By Alberto Riva
Global Finance sat down with economist Dean Baker, co-director and co-founder of the Center for Economic and Policy Research in Washington, DC, and author of several books, including The End of Loser Liberalism: Making Markets Progressive.
Photo Credit: LUCA VENTURA
Economist Dean Baker believes fiscal asceticism is not the answer to a financial crisis. Austerity policies in Europe aren’t working: Greece will leave the eurozone because of unsustainable budget mandates that are a condition for international aid, says Baker, and moderate growth will continue in the United States. Meantime, global consumption is changing as China recognizes the need to raise workers’ living standards to cultivate long-term growth.
The fiscal compact that eurozone countries approved in March is not addressing the root causes of Europe’s problems. “The right way to go is expansionary policy,” says Baker. “The real story is trade imbalance” between countries using the euro. A fixed currency for 17 nations with radically different inflation rates has made prices uncompetitive in higher-inflation countries, hurting their trade balances and leading to huge current-account deficits. And unlike the US, Europe does not have the option of internal transfers and easy population migration to compensate for imbalances in member countries.
Between 2002 and 2007, inflation averaged 1.6% in Germany versus 2.4% in Italy, he notes. “Over six years you’re looking at a 5% relative price difference, and you’re going to have a very serious problem,” says Baker. Imbalances were even more pronounced in other peripheral eurozone countries, with inflation as high as 3.4% in Greece over the same period. Add to that a confidence crisis boosting interest rates on government debt that in some cases, such as Italy’s, is about 100% of GDP, and you have “disastrous deficits for aging, relatively wealthy countries.”
But mandating austerity to fix budgets “has not been very successful to date and does not address the issue of competitiveness” and will drive Greece out of the eurozone, believes Baker. “I don’t see how they can stay in. There’s no light at the end of the tunnel, with IMF projections showing 10 years of high unemployment and zero growth, and it’s hard for me to believe serious people can look at these projections and think that’s actually going to be followed,” he says. “[Dropping out of the eurozone is] something being seriously discussed [in Greece] by people who are not on the fringe. I don’t know when [Greece will exit], but somewhere in the not-too-distant future.” The rest of the so-called PIIGS group (which comprises Portugal, Ireland, Italy, Greece and Spain) will muddle through the crisis, see a decade of weak growth but stay in the eurozone, says Baker.
A BETTER ANSWER
A better answer, according to Baker, would be the opposite of what the EU, ECB and International Monetary Fund are doing: Focus on growth and foster higher inflation in those markets where it has been low—to bring prices into balance. Two or three years of prices in Germany rising at 4% versus 1% to 2% in crisis countries could rebalance trade. The issue is whether Germans would accept it. It is unlikely—at least at present, according to Baker. “I talked to a former finance minister of Germany a couple weeks ago, and someone raised that issue at the table. He looked like someone had just spit up on him.”
Global economic growth will be found outside of Europe, especially in China, where the government will continue to boost internal consumption. “They want to go that way, the only question is when,” says Baker.
In the US, Baker does not see obstacles to moderate growth of 2.5% to 3% a year but does not expect it to go much higher. The housing collapse that started the American recession means that GDP will rise much slower than after the downturns of the early 1980s and mid-1970s. “Those were classic recessions brought about by the Fed raising interest rates to stop inflation. The way out was to lower interest rates.” But this time it’s different: “This was caused by the collapse of a bubble. There is no shortage of houses, so there will be no housing boom for years, and it’s not like we can just lower interest rates. We don’t have the fuel for a steep recovery.”