Keynote Lecture Juergen B. Donges

Summary:

On 15 December 2020, the Rafael del Pino Foundation organised a conference entitled "The market economy, in crisis post Covid-19? Donges, Professor Emeritus of Economics at the University of Cologne.

According to Professor Donges, we have a problem of disaffection with the market economy. It has a number of pillars: individual initiative, free enterprise, private property rights, freedom of contract, free movement of people and capital, and competition in national and international markets.

Monetary activism has rooted the belief in the state pope. It is surprising that citizens accept that governments restrict their rights with little parliamentary oversight, as well as heavy meddling in the economy. We are facing a situation where citizens are willing to pay a not inconsiderable price for control of the pandemic.

This situation is not new. Whenever we have had serious economic problems, disaffection with the market economy has increased, as in the Great Depression, the two oil crises and the Great Recession.

The ills that afflict society in the form of unemployment, poverty, evictions, inequality, environmental damage. All these are attributed to the system of economic freedoms. These problems existed before the pandemic and constitute a permanent challenge for governments, to which some governments respond better than others. From certain intellectual, trade union and political circles, anti-market-economy messages are being voiced in an attempt to relegate the market economy. Even Pope Francis articulates his scepticism towards the market economy, without taking into account how Peronism has impoverished the Argentine economy.

One of the arguments is that the pandemic exonerates those responsible for the previous problems and that external assistance, through European funds, is needed to overcome those problems. Governments are not to blame for the pandemic's massive onslaught, but it is no coincidence that the consequences are more pronounced in some countries than in others. The hardest hit countries have already had structural weaknesses in their economies, such as low productivity, persistently high unemployment rates, inadequate education systems, excessive structural public spending, inefficient administration, weak institutions and a stagnant productive fabric. National governments are responsible for these structural weaknesses, as they have failed to implement the necessary economic policies. The pandemic has made this clear.

Italy is the most striking example, but Spain is not spared from this diagnosis. The ECB has pointed this out without the governments concerned taking any notice. Nor in Spain, where the government's agenda contemplates the repeal of the labour reform despite the good results it has produced in terms of job creation.

Structural defects will not be dissipated with national or European money. Public support to meet short-term business needs can cushion the impact of Covid, but for recovery to be sustainable over time, all the ingredients of the market economy that drive the flexibility of businesses and households to adapt to changing circumstances, including the digital and energy transition, are needed.

The state is not the most appropriate actor to make the economy efficient. Quite the contrary. No official has the ability to predict future economic trends. Central planning systems are illustrative of the tremendous collective failure of these postulates in terms of low economic growth, high unemployment and miserable living standards, as well as the systematic violation of human rights. In highly specialised areas, such as the arms or space industries, they may achieve spectacular successes, but citizens do not demand nuclear weapons or artificial satellites.

China escapes this diagnosis because of the change after Mao's death. Its spectacular development in recent decades highlights all that can be achieved with a little economic freedom.

With the de-escalation, recovery began slightly, with the market economy as the framework for revival. For the coming year, international organisations are forecasting different speeds across countries and sectors. Global growth could be around 5% and world trade could return modestly to the path of expansion as value chains begin to recompose themselves. China would lead the way, with growth above the global average. It should soon return to pre-pandemic levels of activity.

China would be followed by the United States, Germany and France. In these countries, the epidemic is not improving as much as would be desirable, so the recovery would be slower than the previous contraction and would take longer to compensate for the losses in production in the first half of 2020. At the back of the pack would be the countries with the greatest weight in the tertiary sector, in particular tourism, which is where the measures to prevent contagion have the greatest impact.

For Spain, 6% and 7% of GDP growth is forecast. This sounds like a lot, but the base is a historically low level of output and would not return to previous GDP levels until 2023. The recovery would show a K-type profile, with sectors such as manufacturing and digitised activities advancing at a moderate pace, and other activities, such as tourism, lagging behind. These projections include the impact of European funds. The assumption is that these funds will arrive on time and that they will be allocated to future-proof, solid, GDP- and employment-generating investment projects, which is not guaranteed. If the government does not credibly present these projects, it should not receive this aid because it would fall on deaf ears. The funds would be used to plug budget holes and finance social policies without any effect on competitiveness and potential growth in the medium term.

Major central banks will maintain their extremely accommodative course. National governments will continue to use their fiscal tools to stimulate demand. In the United States, these measures are more far-reaching. Spain is sending disconcerting messages to the markets, such as the implementation of tax increases in 2021 for large companies and high incomes, as well as raising some indirect taxes, introducing the Google tax and the Tobin tax, without taking into account the deterrent effect of these measures on business investment, and with little tax collection impact.

Things could go from bad to worse in all countries if the current second wave persists and there is a contagion that forces a tightening of restrictions on activity. This would happen if the availability of effective Covid-19 vaccines is delayed too long. If that happens, confidence would fall, the recovery would not take hold and it would take years to return to pre-pandemic levels of activity, at least until 2026. The recovery would then take the form of a W or an L.

