Fiscal policy? Let the zombies die
The international shift from an emphasis on monetary policy to a focus on fiscal policy is a dangerous diversion. Pumping money into the economy, whether through central banks or fiscal stimulus, cannot resolve the underlying weaknesses that have long plagued western economies. The best it can hope for is simply to store up the potential for even greater turmoil in the future.
Throwing money at a problem, once a derided act, seems to become the default reaction across the western world. Between the advent of the financial crisis in 2008 until today the emphasis has fallen largely on monetary policy. Ultra-loose interest rates and quantitative easing found widespread favour across the western world.
Now the central banks are said to be running out of ammunition. In other words ultra-loose monetary policy is losing its efficacy. Proposed solutions are therefore shifting to fiscal policy.
But this is simply chucking money through a different channel. In the short term it may keep the economy ticking over but it does not tackle its underlying weaknesses. This is not to say monetary policy should never be loose or to deny that more could be invested in infrastructure. It is rather that the fundamental weaknesses of the western economies are insufficiently appreciated. And without a proper diagnosis of the problems, it is not possible to devise the necessary solutions.
At root, the western economies are suffering from low investment and low productivity growth. The two are closely related. Without sufficient investment, it is impossible for economies to maintain their dynamism. Productivity – the fundamental measure of an economy’s strength – will start to stagnate.
These weaknesses are far more entrenched than is generally appreciated. They can be traced at least as far back as the early 1980s. Yet, for decades the favoured response by western authorities has been to pump cheap credit into the system. High public spending and loose monetary policy long pre-date the crisis of 2008-09.
This response misunderstands the nature of economic advance in market economies. It proceeds by what Joseph Schumpeter, one of the most eminent economists of the early twentieth century, referred to as creative destruction. That means older and weaker businesses go to the wall to be replaced by newer and more dynamic ones.
The problem is that western governments have put too much emphasis on shoring up weak firms – so-called zombie companies – and too little on promoting new enterprise. Western economies have become ever more stagnant as a result.
This is a highly conservative response in the most literal sense – focusing on conserving what exists rather than promoting a culture of innovation. Priorities need to shift fundamentally if the western economies are to break out of their lethargy.