|Column : Götterdämmerung|
| Meghnad Desai|
The more the eurozone leaders solve the problem, the more it unravels. Spanish bond yields are back above 7%. The German Constitutional Court has postponed its ruling on the validity of the European Stability Mechanism (ESM) till September. It may yet rule the ESM unconstitutional. Greek public finances are still in precarious shape and the troika visiting Athens has to swallow hard before signing the cheque.
The European real economy isn’t doing too well either. Even Germany has slowed down and the UK’s GDP fell 0.7% in the second quarter of 2012. It is difficult to see where François Hollande can get his growth from. The US is barely managing to keep its head above the water despite having freedom to print money and a large fiscal package earlier in the Obama administration. Now, with four months to go before the election, there will not be any further stimulus.
Keynesians are frustrated that no one listens to them. They decry austerity by saying that Keynes had decisively proved that the economy did not have to be like a household and keep a balanced budget. Why has this sudden change in the direction of austerity happened?
As the Keynesians are fond of quoting Keynes, “When facts change, I change my mind. What do you do?”
So, here once again one needs to spell out how and why facts have changed, Keynesian economics is a delusion, and hopes of a return to sustained growth a mirage. Keynesian theory is for a closed economy where the government can print money to pay its debts. The creditors are citizens of the same country—rentiers, as they are pejoratively called—and it is assumed that they can be squeezed. Keynes wanted to drive interest rates to zero as he was worried about excess savings.
Keynes also wrote a model in which output did not matter; only expenditure did. Demand will create its own supply, reversing the Classical adage that supply will create its own demand. Employment could be created by hiring workers to dig holes and fill them up. Thus, wages were the key, not output produced by workers. Investment is important more as expenditure; its effect on future output is ignored in the General Theory. A whole generation grew up thinking all one had to do was to keep spending up and growth would follow.
Even the Monetarists—New Classical economists—did not demur from this. For the Monetarists, money emissions ensured an output response effortlessly; the only issue was the split between inflation versus real output growth. New Classicals operate on full employment assumptions; productivity is a ‘shock’ and beyond policy. So, they too don’t care about output.
Western economies went on for a while thanks to new innovations, baby boom and unfulfilled demand for goods after the War. This Keynesian golden quarter-century lasted till around the early 1970s. It ended with inflation and the migration of industries from the West to Asia as profitability was squeezed. There was a switch to services, which sparked another boom in the 1990s. This was based on excess spending, negative savings and large borrowings from Asia. Output growth was mainly in services; trade deficits could be financed by capital inflows. But these creditors are foreign ones. Even the local creditors are pension funds who have to protect the value of pensions for future care of the ageing citizens. They cannot be dismissed as Rentiers and squeezed. These debts have to be paid in full.
That credit-fuelled boom having now collapsed, there is no way out for western economies except a hard slog. Even now, no leader is ready to spell out this tough story. Growth will come again when the western societies save and invest substantially in goods and services that the rest of the world wants to buy. Even before they do that, they have to write down their debts—household debts and government debts. That is what is going on now, and since there is resistance, the process is taking longer than it should. Policies like QE, which lower interest rates, are exactly the wrong policies. Any attempt to ease the pain will prolong the agony.
All this is so old-fashioned that it has been forgotten. On the eve of the Keynesian Revolution, Hayek was warning of mal-investments induced by the market rate of interest being below the natural rate for any length of time. This was the Wicksell model, tweaked by Ludwig von Mises and Hayek to accommodate bank credit in the Walrasian framework. It flopped spectacularly in the 1930s and was forgotten. But good ideas never die in economics. They only wait till their time comes. This is Hayek’s time.
Sadly, in Hayek as in Marx, economics is not a policy science and there are no tool kits to fix the problem. Time will restore the equilibrium perhaps not at the old trend but a new one. When that will happen is not within economists power to predict. Just wait and see.
The author is a prominent economist and Labour peer
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