There are real fears that the deep-seated reforms demanded by the global financial and economic crisis will not get the public support that is needed, warns former Polish finance minister Leszek Balcerowicz. He sets out a six-point approach for ensuring long-term recovery
Crises such as present one seriously disrupt our economic growth, but the question we should also be asking is in what ways do they affect longer-term development? It’s an important question, yet it has attracted surprisingly little research.
Traditional growth theories focus on systematic growth forces which by definition operate all the time, although with varying degrees of intensity. These forces consist, among others, of capital accumulation, employment and technical change. And going deeper, there are underlying institutional factors like property rights, market competition, tax and regulatory burdens and the effectiveness of the rule of law.
Another strand of economic research focuses on the causes of the financial and economic crises, but without looking at them in a longer-term growth perspective. And yet another one deals with crisis management, meaning what governments should do once a crisis erupts. In the case of a financial crisis this usually includes fiscal and monetary easing as well as rescue operations for larger financial institutions. The prevailing approach to crisis management has been short-term, and as was amply demonstrated during this latest crisis was based on what I would call, perhaps rather pointedly, the self-justifying doctrine of intervention.
This holds that whatever crisis management measures are adopted, they are invariably justified by the argument that the alternatives would have been worse and might well have provoked catastrophe or even a meltdown of financial markets. Metaphors like ‘if there is a fire, you don’t worry about pouring on too much water’ have been deployed to support this approach, even though they remove from the analysis such elementary questions as how to measure what are optimal doses of anti-crisis medicine that won’t weaken the forces of market recovery, while also assessing the longer-term legacies of their crisis management measures.
This latter problem has only recently begun to surface in the debate under the heading of governments' “exit” strategies from sharply increased levels of public debt, and from sharp increases in central banks’ money supply levels. Not to mention exist strategies from the increasingly widespread belief that large financial institutions will go on being “too big to fail”. Integrating these different streams of analysis into a new and coherent approach to economic growth is a huge challenge to policymakers and academics alike. But a number of points strike me as relevant to the current situation.
First, because financial crises as deep as the present one are socially so costly, it is only natural to try to prevent them. But just as with medicine, this demands an accurate diagnosis of a problem's causes. The proximate reason for all financial crises is the excessive growth of credit – a credit boom which goes bust. But the underlying reasons for the boom differ from crisis to crisis. In the present case, as the De Larosière report emphasised, a major contributory factor was the serious failure of public policies; the U.S. Federal Reserve’s excessively loose monetary policy was followed by many other central banks, while other factors included defective financial regulations, expansionary fiscal policies in countries like the U.S., Britain and Ireland which suffered serious housing bubbles, a lack of appropriate macro-prudential regulations, and so on. Preventive measures should therefore focus on these policy failures rather than degenerating into hostility towards hedge funds and other private equity devices.
My second point is that there are a number of obvious economic channels through which booms that turn into busts will affect growth. These include increased unemployment, the reduction of excessive debt burdens and therefore of credit-driven spending, the restructuring of those sectors that had expanded in response to excessive spending, and the curtailment of lending by previously over-extended financial institutions.
There exist no policies that could suspend the operation of all these linkages without damaging longer-term growth. Continued fiscal expansion is certainly not the answer, as after a while it damages both private spending and business investment. But there are reforms that can facilitate adjustment of the economy, and thus ease social pain by countering the growth in long-term unemployment. These reforms include measures to remove the labour market rigidities while also speeding-up the repair of banks’ balance sheets. The speed with which economic recovery can be achieved would largely reflect the extent to which these steps are taken.
Third, and on a closely related note, most if not all EU countries were already in need of substantial structural reforms long before the crisis broke. This was due to a combination of their fiscal problems, their lack of competitiveness and the aging of their societies. Today’s crisis makes these reforms more imperative than ever.
My fourth point, other than for those who still believe in a free lunch, is that the
employment and growth implications of the EU’s commitments in the area of climate change policy need to be carefully analysed. Multiplying the number of burdens being placed on the European economy is not the best policy to be implementing in the aftermath of a crisis on the scale we now face.
Fifth, it is difficult to overestimate the importance of fiscal discipline to longer-term growth. It is all too easy to find examples of countries that subsequently suffered badly because of sustained expansionary fiscal policies. By the same token, I cannot think of a single case when the long-term growth prospects were damaged by excessive fiscal stinginess. Given the fiscal legacy of the current crisis, no efforts should be spared in anchoring fiscal discipline firmly in the EU countries. Institutional measures such as a fiscal frameworks and public debt thresholds can do much to help. Ultimately, though, it is public opinion that will determine governments’ fiscal stances, so fiscally conservative public opinion would be a great economic asset as it would constrain policymakers’ profligacy. It is therefore up to opinion leaders to strengthen this sort of attitude.
My last point is that crises are of course unpleasant, but they are also widely thought to facilitate growth-enhancing reforms. This isn’t always the case, though, as the policy conclusions that will be drawn from the present crisis will largely depend on what the public perceives as the reasons that caused the trouble. If European public opinion were to put the blame on previous market reforms, the policy lessons to be drawn from the crisis may go off in the wrong direction. This was precisely the case in Russia in 1998 and in Argentina in 2000, as in both cases the dominant stream of public opinion blamed previous reforms for the crisis even though the truth was that both crises had been caused by fiscal irresponsibility and insufficient reform.
Having said that, if public opinion across Europe holds policy errors, or the lack of reform as responsible for the crisis then there is a chance that the right policy lessons will be learned and that sound growth policies will result. The key to overcoming the crisis and its difficult legacy is the way that Europe’s citizens perceive the origins of the financial crisis that erupted in the autumn of 2008.