Emerging Markets: What needs to happen before we see a sustained recovery from the present global economic malaise?
Larry Summers: The dominant reason for economic weakness is lack of demand. The dominant reason for lack of demand is the consequences of deleveraging associated with the major loss of confidence that has taken place. It’s the central irony of financial crises that while it’s caused by too much overconfidence, too much borrowing and lending and too much spending, it is only resolved through more confidence, more borrowing and lending and more spending. The appropriate emphasis today in almost every part of the world has to be on the promotion of growth. It’s inevitable given the magnitude of the shocks that have been experienced that the resumption of growth will be slow, but the speed at which reasonable recovery is attained will depend upon the extent to which the problem is recognized as a deleveraging demand problem and addressed in those terms.
EM: Do you believe there’s anything approaching such a recognition today amongst policymakers?
LS: I think we are well short of the necessary recognition. Austerity in some circumstances may be necessary to avert catastrophe. It is never a growth strategy. There have been times when fiscal consolidation can be a growth strategy, those have been times when interest rates have been very high and fiscal consolidation has permitted them to come down dramatically. At a moment like the present when interest rates are already very close to zero, there is never scope for austerity to be a growth strategy. The risk we face is of a lost decade of potential economic growth in large parts of the world. The experience in Japan which today has a GDP one third to one half below the level that most would have expected in the 1990s is cautionary as the consequences of allowing cyclical problems to harden into structural problems.
EM: How probable is potential break-up of the single currency area, especially given the primary focus on austerity in Europe?
LS: I think it’s become increasingly clear that there is overwhelming political will in Europe, including in Germany to maintain the single currency and to avoid what would really be the quite extraordinary risks associated with even the partial dissolution of the monetary union. There are, though, two substantial risks. The first is of excessive risk-taking as countries seek to pursue monetary policies and they overplay their hand. Once the bank runs start it’s impossible to put the situation back together again. The other substantial risk is that the political desires strain the system past the breaking point. That remains an important area of uncertainty.
EM: How worried should we be about the prospect of the so- called fiscal cliff in the US?
LS: The last thing the world needs right now is a major contractionary impulse from the United States. We have to desperately hope that we don’t get one. My judgment is that when all that is required is that a can be kicked, that even a lame duck session of Congress will be able to do that. But there are certainly no guarantees.
EM: Even if Washington reaches an agreement, how vulnerable is the US nevertheless to fiscal turmoil next year?
LS: Ultimately the United States finances are not on a sustainable basis. We need to find a combination of growth promotion then fiscal adjustment that remedies those imbalances. If we don’t do that those who warn that there will eventually be consequences in bond markets are absolutely correct.
EM: What should be the top economic priority for the next US administration?
LS: The restoration of growth and the re-attainment of the economy’s potential. The economy has been growing for some time. We have moved, we are no longer in a great recession, we are on the brink of a great stagnation if we are not able to enhance confidence and grow the economy more rapidly.
EM: Do you think there is any more support now on Capital Hill for tackling debt in a constructive manner?
LS: I think it’s very difficult to know what the context will be after the election as we see subsequent movement, as we see what happens to the economy. In my experience the transition from inconceivable to inevitable can sometimes be surprisingly rapid in Washington.
EM: What would a recovery actually mean? Could we feasibly expect to see pre-crisis levels of growth?
LS: I don’t expect it to happen in 2013 but it is not unreasonable to aspire to seeing growth rates of 5% or more for the world economy again. Just as there can be vicious cycles, there can be virtuous circles as well in which confidence promotes investment promotes growth promotes confidence promotes investment. So the very same mechanisms of cumulative causation which were engaged to produce this downturn and its aftermath can be engaged to produce an upturn as well. I think there’s no question that the medium term prospects are more challenging than in the past but in my experience it is often darkest before the dawn. There are growth drivers being lost but there are also growth drivers being found.
Larry Summers is president emeritus of Harvard University and former chairman of the National Economic Council. Interview by Taimur Ahmad