A recent IMF report pointed out some supposed vast amounts of room available for the world’s economies to step up government borrowing to finance consumption, investment and production decisions. Oddly the report appeared to ignore other forms of debt and material deterioration in key areas of the economic frame.
When the crisis broke back in 2007 it was clear to me that monetary and fiscal policy would likely need to go for broke to support economic growth and employment at a time of collapsing asset values, debt defaults and a world wide retrenchment in expenditure of all kinds. As it happened a great deal of that support went into asset prices and financial institutions.
But some years after the crisis, after a slow and drawn out recovery with interest rates locked to the floor, economies still appear to be borderline reliant on debt financed government expenditure. Any attempt to reduce borrowing, to either raise taxes or cut expenditure to pay back debt would be considered by many to have an adversely negative impact on economic growth, especially at such low growth rates.
Governments tax and borrow from private entities to fund all manner of expenditure, but in a well balanced economy much of this is expenditure that would otherwise have been made by the private sector.
It is not that I disagree with the argument that a cut back in government expenditure, in today’s climate, would have an adverse and immediate impact on the economy, nor that I believe that austerity is likely to lead to higher immediate growth (something I am highly sceptical of), but that it is a concern that we remain so reliant on government expenditure to drive economic growth. If we are to see further encroachment of government into economic decision making you have to question the efficacy of the capitalist private market place.
The real question, the real issue is why are many of today’s economies so dependent on government borrowing and fiscal policy and what is the perceived end game? Is it because the financial crisis knocked our economies out of kilter, and all we need is government support until they re-establish a growth momentum? Or is our growth potential greatly diminished compared to 20th Century norms for reasons I have discussed in numerous posts, and the crisis itself was a reaction to a build up of complex and divergent forces?
I have discussed the frame, the debt, the global transitions that are impacting growth and I wonder about the consequences of increased encroachment of governments into the private sector in the light of these.
Not much appears to have changed post the debt financed consumption boom of the noughties: we are still dependent to some degree on manufacturing growth on forcing the system to produce, invest and consume more, yet all the while creating concerning divergences between asset prices and economic growth.
For many it seems as if the only choice is one of growth and fiscal largesse and less growth or collapse without, but I have to admit that I believe the choice is more complex than that: the outcomes differ depending on whether fiscal expansion is temporary, long term and whether economic stagnation and the retreat of private sector growth is temporary or long term. The choice of spending and the planning for the different outcomes could well be significantly different depending on the outcome.
While the moneyed niche of the private sector seems overly focussed on financial assets and share buybacks and profit maximisation, our governments are having to take up the slack. This is the reality. I look at charts showing the reversal of income inequality relationships moving back to 19th Century levels (although a return to precise points is highly unlikely), government debt levels more worthy of war time, interest rates and unusual monetary policy and what do I see? I see an accommodated fantasy, a divergence that fiscal policy on its own may be unlikely to contain.
Why are we so reliant on “growth” in consumption and investment in a world where population growth in key economies has likely plateaued? There are a number of reasons, the major one being the significant debt accumulated to finance consumption and investment. If growth falls so do the future flows (revenues, dividends, interest payments, taxation, capex) on which assets are valued. As assets and flows decline debt slowly defaults and valuations fall.
In a world where demographics clearly negatively impact growth and where the drivers of growth in an expanding frame (loan/population/productivity growth) are fundamentally weak or retracting, we risk entering an environment where net infrastructure and productive capacity is either just maintaining itself or depreciating at the margin. Returns in this environment are increasingly cash flow with cash flow being increasingly a return of capital. If assets were correctly valuing flows/risks to flows, and I believe they are not, then the depreciation risks of slower growth would not be a shock to the system and leverage would likewise be naturally reduced. Fiscal policy would not need to support expenditure to such an extent and capital would not risk being wasted on infrastructure projects unsuited to a contracting frame, and there would be much reduced risk of an implosion of the financial system.
Part of the reason we have been allowed to borrow for personal consumption purposes, for share buybacks, for support of financial institutions is the belief that the shock is temporary and that low interest rates enhance returns to financial leverage and that future flows are little affected. The premise on which fiscal support and expansion of that support is based is extremely important. Making sure we have the right infrastructure, technology and socially deployed capital for a smaller world is a different architecture from one merely deployed to support a temporary blip in the activity in an architecture expected to follow a higher trend growth.
I believe that if we are to borrow for government expenditure that this should be focussed on infrastructure on expenditure that is relevant to the frame and the bigger picture. For example, energy efficiency, food production, pollution, dealing with the complex care needs of an aging population and technological processes that improve the lives of everyone as opposed to the higher echelons. Boosting government expenditure merely to support past growth expectations and asset prices similarly framed is too narrow a decision factor. A higher level of distributional efficiency in the world would also help alleviate some of the transitional dynamics of a high debt, weakening growth and demographically challenged frame. But distributional efficiency would initially impact returns to risky assets, may raise per capita consumption and possibly inflation. But we are still faced with an asset price/future flow disconnect that is central to determining what should be our fiscal planning policy.
It does concern me that many influential thinkers are supporting government borrowing ad infinitum on the assumption that the rate of return on investment exceeds the interest rate cost. This rate of return is partly a decaying function of past returns on capital and lagged responses to prior positive growth shocks so how can we be sure of this rate of return especially on marginal capital investment and given other growth frame issues. Recognise that aspects of capital will depreciate and focus on those which remain or will become increasingly relevant?
Some believe that we are in a temporary blip, that all we need do is to raise inflation expectations and keep interest rates low and all the excess “saving” that has been kept out of the loop will once again be put back to work. But monetary policy has failed to stimulate growth for the same reason that negative rates and “higher inflation expectations” will: the frame is declining (population/productivity) and high debt burdens remain a significant constraint on organic growth potential. Yes we have had a major financial shock but this was in response to inappropriate accommodation, so growth would have been lower, as would asset prices and debt and the path towards a future trajectory one with considerably much less risk.
Forget the assumption that debt is money we owe ourselves: it is only such an asset if it can be repaid at par and will only yield an expected future stream of income if expected economic flows materialise. With income inequality issues, a far too significant percentage of our GDP is still dependent on new loans/money supply growth – just look at the data on new US auto loans and the steady lengthening of repayment terms. Non revolving credit growth has far exceeded the growth rate of incomes post the financial crisis, so we already know that flows remain divergent.
Is the world economy still viable? Yes of course: vast populations with associated infrastructure provide an important organic basis for consumption, investment, saving and production, but S and I and new loan growth may be subdued and we will likely need to move through a) a significant asset price and debt adjustment event and b) a change in the way returns on production are distributed. Trying to spend our way out of this funk without allowing for necessary adjustments in key areas is delusional. It risks impairing the natural organic efficiency of private sector C/S/I/P decisions, raises debt levels and heightens doubts over the return on that expenditure and hence the ability to finance debt.
Why are governments having to increase debt to GDP ratios to fund consumption and investment expenditures? Because the private sector is not growing at a sufficiently high rate that would raise growth to a level whereby it could cope with cuts in government expenditure without risking a return to recession. Because the growth rate of incomes and especially the growth rate of incomes in an increasingly significant majority of the population have hardly been growing at all in real terms for some time. Because population growth has slowed, populations are aging and longer term trends in capital investment have been especially weak. But I hear you ask, asset prices are at historical highs relative to GDP in many countries and there is all sorts of money sloshing around. Well much of this money is asset focussed and in the hands of those who may not need or wish to spend it on consumption or investment in productive capacity to produce consumption goods.
Should our governments further this divergence by supporting an architecture that can no longer support itself? What architecture should we be supporting?