The threat of austerity measures

To say we live in uncertain global economic times would be a silly understatement. The illnesses that prevail are well understood. Prescriptions to cure them flow frequently and fast. The big question is whether the policymakers are getting those prescriptions right. In our case we have to fervently hope that, right or wrong, we shall not be hit as viciously as might be the case.

Over the past two years most countries have had to deal with two major problems. One was the financial crisis. It was triggered by the banks bust-up in the USA where borrowing and easy lending had reached incredibly irresponsible proportions.

More than one government had to intervene, putting up public money to effectively socialise what was a private sector problem. Governments acted to save banks, to get them lending to each other again, to induce them to pick up lending to private entrepreneurs who were being shut out in the cold.

The interventions by public authorities - governments and central banks - were among the biggest ever mounted, turning the notion of non-state intervention and small government on its head. Public finances suffered strain because of such interventions.

The second problem which hit the global economy in parallel with the financial catastrophe was rooted in the real economy. Recession reared its ugly head once more, gripping one country after the other. Fear that it might turn into a depression was one reason why governments shored up the private financial system with public money.

They also took such steps as they could to boost economic activity through countervailing measures to the recessions. Thereby the public finances, already heavily burdened, were stretched further.

Along the way many financial and economic bubbles burst, leading to pious declarations of intent never to be so foolish again. Six months ago a third problem swept parts of the world. As everyone now knows, it started in Greece.

With a very high public deficit relative to GDP and a massive debt overhang, doubt began to grow whether Greece would be able to roll over its maturing debt at a carrying cost in high interest rates which would not cripple it further. Soon enough the doubt was whether it would be able to do so at any rate, leading to fears of default.

The eurozone dithered and the Greece crisis worsened. Eventually it was agreed to help out Greece, also with the aid of the International Monetary Fund, turning European Central Bank policy on its head, as it was effectively forced to start buying Hellenic bonds to support a panicky market.

The markets weren't impressed and a massive standby credit had to be created by the whole European Union, not just the eurozone. Reality began to strike home. The obvious became evident - it was established that the Greek situation of high public deficit and debt was replicated in various countries. In small Ireland and Portugal, yes, but also in the bigger countries, Spain, Italy and the United Kingdom.

Astonishingly, Germany too classified itself in an unacceptable category and France was not immune from the malady, either.

All those countries committed themselves to austerity measures to rein in and reduce the public deficit and, eventually, to arrest the public debt. Last Tuesday the UK's new government gave a clear example of what these measures will consist of, saying that every person in Britain would be affected.

Not everybody agreed with the UK Chancellor. Reputable and respected Keynesians joined the Labour opposition in warning that the measures to slash public expenditure were coming at the wrong time, given that the UK was only just limping out of recession. Strong recovery was a long way away and could be pushed back further by the austerity measures.

This fear applies to the other economies which will be getting the same treatment, even though their governments insist it is the only way, paradoxically, to devise growth paths once again. It remains to be seen who is right - the Keynesians or the immediate austerity pushers. It also remains to be seen whether the negative impact of the measures on aggregate demand will be offset by export-led growth.

That will depend on the extent to which China, India, Brazil and Indonesia too will absorb European exports. The USA too, is under threat, with another massive deficit and debt.

Whoever is right about exports offsetting the impact of austerity measures, we could be badly affected for the foreseeable future. We have a deficit and debt problem, but nowhere near those of the countries mentioned above. But lower aggregate demand in the UK, Italy, France and Spain could affect both our manufacturing exports and tourism, at a time when they are slowly recovering from the declines of 2009.

Now more than ever the priority for the exporters of our visible and invisible goods and services has to be competitiveness and quality combined. Worse times than we have been through might be coming.