The Food Community

Food is likely to be a key issue out to 2030. Already long term food prices are rising as demand starts to outstrip supply. This could be a mixed blessing for Suffolk. As an agricultural county, Suffolk is well placed to benefit from the rising prices of agricultural produce. However, this benefit may not be shared generally as rising food prices squeeze the living standards of everyone and act as a tax upon consumption in general. This reduction in disposable income has the potential to keep the economy in Suffolk subdued for some time to come.

It is expected that disruptive climate change could start to become evident within the next twenty years. Rainfall could become more extreme, whilst long periods where no rain falls also become manifest. There are those who argue that we are already seeing this changing weather pattern, and warn that it could become even more extreme in the years to come. This may change our ability to produce food within the county. In turn, it could have major implications for the water infrastructure that is needed to irrigate the crops grown.

It is also expected that the impacts of peak oil could start to become evident within the next twenty years. The disruptions caused to the food distribution system caused by peak oil could mean that food is not necessarily delivered to market in a timely manner, and the possible cost of food storage could become an issue by 2030. As much of agriculture is now dependent upon products derived from oil, the possibility of the increased cost of oil is likely to have the effect of increasing the cost base of farming.

How the balance of increased crop prices and increased input costs will play upon the farming community is largely uncertain at the moment. What is more evident is that the price of food paid by consumers is set to increase. This could have all sorts of consequences, but is likely to impact upon patterns of rural crime within the county. Just as the proceeds of crime increase in value, the ability of rural policing efforts to deal with those crime patterns is set to diminish.

This is not a given future though. It is possible to act now to mitigate the more dystopian effects of this future. For example, we could encourage less waste in our consumption of food. Households could be encouraged to grow more of their own food. Communities could develop strategies of resilience to counter food poverty. There is a great deal of scope for social enterprises to act as an alternative distribution method for those in food poverty. The basic infrastructure is currently in place. All we have to do is use it to secure a better future.

© The European Futures Observatory 2012

The Coastal Community

It is expected that disruptive climate change could start to become evident within the next twenty years. The disruptions caused by climate change are likely to manifest themselves through changes to the water cycle. Rainfall could become more extreme, whilst long periods where no rain falls also become manifest. For those communities based on the coast, this could imply threats from both river flooding and from tidal flooding resulting from stormier weather.

It is unlikely that coastal communities will experience an inundation from the sea due to rising sea levels by 2030. In this time, the level of the sea can be expected to rise by 6cm on average, which suggests that stories of parts of the coast becoming islands are something of an exaggeration. The root of this exaggeration lies in our inability to think in climactic timescales. A far more likely case is that the processes of sea erosion and deposition may act to reposition the coastline over this period.

The Suffolk coast ought not to be seen as a homogenous entity. Parts of the coast have a high industrial value, whilst parts of the coast have a high residential value. And yet again, parts of the coast have been scheduled to be abandoned to the sea on the grounds that the cost of sea defence is far higher than the economic value of the land to be protected. Whilst this may be an argument of economic efficiency, it is hardly likely to be seen as a good solution in terms of community equity. It is by no means certain that we have an adequate structure to balance the needs of equity and efficiency at present. This is unlikely to change too much as we go into the future.

It is also the case that, when we view the water cycle throughout Suffolk, a high degree of externality exists within current and future land use patterns. The construction of residential property on river flood plains has led to a much faster throughput of high rainfall onto coastal communities. The investment to protect the downstream communities from high peaks of river flow hasn’t been adequate for the job required, leaving the coastal communities to pay the external costs of development upstream. There is a case for a greater sensitivity to downstream impacts when planning applications are considered by the planning authorities.

The issue of the water cycle and the Suffolk coastal communities is one that is dominated by externalities. It calls into question what economic efficiency means, and leads us to ask where equity fits into that calculation. As we move into the future, we can expect key parts of the infrastructure, which reflect a different weather cycle, to be placed under severe strain. It is by no means evident that sufficient funds will be made available to fill those gaps in infrastructure. This suggests that we can expect the number of disruptive events to occur more regularly as time goes by.

