resolve. The real reason to be afraid is that what occurred after 2008 merely suppressed the symptoms of an underlying sickness.

They can’t. Only real reform — solving the underlying problems — can.