Column: Are we back to the past

Written by Meghnad Desai | Updated: Oct 28 2013, 08:51am hrs
With the centenary of the First World War approaching, there are peculiar things happening to the global economy which echo the past. For one thing, we are in the fifth year of recession, something which was not supposed to happen after the advent of Keynesian economics. Yet, no country has relented and reflated with an aggressive fiscal policy. Monetary policy which the Keynesians had written off (You cant push on a string as the cliche went) has been rampant in the US and the UK and Japan. Only the ECB has been prevented legally from an outright QE operation.

The surprise though is that everywhere in the developed economies, there are signs of revival. The US recovery has been around for a while though the Fed still does not feel confident enough that it can start tapering. It has fixed a single target figure for unemployment which it is waiting to be reached before tapering. Unemployment figures are notoriously countercyclical and tend to stay stubbornly up just as the economy is reviving due to workers previously out of the labour force coming back in and re-registering as seeking work. This is the opposite of the discouraged worker effect. The signal is thus somewhat like the thermostat in your shower and may lead you to delay action for too long and then overdo the reaction. This is why a single target number is the worst signal to give to the markets but let that be.

The surprise is that, thanks to its dysfunctional legislative system, there is an enforced budget cut happeningsequestration as it is called. Despite this slight fiscal tightening, the US economy is recovering with growth in the range of 2-3%. This is below the historical path of 1992-2007 but then that growth rate proved unsustainable without excessive borrowing. So, one would expect the US economy to converge to a growth path at a lower secular rate than before.

The UK economy seems to have finally turned the corner in the third quarter of 2013. The UK has adopted a tight fiscal path which aims to eliminate the budget deficit in five to seven years. This was an explicit anti-Keynesian strategy. The UK Chancellor of the Exchequer George Osborne was much criticised by the IMF and many Keynesians. There were dire predictions of a double-dip recession. Despite all that, the economy has turned around and is set to go one growing at 2-3% in the next two to three years. Here again, the trend path will be lower than before but the economy will be hugging that trend path.

The biggest surprise is the eurozone. Bill Gates buying into the Spanish economy is just the most recent sign of the long-awaited albeit still very fragile recovery of the eurozone. Spanish GDP growth is back, just, into non-negative territory though, and as yet can be counted only in basis points rather than percentages. The eurozone has averted a break up. There have been no exits as some of us predicted or even heartily wished for as in my case with Greece. Ireland has been off the bottom for a while now thanks to its flexible labour market. Spains problem was not fiscal but due to a bubble in the housing market. Now it seems there are takers for its bad debts coming in from around the world. Thus, if its bad debt problem is dealt with by profit takers then it may forge ahead. A similar story can be told about Italy where the political obstacles are being removed slowly to make room for reform. It will take time but the relentless pressure of bond markets has eased. Again there will be positive territory for GDP growth.

What seems to be happening is what used to be the conventional wisdom in the pre-Keynesian days. Hayek is the only person who is still read and whose theory reflects this attitude. An economy goes through booms and bust in the normal course of capitalist accumulation, to use a Marxian phrase. Its up and downs can be exaggerated by bad policies which try and fail to stabilise. But eventually decumulation and deleveraging takes place and the economy reaches a bottom from which it will rebound. As far as Hayek was concerned, when the economy was down, it was fatal error to try artificial stimulus. That would make things worse. But if every policymaker can bear to refrain from interfering, the recovery would come naturally.

Luckily for the eurozone and for the UK there has been little room for fiscal interference. That perhaps singly explains why the economy had the room to behave in its natural manner. Crises, as Marx would say, are ways in which a capitalist economy purges itself of all the bad stuff it has ingested. It is a purgative. When the effects of the purgative have been washed out, the economy is ready to recover. That is the good news.

The author is a prominent economist and Labour peer