© The European Futures Observatory 2012

Am I A Busy Fool?

“Are you a busy fool?” I was asked that question last week in the context of The Productivity Puzzle. The Productivity Puzzle is something we currently face in the UK where overall employment has been rising, but overall production has either fallen, or is stagnant, as the economy flatlines. This is counter-intuitive, because, as employment rises, we would expect output to rise as well. It suggests that overall productivity in the economy is falling. One possible explanation of this is that, to a certain extent, we are becoming a nation of busy fools. A busy fool is one of those people who rushes around all day in a hive of activity, but actually achieves very little. They may be very busy, but they are not very productive. I am sure that we all know someone in our working lives who is like this.

My initial reaction was to say that perhaps I am a bit of a busy fool. The nature of our business model makes me so. The way it works for us is that our prosperity depends upon our professional reputation. We operate on the basis that free work builds reputation, reputation generates enquiries, enquiries lead to commissions, commissions give us the money to be able to undertake more free work. And so the cycle continues around and around. As our reputation grows, so does the level of fees that we can command. Without the free work (i.e. the busy fool element) at the start of the cycle, then our future prosperity will become severely impaired. A sacrifice of productivity now ensures greater productivity in the future.

As I was driving home from the meeting, I found this aspect of the conversation nagging away at me. I think that the aspect of the question that made me most uncomfortable was the time horizon that underlies the question. On reflection, I found the question to be very short-termist. An implicit assumption in the question is that every new hire needs to join an organisation at their maximum level of output. I question this on two counts. First, even the most experienced person needs a bit of time to find their way in a new organisation. We normally reckon on people needing six months to find their feet. Second, if inexperienced people are hired, then not only does it take much longer for them to find their way (we reckon on two to three years), but also it makes the existing workforce a little less productive as they have to support the inexperienced member of staff in finding their way. This diminishes the productivity of an experienced workforce, but it is part of the cost of training and developing people within an organisation.

The whole issue of productivity, particularly my own personal productivity, led me to think further about the subject of which we were talking. This needed a bit of deeper thought – a problem to take to the shed at the weekend. On deeper reflection, I am not happy with one of the underlying assumptions of the busy fool argument. To argue such a case makes the presumption that the purpose in life is to work productively (i.e. in generating money). What, I wondered, is the role of love and service (two important elements in my life) in this worldview? In thinking about it, I feel that we have touched upon a major flaw in modern economics. There is a presumption in economics that the role of the individual is to produce more stuff – the rational utility maximising economic agent. I haven’t lived that way for over a decade.

Instead, I operate a system which nowadays we call ‘enoughness’, and which previously we called ‘satisficing’. What I do is to arrange my affairs so that I can earn enough money to satisfy my material needs, plus a bit over so that I can put something by for rainy days, plus a bit more so that I can make a contribution to my community. Beyond that lies making money just for the sake of making money, which doesn’t attract me at all. In my present arrangements, this means that I only need to work one and a half to two days a week to satisfy my material needs. What, you might ask, do I do with the rest of the time?

The answer to that is quite complex. I spend time with my family (yes, I was the dad at the netball matches watching his daughters play in the frost) because I am not impressed by absentee parents. I devote time to providing service to my community. This occurs in various roles. For the past two years, I have been spending time with my local authority on helping them to cope with the problems of austerity whilst making their services future ready. They can’t afford to pay me a fee, so I don’t charge them one. I find myself working with young people, helping them to find their paths in a pretty hostile world. They don’t have the money to pay me, so I don’t ask for any. In my mind, although it makes me poorer in a monetary sense, it actually makes me far richer in a sense of well being. To my mind, in order to live a good life, one has to volunteer and to provide service to our communities, however we may define them.

