Growth pact - France, Chile & Sweden
With the new French winds blowing at the Elysée, the debate on a growth pact gathers momentum: briefly “piano piano” on austerity and public investment providing the growth kicker EMU urgently needs. Also the IMF issued some warnings earlier on that moving too quickly on austerity might in the end even be counterproductive. The reasoning would be that fiscal gains could get lost through lower growth and could move interest rates even up in the end (cfr Spain/Italy - http://blog-imfdirect.imf.org/2012/01/29/fiscal-adjustment-too-much-of-a-good-thing/).
Before discussing this kind of “new deal” and its usefulness, I would like to take a couple of seconds to comment on the Hollande démarche. First of all, it seems kind of strange that of all nations, France is now the no1 advocate against austerity and pro-growth. Why? Well, looking into some historical numbers, it seems that France since the mid-seventies not once – I repeat not once – managed to have a budget in the black or even balance its budget. France by the way was the first to breach the 3% Maastricht prescription way back in 2002 (Germany as well). And when looking at the current stance, the French structural budget is in a very bad shape. In fact, it is even worse than the structural budgets of Belgium, Italy or Spain for that matter. In addition, the cry coming out of Paris being solidaire with Athens or Madrid/Rome/Lisbon/Brussels for that matter is even more astonishing: Paris is in fact the last one in the row to even begin with some kind of austerity packages. Briefly, up until now, France has achieved no commitment towards structural budget reform and shows no intention whatsoever to implement them.
Now on the debate of fiscal austerity, growth and counter-cyclical fiscal policy. And with counter-cyIical fiscal policy, the present definition for a majority of advocats (politicians, economists) seems to be that “when the going gets tough, you shouldn’t aggravate the burden by standing on the budgetary brakes, briefly let your deficits run”. I have 2 problems with this approach: Primo, this is only 1 side of the story because counter-cyclical also implies “let your budgetary surpluses run when the good times roll”. This is however a part of the Keynesian theory no common politician ever dared to read, let alone understand or apply. And this is also the main reason why financial markets don't entirely trust this when coming from out of "old Europe". Two, are circumstances optimal to consider implementing a discretionary counter-cyclical fiscal policy today ?
Counter-cyclical fiscal policy can have its economic merits but there are a lot of boundary conditions to be fulfilled. The 2 most successful examples I have encountered in literature are Sweden (1992) and Chile (previous decade).
In the early nineties of the previous century, Sweden and Scandinavia as a whole were hit by a double whammy: The implosion of trading neighbor Russia (Finland) and a very vety severe real estate crash annex banking crisis across the region. In the case of Sweden, the national debt increased from 50 to 75% with consecutive years of fiscal deficits. Next to the fact that the resolution of the Scandinavian banking crisis can learn us a lesson or 2, the budgetary aftermath of Sweden is an interesting experiment. Swedish budgetary policy by law sets out clear medium term targets which are regularly been checked by an independent council. One of the objectives is to have at least a balanced budget over the entire business cycle, allowing for deficits during the recession and imposing surpluses during the upswing. The institutionalized discipline worked very well because Sweden year after year managed to turn its budget and skim its debt ratio towards 38% in 2008. It allowed for a deficit in 2009 (growth -5,5%) and very swiftly recovered with a German style matching GDP growth in 2010/2011. Its debt ratio is now equal to the pre-crisis low level. And hence has plenty of space to allow for deficits should the business cycle turn soar again.
Chile – next to Brazil - is also an interesting example of fiscal innovation. An institutional legal framework secures a medium term structured balanced budget regime allowing for deficits under a specific set of well described conditions: output gap (business cycle) and deviations from the estimated medium term equilibrium price of copper (75% of Chilean exports). For example, when the price of copper soared in 2006/07, the economic council (8 experts from universities, economists) advised not to spend the commodity bonanza but further save for a rainy day in view of the fact that this price was probably unsustainable and hence peak budget revenue was behind them. And when looking at what Chile achieved over the previous decade, we can only be envious of budgetary results. (footnote : pension burden on the budget is virtually non-existing in view of private pension schemes ; on the other hand, Swedish pension reforms also entailed a 3 pillar pension set with the state no longer covering every need).
Further interesting links (Chile/Sweden) :
So it can be done but is it appropriate in the European case ? As a further browsing into economic literature will reveal, it first of all requires political will to abstain from political arbitrary policy. A clear view should underpin the strategy, enabling the buildup of a national credible track record regardless of the political family at the steering wheel (I know I sound fairly idealistic here). And here the French call of course raises markets' eyebrows. This is probably also the reason why Sweden's credit rating status has so far not being questioned. In fact, it resembles a bit the appointment of a politically independent central banker which should transgress the average duration of a political cycle (7 years versus 4 years on average). In the case of Europe, the current fiscal compact moves into that direction ; My only question is "too little too late", this in view of the magnitude of the problems and the debt starting point (nearly 90% of GDP and increasing). We should have thought of this before 1999 kicked off.
Finally, experimental Keynesian laboratory economics, counter-cyclical fiscal policy, or pouring substance A into substance B as a controlled economic experiment, can cushion the pain or avoid further short term misery (cfr Sweden). Depending on the nature of the problem, it is certainly not necessarily a treatment with long term lasting effects on growth nor employment. And above all, when engaging on these kinds of experiments, do not let Mr Bean be in charge of the laboratory : He will most likely be a perfect recipe for a track record in disaster.