Opinion At a tipping point

The enhanced emergency loan facility and guarantee funds of the EFSF,totalling $1 trillion,could instantly go into a black hole once the true value of all the sovereign debt and other assets held by the big European banks is assessed. Money seems to have lost its meaning in this continuous bailout exercise. A Citigroup research paper says,“We are facing the likelihood of multiple sovereign defaults in the outer periphery of European area (EA),mainly Greece,Portugal and Ireland. In addition there is the problem of sovereign illiquidity despite fundamental sovereign solvency in the inner periphery of EA — Italy and Spain. If handled badly,illiquidity could threaten default and there is the risk of this spreading to the core of Europe,notably France and Belgium.”

The problem is Europe will have to politically determine how it will restructure its debt and impose austerity measures to return to sustainable economics. The catch-22 situation is any hard austerity measures will further dampen demand and deepen the recession. That will worsen the national debt situation. After all,you need some growth in incomes to pay back debt. This is the dilemma Europe will grapple with over the medium and long term as it slips into a recession.

The biggest worry for the global economy in the 21st century is that all OECD economies,which acted as engines of world growth through the 20th century,seem to have lost steam. We are for the first time faced with the prospect of the US,EU and Japan,all three,going into a long-term low growth trap with periodic recessions.

The US faces the prospect of the longest recovery from a recession in its history. The consensus view is it may take about five years for the US to return to a desirable unemployment level of 3 per cent from over 9 per cent at present. Economist Michael Spence recently provided very interesting data. He said that over the past 15-odd years America’s employed increased from 120 million to 147 million. However,much of the 27 million added to the pool of the employed came from either the government sector or somewhat low productivity services segment such as healthcare. Indeed,the government appears to have become the biggest employer,directly or indirectly,in capitalist America. This,in a nutshell,represents the crises of capitalism in the West where fundamental growth impulses are in decline over the longer term.

During much of the 20th century,the wisdom of Keynesian economics told us that governments would create budget surpluses during an economic boom and use the surplus for deficit financing during downward business cycles so that aggregate demand was kept up. However,this cardinal rule was thrown to the winds as the US piled up its largest chunk of debt during the boom period of 2001 to 2008. Of the total debt of about $14 trillion that America has accumulated,about $6 trillion was piled up during George W. Bush’s tenure,thus squandering all the surpluses generated during Bill Clinton’s tenure. Why,even a traditionally strong and industrious economy like Germany is staring at debt to GDP ratio of over 90 per cent! Now Germany too is faced with the prospect of slipping into a mild recession.

In fact,the first decade of this century was marked by galloping debt to GDP ratios for all Western economies,most of whom have national debt pretty close to 100 per cent of their GDP. Only 20 years ago,these economies had debt to GDP ratios of less than 40 per cent. Something has gone wrong for them in the past decade-and-a-half. Obviously,unsustainable borrowings have dulled their growth impulse.

India has a big lesson to learn from these experiences. The debate in India today is less on improving productivity and much more on how to expand the welfare state. There was a substantial expansion of welfare programmes following the economic boom of 2002-03 to 2007-08,when tax revenues increased by over three times. However,against the backdrop of another imminent recession in the West,growth in India is slowing. But the current,highly fractious political climate has resulted in the government paying much attention to further expanding welfare schemes with little or no focus on how to generate sustained income growth through domestic drivers. An indigenous growth strategy is needed especially when the developed economies are tanking. A successful domestic growth strategy will also support welfare spending.

The writer is managing editor,‘The Financial Express’,mk.venu@expressindia.com