Indeed, economists are now arguing that economics, as a discipline, has lost sight of the ends (living a good life) by an excessive focus upon the means (material accumulation). The argument is that, in order to re-adjust ourselves properly from our current malaise, we need to move away from the central premise that the purpose in life is material accumulation. This would represent a change in values which, if it caught hold, would revolutionise economic theory. The current body of theory, without the central premise of the rational utility-maximising economic agent, would simply fall apart. Economists could then learn what the rest of the world has known for some time: that economic theory is bunkum. It fails in its core purpose of describing the world as it is.

Taking the argument further, there are those who argue that our current problems stem from the real world not quite following the recipe laid down by the neo-classical logic of economic theory. If you doubt this, then brush up on the Efficient Market Hypothesis. We had a banking crisis because markets aren’t efficient when we assumed them to be. It has taken us five years to wake up to the real world being right and the theory being wrong, although there are still those, mainly in the United States, who deny this. Attempts have been made in the past to describe an economics without homo economicus. The revival of these works is a really positive step in the right direction. Who knows, we may even end up with a body of economic theory that is fit for purpose.

Coming back to the original question, am I a busy fool? I guess that I am. However, I would also argue that I am a better person because of it, and I would invite as many as possible to join me in my foolishness.

© The European Futures Observatory 2012

The Great Stagnation

by Tyler Cowen (Dutton 2011 – ISBN 978-0-525-95271-8)

This is an interesting little book. It is tightly written and well argued, which serve to make it a very easy read. In fact, I managed the whole book on one return train ride to London.

There are a number of ideas that are worth exploring within the book, but the core message is that technology has driven economic growth since the late Eighteenth Century, and that the pace of innovation has fallen to the point where the pace of growth is slowing as well. What does that mean? Well, first and foremost, it means that the singularity is not near. This is a position that I have agreed with for a few years now.

In part, the author ascribes this to knowledge passing from being a public good to becoming a private good. This is fortunate for the few lucky owners who possess that knowledge - they do well in the 'winner takes all' economy that it creates. However, for the rest of us - for whom we call the 99% nowadays - it is not so fortunate. Our ability to consume at the levels to which we are accustomed has been maintained not by growth, but by debt in recent decades. However, the lack of productivity growth has undermined our ability to repay the debt we have taken out.

This is an important message for governments. Debt reduction and austerity plans presume that we shall be able to return to previously attained growth levels. What happens if we can't? I guess that means we are due for a very long period of stagnation. And this is the important message coming from the book. We are heading towards a new normal, and a return to business as usual is no longer an option. This is what policy makers are not yet getting.

I would strongly recommend this book. It is an antidote to the blind optimism we find in technology nowadays. It explains why a policy of austerity will only make things worse. And it serves as a warning that we are unable to continue as if the financial crisis did not happen. We have reached the point where the bills have to be paid.

© The European Futures Observatory 2012

The Caring Community

One aspect of sustainability that is often overlooked is the need to operate a fair and just society. The definition of what is fair varies between communities and changes over time. However, it is usually the case that an equitable solution should be reached as a pre-requisite for a well balanced society.

A key measure of equity in society is how its vulnerable members are treated. Traditionally, the focus has been upon the education of the young, the social care of the old, and the healthcare of society as a whole. We are living at a time when these definitions are blurring and the traditional compartments for social care no longer work as well.

For example, to serve the needs of a knowledge economy, there has to be provision for life-long learning well beyond the traditional school leaving age. Alternatively, as our society ages, the link between chronological age and dependency age is weakening. In the field of healthcare, we are all becoming more demanding of services as our expectations rise. As we move into the next two decades, technology has the promise of upsetting the traditional relationships even further.

The direction of technology is to allow our devices to become smaller, faster, more connected, and cheaper to run. This has the potential to revolutionise the way in which care is delivered in a very short timeframe. So far, it has given rise to more distributed forms of care delivery, a trend that has a great deal of momentum as we move out to 2030. By this time, it is entirely possible that a good part of education, eldercare, and healthcare are delivered in the home. If this comes to pass, then it raises questions about our current investment in centralised delivery services.

