There has been no serious attempt to get to grips with the financial cycle, which requires moving away from debt as the engine of growth.
Growth is back – after a fashion – but debt levels are rising again, productivity growth in advanced economies is close to post- war lows, capital spending is becalmed, and in Britain, inroads into deep fiscal and current account deficits are proceeding only at glacial pace. Is this a sustainable economic model?
The answer from the venerable Basel-based Bank for International Settlements is a definitive no. “As history reminds us, there is little appetite for taking the long-term view”, the BIS thunders in its latest annual report.
“Few are ready to curb financial booms that make everyone feel illusively richer. Or to hold back on quick fixes for output slowdowns, even if such measures threaten to add fuel to unsustainable financial booms. Or to address balance sheet problems head-on during a bust when seemingly easier policies are on offer. The temptation to go for shortcuts is simply too strong, even if these shortcuts lead nowhere in the end”.
As you can see, the BIS has lost none of none of its penchant for dampening any suggestion of better times to come with another bucket load of gloom. The BIS is, if you like, the conscience of markets, bankers and policymakers, so pessimism and proselytising come naturally. It is the BIS’s job to warn of developing economic risks, however clement the conditions outside seem to be.
This gives the central banks’ banker the characteristics of a stopped clock. Much of the time, it is going to be wrong, with the natural exuberance and animal spirits of markets oblivious to its warnings. Twice a day, however, it is going to be right, as indeed it was about the financial crisis, when it came closer than any to predicting the maelstrom to come.
And now its warning lights are flashing red once again – about the disconnect between buoyant financial markets and underlying economic realities, about a recovery which is too dependent on debt and unconventional monetary stimulus, about the depressing lack of productivity growth, about companies that prefer to downsize and buyback their own shares to investing in the future, about developing asset bubbles and the risk they pose to financial stability, and about the cowardly propensity of policymakers to take the easy option, rather than the tough decisions necessary to create a durable recovery.
Is the BIS right to be playing the Prophet of Doom once more? This might seem something of a cop out, but the answer is both yes and no. Take the UK economy. Barring accidents, the UK probably has at least another two years of above trend growth left in it, and with a bit of luck, rather more.
Goldman Sachs reports that its proprietary current activity indicator points to annualised growth right now of 3.5 per cent. The investment bank has also broken with the consensus to predict 3 per cent growth next year, with unemployment falling to 6 per cent next year and 5.8 per cent the year after – or a level generally considered to be synonymous with “full employment”.
Little more than a year ago, such suggestions would have been dismissed as delusional, but much of today’s survey evidence seems to back them up. Business optimism is at its highest level in 22 years, according to a survey of 1,500 businesses by Lloyds Bank. Perhaps it is the likes of the BIS who are out of step with underlying realities.
Unfortunately, the UK may be something of a special case; the international picture doesn’t look nearly so reassuring.
Some of the best evidence for this more downbeat view comes from the latest Standard & Poor’s “global corporate capital expenditure survey”, which glumly observes that despite a corporate sector awash with cash – an astonishing $4.5 trillion of it for the top 2000 capex spenders alone – a recovery in global business investment spending “still appears some way off”.
Corporate capital spending fell by 1 per cent in real terms last year, with current estimates suggesting little better for this year. Admittedly, some part of the explanation is the cyclical downturn in spending by natural resource companies, which together account for an almost unbelievably large share of all capital spending by business.
But as the BIS points out, other investment patterns do not bode well for future growth. In many advanced economies, companies are holding back on investment in plant and equipment. Infrastructure investment is also languishing, in advanced and emerging markets economies alike.
I get no sense from business leaders of some great dam burst of investment about to break on an unsuspecting world. They worry more about subdued demand, political uncertainty, and the persistence of unduly poor rates of return than the opportunity missed.
Others complain of a world so hemmed in by regulatory constraint and/or fear of censor that sensible, long term planning and investment has become all but impossible. We live in a world where business strategy sometimes seems more beholden to the diktats of risk averse regulation than the demands of the market and the power of the imagination – a truly desperate state of affairs.
This bankruptcy of corporate ambition, ideas and innovation finds its natural expression in the renewed fashion for buybacks and cost cutting mergers.
Britain is in the midst of a strong cyclical rebound right now, but it cannot for ever row against these global influences, or indeed the deep economic malaise which afflicts large parts of the Eurozone.
So yes, the BIS is right to worry. What growth there is remains highly dependent on extraordinary monetary stimulus. Despite lacklustre prospects for investment and demand, debt continues to rise almost everywhere.
These debt pressures, the BIS judges, last well beyond the normal parameters of the business cycle. Typically, business cycles are of seven to eight years duration, and are to a large extent creatures of political ambition. That is to say, they tend to mirror the political cycle. Impatience at the slow pace of economic recovery will inevitably be one of the prime drivers of macro-economic policy. A consequent premium will be put on artificial remedies that support demand and growth, especially in the run up to elections.
Such remedies generally involve piling on a load more debt, making the underlying financial cycle – which tends to be much longer – very much worse, a theory which has been compellingly argued by Claudio Borio, Head of the BIS’s Monetary and Economic Department.
In any case, the BIS is surely right to observe that there has been no serious attempt to get to grips with the financial cycle, which requires moving away from debt as the engine of growth, and substituting effective measures to improve the economy’s long term supply.
To the contrary, since 2007, the ratio of non-financial sector debt to GDP across the G20 as a whole has risen by more than a fifth. This has helped prop up demand, but it has led to new financial booms which mask fundamental weaknesses and loss of productive potential in many advanced economies.
Britain is lucky. Today’s growth spurt provides a window of opportunity to set things right. But unless policymakers rise quickly to the challenge with radical tax, deregulatory and other forms of supply side reform, it will be squandered.
With the electoral cycle once again dictating policy, and the polls continuing to indicate a Labour majority at the ballot box, it seems depressingly likely that the opportunity will once again be missed. Good policy is less a question of seeking to pump up growth at all costs, the BIS observes, than of removing the obstacles that hold it back. Quite so.
Courtesy: Jeremy Warner via The Telegraph
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