Mr Richard Koo, the chef economist at Nomura Research institute, in his latest publication has made an argument that in responding to current financial crisis, and by discovering that macroeconomic policies do not give a desired effect, the countries should go for a fiscal stimulus in order to maintain growth. He supports his argument by saying that in period of financial crisis the businesses tend to minimise debt and clean their balance sheets instead of taking a risk for profits and growth. And if nobody wants to borrow, then the state should become a borrower of last resort to keep economy working.
By giving this explanation the author referred to an enigma of the Baltic economies (he based his argument on Lithuania) with leading current and forecasted growth rates in the EU (see European Commission’s autumn EU economic forecast). As Mr Koo noted, the policies in Baltics were based not on a fiscal stimulus, but rather on a fiscal consolidation, so this required a separate explanation on how can austerity coexist with growth.
According to Mr Koo there were basically three assumptions behind this phenomenon. First, by vanishing the housing bubbles produced a rather moderate one time-shock effect in the Baltic States, caused by a relatively low share of population with mortgages (e.g. only 9% in Lithuania). Secondly, the Baltic economies have preserved an export led growth due to their competitiveness with low labour costs. And thirdly, the generous EU structural funds served as a cushion to global shocks.
This analysis deserves few observations. First of all, the contraction of GDP in 2009 in three Baltic States was indeed painful and among the highest due to the openness and reliance on export markets by Baltic economies. On the other hand this situation made it possible to restructure and improve competitiveness at the same time delivering necessary structural policy changes.
As to the mortgages, I would argue that a low share of financing by mortgages has only partially mitigated a bubble effect. We can note, that in some EU Member states a share of mortgages was similar to those in the Baltics remaining at low levels (e.g. 15.4% in Italy), however economic realities in these countries were different. In addition, a tighter supervision of bank policies on loans is also as important or even more relevant to this case.
And finally lets come back to stimulus. The EU financial assistance in the range of 3% of GDP ceiling could be also called ‘a stimulus’. However, one can also acknowledge real numbers explaining debt dynamics. With a start of financial crisis a general government gross debt of EU 27 member states has increased by 20% of GDP over a period of 2009-2011. Even in Germany it has jumped by nearly 14 % of GDP. By some this can be interpreted as de facto stimulus all over the Europe, by others, contrary, as an evidence of not being sufficiently prepared to economic adjustment with a price paid.
In this case it would be appropriate to conclude that in 2009-2010 a stimulus was a part of mainstream policies (we do remember a European recovery plan) and in effect this explains that a consolidation up until today remains a necessity to ensure effective spending targeted to growth and at improving competitiveness. Furthermore, this cannot be done without structural policy changes, especially in areas of labour code or cutting red tape. There I can agree with Mr Koo that maintaining a competitive edge is essential in this debate.