Another area in which technology could impact upon the caring community in the next two decades is through the advances in bio-technology and pharmaceuticals. The current direction of bio-tech is to retard the ageing process and to augment our natural abilities, both through the mechanical augmentation of our body organs and through the pharmaceutical enhancement of our mental capabilities. Both of these developments have the potential to significantly alter the care paradigm.

We are at a point where the boundaries of public and private provision are changing, where the private sector has a greater role to play in activities formerly undertaken by the public sector. It is uncertain as to how far will the pendulum move in that direction. It really depends upon what the future needs base looks like. Technology could assist or impede this process. What we can say with some certainty is that there is a very real chance that the caring community in 2030 will be radically different from how it is today.

© The European Futures Observatory 2012

So Far, So Good …

There was a palpable sigh of relief this weekend. We have managed to navigate the first quarter of the year without a globe stopping event occurring. There have been one or two hairy moments, but Greece has managed to secure a second bailout; large tranches of debt have been retired by Spain, Italy, and Greece; and we have managed to avoid hitting any of the speed-bumps that we feared at the start of the year.

Indeed, the prospect now looks, if not exactly rosy, then much better than it did in January. There are glimmers of recovery in the US. True, as yet it is a jobless recovery, as some of the higher levels of activity are soaked into output gap, but without a doubt economic activity is picking up in America. The Chinese property market does not look as volatile as it did at Christmas and the transition from the old guard to the new guard seems to be going reasonably well. Even in Europe things are not looking as bad as previously feared. Whilst still likely to be touched by recession, the expected recession in Europe is not thought to be as bad as previously forecast. In the UK, with inflation coming down, those people with work are finding that their living standards are gradually improving.

We are now moving into a phase where, as the threat of economic catastrophe recedes, we have time to worry about the more usual matters of geo-politics. Top of the list has to be Iran. It would appear that the US has no real appetite for military action against Iran, but is concerned about the prospect of military action undertaken by Israel. Underpinning this is a window of opportunity for military action that is starting to close. Israel is attempting to keep this window open by leasing airbases in Azerbaijan, which could prolong the period of uncertainty. Either way, the prospect of disruption to global energy markets caused by intervention in Iran has propelled the price of oil into the $125 a barrel region. This will have an effect on the world economy later in the year.

Although our focus is dominated by one geo-political hotspot – the Caspian Basin – another - the South China Sea - is quietly starting to come to the boil. The South China Sea is full of little rocky islets, whose ownership is disputed by a number of countries, including China. They occupy key sea lanes in the trade between East Asia and the Middle East, Europe, and Africa; they contain key oil and gas reserves; and they contain a number of important fisheries. China claims sovereignty to all of the South China Sea and is developing the naval capacity to back its claim. The US is pledged to guarantee the claims of a number of key nations – particularly Taiwan and the Philippines. With the change in stance of US security policy towards Asia (read: the containment of China), the stage is set for a number of de-stabilising showdowns in coming years.

What could bring things to a head is a change of government in both China and the US this year. It is by no means certain that the policy of ‘business as usual’ will apply in the second half of the year. However, before that there are two potentially difficult elections scheduled. Sometime in the next quarter the people of Greece will go to the polls. This will be the first opportunity they will have had to voice an opinion over the two bailouts that have been negotiated on their behalf. It is quite possible that a popular vote to reject the policy of austerity (and thus the terms of the two bailouts) will carry the day. If that happens, then a ‘risk on’ moment is likely to be triggered in financial markets.

The second difficult election is the presidential election in France. If Mr Sarkozy loses, as the polls currently suggests, the we all ought to be worried about the impact that a newly appointed Socialist President might have. The policy of soaking the rich, doling out borrowed money to client groups, along with reversing the limited reforms achieved in recent years is bound to spook the bond markets. A run on French banks, as depositors seek a safer haven such as German banks, is the likely and unwelcome crisis that could face the incoming President. If it does, then the global financial markets could face a period of turbulence.

