European Student Think Tank

Infla­tion­ary bottleneck

The pre­dic­tion I men­tioned was based on a simple and quite logical the­ory: when an eco­nomy grows too fast, infla­tion spurs, and the chance of a so-called infla­tion­ary ‘bot­tle­neck’ increases. At this point an eco­nomy needs to slow down because not every com­pon­ent can keep up with the demand. Simply said, some parts of the eco­nomy are run­ning faster than oth­ers. Weapons to fight an infla­tion­ary bot­tle­neck are for example tax-raising (or the intro­duc­tion of new and higher bank fees) and spend­ing cuts. But why did nobody step on the brakes, even though it was a real­istic possibility?.

In the nineties most eco­nom­ies went through an excess­ive growth spurt. What’s more, the coun­tries that now face the biggest prob­lems, grew the most. Ireland’s GDP (Gross Domestic Product) grew almost 11%, Por­tugal and Spain ‘s about 4%. Italy (the coun­try with one of the highest pub­lic defi­cits of Europe) and Fin­land showed sim­ilar growth fig­ures. If you com­pare these stat­ist­ics with the cur­rent situ­ation, it can be argued that coun­tries like Ire­land, Italy, Por­tugal and Spain could have pre­dicted the prob­lems they have now. For example, Ire­land has a pub­lic debt of over 100% of its GDP and a budget defi­cit of more than 12%. Spain and Por­tugal, who did not grow as much as Ire­land back in the nineties but also faced the infla­tion­ary bot­tle­neck prob­lem, have pub­lic debts of about 90% of their GDP and a 7-9% budget defi­cit. Rel­at­ively healthy coun­tries in the nineties, like Ger­many and the Neth­er­lands, now mostly stay out of trouble. 

What gov­ern­ments should have done

I already men­tioned tax raise and spend­ing cuts but espe­cially the last one is inter­est­ing. Rais­ing taxes is hard enough, but tight­en­ing your budgets may be even harder. People often strongly oppose dir­ect cuts on their wel­fare. When for example edu­ca­tion and health care suf­fer from the eco­nomic situ­ation, protests are likely to fol­low. In the nineties gov­ern­ments assumed that they made the logical decisions: money is there to spend. In some cases they were right, but for example the Irish and Span­ish gov­ern­ment made wrong decisions when they planned to raise spend­ing by 6% and cut their income tax in 1997. But it is the duty of a gov­ern­ment to look for altern­at­ives, whether they‘re logical at the moment or not.

The role of the market

The increas­ing role of the inter­na­tional mar­ket caused a decline of the role of states. Simply said, gov­ern­ments had less to gov­ern and what was left was hard(er) to con­trol. As I poin­ted out in my last blog (The state of the state in Europe ), glob­al­isa­tion had a major impact on European states and gov­ern­ments: “in the nineties it wasn’t the ques­tion whether glob­al­isa­tion would influ­ence the world [and the European Union], but when and how fast.” The com­bin­a­tion of glob­al­isa­tion and over­heat­ing gave ‘the mar­ket’ a strong argu­ment for more lib­er­al­isa­tion: ‘Give us space and we sort it out’ seemed to be the motto. In reac­tion to the eco­nomic prosper­ity (and the call to fight the over­heat­ing), gov­ern­ments lib­er­al­ised their eco­nom­ies. But mainly, the gov­ern­ment just listened to banks and mul­tina­tion­als who asked for more flex­ib­il­ity. In fact, the lib­er­al­isa­tion in the nineties almost robbed the gov­ern­ments of their instru­ments to fight the eco­nomic crisis we now face. It’s  a bit para­dox­ical: the state made itself less import­ant while the pro­cess of over­heat­ing could only be stopped by a strong state. 

Les­sons to be learned

Since the eco­nomic crisis mem­ber states of the European Union have changed their policies. Pub­lic debts are still high, unem­ploy­ment rates haven’t dropped and most coun­tries have a large budget defi­cit, so much has to be done. But I’m sure that most mem­ber states have learned from the past. The nineties were a warn­ing. The excess­ive growth and the (some­times) irre­spons­ible meas­ures taken by most states in a period of over­all eco­nomic growth, must not be for­got­ten. Over­heat­ing proved to be as much of  a prob­lem as a decreas­ing eco­nomy. So when money is pour­ing in, think twice before you spend it.

Related posts:

1. Call for Strategy Groups Par­ti­cipants: 10th till 12th of June 2013 in the House of Europe in The Hague
   March 28th, 2013
2. The state of the state in Europe
   March 28th, 2011
3. Why Social Demo­cracy left Europe
   Feb­ru­ary 21st, 2011
4. Get­ting to Den­mark
   May 23rd, 2011
5. The Cent­ri­petal The­ory of Gov­ernance: A Bor­der­less Union
   Novem­ber 5th, 2012