Eurozone Crisis

Lord Desai Excerpts

Thursday 1st December 2011 Grand Committee

[Lord Desai]

My Lords, first I thank the noble Lord, Lord Lamont, for giving us this opportunity. I shall also heed what my noble friend Lord Monks said: this is not just an economic crisis, but a crisis of economics. I guess, as the first paid-up academic economist to speak in this debate, I had better take that seriously.

I want to talk simultaneously about the UK economy and the European zone, but I also want to include the USA. I see this as a crisis of the developed economies. I see this as an historic moment when the tectonic plates are shifting, and we are now landed with a geriatric capitalism. The young and dynamic capitalism has moved eastwards and southwards—indeed anywhere but to the old, developed economies.

It is not just that the eurozone is in crisis—and it not just an exchange rate crisis, it is a sovereign debt crisis. The United States is in a crisis of debt and deficit, and so are we. The question we have to ask is this: why is no one practising good old-fashioned Keynesian economics? We told the world for many years that we had the answer and that this would never happen again. Perfectly sane people—I presume they are sane—across many countries are finding that they are restricted by debt and they have to tackle deficits, but they cannot use the fiscal spending instrument that they thought they could always use. One answer is that we are all cowards, but I shall resist that.

There are a couple of things that are worth saying. A long-running cycle started in the 1970s, at which stage manufacturing began to leave the developed economies and migrate eastwards. That came about partly as the result of globalisation and partly through a profitability crisis in western countries. Our labour costs were too high and capital went in search of cheaper labour elsewhere. This happened not just in the UK, but by and large a group of developed countries had the same experience. There are one or two exceptions, but I will stick to this argument. We tried to find substitutes in the services sector, both in public services and in financial services. At the end of 40 years, we have finally come to the crunch. They are no longer a viable solution to our problems.

In the mean time, especially during the long boom from 1992 to 2007, probably the longest boom in the history of capitalism, we compensated for our lack of wealth-creating capacity by finding debt instruments. Both households and Governments were in debt before the recession hit. It is important to remember that both Germany and France broke the growth and stability pact not while there was unemployment but when there was full employment. Our debts started to go up while we still had full employment, as did our household debt. When we entered this recession, unlike any previous recession, we were already in a highly indebted position for both households and Governments. It is this which makes the application of the Keynesian solution somewhat difficult. First, there are large leakages due to imports since we do not make very many things. If you do spend money, there is bound to be import leakage. But it is also the fact that households, especially in the latest crash, feel compelled to deleverage because they have acquired debt and they now feel that they have to get out of it.

There is money in the private non-financial corporations. They are sitting on large surpluses. The puzzle is this: why is it that when interest rates are at historically low levels, private non-financial corporations are not investing? One obvious answer is that there is no demand. But if investment has to be for the long run, surely no one believes that demand is going to stay low for ever. There is an obstacle to private investment spending in the economy, and that is one of the things we need to tackle.

I shall now read out a headline from yesterday’s Financial Times. It states:

“Europe squeeze makes Osborne look soft”—

we are all in this together; all countries are tackling it. In the UK, it was quite clear before the election in 2010 that the problem of our debt levels had somehow to be tackled. There was almost an all-party consensus; the difference was on at what rate we should try to eliminate the deficit. My party took the view that within the Parliament we would eliminate half the deficit, and of course the coalition Government took the view that all the deficit should be eliminated. Now, if we are to believe the OBR, it will not be possible to do it within a single Parliament and will take longer. I reserve my judgment on that; it may be much too pessimistic a view but, for the time being, let us leave it.

Could something else have been done? That is the real question. Could a slower cutting of deficit have led to less of a drop in demand and employment? If so, would we still be suffering from the extra shock of the eurozone crisis—the inflation and all that has derailed the Osborne policy? There are two problems, and I am sure that the noble Lord, Lord Skidelsky, will speak on them. First, I am sceptical that the half-deficit elimination strategy could have been sustainable, especially when markets all around were going hysterical about sovereign debt. That is a matter of judgment and people will disagree. Secondly, even if it was possible to do it, the eurozone crisis and the inflation shock caused by the quantitative easing policy of the Federal Reserve and the Bank of England would have been there anyway.

The room we have for manoeuvre is quite limited. I only have half a minute. We need to develop a very different economy in which households restore the habit of saving and Governments restore the habit of balanced budgets. If we can do that—perhaps not by 2015 but in another decade or so—we might be able to restore western economies to a healthy state.