Whether or not the forecasts will be fulfilled will largely depend on the proper functioning of the market economy, for which three things are essential: globalisation of economic activity, specialisation in the production of goods and services in accordance with the comparative advantages of each country and business sector, and efficient value chains, spread multilaterally and not only with China as the epicentre, as has been the case until now. In other words, there is an urgent need for a high degree of openness of economies along with free trade and free movement of capital and people. This has two implications: tariff and non-tariff protectionism must be contained. With Biden things may possibly change, but only possibly, because Biden is not a convinced anti-protectionist, but represents the Democratic Party, which tends to intervene in the economy, to protectionism.

The second implication concerns the transit of people. Border health controls will need to be strengthened. The question is how to do this. It should be done in a transparent way, coordinated between countries and in clear terms for economic operators in order to avoid distortions.

As supply shocks created shortages of sensitive products, a new idea is now gaining ground: the need to regain national control over global value chains and thereby reduce excessive dependence on China and other countries. This idea is championed by the French government together with the German government. These two governments enact the goal of repatriating sectors considered strategic, including healthcare, whose activities have been outsourced to countries with lower labour costs. They also intend to legislate global value chains, demanding that decent working conditions be respected in those countries. This is cynical because developing economies have no reason to share positions on how to regulate labour markets.

The distrust of many politicians, especially populist politicians, towards market forces prevents them from appreciating the negative consequences, such as the flattening of the learning curve, which keeps the costs of production and technological innovation high. This also discriminates against emerging and developing countries that want to integrate. Their exclusion from value chains means that they will receive less investment, less technology.

In the market economy there are no such contradictions. Companies decide on the international production model they consider profitable. They may consider it desirable to change the structure of the value chain and reduce dependence on foreign suppliers. The important thing is not to spoil the large beneficial effects generated by the international division of labour.

A currently highly contentious issue is whether strong and sustained growth trajectories over time would require an expansion of borrowing. The issue is not that the pandemic is taking its toll on public accounts, pushing deficits and debt to historic levels. The expectation is that the recovery will help generate the primary surplus that will reduce debt levels. This is not the problem. We are not talking about current public deficits.

The underlying issue of concern is the possibility that the market economy will suffer from secularly excessive capital accumulation because, with rising living standards and ageing populations, people tend to increase savings, while the demand for capital remains constant and increases at the pace of technological developments. In addition, there is an increase in involuntary savings, and also a sharp rise in household precautionary savings in the face of an exceptional situation of occupational risk. This widens the gap between supply and demand for capital. To close it, the argument goes, would require a permanent increase in public debt that would increase the demand for capital and reduce consumption. Moreover, according to these analysts, the constitutional rule limiting the use of the structural deficit would have to be eliminated. This is the scenario we are now in, which is giving socialists and trade unionists a hard time.

This message, however, is not logical if we look at it from the point of view of economic efficiency, because the implications of such a policy in reality have to be assessed. There are three fundamental factors. One, there is no effective mechanism to channel public debt into efficient investment. Two, there is no guarantee that the real interest rate will remain below the growth rate of the economy, irrespective of monetary policy. This would have to happen permanently so that the increased public borrowing is sustainable over time and the state is not subjected to speculative attacks. It is normal for the interest rate to be higher than the growth rate. Three, the ageing of the population, which will lead to the long-term de-saving of households.

In this situation, it is appropriate to prioritise the principle of medium- and long-term fiscal stability, because it encourages foreign investors to buy sovereign debt and protects future generations from inheriting public debt mortgages that reduce the government's fiscal space to implement counter-cyclical policies and force tax increases.

What economic actors need now is certainty for the future. They cannot get it in terms of the evolution of the pandemic because it all depends on when there will be an effective vaccine. But they can get it from economic policy. The right model is the market economy, and no other, not one with a greater state presence, which helps no one, least of all those seeking employment. Without entrepreneurial freedom in a framework of competition, we would not be witnessing the research race with which pharmaceutical companies around the world are searching for effective vaccines against the coronavirus. This takes place in a market economy.

The Rafael del Pino Foundation is not responsible for the comments, opinions or statements made by the people who participate in its activities and which are expressed as a result of their inalienable right to freedom of expression and under their sole responsibility. The contents included in the summary of this conference, written for the Rafael del Pino Foundation by Professor Emilio González, are the result of the debates held at the meeting held for this purpose at the Foundation and are the responsibility of the authors.

The Rafael del Pino Foundation is not responsible for any comments, opinions or statements made by third parties. In this respect, the FRP is not obliged to monitor the views expressed by such third parties who participate in its activities and which are expressed as a result of their inalienable right to freedom of expression and under their own responsibility. The contents included in the summary of this conference, written for the Rafael del Pino Foundation by Professor Emilio J. González, are the result of the discussions that took place during the conference organised for this purpose at the Foundation and are the sole responsibility of its authors.

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