ABSTRACT
Throughout recent decades economic development has been based on a range of unsustainable structures. Thus, many economies are characterised by volatile asset markets that are associated with volatile exchange rates, stock market and real estate markets bubbles, unstable prices of natural resources, and unsustainable credit expansion that was not only targeted at productive investment. Moreover, consumption demand deviated from its role as the core engine of stable and sustainable demand. In some cases consumption demand was unable to create sufficient economic growth, while in others it was financed by unsustainable private household indebtedness and wealth created by increasing asset prices. Germany and Japan are good examples of the first case. In the past decades both have been unable to create sufficient economic growth to prevent high and/or increasing unemployment. Both countries have stabilised demand by means of high exports, but have suffered from a lack of domestic demand. Without export surpluses their growth performance would have been even worse. However, it has also become clear that the mercantilist orientation of these countries that was successfully combined with high domestic demand in the past has broken apart. While consumption demand in the US and the UK was extensive, it was unsustainably financed. Albeit both countries achieved relatively high growth and employment creation, they experienced huge stock market bubbles and even greater real estate bubbles as well as large increases in household indebtedness. Countries like Ireland, Spain and other southern European countries also fit this scenario. Sometimes asset price bubbles went along with high credit expansion and high investment in the real sector. An example is the new economy bubble of the 1990s in most developed countries. However, to increase returns on equity, corporations increased their leverage to historically high levels. Sometimes asset price bubbles led to credit expansion without investment in the productive sector. Examples are from the frequent real estate bubbles after the 1970s. Last but not least, during the past decades unstable international capital flows built up huge international imbalances which frequently led to violent adjustments. The long list of currency and financial crises in developing countries shows this very clearly. Developed and developing countries furthermore suffered
from large exchange rate adjustments which turned the international financial system into a worldwide shock machine. The ballooning and subsequent shrinking of current account imbalances can be considered boom-bust cycles that express international bubbles caused by capital flows. Asset price bubbles and unsustainable credit expansion are always two sides of one coin. The bubble economies in the US, the UK, Spain, Greece, Ireland, the Baltic countries and others were able to realise relatively high growth despite frequent asset market shocks. However, in western countries a new bubble, which would lead again to a strong increase in investment and/or consumption demand, seems highly unlikely in the foreseeable future. What we have found in recent decades in the bubble countries is not an economic cycle which turns on the same level, but a cycle of bubbles turning on a higher level – a metaphorical cycle of asset price inflations following asset price deflations that changes its level upwards. A clear sign of this is the increase of credit quotas measured in percentage of GDP of almost all economic sectors in all countries. In the tradition of Hyman Minsky (1975, 1982) and Irving Fisher (1933) it can be argued that escalating leverages of all types of economic agents have created a fragile economic constellation. The historically high indebtedness of the enterprise sector, private households, governments and sometimes whole states makes it extremely unlikely that a new bubble with new credit expansion and a new growth phase will be triggered, at least not in an appreciable number of countries. And even if this were the case, the fragility of the economic system would be increased even further and a new crisis like the subprime crisis would be the outcome. Without fundamental institutional and structural changes (Ordnungspolitik) western economies will most likely fall into a medium-or even long-term phase of low growth or even stagnation. The most recent and best example of such a development is Japan, which fell into a long phase of stagnation after its stock market and real estate market had suffered an asset price deflation following the bubbles in the second half of the 1980s. There is the danger that a period of low growth in the US, Europe and other countries will lead to the Japanese deflationary constellation. Four scenarios seem to be possible in the medium term. First, as mentioned, new bubbles are theoretically possible. They could lead to a new phase of unsustainable credit expansion and relatively high GDP growth and after some time to a new financial crisis with again deep, negative effects on growth, employment and distribution. However, this scenario is not very likely as indebtedness of all economic sectors is already very high and new credit expansion difficult. And even if this first scenario were to materialise, it would eventually lead to the scenarios discussed below. The second scenario describes economies trapped in long-term stagnation. In this case GDP growth is low and unemployment rates are high. There is a lack of demand dynamics from earned wages or other income as well as from bubbles. Such a scenario is characterised by highly or increasingly unequal income distribution and a high or increasing population living from precarious work and living in unstable personal conditions in high relative poverty. The results are lost decades for societies. Such a scenario is not theoretical. The Latin American development
