Economic Policy Review ISSN 1313 - 0544

The “recovery” plan of the European Commission

Author: Dimitar Chobanov / 11.12.2008
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The European commission (EC) announced recently a plan for economic recovery, which aims are to stimulate consumer demand, to reduce the effects on the workers from the economic crisis, to improve competitiveness of the European economy in the future and to direct it towards greener production. This must happen by spending €200 billion, which should be gathered through payments from the budgets of the separate states (€170 billion) and the common budget (€30 billion).

The idea of the EC for "recovery" represents a typical example of undertaking actions which not only are not going to achieve their short term objectives, but would do harm in the long term. They are dependant on the old ideas for stimulating the economy by increased government spending, which is ineffective under the conditions of economic crisis. At present we have a situation where we observe low or negative growth of production combined with inflation. The reaction of EC is to stimulate mainly the demand and to attempt to "cure" the symptoms of the crisis, but not to change the factors which led to its arising.

One of the measures used is the large scale injection of purchasing power into the economy in order to increase demand; the second is to stimulate investments. "Injecting" purchasing power however, does not represent the increase of production of goods and services, but increasing the liquidity in the economy - in other words increasing the currency mass by printing additional money. Actually this is one of the main factors which are the reason for arising of the crisis on the World markets. Economic growth is based on the real savings, which are the result from greater production than consumption.  From that follows Say's law - supply is creating demand, since if there is no artificial credit, only the people who produce goods and services could demand other goods and services. In other words there could be no demand without supply. When however exist uncovered money, when the central banks have a monopoly over the creation of the money base, they could practically produce money from nothing, in other words to increase the money supply in such a way that it exceeds the demand for money, generated by the transactions within the economy. Under such conditions the people attempt to compensate their unnecessary liquidity through increased demand for goods and services, which however is not combined with increased supply. The result is increased prices and redistribution of incomes within the economy, while in the long term - sending the wrong signals to the producers, which leads to over investment in certain sectors, diverting resources from the normal preferences of the people towards other sectors of the economy, strengthening of the financial sector (which is at the beginning of the chain of a new money emission and respectfully is using that to redistribute income in the remaining sectors). It all means a policy of lower interest rates by the central bank - in other words discouraging the real savings at the expense of consumption.  Lower real savings however mean reduced potential for future production. At the same time at a certain moment in time due to the inflationary pressure the central banks are forced to raise the interest rates. At that time it becomes clear that there is a lasting disparity between savings and investments and the artificially stimulated demand must stop. At the end of the day this leads to the situation with low or negative growth and inflation.

Thus creating additional liquidity means that the authorities in the EC at attempting to cure the economy by injecting additional viruses. Actually the real savings must be encouraged, i.e. production of goods and services. This however would not happen with the aid of such plan. Taking funds from the working sectors and subsidizing the not working ones is not a solution in this case. This applies also about taking income from the more productive people and redistributing it to the less qualified. These measures would further impede the efforts to get out of the crisis, since they are not stimulating the people and companies, which generate growth.

Something more, most of the proposals are connected to introducing serious discrepancies - reduction of VAT only for some sectors, guarantees and subsidies of credits, which would help only the financial sector, in addition specific support for the automotive and construction industries. All of these are referring to significant spending, which in the long run means higher taxes for specific groups. The short term stimulation of the economy by increased public spending is a policy, which in the long run could prove one more obstacle to economic growth.  Some of the proposed measures in the plan would have a positive effect, such as easing the starting up of a new business and reduction of the regulatory burden on the business. Unfortunately these are a very small part of the entire package.

Over all, the entire proposed plan must not be approved by the member countries of the EU. Up to now the Bulgarian government is restraining from such expensive reactions to the crisis and it should continue with this policy. Stimulation of the economy must take place through increased flexibility, by improving the business environment and encouragement of the real savings which result from real production. Otherwise there is a risk that the crisis would continue longer and would cost more to the Bulgarian people.