Despite looking good at the moment, we haven’t quite come out of the woods yet. It could be that we are currently in a lull before a renewed storm. Equally, it could be that the worst is behind us and that a slow recovery takes hold this year. It is too early to determine which path we are currently following. All we can do is just watch and wait.

© The European Futures Observatory 2012

The Price Of Fish

The Price Of Fish by Michael Mainelli and Ian Harris (Nicholas Brealey 2011 – ISBN 978-1-85788-571-2)

“What does that have to do with the price of fish?” That is a question often asked in the UK when we encounter seemingly random and unconnected events. It is an unusual title for a book. However, the subtitle gives the game away. The full title of the book by Michael Mainelli and Ian Harris is: ‘The Price Of Fish: A New Approach To Wicked Economics And Better Decisions’. As is true in many economics texts, the seemingly unconnected are, actually, well connected.

Wicked problems are those which are messy, circular, inconsistent, and aggressive. The sort of problems we encounter in real life. Wicked economics is the use of a set of economic principles to attempt to solve wicked problems. Almost by definition, such solutions are generally complex, inconsistent, and circular. This is quite a step forward because it contains an implicit rejection of the Enlightenment view that for every problem, there is a single, unique, and optimal solution. The world of wicked problems is one in which there is no right solution, ‘better’ or ‘worse’ solutions are difficult to define, where we live with profound unintended consequences, and where we struggle to find a compass that will suggest the right thing to do.

The right thing to do is an important aspect of the book. It takes the view that the point of economics is not to produce an elegant solution but to have a tangible impact upon the real world. To allow us to make better decisions in the real world. For example, in explaining the ‘winners curse’, we can see why it is that competitive tendering for contracts will almost always result in a sub-optimal result, both for the contractor and for the client. But what can we do about it? One response is to refuse to engage in ‘beauty parades’. Your competitor will always win the contract, but not at a decent profit margin, leaving you a clearer field in the longer term.

There are a large number of really interesting ideas in the book. However, one that struck me as very useful, from the perspective of an economist, was the idea of viewing money as a means of communication in a relationship of trust. Money says something about us as people. It defines how we value ourselves, others, and the material things around us. A core issue in economics, one that has rarely been explained, is the concept of value. Perhaps economists have been looking in the wrong place? Perhaps we should have been looking into studies in inter-personal relationships for answers to the question of value? It could be the case that the study of communication theory would be more useful to us than monetary theory. I find these to be very interesting thoughts.

This is not a simple book. Some of the concepts it contains are quite complex. However, they are explained in a way that will allow a non-technical reader to get to grips with them quite easily. It provides a framework and structure whereby we can view wicked problems and attempt their solution. That alone commends this book.

© The European Futures Observatory 2012

Balancing The Books

There is a good deal of talk in Europe at the moment about balanced budgets and the need for public authorities to achieve these. Indeed, the need to balance the books provides the whole rationale for the current programmes of deficit reduction. What is missing from the conversation is an explanation of what a balanced budget is, and why it might be good for us. The purpose of this piece is to explore these issues.

If we were to take a very strict view of a balanced budget, public authorities would not incur any expenditure unless they had received a corresponding amount of income. This, of course, is an absurd position. The flow of income into the public coffers is episodic and anything other than smooth. For example, the self-employed in the UK pay their taxes on 31st January and 31st July each year. A strict view of a balanced budget would have it that the UK government could only spend money on those days. This is not practical. Much government expenditure is on salaries, and staff like to be paid monthly. Indeed, those authorities that have mismanaged their affairs, such as the State of California, have to resort to issuing IOUs to staff when there is insufficient cash to make the salary run, which is not a sustainable situation for any length of time. In order to smooth the peaks and troughs between income and expenditure flows, public authorities have to resort to borrowing. Indeed, most public borrowing is short term (i.e. less than three months) just for this purpose.

