This article was published in the Cape Times, 27 June 2012
With the publication of his blockbuster End This Recession Now Paul Krugman dominates the global debate about solutions to the global economic crisis. Besides a hectic schedule of talks, interviews and weekly columns, this Princeton University Economics Professor has hit the prime exposure spots in influential mainstream media from CNN to the Financial Times. His message is good old fashioned Keynesian folklore: recession time is when you spend to stimulate demand and build confidence; boom time is when you cut back and repay your debts. Electorates in rich countries seem to agree as they continue to vote against austerity, with France the current exemplar of this trend. The UK’s Tories currently trail Labour in the polls, and Syriza lost the Greek election by a whisker.
Krugman is at his scintillating best when he explains how free market dogmas can be blamed for causing the global economic crisis and for the failures to resolve the crisis. He must surely be correct when he argues that if everyone cuts back spending at the same time – banks, governments, households – the result will not be savings to pay down debt but deepening recession as confidence dissipates. To escape this liquidity trap, he argues, its not austerity that we need, but government spending to stimulate demand and restore confidence amongst investors.
Krugman naively believes that we are in this mess because we simply believe in the wrong theories. Although he rants and raves against the theoretical and empirical assumptions of the economic orthodoxies that underpin the political ideology of ‘expansionary austerity’, there is at least one paragraph where he steps ever so briefly beyond the realm of wrong ideas to provide a more realistic material explanation for austerity policies. He argues that the current determination to use fiscal policies to reduce deficits instead of creating jobs, monetary policy to keep inflation as low as possible and even a desire to raise interest rates despite mass unemployment “in effect serves the interests of creditors, and those who lend as opposed to those who borrow and/or work for a living. Lenders want governments to make honouring their debts the highest priority; and they oppose any action on the monetary side that either deprives bankers of returns by keeping rates low or erodes the value of claims through inflation.”
The most remarkable sentence of all appears at the start of Chapter 12: “As it was in 1936, so it is today.” This sums up Krugman: for him there are no deep “structural” problems; spending worked in the 1930s as Keynes said it would, therefore it will work today. There is no recognition whatsoever of the fact that back in the 1930s oil was cheaper than water, colonial empires made resources cheap, wars created demand and markets were unsaturated, to name but a few key conditions that were different. Can he really be serious that our context is no different to 1936?
What happened to Krugman’s realisation in his column back in 2010 (republished in The International Herald Tribune on December 28, 2010) that rising resource prices reflect “growing pressure on world oil and food supplies”. This, he suggested, explains the rising price of corn, commodities and oil. “What the commodity markets are telling us is that we’re living in a finite world … .” Spot on says the McKinsey Global Institute in a 2011 report entitled Resource Revolution: Meeting the world’s energy, materials, food, and water needs. According to this report, commodity prices have increased by 147% since 2000 thus ending a century of declining real resource prices. Indeed, ever since the start of the industrial era in the mid-1700s, no economic recovery has ever succeeded without lowering real resource prices. This is no longer possible in a “finite world” – a conclusion rammed home by another 2011 report by UNEP’s International Resource Panel entitled Decoupling Natural Resource Use and Environmental Impacts from Economic Growth.
So does Krugman in his manifesto to end the recession remind us we are “living in a finite world”? As we spend more to stimulate demand, does he consider the fact that all this could be undermined by rising oil prices? After all, he must know that oil production has remained constant for 5 years now and global exports of oil have declined since 2005? Surely he must be aware of the bone chilling report from a mainstream Chinese research institute that China could hit ‘peak coal’ by 2030? Total silence – not a word on any of this from Krugman as he pontificates on the world stage about the virtues of just spending.
According to conventional economic logic to reduce deficits and debt developed and some developing economies desperately need economic growth. However, high debt levels – despite Krugman’s cavalier dismissal of the notion that debt levels are high – do constrain stimulatory fiscal interventions and ultra-low interest rates (in many places) means monetary policy can achieve very little. This leaves only one other alternative, namely investment as a real option to stimulate growth. However, investment has steadily dropped as confidence has eroded. Instead of taking risks, more and more spare funds have been squirreled away in safe low interest solvent sovereign bonds.
By 2011 Gross Domestic Investment dropped to 16% of GDP in the USA which is below what it was in the early 1960s and way below the 1979 peak of 23%; and in the UK Gross Fixed Capital Formation dropped to just above 14% which is below what it was in 1960 and way below the 1990 peak of 22%. In plain English this means investors are not spending the profits they are making. The Economist reported on 31 March 2012 that the profits of American companies are now higher than at any time in the past 65 years. In simple numbers, this amounted to over $1 trillion of unspent cash. In South Africa, our Minister of Finance says there is R500 billion of unspent cash.
So if fiscal and monetary policies won’t work, how can we end the global investment strike (because make no mistake, that is what it is). Dimitri Zhengelis from the London School of Economics and Senior Advisor to Cisco recently published a paper entitled A strategy for restoring confidence and economic growth through green investment and innovation. Unlike Krugman, he does not ignore rising resource prices and climate change; and unlike many political leaders gathering in Rio he agrees with the McKinsey report that these constraints can become opportunities. Zhengelis argues that there are two compelling reasons why investments in green growth can unlock unspent investment funds: they can go to scale rapidly (decentralised renewable energy plants, for example) and they will be responsive to credible multi-year policy interventions that limit uncertainty and build confidence over time. In his words:
“It is precisely the overwhelming and growing long-term need to address numerous market failures [such as climate change] through transformational investment and innovation that has the potential to make the opportunity from intervention so credible. ‘Green’ investment is also large-scale and offers potentially profitable markets for decades. It can therefore leverage in serious private money. As a result, much of this private investment should be additive (rather than displaced from elsewhere), helping to break out of the deflationary confidence spiral, much as Roosevelt’s New Deal did in the United States from 1933.”
In short, while the financial world waits for Angela Merkel to blink during the debate about how to save the Eurozone at the G20 meeting in Mexico, a much more colourful, noisier and less effective meeting is getting underway in Rio to consider ways to green the global economy. If the debate in Mexico is purely about austerity or spend, then Krugman should be blamed for the inevitable stalemate. A far more creative outcome would be to recognise that green growth may well provide the most credible and viable way of unlocking the mountains of unspent cash chasing the diminishing pool of solvent sovereign bonds. Immediate actions will have to include cessation of subsidies for the fossil fuel industry (including for South Africa’s increasingly expensive coal and nuclear plants), removing constraints on the rapidly cheapening renewable energy technologies and the unleashing of new waves of innovation created by the historic merging of information and renewable energy technologies to create stunning new network infrastructures for running everything from cities to ships. If the breakthrough does not come in Mexico, then lets hope for something sane out of Rio. The next long-term development cycle will be led by those who recognise – and seize - this strategic moment of opportunity.
On reflection, I made a mistake in staying that investment is the only alternative to debt-constrained fiscal policy and monetary policies constrained by low interest rates - there is, of course, another option which is the traditional capitalist strategic of lowering wages which is, of course, most easily achieved through currency devaluation (if you want to avoid the political consequences). However, if you are part of the Eurozone, this is not an option hence the politically volatile and probably impossible option of lowering wages directly.