A lot of debates, opinions, analyses of monetary policies of central banks around the world, and of fiscal policies of their respective governments have been taking place since 2008. How good or bad the situation is and which analogy is appropriate, what research â€“ and for which period and which nations best describe present situations and therebyÂ suggest what findings, it is better to tackle the problem locally (nationally) or globally, it is better to take care of the short term as over the years longer terms would take of care of itself or vice-versa, many moreÂ such articles are everywhere.
Almost everyone has an opinion on economy, policy, and the likely best solution. There are times when I come across probably more than fifty such views, over cable TV, or over online news-articles.
And this gets momentum with every new crisis emerging in the developed West.Â Following product life cyclesÂ that is gettingÂ shorter, and more products flooding the market; it seems that the life cycle of economic crises are also getting shorter, but hitting us more often. It is natural in a globalized world whereÂ the integration of financial markets with deregulated fund flows are more than the integration in real economies.
Gone are the days of the twentieth century when economic crisis was similar to polio or malaria, to be found only in the 3rd world developing nations. Asian Crisis of 1990s or Argentina-debt crisis in theÂ beginning of the new millennium or that of other Latin American nations or evenÂ when former USSR disintegrated to Russia and CIS states in late 1980s â€“ West always had the luxury ofÂ deliverng the judgment as well as excuting same, with their strong currencies, and with their inherent economic fundamental strengths.
But this time, the crisis is in the core of the developed world. So long theyÂ advised rest of the world whatâ€™s to be done while facing an economic crisis, and they also controlled the remedy â€“ how much drug is to be administered and when, and not always necessarily when the patient needed it the most.
Unfortunately, economic crises always happen to be much more unpredictable than weather forecasting as Bernanke et al. know itÂ too well. So the relevant question is: Whatâ€™s next?
June has come, and Greece is in the process of facing an election which is viewed by many as a referendum of Greek nationals on Euro. They want to stay in, or they want to get out, or the situation will remain grey for some more time, as it has been over last couple of years â€“ all these queries remain unanswered as of now, and it is expected that better clarity may emerge from the elections. Many predict inevitable â€˜Grexitâ€™, more matured ones see the outcome â€“ whatever it be, to be a gradual one â€“ although transient hiccups cannot be ruled out, in spite of meticulous planning by some of the best brains.
This Greek dilemma brought a lot of specific debates which looked at the analogy of United States of America vs. non-existentÂ United States of Europe. If my numbers are not much wrong, both the regions have similar population figures with Euro zone having 7% more, similar GDP figures with Euro-area being little higher until recently. Economically speaking, euro area in recent past always looked stronger than the US, with lower fiscal deficits for the whole region, and lower trade deficits with outside region nations. It also had less debt issues (GDP to debt ratio), and its central bank balance sheet also looked healthier than that of the USÂ Fed.
So, naturally when the US apparently recovered quite fast from the worst economic crisis, since the Great Depression, as many thought and called it so, and found things moving towards normal figures with different data points, albeit at times too slowly and at times even moving backward; Euro area continued to get into more trouble. In the US, both the government and the Federal Reserve created unprecedented liquidity. There was QE 1, QE 2; and now there is discussions on QE 3.
As expected, there were supporters and critiques of those actions. Supporters called for more, and critiques like me failed to understand how the scarcity of drinking water can be met by flood, or even how fire can be used to douse fire (well, barring exceptions of controlling forest fire, or drinking water scarcity due to non-availability of water itself which people from developing nations face at times). However, when the US economy found to be standing on its feet again with growth enginesÂ in different stages of starting-up as per interpretations of data emeging post the QEs and other measures, and even more so when Government or Fed made money from that bail-out funds; critiques like us had to be silenced.
Yes, Bernanke et al. have won with stimulus package, and we stupid people not understanding anything from Keynes to depressions, have lost it. That has been the popular verdict.
Further when Europe started sinking more withÂ adamant Angela Merkel sticking to austerity when rest of Europe, as projected by media cried for stimulus following US success across tha Atlantic, and â€˜Grexitâ€™ possibility threatening Euro as a concept itself; our defeat had been complete.
Another nail in the coffin, so to speak, came from an Editorial in The New York Times, because it mostly takes a matured and balanced view of things unlike its peers who jump to conclusions too soon. This Old Gray Lady too finally joined the bandwagon and called the austerity in Europe to be a complete failure. On 24th May, it delivered the verdict as:
Â â€œBy this point, there should be no debate: Austerity has been a failure, shrinking economies and making it ever harder for indebted countries to repay their debts. â€˜
Admitting defeat, I still wondered â€“ are we not declaring the results too soon? Economic austerity is always expected to be painful in the short term and beneficial over the longer run.Â No one essentially has the answer on how short is short term here. If stimulus means a loss-making business continues to borrow more expecting it will make profit some day without cutting costs, austerity means it goes through significant cost cutting, or a Business Process Reengineering to be more competitive.
Present day Germany is the best example of austerity of 1990s, from a national perspective. And China also is another exemplary nation that has, in spite of being a developingÂ one, and thereby a majorÂ receiver of cyclical nature of fund flow and trades. China managed same by both liquidity initially, and then by some austerity when economy showed signs of asset bubbles or inflationary pressures.
Austerity does not mean selling the assets of the firm and closing it down. Similarly stimulus, when used beyond debt-servicing capacity of the firm even if it turns around temporarily, becomes problematic when time turns bad again. This too can result in the firm, having huge debts in their balance sheet,Â needing bailout or being acquired by rivals at a cheap cost.
