Beyond the false growth vs austerity debate

FT:

This weekend’s G20 meeting will likely fuel, not resolve, the heated debate triggered by a combination of exploding debt and deficits in industrial countries, and the recognition that many now face a future of muted growth and high unemployment.

In one corner stand the “growth now” camp, arguing that expansion is a pre-requisite to service their debt sustainably. Without it tax receipts implode, investment is turned away, and meeting future debt payments is harder. This camp abhors Europe’s shift towards austerity, questions Tuesday’s tough UK budget, and urges countries like Germany to adopt expansionary policies. Some advocate additional fiscal stimulus even for high deficit countries, like the US.

Against them stand the “austerity now” camp. They point to worsening sovereign debt ratings, noting especially that (despite Europe’s rescue package) Greek and Spanish debt risk is back to worrisome levels. They are concerned a coming sell-off in equity and corporate bond markets will deter new investments and aggravate many country’s debt problems. For this camp America’s request that others postpone fiscal adjustment is irresponsible. Instead, they want budget cuts to lower risk premiums and stave off disruptive debt restructurings.

The two sides are both right, and wrong. Their impasse will persist until both understand that the debate is incomplete. In particular their discussion takes too narrow an historical perspective, looking excessively to the past experience of industrial countries as opposed to also reflecting that of emerging economies.

As a general rule industrial countries need to adopt both fiscal adjustment and higher medium-term growth as twin policy goals. The balance between the two will vary. Some, like Greece, need immediate fiscal retrenchment. Others, like Germany, the US and Japan have more room for manoeuvre. But no one should pursue just one of these objectives.

To begin to achieve both, countries must quickly implement what were once known in the emerging market lexicon as “second generation structural reforms”. Basically these involve enhancing the longer-term responsiveness of western economies that have had their comparative advantages eroded, and now see their populations stranded on the wrong side of significant global changes.

Squaring the circle of growth and fiscal stability needs policies that focus on long-term productivity gains and immediate help for those left behind. This means first enhancing human capital, including retraining parts of the labour force, and increasing labour mobility. Then new emphasis on infrastructure and technology investment is needed, with greater support for scientific advances that promise increased productivity. Finally all nations must begin an honest assessment of the social frictions coming in the next few years. In some countries (like the US) this means an urgent bolstering of social safety nets.

The experience of emerging economies cautions that such reforms are difficult to design, and politically hard to implement. They often mean short-term pain for long-term gain – the reason policymakers take so long to realise they are the right path. And they are all the more difficult now the impressive multilateral coordination that typified April 2009’s G20 meeting has given way to uncoordinated national approaches and lecturing.

Yet without these moves industrial countries will soon find themselves on the unstable side of an increasingly multi-speed world. Some, like Greece, will attempt ambitious fiscal adjustments that fail to deliver due to a rapidly contracting economy. Others, notably the UK, will press forward with both fiscal adjustment and reform. A third group, including Germany and the US, have more time to adjust, but find themselves stuck on opposite sides of a very public argument and unable to cooperate to achieve the best outcome: fiscal stability in the context of dynamic, sustainable growth.

The world is facing deep structural challenges yet its leaders are stuck in a short-term, cyclical mindset. Until they break out of it we will see little more than fruitless discussions, national policy flip-flops, and a troubling lack of global policy harmonisation. Without action our future will be disappointing global growth and periodic sovereign debt crises. Let us hope this, if nothing else, is enough to bring the two camps together.

The writer is chief executive and co-chief investment officer of Pimco