We might argue a less strict rule by holding that budgets need to be balanced each year. Laying to one side the issue of why a year is a convenient accounting period as opposed to, say, 9 months, or 15 months, and so on; it is worth delving into this view a bit further. Many advocates for balanced budgets take the view that expenditure should be matched to income over a single accounting period. Intuitively, this makes sense, but it can lead to some pretty untoward results. There will be good years and bad years. Years of relatively high economic activity (when the tax take is high) and periods of relatively low economic activity (when the tax take is low). If a nation were to balance its books so that expenditure matched its income in any one year, then the result would be to destabilise its economy by making the booms much higher than they otherwise would have been and the troughs much lower than they needed to be. One could argue that the last time this was tried was between the two World Wars, with the overheating of the 1920s being followed by the depression of the 1930s. Despite where we are today, we are nowhere near as badly off as we were in the 1930s.

One of the insights of Keynes was to show us that an annually balanced budget would lead to long periods of acute economic inactivity. This has led to the view that budgets should be balanced over the course of the business cycle. There is much to commend in this view, except that it doesn’t take into account the issue of investment, particularly investment in infrastructure. This has led to what has come to be known as ‘The Golden Rule’ of public finance, that states that budgets should be balanced over the business cycle, except for borrowing to pay for public infrastructure projects. In many respects, this makes sense. Public infrastructure projects, such as roads, bridges, hospitals, prisons, and so on, have a useful economic life that well exceeds the course of a single business cycle. A well placed road, or a well built building, may last for centuries.

Whilst the rule appears to make sense, it doesn’t really address the issue of when the borrowing would be paid back, and the structural surplus in the budget that would be required to do so. If an authority ducks the issue of raising the structural surplus, for which there is a major political incentive to do, then the result will be an accumulation of public sector debt, albeit structural debt. It is concerns about the accumulation of debt that lead observers to advocate balanced budgets.

The rationale for balanced budgets is that we should all live within our means. This is readily evident from the perspective of the Hausfrau, but is very different when applied to a national government. The government differs from households in three important ways. First, it can print its own money. The Hausfrau is not able to take a piece of paper, write ‘Five Euros’ (or whatever the currency is), and then compel everyone to accept that piece of paper as fair value in exchange. A government can. The electronic version of this – Quantitative Easing – is exactly what is happening today. The second difference is the power of taxation. The Hausfrau is not able to go into a shop, open the till, and take part of the shop proceeds. A government can – it’s called taxation. The third difference is that a Hausfrau is unable to manipulate the value of her obligations by controlling both the exchange rate and the internal rate of inflation. A government can manipulate the real value of its currency. It is absurd to say that a nation needs to live within its means when it has the ability to print its way out of debt, tax its way out of debt, and to inflate its way out of debt.

This is important when we consider our medium term economic futures. In many respects, both the US and the UK have worse debt positions than the Eurozone. And yet, it is the Eurozone that faces economic turmoil. This is because the US and the UK still have access to the three levers at a national level, whilst the Eurozone nations that are in trouble do not. The case of Greece is quite instructive here. The taxation of Greek society has gone to the point where any further fiscal tightening could seriously destabilise Greece as a nation. And yet there is more to do. Greece desperately needs to print money, but the ECB is prevented from functioning as a Central Bank by acting as a sovereign lender of last resort through the mutualisation of obligation. Greece urgently needs a monetary restructuring, either from an external devaluation or internal inflation, but the ECB is charged with acting to prevent this from happening. Increasingly, the solution that seems to be gaining ground is for Greece to leave the Eurozone so that the Greek government can regain control of the two levers that the ECB presently denies them. This is not a foregone conclusion though, because it is still possible for other Eurozone nations to come to the aid of Greece through the mutualisation of obligation at the ECB.

In considering Greece, we hit upon an important limiting factor to the need for a body to balance its budgets, and that is the willingness of its lenders to continue lending to it. The issue of balanced budgets is being forced upon Greece, and not the US and the UK, because its lenders are increasingly reluctant to loan further funds. If the Greek creditors were confident in making further loans, then the issue of balanced budgets would be relegated from being most pressing to being one of a number of possible strategic vulnerabilities. Perhaps that is the biggest indictment of the Greek government – not having sufficient foresight in managing its strategic vulnerabilities.