Therefore, what would work and what wonâ€™t remains a management case dilemma.
A classic example of this would be Apple and Dell little over a decade ago. Michael Dell felt Apple should be sold as it allowed Microsoft to invest in it for its survival at its darkest hour when Steve Jobs rejoined the firm; whereas today Dell struggles with a market capitalization less than what Apple makes each year in profits.
Things change. And what works and what doesnâ€™t, other than depending on unknown luck factorsÂ or externalities, remain a dynamic picture. It is a shiftingÂ competitive advantage than a permanent one. In management, we call it a ‘Sense-and-Response Strategy’ than one of one fixed one, irrespective of external factors and developments. In such a scenario, with austerity, one has lots of ammunitions in reserve whereas with stimulus, reserves are used in the beginning itself. The fundamental assumption in Sense-and-Response strategy is future can not be predicted, but we can build different scenarios of the future, and with the passage of time, the view gets clearer for the shorter term future,
In my opinion, we are taking our calls on liquidity vs. austerity too soon, by terming Europeâ€™s austerity a complete failure. Greece should not exit from Euro, austerity broadly should stay with some flexibility, Greek nationals too should not bear all the pain of the austerity and lenders should take significant cuts â€“ all of these four are made out to be an impossible task-list now, when it all mayÂ still be practically possible.
Moreover, since long, I have been a votary of Euro to remain as another global currency, Â particularly to counter dollar hegemony. Failure of euro would also lead to a deadly blow to early talks of one such common currency in certain Asian blocks including China, or Latin American ones. At the same time, Chinese Renminbi is not yet ready to take up the void created by possible Euro failure; nonetheless I am positively surprised by its present stature as it makes significant progress toward that objective in a short span of difficult time-period.
Buffet once said that a rising tide lifts all boats. And a receding tide shows who have been swimming naked. True that firm level economies donâ€™t apply to national economies, and there may not be any lesson from Dell or Apple story for the US or Europe. Nevertheless, calling austerity a complete failure would be taking an early call on it, as it would be to term stimulus a complete success. I canâ€™t answer a time frame by which it can be judged, nor it is that the success and failure would be determined only by austerity or stimulus; there are other externalities as well. US Dollar gained much needed strength due to euro-crisis for which Timothy Geithner must thank Merkel; similarly Germanâ€™s export grew due to a depreciating euro against dollar. They balance out too much one sided currency movements. Had the US too gone for austerity, no one knoews what could have happened; and has Europe too followed stimulus as US did, sky rocketing commodity prices and inflationÂ with gold asÂ Â the onlyÂ safe haven might have been the picture.
Had any of the other two scenarios been any better than the present one â€“ where US followed stimulus and Euro selected austerity? In one way, it probably would have been worse,Â because presently excesses of one isÂ balanced by austerity of the other. Any of theÂ extremes, had bothÂ chosenÂ same approach, could have been worse for overall global economy than present scenario (with a high degree of probablity).
Problem is, following corporate governance practices and quarterly targets, economies also now get measured by quarterlyÂ GDP growth figures. One seldom takes into account that short-term economic growth can be achieved through stimulus, but it is unlikely to be unsustainable; just as companies can show few quarters of abnormal profit/performance through different means, but unless it is supported operationally – it would not be sustainable.
Stimulus is an easy option whereas austerity is a difficult one. How US tightes its belt eventually when there is further demands of another stimulus like a drug-addict; and how Europe handles austerity ensuring Greek national donâ€™t suffer too muchÂ remain to be seen yet. The markets in US tanked on 1st June with monthly employment figures dropping, and immediate noise of QE3Â gains further ground. So, stimulus can be as dangerous as drug-addiction, similarly austerity should also not be like traditional Indian fakirs who supposedly lived with one grain of rice a day.
Both need balanceÂ as too much of either is dangerous. The Middle-Path as advised in BuddhismÂ comes handy in most cases.
In my opinion, the result is not yet out. The redult can not be measured by 8-10 quarterly GDP growth figures alone, it needs to be seen as a summation for next few more years. Even if the inevitable ‘Grexit’ happens, which in my opinionon may be avoidable, it still should not be seen as a complete failure of austerity. Neither should the stimulus-driven performance of the US economy should be seen asÂ a complete success. Economics and social science is all about asking the right questions and degrees to which one should adopt a solution, to the extent of possibilities and realities. Let US first function without stimulus for couple of years followed by austerity to take care of its growing fiscal deficits; similarly let Europe slowly relax its austerity a bit as and when needed to protect citizens more to keep the monetary integration without the much-needed political one. And the bankersÂ should be ready to take their cuts in the loss as well rather than making them face systematic failure.
So there may be a case when both austerity in Europe and stimulus in the US can win. It should not be viewed as an either-or scenario, as it is made out to be,Â following Sense-and-response strategy. Or else, in the worse outcome, if both fail until the medium term (stimulus in US & austerity in euro-zone), things may get nasty globally. In such a scenario, I would be more hopeful of a quicker recovery from the region that adopted austerity to get into the mess. One following stimulus after stimulus and still getting inÂ this messÂ may not have much remedy at such a point of time.
Â Prof. Ranjit Goswami works as theÂ Director of School of Management of RK University. Opinion expressed in this article is personal. HeÂ invites you to visit his blog,Â Wondering ManÂ (or take a look at his book, Wondering Man, Money & Go(l)d). You are also invited to join him onÂ Twitter