Balancing austerity and growth isn’t impossible

Donald James Johnston, Secretary General of the OECD from 1996-2006 and Canada's economic development minister in the 1980s


The International Institute for Middle-East and Balkan Studies (IFIMES) in Ljubljana, Slovenia, regularly analyses events in the Middle East and the Balkans. Donald James Johnston*, Secretary General of the OECD from 1996-2006 and Canada's economic development minister in the 1980s has analyzed the world's economic situation and possibility of reaching agreement between politicians and their economic advisers. His article entitled “Balancing austerity and growth isn’t impossible” is published below.

Balancing austerity and growth isn’t impossible

The economic crisis has once again ignited the debate about whether we can have both austerity and growth. The obvious answer is that we must if economies like those of Greece or Spain are to be pulled back from the chasm of socio-economic collapse.

But growth accompanied by austerity (better characterised as “fiscal consolidation”) do not go hand in hand. The latter precedes the former, but austerity must lay the foundations for productivity and growth without destroying the intellectual and business infrastructure upon which they depend.

Too often it would seem, drastic measures are taken to improve macro- economic data in the near term to attract international capital at affordable interest rates, without considering the “collateral damage” that may ensue. This can range from the collapse of small and medium size enterprises (SMEs) unable to obtain loans from a paralysed banking sector preoccupied with trying to improve their balance sheets to massive unemployment with the risk of an outward migration of the 21st century’s most important resource, human capital. The price may be a demoralised and bitter citizenry faced with the prospect of reduced standards of living in their own lifetimes and perhaps those of their children.

Political decision-makers are, of course, very much in the hands of their advisers when developing and implementing public policy, especially on economic matters. So when there is an economic crisis of the present kind, it is economists who are whispering in the ears of politicians. And where there is no consensus amongst economists, there is unlikely to be amongst political leaders. This is the dilemma faced in the EU and in all democracies.

“Can there be a sensible balance which would discipline public spending but stimulate growth? It’s not easy, yet it is possible”

In my native Canada, a commentator in Toronto’s Globe and Mail newspaper observed in May 2009: “Economists…tore themselves to public shreds during debate over the past 12 months about what to do. More stimulus or less stimulus? We had prominent economists arguing both sides. Lower interest rates or higher interest rates? Again, there are economists on either side. Deflation or inflation as the major concern? You guessed it: economists on both sides of the question. The list went on and on, and it became publicly and embarrassingly obvious that economics, outside of a few basic pricing, trade and profits tenets, has so little consensus as to make astrologers look predictable when it comes to policy prescriptions.”

From diagnosis of the crisis when it was still looming, which by and large the economic community missed, to the question of recovery, no consensus is apparent amongst many of the most well-known economists of our era. And the stark division of opinions amongst them places a very heavy burden on political leaders who will ultimately pay the political price, or reap the political benefits, of the success or failure of whichever road they take.

Some economists elect for the austerity road, with all its negative consequences while others choose the road marked stimulus and a more Keynesian approach to recovery. But can there be a sensible balance between these two roads which would discipline public spending on the one hand through “fiscal consolidation”, but stimulate growth on the other while meeting the political imperative of getting re-elected?

It’s not easy, yet it is possible. The political economy is central to this dilemma, and there are examples from which lessons can be drawn. First, if fiscal consolidation is necessary and a political leadership enjoys the benefits of being a newly elected government, it should move quickly to introduce the measures required to establish sound public finances.

This means unpopular choices because vested social and economic interests must be targeted. Such moves will prove unpopular in the short term, but if introduced early in an electoral mandate, they may produce enough positive results prior to the campaign for re-election. In Germany, the Schroeder government did this under the guidance of his economics minister Wolfgang Clement, but it was too late. The unpopularity of these reforms, essential as they were led to Schroeder’s defeat in 2005. It might be said that “Gerhard Schroeder planted the seeds and Angela Merkel picked the fruit.”

Second, political leaders should never suggest that such fiscal discipline and concomitant sacrifices will reduce living standards and job prospects well into the future. It isn’t necessarily true, and it risks encouraging the young and talented, the most important economic resource of the 21st century, to leave their native lands for what may appear to be more promising opportunities elsewhere.

Political leadership must play a central role, as President Kim Dae Jung did in South Korea during the crisis of 1997 when explaining to his people the importance of “belt tightening” in the interests of short and medium-term economic growth. Korea should serve as an example of what can be done through strong political leadership and their effective communication of the sacrifices and their promise for the future. For in Korea, GDP had fallen by -6.7% in 1998, but that was followed by an expansion of 10.9% in 1999! Koreans suffered short-term pain for-long term gain.

“It is clear that there is no one size that fits all, and that massive public expenditure cuts in the name of austerity don’t constitute a formula that will lead countries back to growth and prosperity”

Finland’s recovery from economic collapse following the dissolution of the Soviet Union took longer, but there was never a sense of despair about the future despite high unemployment there during most of the 1990s. Finnish GDP growth fell from 5.6% in 1989 to zero in 1990, and was deep into negative territory until the mid-1990s.

Yet, morale remained high there perhaps because unlike with the Korean crisis and the current global one, it was not the greed of an elite few that triggered economic collapse.

The message to the Greeks and Spaniards should be that if others have recovered rapidly from a major economic crisis, then so can you. Sacrifices must be made, but they must be seen as fair and being suffered by everyone. Government at all levels must visibly share the pain. From the President and Prime Minister to elected representatives and the bureaucracy, everyone on the public payroll must accept income reductions if the general public is doing so. Citizens who endure individual hardship are understandably outraged when bad governance and the self-serving greed of a privileged few combine to destroy their livelihoods and dreams of the future. Think of Wall Street.

Third, in attacking government spending, fiscal discipline should be applied with a rifle, not a shotgun. This is difficult because each department of government attempts to protect its own budget. Often the result of a deadlock is an across-the-board cut, which is the worst outcome. Recovery of growth and job creation will depend upon specific sectors of every economy. Those sectors and government programmes which support them must be protected, and if possible strengthened. The sectors that should be favoured are those which create jobs, and which in Greece and Spain will maximise export opportunities and job creation.

It is clear that there is no one size that fits all, and that massive public expenditure cuts in the name of austerity don’t constitute a formula that will lead countries back to growth and prosperity. As banks write off non-performing loans and try to improve their balance sheets public investment is critical. Government departments normally have a backlog of good projects which have not been immediately financeable, and these should be investments that will increase productivity, provide near-term jobs and future tax revenues. These are not just bricks and mortar projects, but also high-tech infrastructure in ICT, public research laboratories and environmental challenges in agriculture, forestry and fisheries. There are precedents for this kind of programme.

An appropriate balance between austerity and growth should not be as great a challenge as many would have us believe. When the economy is faced with a meltdown of the kind we saw in 2008, it is hard to believe that severe austerity with all its potential collateral damage is the answer. It may redress the balance sheets of some banks, and even of governments, but will it contribute to the well-being of millions of people around the world who have innocently become the victims in this crisis of the insatiable greed of a few?

(first published by the EUROPE’s WORLD, Spring 2013, reposted with the author’s permission)

*Donald James Johnston, former Canadian politician, lawyer

Secretary-General of the Paris-based OECD (Organisation for Economic Co-operation and Development) from 1996 to 2006.

Born: June 26, 1936 (Ottawa, Canada)

Education: McGill University;

Political Party affiliation: Liberal Party of Canada