In memory of Dr. Andreas Höfert

Austerity or growth – is it the right question?

| Tags: Andreas Höfert

Five years after the Great Recession 2008–09 is a good time to assess the policies enacted by countries and regions to fight it. Two years ago such an analysis would have opposed two ways of dealing with the recovery – austerity versus growth. By now there should be a clear winner. Or is the debate subtler?

Economic policy based upon austerity has been associated with the Eurozone and Germany’s recommendations toward the “profligate” countries of the European periphery to bring public finances back in order and to carry out structural reforms. According to the austerity narrative, this should ensure in the longer run the right conditions to embark on a virtuous growth cycle. Ireland has been used here as a poster child to illustrate the benefits of this approach.
Economic policy that favored growth, despite the expense of higher public debt and deficits, was the one chosen by the US and to a lesser extent the UK. This narrative suggested that once growth returned, getting public finances in order would be more manageable.
Which policy is currently the better one? From a pure business cycle and unemployment perspective, the growth option has fared better. While the US is forecast to grow at 3% for 2014, the Eurozone is forecast to achieve only slightly above 1%, following two years of decline. The unemployment rate is still historically high in the US at 6.7% in December, but is low when compared with the unemployment rates in the European periphery, which range from 13% for Italy to 28% for Greece.
Public debt statistics show that the US, with its estimated 106% gross debt-to-GDP ratio in 2013, doesn’t look as good as Germany with 80%, but is not so far from France with its 95%, and is lower than most of the European periphery (132% for Italy and 176% for Greece). Moreover, while many Eurozone countries might have been proud of their austerity measures by 2013, when growth was still lackluster there, the most fiscally restrictive country was in fact the US, with tightening measures amounting to roughly 2.5% of GDP (this number represents the reduction in the so-called structural deficit), while “frugal” Germany, with far less growth, according to International Monetary Fund estimates, actually exhibited a slightly expansive fiscal policy amounting to 0.2% of GDP.
Moreover, as noted in a white paper written as an input for the World Economic Forum in Davos by UBS opinion leaders, austerity should not be seen solely through the lens of fiscal policy. According to this report, there is a second “’silent austerity,’ which is to be found in the banking sector, and in the evolving regulations that govern it.”
Here again the US and to a lesser extent the UK have chosen a different, less constrained path than the Eurozone. Indeed, while credit activity has risen for over two years in the US and in the UK, explaining a pickup in private investment and in the construction sector, it is still shrinking in the Eurozone, reflecting the continued uncertainty of the financial intermediaries there in relation to both their counterparts and rules and regulations that are still being written.
Only the setup of the European banking union scheduled later in 2014 will bring clarity here, though as also stressed in the aforementioned report, not every regulation currently discussed will halt the ongoing deleveraging process and reluctance of European banks to lend.
Ultimately the debate “growth versus austerity” is misleading. Growth is certainly needed to heal economies’ financial crisis wounds. But so too must public finances be brought back in order to ensure that financial intermediaries are both stable and unconstrained enough to provide credit to an economy smoothly. In this respect the filter we should use to compare Anglo-Saxon economies to that of the Eurozone five years after the Great Recession remains “pragmatism versus dogmatism.”