The problem of overheating: why the nineties were a warningApr 14th, 2011 | By Daniel Boomsma | Tags: economic crisis, GDP, inflationary bottleneck, nineties, Overheating
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.
- Call for Strategy Groups Participants: 10th till 12th of June 2013 in the House of Europe in The Hague
March 28th, 2013
- The state of the state in Europe
March 28th, 2011
- Why Social Democracy left Europe
February 21st, 2011
- Getting to Denmark
May 23rd, 2011
- The Centripetal Theory of Governance: A Borderless Union
November 5th, 2012