Fiscal and Growth Pact

Perhaps German Chancellor Angela Merkel and Francois Hollande, if the latter becomes the French President following the upcoming second round of French presidential elections, will each save face by settling for a combined Fiscal and Growth Pact. Mario Draghi the President of the European Central Bank, has already said last week that the Euro-zone region needed a Growth Pact. Fiscal austerity alone is seen by some as only deepening the jobs crisis in Europe and could even lead to another recession, since the deficit reduction efforts in many countries would not necessarily create conditions for private sector employment growth, if these countries were just simply crushing economic activity and making great cuts in productive public investment.
The Conservative-led Coalition government in Britain is facing a similar challenge with initial figures from the Office for National Statistics pointing to a small contraction in GDP for the last two quarters in succession, the economy of the country thereby being defined as technically again in recession. The downturn in the European markets which normally represent some 50-60% of British exports is one contributing factor to this slow growth in the economy. However, more importantly, growth in the domestic economy is being held back by weak lending to business which is not helped by evidence that Britain is going further than its international competitors in tightening regulations to ensure a stable and safe banking system. As a result, the UK has a banking system that is continuing to raise prices and shrink lending to conserve capital and meet stricter regulatory requirements. Add in the need for the 11% of GDP budget deficit to be tackled by raising taxes e.g. VAT from 17.5 to 20% in the face of an already heavily-indebted consumer, and cutting government spending, it is not so surprising that growth in the economy is so weak.
This again leads the opposition Labour party to claim that the government Plan A to cut the deficit and restore growth in the economy has failed, pointing out the example of the US economy which appears to be growing at some three times the rate of the UK, through a policy of borrow-and-spend while Europe has chosen austerity as the path out of recession. However, here the Americans have the advantage of the US Dollar as the major reserve currency**(see below) and can keep government borrowing costs low, with currently an in-built confidence in the financial markets and assurance to creditors that they will be paid, even if only in depreciated Dollars, that also most conveniently stimulate exports. Any such reduction in exports to Europe is again offset by the fact that the volume of US exports to e.g. Canada, Mexico and Asia is traditionally much greater than that to Europe, and the growth in these three markets is much faster. Any comparable move by the British government to push up borrowing-and-spending e.g. in line with the so-called Balanced Plan for Deficit Reduction of the Labour party, would be highly likely to be penalised by the rating agencies and financial markets. The value of the £ Sterling would fall, inflation would in turn increase, further squeezing household real incomes and weakening demand, as well as the reduced confidence in the future of the British economy being reflected in increased borrowing costs for a British government currently running a budget deficit greater than that of Spain.
There are, therefore, no easy solutions but an effective growth pact for the Euro-zone would be good news for Britain in terms of growth from exports, as would an increased credit flow to small businesses in Britain, together with larger businesses demonstrating their confidence in government policy and the future of the British economy, by starting to spend more of the capital they are currently conserving.

** World Foreign Exchange Reserve Holdings: US$ 62%; Euro 27%; £ Sterling 4%; Japanese Yen 3%; Other 4%

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