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G8 – An increasing focus on growth, not austerity

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From The Economist Intelligence Unit

The spectre of financial meltdown in the euro zone was a dominant theme at the summit of G8 leaders at Camp David in the US on May 18th-19th. The summit ended with a joint declaration covering a typically sweeping array of topics, from the risks facing the global economy to the crisis in Syria. But there was no mistaking the fact that the emerging growth-vs-austerity debate—fuelled by political developments in France and Greece, and by fears surrounding financial stresses in Europe—was the issue of the moment. The consensus of international opinion is shifting towards the need for growth-focused policies, but it is also clear that fiscal consolidation will remain paramount.

Given growing fears of a Greek exit from the euro, and the consequent strains in financial markets since the inconclusive Greek general election on May 6th, it was no surprise that one of the focuses of the G8 summit was, in effect, how to save the European single currency and by extension prevent a global recession potentially far more severe than the one in 2008-09. In their joint declaration, the leaders of the US, UK, Germany, France, Italy, Russia, Japan and Canada put economic growth right at the top of the agenda. “Our imperative is to promote growth and jobs,” read the official text.

The problem with summits is that there are too many of them and that they rarely produce concrete policy steps. The former is in some respects a natural consequence of globalisation and of the changing balance of economic forces. China, the world’s second-largest economy, is conspicuous by its absence from the G8. Excluding the EU as a whole (the representatives of which also attend G8 meetings), the grouping’s members accounted for only half of world GDP in 2011. This compares with two-thirds a decade earlier. In the same period, the US’s share has fallen from 32% to 22%, while China’s has risen from 4% to 10%; of the G8 countries, only Russia and Canada now account for larger shares of global GDP than in 2001. The rise of fast-growing large emerging markets has changed the global centre of economic gravity in recent years, and has contributed to the rise of competing groupings and forums such as the G20.

The proliferation of international talking-shops and summits makes it harder for the G8 to stay relevant. G8 and G20 summits rarely result in concrete and specific policy proposals, in large part because the process of hammering out policy is long and complex, and ill-suited to the summit format. Yet given the need for leaders to show something for their efforts, and scrutiny in the international media, the prevailing formula is to release a policy communiqué that is essentially aspirational in nature. The latest G8 summit at Camp David was true to form, ending in a 40-point declaration that, among other things, stressed economic growth and fiscal responsibility, announced the launch of a programme to promote food security in Africa, condemned the violence in Syria, called on Iran to address concerns about its nuclear programme, and praised the ongoing political reforms in Myanmar. In other words, the declaration pretty much covered all bases from “world peace” to progress in the fight against climate change.

Aspirational growth

None of this is a surprise, yet nor does it necessarily negate the value of such forums, as getting international leaders together to discuss global economic and security issues can be valuable in its own right. During the G8 summit the US is likely to have pressed the EU for more action to solve the debt crisis. If euro zone leaders ever take a truly big step, such as allowing the issue of joint eurobonds, US pressure would likely be a big contributing factor.

The latest G8 summit nonetheless followed the “aspirational” blueprint in one especially significant respect: its position on the relationship between growth and austerity. The leaders’ statement read: “We welcome the ongoing discussion in Europe on how to generate growth, while maintaining a firm commitment to implement fiscal consolidation to be assessed on a structural basis.”

The dilemma for European policymakers, in particular, though also for the US, is how to reconcile pro-growth policies and fiscal consolidation at a time when both are clearly needed, and when the combination of growth and fiscal responsibility is increasingly expected by financial markets. Much has been made of the pro-growth focus of the new French president, François Hollande, and it is true that he has contributed to a shift in the tone of the economic debate in the euro zone. During his election campaign, Mr Hollande promised to renegotiate the EU’s “fiscal compact” (which in essence seeks to institutionalise budget discipline and strengthen supranational powers of fiscal oversight) to include economic stimulus. This is likely to be watered down, so that the fiscal treaty remains essentially untouched but so that new pro-growth measures are potentially agreed as an adjunct to it. Even Germany, which has insisted on fiscal consolidation as the path to solving the euro zone’s sovereign debt crisis, has shown signs of relaxing its position to the extent that it admits that growth is also a desirable component of any strategy for saving the euro.

This does not mean that Germany is about to abandon its insistence on austerity, rather that it is seeking to present the policy challenges facing Europe in a more nuanced way, as opposed to the either/or terms in which the debate has often been couched (which in turn partly reflects seething popular anger at austerity, which has increased the appeal of populist demagoguery in various countries). Many politicians increasingly recognise that the scale of the fiscal corrections currently being demanded of many European countries is both politically explosive and fiscally counterproductive, as austerity-induced recession reduces tax revenue so much that the debt- or deficit-reduction targets become more distant than ever.

Any shift to a more integrated view of the relationship between growth and austerity is therefore welcome—at least in theory—and could presage the introduction of more balanced policymaking. In the euro zone, the principal practical shortcoming of this approach is that the weak “peripheral” economies—that is, those most in need of stimulus—are the least well-equipped to provide stimulus. These governments have little or no money to boost growth, and the structural reforms that are important for long-term productivity are slow-acting and do not provide the immediate economic jolt that is also desired. In short, it is all very well for G8 politicians to espouse the idea of growth as being desirable, but where this growth will come from is quite another matter. Germany, the strongest euro zone economy, has the potential to boost its domestic demand, with beneficial knock-on effects for other members of the currency union. But for now entrenched German concerns about inflation, a policy focus on fiscal rectitude and increasing popular resistance to the idea of Germany in effect paying for the rescue of weaker euro members make this politically awkward.

The G8 declaration’s wording reflects the policy constraints and contradictions facing politicians and policymakers. Of particular note is the reference to the implementation of fiscal consolidation “on a structural basis”. This implies some latitude for short-term stimulus—or rather, a partial relaxation of austerity—on the condition that credible plans are put in place to ensure a return to fiscal balance in the long term. This compromise is at the heart of the US fiscal-policy debate, though political partisanship is impeding progress. In Europe, the key word is arguably “credible”, as any proposed relaxation of fiscal retrenchment would still have to provide enough reassurance to financial markets to prevent further sharp rises in bond yields.

Source: The Economist Intelligence Unit

Important:  See European data from WSJ – The link

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