The Elusive Quest for Recovery

The United States and Europe are still struggling to find the path of sustainable recovery. While many in the U.S. think they only should have spent more and would have needed a bigger stimulus, Europe tries to get back on track by taking austerity measures. The logic behind both policies to fight the slump and help the economy recover, however, is the same:

The system was right and as soon as we get back on track, we have fulfilled our task and can go on.

BUT: Something went wrong, terribly wrong. Getting back on track will lead to a next, maybe even bigger crisis. It seems that we have not learned our lesson yet. The prevailing opinion is that we need to fix some minor flaws of our current systems, e.g. more regulation and that's it.

Americans look critical on Germany's export-based economy. Germans, in the meanwhile, remain critical of America's fight of debt with even more debt and money. However, instead of criticizing Germany and China for their export-based economy, Americans should consider the shortcomings of their private- and public-debt driven economy. In contrast, Germans should question the soundness of its export based growth model, realizing that countries from the Eurozone finance their purchases of German goods with credit from Germany. In both cases, the system is very prone to sudden stops of credit to consumers. Not only may debt not be repaid, a huge part of the demand may also break away and balance-sheets recessions arise. Therefore, we all should question the soundness of the success-stories of our own economies. This requires to closely monitor credit growth and cash flows - domestically and across boarders. It is true that credit and money are the blood and water of our economies. The naive view that more credit and higher cash flows are always good, however, is outdated and false. Having sanguinely relied on virtuous cycles that more credit and higher cash flows create in good times, we have forgotten the dependencies they create and their destructive effects on the economy when virtuous cycles transform into vicious circles and sudden stops. Along with these comes a loss of trust which can be seen as the pace maker of our economies.

-> 1.

For these reasons, we not only need to closely monitor the finance industry and reform regulation, but we need also a vision of how we can make the finance industry serve the productive industry again. Since I (and perhaps many others) do not (yet) fully understand what investment bankers and finance people in general exactly do, we should be careful to see very strict regulation as silver bullet for all our problems. Correct prices are essential to avoid mis-allocation of resources and requires speculation to a certain extent. The marginal value of the derivative of the derivative on a certain event or the reasonableness of the insurance against events which do not affect us directly can be questioned and the intertwined connections between all these instruments should not be underestimated. Therefore, we need more macro-prudential oversight and more emergency brakes in the organization of our economies without becoming paralyzed by fear. After a correction of the relation between finance and the real economy, one can only hope that more smart people again decide to choose careers in productive firms, international organizations and governmental agencies.

-> 2.

Expanding education and teaching general analytical skills, which enable everyone of us to master the career we have chosen, is critical to reduce inequality. We should limit unsustainable redistribution via credit and simple money-transfers, which are illusional instruments to alleviate inequality. Over time, we should reduce those measures and instead increase our educational efforts.  In the long run, those efforts hopefully reconcile freedom, creativity and responsibility.

-> 3.

The two preceding "solutions" are generalized approaches for every society.

More precisely for Europe:

Europe has to establish the foundations of one currency area, comprising a higher mobility of workers, more flexible wages and prices, the completion of the Single Market including a Single Market for Services and a fiscal union. This, however, requires democratic justification, which is tremendously lacking at the European level. Mere austerity measure won't help Europe without having any promotion of growth. Industrial, energy and innovation policy at the European level may be first steps towards a perspective for European growth in the future.

-> 4.

Internationally, we also should consider closer cooperation. International coordination of monetary policy instead of every country choosing its own monetary regime and policy. We should consider taking asset prices into account for monetary policy in order to make credit-driven bubbles less likely. We should monitor cash flows and global imbalances and have a neutral organization alerting the world public if certain measure are out of line with historical values.

Finally, we should re-consider our expectations for growth. Prevailing expectations of approximately 2% GDP growth per year mean that our GDP would double every 35 years! Reducing our expectations to 1% per year still leads to a doubling of our GDP every 70 years. It also means that Azerbaijan (No. 100 in per capita GDP) per GDP capita would have to grow at 3% every year over the next 35 years if the absolute gap between the U.S. and Azerbaijan in terms of GDP per capita is supposed to remain constant.

These proposals may sound utopian. If they did not, they would be too realistic to make any difference. Nonetheless, I hope to have outlined a superficial direction of where we ought to go and what steps we should take first to choose this way.