in the 1990s was characterised by the expression ‘lost decades’; both Japan and Germany in the 1990s and 2000s to a certain extent fit the scenario. We can easily imagine that long-term stagnation could even lead to substantially lower economic dynamics than in the past decades in Japan and Germany. Third, we cannot exclude that a scenario of low growth and long-term or ever-increasing unemployment problems combined with weak unions and deregulated labour markets could lead to nominal wage cuts and deflation. In the Japanese case deflationary developments started a period of more than half a decade of low GDP growth and high pressure in the labour market. Expansionary fiscal policy leading to a ratio of public debt to GDP of over 200 per cent in 2010 and current account surpluses in the background of an expanding world market prevented deflation from getting out of control in Japan. It does not look as if all countries after the subprime crisis are willing or able to follow a fiscal policy as in Japan, which was forced to accept high budget deficits for a long period of time. Hard deflationary policies have been forced upon Greece, Ireland and other countries after the outbreak of its sovereign debt crisis in 2010. These policies combine hard fiscal austerity programmes with nominal wage cuts in the public sector. The latter will most likely spill over to the private sector quickly. The therapy applied to these countries is similar to the public sector wage reductions of 1930-1932 implemented by German Chancellor Heinrich Brüning (with his emergency decrees) that paved the way for Nazism. Portugal, Spain and Italy are in the same constellation within the European Monetary Unions and may also follow a Brüning policy in upcoming years. Countries outside the currency union in Europe, such as Hungary and the Baltic countries, have applied similar policies too. It remains an open question as to how long countries like the US can follow medium-term oriented expansionary fiscal policies with escalating public debt. But even without public expenditure cuts and nominal wage cuts in the public sector, we cannot exclude deflationary developments. Unions and employers’ associations have become weak since the neoliberal era and the microeconomic logic for firms to survive as well as neoclassical thinking demand wage cuts. This third scenario is destabilising for the economy and unsustainable. It may lead to the last scenario. In our fourth scenario debt quotas of all economic sectors are high and may even increase further. Public debt to GDP increased substantially throughout recent decades in almost all western countries and as a result of the subprime crisis quickly increased further. Japan is only the tip of the iceberg. Imagine interest rates jumping to 10 per cent in Japan; given the 200 per cent public debt to GDP this would mean a frightening public interest rate burden of 20 per cent of GDP. Other economic sectors in some of the countries have extremely high indebtedness too. Examples are private households in the US and the UK or the enterprise sector in Japan and in the UK. High debt can lead to constellations in which ‘non-market’ policies become attractive for policy-makers. For example, budget deficits can be directly financed by the central bank, either because private agents do not give credit to the government or in case the public debt has curtailed the room for manoeuvre of public households. To a certain
extent the financing of public households by printing money is possible. However, excessive money creation to finance governments involves the danger of destroying the reputation of the currency. Capital flight may bring about higher import prices and can trigger nominal income increases which lead to a cumulative inflation and even hyperinflation. When public budgets are financed by money creation, inflationary developments as a result of capital flight in real assets like real estate or even durable goods are also possible. Yet, high public debt does not automatically lead to inflation – a good example for this is Japan from the 1990s to the 2000s – but it can lead to constellations in which governments see taking credit from the central bank as the only possibility to keep society functioning. In a critical situation this seems better than sacking policemen and closing hospitals or schools. A currency reform is a second instrument for reducing public debt and domestic debt in general. It means that the stock of domestic debt and monetary wealth is depreciated in comparison with flows like wages, rents or tax payments. A high inflation rate without central bank’s adjustments in the nominal interest rate and a currency reform destroy monetary wealth and thus the savings of private households. Both of these ‘non-market’ measures have deep distributional effects and can hardly be carried out without political destabilisation. The scenario described here is not a short-term one. But without deep reforms similar to those implemented by the New Deal in the 1930s, the likelihood of its occurrence is high.
