Investment Chart Kondratiev Wave

Investment Chart Kondratiev Wave

Sunday, 27 May 2012

Is austerity bad? Why no push for infrastructure investments in the West?

It is hard to call economics a science. You cannot give an emprirical and theoretical answer that is not contested on the almost most important question of the moment: is fiscal austerity good or bad?

The opinions about this topic vary immensely. There is some consensus that 1% more austerity by governments leads to 0.5% lower expected economic growth. That is what according to Brian Reading of Lombard Street Research for example the OECD is doing for its forecasts of 2013.

Some economists like Richard Barro see almost no negative influence of fiscal austerity. Other economists like Krugman and Summers see the end of the world (at least a rehearsal of 1937-1942) when there is much austerity.
They think (and write) that the current economic conditions are causing a way bigger negatieve influence of austerity: maybe 1% austerity leads to -1.5% less growth. This is happening now in several countries because the output gap is big combined with a credit crunch. According to some simulations with numbers of the IMF you can get these results, so warns also Reading. So austerity will not cause a multiplier effect but a divider.
This clearly seems the case now for Greece and Spain.

Macky of JP Morgan had a scenario analysis for Spain. When you have a divider of 1.5, then growth collapses: -21% per year in the next decade (every year). A divider of >  1 makes the situation unstable: total collapse is possible in that situation.

Keynes was not insane with his tehrapy for governments in the great depression:  more austerity was a disaster, we are still mocking Herbert Hoover and his stupid policies, and more fiscal stimulus will help when nobody else spends money.

There is uninamous agreement under economists that the multiplier of investements is the biggest, bigger than that of consumption. There is also a majority that thinks that it is wise to do more fiscal  austerity when the output gap is about zero or better. Stimulus will only lead to more inflation in that situation. So for countries with  a low unemployment rate like Germany and the Netherlands fiscal austerity will not be bad (for the Netehrlands it also helps it is a small country). But it definitely will help when you push investments / R&D, / education and then accept a bigger government deficit.

In Europe and the US they only talk about how to reduce spending/ how much the deficit has to go down, but not how to do that. How do we get to the extra growth that
Hollande rightly sees as necessary?

It is clear that governments have to invest more in infrastructure. That must be made possible with European bonds only for infrastructure (from EIB for example). That would help. You must isolate deficits because of infrastructure spending from other deficits. We need a return of the old fashioned golden rule: government deficit has to be zero ex government investments.


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