Monday, June 15, 2009

Immaculate Recovery

Where will growth come from? That's the question bugging me and quite a few of my clients. Wolfgang Münchau puts it well in today's FT:
Instead of solving the problems to generate a recovery, the political strategies have consisted of waiting for a recovery to solve the problem. The Europeans are relying on the Americans to generate growth. The Americans are relying on the Chinese, who in turn are waiting for the rest of the world.
At this rate, any recovery will be an immaculate recovery as it seems none of the necessary conditions for it are actually in place. But at least it looks like a re-run of the Great Depression has been avoided - though at a price. This week's Economist paints a bleak picture of the growing indebtedness of the consumer, corporate and government sectors. A situation now being exacerbated by demographic change in countries like the United States that are facing huge payouts for medical and social welfare payments for their ageing populations. And the only way of making such payments will be to foist more debt on future generations ...

The huge level of debts that now constrain governments mean that traditional fiscal and monetary policies no longer have the same multiplier impact on the wider economy. As noted in this recent guest post on Willem Buiter's blog:
Yet the decision to use monetary policy to keep alive an economy drowning in debt turns also fiscal policy incapable of stimulating the economy, as noted by Irving Fisher. As long as excessive debt is not digested, both monetary and fiscal policies are inefficient. There is not much of an alternative. Either to let the economy collapse, in order to reduce debts, and then use fiscal policy to revive it, or inundate the insolvent economy with public credit, to avoid the collapse, and loose the ability of fiscal policy to pull it out of a prolonged lethargy. Either a horrible end or an endless horror.
So which way is out for Ireland? Exports and trade generally will have a limited role in generating growth so long as the global economy remains stagnant. Investment has collapsed due to the housing crunch, and will keep falling so long as the banks absent themselves from the business of lending. That leaves public spending and consumer spending. Unfortunately the government's insistence on fuelling the former via tax increases means that the latter is falling rather than rising. Worse, we have an inflating state weighing on a deflating economy: not exactly a recipe for success ...

But it doesn't have to be that way. We should be demanding more bang for our buck from public spending: in particular through a focus on public sector productivity. The UK publishes regular updates on its own public sector's performance (not great), and by bringing a similar focus to bear on Irish public sector performance we should be able to get much more for a great deal less. And no, I don't know where or how - but by empowering managers throughout the ranks of the civil and public service (including the power to hire and fire) we will tap into the knowledge that is already there about where real efficiency gains can be made.

This needs to be done quickly: otherwise we are going to have the one possible engine of growth - consumer spending - put on hold because of a political unwillingness to make significant changes to how taxpayers' money is spent. However, if politicians can grasp that particular nettle, the prize will be a surge in consumer spending if taxes are cut. Indeed, I suspect the Irish consumer will play a more important part in the coming recovery than most give him or her credit for. And I'll explain why in a future post.

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