But then, I would say that wouldn’t I? After all, I am a futurist, and that is what we do.

© The European Futures Observatory 2012

Light At The End Of The Tunnel

2012 has started with some of the gloomiest economic forecasts for years. Let us not diminish the seriousness of the situation. There is a reasonable chance of a severe deterioration in the world economy this year. However, as a futurist I starting to wonder what it might mean if our fears were to be unfounded. Whilst currently we can only see problems ahead, might we also be looking at grounds for optimism at the same time?

There are three key assumptions to our thinking. First, the Eurozone continues to find a way of muddling through the crisis that it faces. There is a danger that, in wanting a quick and effective solution, we might also lay down a structure that we later come to regret. But just suppose that there are no major problems with the debt retirement programme, there are no major increases in sovereign borrowing costs, no countries are forced to leave the Euro, and that the Euro continues to soften against the US Dollar, then we can hope that the signs of growth will return to the Eurozone by the end of 2013.

Our second major assumption is that the fear of a fiscal implosion in the US does not materialise. What this means is that the prospect of the Presidential Election in November acts as a restraint upon the lunatic fringe in US politics (e.g. America does not return to the Gold Standard, that the US remains plugged into the global economy, and so on), that America initiates only a mild fiscal contraction, and that the Fed. is prepared to undertake monetary expansion to more than compensate for the fiscal contraction. In this case, there are grounds to believe that the US economy will continue to motor along as one of the higher performers in the OECD.

Our third assumption is that China manages to achieve a soft landing. This would imply that growth in GDP just comes off the boil rather than there being a dramatic decline in GDP, that the change of leadership in China can be managed without resulting in a high degree of social unrest, and that the housing market – and the financial system that underpins it – softens rather than crashes. If this happens, then the process of re-balancing the Chinese economy away from exports and towards consumption can continue during 2012.

If these three conditions occur, then we can be cautiously optimistic about where we shall be at the end of the year. The key is the weakening of the Euro against the US Dollar. This will assist the Eurozone in exporting to America, and those economies whose currencies are tied to the US Dollar – mainly the Middle East, Latin America, and the Far East. The recessionary pressure experienced at the start of 2012 is likely to soften commodity prices even further. This could result in the happy coincidence of rising incomes (from export led growth) in conjunction with softening prices leading to rising disposable incomes at the end of the year. If this happens, it will ease the fiscal pressure within the Eurozone by restoring part of the tax base and reducing the welfare bill.

If Europe heads into recovery, then the rest of the world will benefit from this. It has the potential to kick start the global economy, not in a dramatic way, but sufficient enough to cause a change of direction in where the economy is heading. What would help even further is if, as the fiscal position improves, the benefits were to be spent more upon fiscal stimuli, such as infrastructure projects, than upon debt repayment. It is unlikely that 2012 will see the point at which debt repayment makes more sense than a fiscal expansion. This is, of course, a question of balance, and some fiscal expansion will occur naturally, whilst debt is continually being repaid.

If these three assumptions hold, and if there are no major shocks to the system that would blow things off course, then we may well see some light at the end of the tunnel by the end of the year. Although economics is the ‘dismal science’, the economic outlook is never wholly good or bad, and it is up to us to find the upside when everything seems down.

© The European Futures Observatory 2012

Does Austerity Work?

In 2011, the case for austerity was made across Europe and North America. Austerity was seen as the way in which nations could put their houses in order. Restraint was to be the order of the day as a prelude to paying down the mountains of debt that nations had accumulated in bailing out the financial system at the start of the present financial crisis. Some countries, such as Ireland, embraced the austerity agenda at an early stage. Others, such as Greece and Spain, have had it thrust upon them by a combination of events, bullying by other nations, and as a condition of financial support imposed by international bodies, especially the IMF. The purpose of this piece is to consider whether austerity will work in the longer term.

