Growth vs. austerity

11th May 2012

A 'growth bloc'

Growth is increasingly winning out across Europe, leading the Telegraph to start talking about a ‘growth bloc' led by newly elected President Hollande in France: "This then is the birth of a Euroland growth bloc with well over 200m people and a commanding majority vote in the European Council, a defining moment in this saga. Mario Draghi at the European Central Bank is quickly bending to the new political dispensation with calls for a "Growth Compact": 

Hollande, for his part, has been spending his first few days in office selling a ‘growth' agenda to his Eurozone counterparts. But what might this new growth agenda look like? Although Hollande's original growth plan looked to his detractors suspiciously like an old-fashioned tax and spend programme, he has refined it since:  He now suggests: "He (will) urge France's European partners to promote growth and job creation by adopting a financial transactions tax, making better use of EU structural funds, expanding the resources of the European Investment Bank, and launching ‘project bonds' to promote infrastructure development. 

This is more sophisticated than his initial campaign rhetoric, which promised to tax the rich and big business to fund 150,000 state jobs.

What does a growth agenda look like?

The BBC posed the question on how a growth agenda might look to various economists. The results showed a vast disparity of views:  

Paola Subacchi, research director for international economics, Chatham House talks about short-term VAT cuts and a restoration of confidence; Pippa Malmgren, president, Principalis Asset Management says: "If you really want a growth agenda and austerity is not an option, you have to immediately, totally deregulate and vastly reduce the tax rate on all entrepreneurial activities."

Jonathan Portes, director, National Institute of Economic and Social Research suggests an immediate and radical increase in infrastructure spending, while Prof Charles Wyplosz of the Graduate Institute in Geneva argues that while policymakers are rediscovering the merits of structural reforms, these benefits accrue very, very slowly, concluding: "Individual eurozone member countries are effectively powerless."

Growth vs. austerity

Christine Lagarde, managing director of the IMF, has made it clear that she believes ‘growth' versus ‘austerity' is a false choice. She suggests it may not be possible to have growth without austerity: "Both short-term steps to boost demand and longer-run steps to rein in spending are needed, Lagarde said in a speech at the University of Zurich. While monetary policy is already at close to full speed, there might be some scope and need for it to go faster, Lagarde said. At the same time, countries must lay out credible medium-term plan to lower debt."

What's going on across the pond

Many Europeans have been looking enviously across the pond to the US, where growth rates have held up at a steady 2-2.5%. A number have equated this with the fact that the US has not yet attempted any kind of austerity drive. Yet the key component of US growth has been a resumption in consumer spending. "Consumer spending, which accounts for about 70% of the US economy, grew by a 2.9% annual rate, the fastest pace since the fourth quarter of 2010.

There has been some expansion in exports and in construction: "Motor vehicle sales rose at 2.1% in the fourth quarter, the fastest rate in four years. Home construction rose at its fastest pace since the second quarter of 2010, boosted by the warmer weather". But in general, business spending and government spending have been the weak spots in the economy, acting as a drag on growth. Yet the Eurozone growth agenda, such as it is, appears to be prioritising these areas. Consumer spending has become an unfashionable means to promote growth and is now increasingly associated with contributing to the debt crisis.  

Is growth as good as it sounds?

Eurozone politicians should be wary of suggesting that ‘growth' is an easy solution to the Eurozone crisis. Growth comes in many guises and involves just as many uncomfortable policy choices as austerity. It may be creating a new narrative within Europe, but Azad Zangana, European Economist at Schroders doubts it can resolve the problems at the heart of Europe: "Angela Merkel has already rejected Hollande's calls for a ‘Growth Pact' and there is no doubt that the two will clash again on this issue in the future. France has not run a balanced budget since 1974 and has been one of the worst offenders against the existing Stability and Growth Pact. We doubt Hollande will have much success in changing the mind of Merkel, though we do expect financial markets and sovereign rating agencies to exert more pressure on Hollande to ensure he oversees a reduction in France's budget deficit. This could be a case of Hollande's bark being worse than his bite."


More on Mindful Money:

The Age of 'Austerity' – But what is it, and does it work?

Europe: Where next for investors?

A missed opportunity for Sir Mervyn King

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