Sustaining growth is a problem for Europe
Europe’s leaders are in Brussels today. Their annual March summit is supposed to be about bread-and-butter economic issues first and foremost. At this year’s gathering they should be focusing on ways they can spur growth in their economies and across the wider EU economy. But, as is often the case, more immediate matters intrude to distract from the main agenda issue – in this case it is what sort of collective action they are to take in response to Russia’s annexation of Crimea.
But even if the two-day summit does not end up being entirely dominated by developments in the east of the continent, it is not at all clear that there are ready answers to the question of what Europe’s politicians can do and are prepared to do to accelerate economic growth – either in the short run (by boosting the demand side of the economy), or in the longer run (by making their economies more competitive on the supply side).
In the short run, governments can boost demand in economies using both fiscal and monetary policy.
By spending more and/or cutting taxes, fiscal policy can boost demand. This can be particularly important when consumers and business don’t want to spend or are nervous about doing so.
But, as is well known, some countries, including Ireland, already have dangerously high debt levels and don’t have the capacity to stimulate their economies fiscally. Others, particularly in northern Europe, believe the costs of fiscal stimulus ultimately outweigh the benefits. The differences of opinion on this subject are deep and wide. They are also so well established that EU politicians have simply agreed to differ on the matter. They won’t be rehashing that stimulus-versus-austerity debate at the on-going summit.
The second lever states can use to boost demand in the short term is monetary policy, which, in our case, is under the control of the European Central Bank in Frankfurt and not something national politicians and Brussels types can determine.
But just as those with their hands on the fiscal levers in Europe have very different views on how they should be used, the monetary policy people differ on how interest rates and other tools at their disposal should be deployed.
With interest rates already close to zero, the conventional monetary policy lever has been pulled almost as far as it will go. To boost demand, the ECB would have to resort to unorthodox policies, such as the money printing that some other central banks have been engaged in.
For representatives of some member states – and Germany stands out in this regard – the downsides of messing with money are too serious: consumer price inflation could end up surging and it is hard to argue that the massive money printing in the US in particular has not had a role in inflating bubbles in financial markets (by making financiers take too many risks in the belief that central bankers will always be there to bail them out).
Advocates say that money printing has helped spur recovery where it has been tried and has not certainly led to hyper-inflation, as some economists claimed it would. Moreover, they argue, with the current inflation far below the ECB’s mandated target, it is legally obliged to take action that would bring inflation nearer to its target of a year on year increase of just under 2pc. That debate rages on in Frankfurt.
But however depressing it is that politicians and central bankers (and, for that matter, economists) cannot agree on the best course of action in the short run, what it more depressing is the much longer term picture showing a slowdown of growth in most rich countries. That in turn raises questions about the pay-off for introducing the “structural reforms” that are advocated by most economists as a means of making economies more competitive.
In the longer run, it is the supply side rather than the demand side of economies that determines how they grow. A shrinking supply of labour if birth rates fall, for instance, will reduce the potential capacity for any economy to grow.
But the big question for all policy-makers and policy-thinkers, including those gathered in Brussels today, is how to improve the supply side so that growth can accelerate.
Breaking up monopolies which rip off consumers, liberalising markets so they function more efficiently and opening up to international trade and investment are all classic supply side prescriptions.
Yet all of these things happened in recent decades in the rich world and despite their implementation, many measures of underlying economic performance point to a decades-long deceleration in developed economies.
One such measure is how rich we are and the rate at which we are getting richer. The best measure of the average standard of living in an economy is gross national income, or GNI. The chart shows that per person, in the rich countries in the OECD collectively, the rate of growth has been trending downwards for decades.
Europe has been no exception and in countries such as Italy the average person has actually been getting poorer since the turn of the century.
Somewhat surprisingly, the economics community around the world has not been as interested in this hugely important trend as one might expect given its import. Nor have policy-makers in Europe.
A better understanding of what is happening is needed if the trend is to be reversed. Europe’s leaders may be facing an even greater challenge in their efforts to spur growth than they realise.