WARSAW — Episodes like the current financial crisis seriously disrupt economic growth. But the question that we should be asking concerns such episodes’ impact on longer-term development. And that question has attracted surprisingly little interest.
Traditional growth theories focus on systematic forces — for example, capital accumulation, employment and technical change — that, by definition, operate all the time, although with varying degrees of intensity. Some theories also consider underlying institutional factors like property rights, market competition, tax and regulatory burdens, and the level of the rule of law.
Another strand of research deals with crisis management, but without examining the impact on longer-term growth. In the case of a financial crisis, this usually includes fiscal and monetary easing, as well as rescue operations for larger financial institutions. The prevailing approach to crisis management has been short term and, as was amply demonstrated during this latest crisis, is based on what I call the self-justifying doctrine of intervention.
This doctrine holds that, just as one should never worry about pouring too much water on a fire, whatever crisis-management measures are adopted are justified, because the alternatives would have been worse and might well have provoked catastrophe and/or a meltdown of financial markets.
But the fire metaphor rules out such elementary questions as how to ensure that anti-crisis measures will not weaken the forces of market recovery, or how to measure such measures’ longer-term consequences.
The latter problem has only recently begun to surface in debates about “exit” strategies from sharply increased levels of public debt and money supply.
Integrating these different streams of analysis into a coherent approach to economic growth is a huge challenge to policymakers and academics alike. But a number of points strike me as relevant to the current situation.
• First, because financial crises as deep as the latest one are socially so costly, it is only natural to try to prevent them. But, just as with medicine, this demands an accurate diagnosis of a problem’s causes.
The proximate reason for all financial crises is excessive credit growth — a credit boom that goes bust. But the underlying reasons for the boom differ from crisis to crisis. In the present case, as a report last year prepared by a group led by a former IMF managing director emphasized that a major contributing factor was a serious failure of public policies.
For example, many central banks followed the Federal Reserve’s excessively loose monetary policy. Other factors included defective financial regulations, expansionary fiscal policies in countries like the United States, Britain and Ireland, a lack of appropriate macro-prudential regulations, and so on. Preventive measures should therefore focus on these policy failures rather than degenerating into hostility toward hedge funds and other private-equity devices.
• My second point is that there are several obvious economic channels through which booms that turn into busts affect growth. These include increased unemployment, the reduction of excessive debt burdens and therefore of credit-driven spending, the restructuring of sectors that had expanded in response to excessive spending, and the curtailment of lending by over-extended financial institutions.
There are no policies that could suspend the operation of all these linkages without damaging longer-term growth. Continued fiscal expansion is certainly not the answer, as it ultimately damages both private spending and business investment. But there are reforms that can facilitate economic adjustment, and thus ease social pain by countering the growth in long-term unemployment. These reforms include measures to remove labor-market rigidities while also accelerating the repair of banks’ balance sheets. The speed of economic recovery would largely reflect the extent to which these steps are taken.
• A third point, intended for all but those who still believe in a free lunch, is that the employment and growth implications of a country’s commitments in the area of climate-change policy need to be carefully analyzed. Multiplying the number of burdens on an economy is not the best policy to implement in the aftermath of a major crisis.
• Fourth, it is difficult to overestimate the importance of fiscal discipline to longer-term growth. It is all too easy to find examples of countries that subsequently suffered badly because of sustained fiscal expansion. By the same token, I cannot think of a single economy whose long-term growth prospects were damaged by excessive fiscal stinginess.
Given the fiscal legacy of the current crisis, no efforts should be spared in anchoring fiscal discipline firmly in European Union countries. Institutional measures such as fiscal frameworks and public-debt thresholds can do much to help.
Ultimately, it is public opinion that will determine governments’ fiscal stances, so fiscally conservative public opinion would be a great economic asset, as it would constrain policymakers’ profligacy.
• My last point is that crises, while unpleasant, are also widely thought to facilitate growth-enhancing reforms. This is not always the case, though, as the policy conclusions that are drawn from a crisis largely depend on what the public perceives as the cause of the crisis.
If public opinion blames earlier market reforms for the current crisis, the policy lessons may go off in the wrong direction. That was the case in Russia in 1998 and in Argentina in 2000: in both cases, public opinion largely blamed previous reforms for the crisis, even though both crises were caused by fiscal irresponsibility and insufficient reform.
This time, too, the key to overcoming the difficult legacy of the crisis will consist in how its origins are perceived. If public opinion attributes the crisis to policy errors or lack of reform, there is a chance that the right policy lessons will be learned, and that sound growth policies will result.
Leszek Balcerowicz is a former deputy prime minister and finance minister of Poland (1989-1991; 1997-2000) and a former president of the National Bank of Poland (2001-2007). © 2010 Project Syndicate