Perhaps it is worth starting by stating what we mean by austerity. There is no doubt that austerity means fiscal contraction, either by reducing public expenditures, increasing taxes, or a combination of both. However, in the light of this, we ought not to exclude monetary policy and exchange rate policy. Whilst many nations have been subject to fiscal contraction in 2011, there has also been a corresponding monetary expansion at the same time. By keeping interest rates at an historically low level, and by pumping domestic money supply through QE, the monetary stance of most European and North American governments has been expansionary. Exchange rates have also been used as an adjustment mechanism to accommodate fiscal contraction, although in less a deliberate way. Taken together, the typical path to austerity in 2011 would often be a sharp fiscal contraction, accompanied by a monetary expansion, along with a softening of the exchange rate.

This policy has been used in differently over 2011. The most expansionary economy of the group – that of the United States – has seen a combination of fiscal expansion, monetary expansion, and a reasonably static exchange rate over 2011. This has resulted in US GDP growth of about 1.8% in 2011. The least expansionary of the group – that of the Eurozone – has seen a combination of fiscal contraction, initially a tight monetary contraction followed by a little loosening of monetary policy, and an exchange rate that has fallen in Dollar terms. This has resulted in Eurozone GDP growth of 1.6% in 2011. The UK occupies a middle stance, with a fiscal contraction, a monetary expansion, and an exchange rate that is competitive in both Dollar and Euro terms. Even so, the UK should manage GDP growth of about 0.9% for 2011. This variety of approaches to austerity gives us some initial readings to indicate the usefulness of the policy.

The argument against austerity is that it chokes growth. This has two unhelpful consequences. The first is that it makes the deficit worse than originally planned as the cost of social benefits rises and the tax take falls. These are the ‘automatic stabilisers’. The UK, Ireland and Spain appear to be suffering from this problem as the tax bases of these countries – which were heavily dependent upon a property boom – have melted away. The second consequence is more technical. As GDP falls and the deficit fails to keep pace, the Deficit-to-GDP ratio will rise, making more severe austerity needed in following years. It is likely that Greece has reached that position now. It would appear that Spain, which will miss it’s deficit reduction targets because of the automatic stabilisers, is likely to head into this position in 2012. From the perspective of the Eurozone, it is difficult to see from where any growth may come in 2012. Even Germany, the powerhouse of the Eurozone, could be heading towards a period of sluggish growth. This would suggest that austerity has choked growth in 2011.

And yet, is there an alternative? We are often told that a nation cannot borrow its way out of a recession. I’m afraid that we beg to differ. The US in 2011 has borrowed it way out of recession, and it would appear that the UK is about to do so for 2012. In a surprising change of direction, the UK chancellor announced late in 2011 that a programme of public infrastructure works would be initiated in 2012. This is exactly the type of fiscal expansion that we believe is needed in the UK, if not throughout Europe and North America. What is also interesting is that the UK works are to be part funded by the public sector, but the majority are to be funded by the idle balances within the UK financial sector. The policy of putting unproductive balances in the money economy to work on productive assets in the real economy has to be commended. We shall see if this has an impact in 2012 by the UK having an easier recession that the rest of our trading partners.

It is a shame that the US has abandoned the stance held in 2011 and appears to be embracing austerity for 2012 with both a fiscal contraction and a potential monetary contraction. The US seems plagued by populist politicians who don’t appear to understand the basic fundamentals of monetary policy. In a Presidential Election year, this simplistic approach is likely to just cause more problems for the American economy. If our model is right, and if the populists were to gain the upper hand, then the outlook for the US could be quite gloomy. However, we can all hope that common sense will prevail and that, even if there is a mild fiscal tightening, the Fed will continue the policy of monetary expansion.

To return to our original question, does austerity work? It does in that it helps to calm the financial markets and it gives the speculators a different target for their attention, such as gold. However, it also chokes growth and, by doing so, also reduces its long term effectiveness. Fortunately for those of us in the UK, austerity has been abandoned for 2012. If the US and the Eurozone embraces that agenda whilst the UK doesn’t, then we should continue to have quite a good recession.

© The European Futures Observatory 2012