Bernanke versus Summers and the Irish ‘Recovery’

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mb3There is widely followed debate between Ben Bernanke and Larry Summers which has important implications for the Irish economy and its trajectory.

Summers, who holds innumerable titles is a Harvard Professor and formerly chief economist at the World Bank, initiated the debate with the view that the advanced industrialised economies were experiencing ‘secular stagnation’ (pdf). Bernanke, who is ex-chair of the Board of the US Federal Reserve Bank, accepts that the industrialised economies have been experiencing weak growth but argues that that this was because of very different and easily remedial problems.

They are both wrong. Those who are interested in their detailed arguments, and the responses and counters, should read their many articles and papers in full. But the debate does shed light on some key problems, and the shortcomings of mainstream answers. Here the particular relevance is to the Irish economy.i

In dismissing the idea of ‘secular stagnation’ (that is, a long-term economic malaise which is distinct from the recent slump and its aftermath) Bernanke argues that it is the imbalances of savings and investment between countries that are the key problems. In a generic sense this would place Ireland in the dock, since the CSO reports a current account surplus in 2014 of €11.4bn, roughly 6% of GDP. Ireland escapes Bernanke’s censure, unlike China, because the scale of the Irish surplus is trivial in a global context.

But this highlights a wider point. The Irish current account surplus barely represents the activities of anyone based in Ireland at all. It is due to the activities of multinational corporations, many of them US-based, who park profits and other activity in Ireland to avail of ultra-low corporate taxes. Any national accounts are the sum of the different sectors, or classes, operating within it.

Risk and reward

Summers’ analysis has the merit of not treating the world as an economic version of the board game Risk. He relates ‘secular stagnation’ to the declining rate of productive investment (plant & machinery, factories, software, vehicles and so on, not housing) by companies operating in the industrialised economies.  He also argues austerity is counter-productive, as it reduces their incentives to invest.

But Summers uses the economic jargon the ‘declining natural rate of interest’ to describe the decline of investment. This is in effect a decline in profitable investment or the requirement for investment to achieve profitability (citing companies such as Google and Apple who are hoarding vast sums of cash or WhatsApp which required little productive investment before becoming a stock market darling).

Yet WhatsApp made only losses, not profits before it was bought by Facebook for $22billion. Summers confuses stock market or financial speculation returns with profits. It is also the case that both Apple and Google do invest in new products, and require increasing productive capacity to do so. It is simply that the growth in their profits exceeds the growth in their investment, so that the cash hoard continues to grow. In effect, this is a drain on the economy as profits are realised but this capital is withdrawn from productive use.

How does any of this affect Ireland (apart from many of these companies being based here, for accounting purposes or otherwise)?  This is shown in Fig.1 below, the total financial balances of two key sectors of the economy, companies (Non-Financial Corporations, NFCs) and government.

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Fig.1 Saving/Borrowing of the Government and Non-Financial Corporations, €mn

 

It was the sharp rise in the savings of the NFCs which provided the backdrop for the economic crisis and the sharp deterioration in government finances. Between 1999 and 2006 the savings of the NFCs rose by €15.3bn. Government finances were only able to appear sound because of the unsustainable housing boom. When households also increased their savings in 2007 the crash and the rise in the government deficit were unavoidable.

Fig. 2 shows the levels of NFCs gross savings as well as their level of productive investment (Gross Fixed Capital Formation).  In 1999 the level of company investment was €10.9bn and their level of gross savings was €8bn. In the course of the Great Recession both savings and investment fell. But it is the former which have been rebuilt at the expense of the latter. In 2013 savings were €25.5bn and investment was just €17.5bn and has been in a downtrend since the crisis. (CSO reports that the level of NFCs saving has since risen to €28.4bn in 2014). Companies in Ireland are saving more and investing less.

 

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Fig.2 Gross Savings & GFCF, €mn

 

This saving by the company sector is a refusal to invest profits that are accumulating. The policy of austerity is an attempt to force household savings lower, representing a transfer of incomes from households to companies. In the process, because taxation is weighted much more to workers’ incomes and their consumption rather than company profits, the hope is that government finances will improve as a by-product.

In their debate, Bernanke pointed out that Summers’ phrase ‘secular stagnation’ was coined by Alvin Hansen in 1938, one of the leading US economists of the time and suggests that Hansen was “proved quite wrong, of course, failing to anticipate the post-war economic boom”.

Bernanke’s reputation as an economic historian is not enhanced by repetition of this commonplace fallacy. The boom in the US economy took place during the war, with GDP effectively doubling in 5 years. The post-war period was relatively feeble by comparison, requiring a further 22 years to double again in size.

This is important for current policy. It was not the private sector which led the recovery from 1930s ‘secular stagnation’ or the so-called post-war boom. It was government investment -for the war effort. This required more than the fiscal stimulus which Summers advocates. It required a massive increase in government investment, pushing aside the private sector which remained unwilling to invest.

This is possible because government achieves returns on the same investments that are simply not available to the private sector in the form of increased tax revenues and lower social security outlays from rising economic activity. The secular stagnation of the Western economies will continue without increased government investment.

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