The West must make goods that the Rest want

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Try as it might, the West just cannot seem to get its foot out of the rut. The credit crunch gave way to a full blown financial crisis, which has now engulfed Europe and, to a greater or lesser extent, most of the Western world.

The West today divides kind of four-fold. Firstly there is Europe, which has debt, demographics and a socio-economic model which could drag the continent off the economic cliff. Austerity may be the answer. But the problems are so great, that by the time austerity has worked its magic, there may not be much of a Europe as we see it today, left.

Secondly there is Britain, which may not go down with Europe €" it is
not in the Eurozone, it has healthy demographics and it is the only developed country which is seriously cutting unsustainable debt €" but it will get very wet in the process. Years of hardship may be ahead, although the sun will shine again . . one day.

Thirdly there is the US, which is growing. That is good news. Although despite the cheers, it is a patchwork recovery built too much on government, healthcare, education and part-time workers. If the US does not sort its debt out €" like Britain is €" it will be past the point of no return by 2017. Simple as that.

Finally the rest of the West €" Australia, Canada and New Zealand €" remains about the best of the bad bunch. They have healthy demographics (primarily now picking up gains from European immigrants), decent finances, well-educated populations, good quality of life and have enough natural resources to keep growing.

The only real way out of this mess is a mixture of huge debt reductions and a burgeoning private sector. The demographics of Europe mean the latter is almost impossible. This is catastrophic enough for the now prosperous German, Dutch, Belgian, Finnish and Austrian economies. It is cataclysmic for the likes of Italy, Spain, Portugal and Greece.

When this all kicked off the response fell broadly into two camps. Followers of the late Milton Friedman urged the Federal Reserve to print more money to prevent more bank failures. Followers of John Maynard Keynes argued for large scale borrowing and expenditure on public works. The US responded with a mix of the two: the Fed nearly doubled the monetary base while the Treasury ran deficits of up to 10% of GDP.

But just as generals are often accused of fighting the last war, so many economists today are arguably fighting the last depression. Unlike the 1930s, today's economies remain open and interconnected. This means that stimulus tends to leak across borders €" boosting the price of a commodity in a part of Asia rather than helping households in the US or Europe.

Unlike the 1930s, this crisis has hit the poorest not the richest. This undermines Keynesian thinking because Keynesianism relies on average households boosting spending. What is really needed is a huge boost to the private sector.

In the Eurozone market reforms and austerity have not bought private sector salaries down fast enough to make their economies competitive. Austerity has hit domestic consumption by hitting employment.

Structurally, since the euro is stronger than the lira, peseta and drachma would have been but weaker than the deutschmark would have been, German goods win for competitiveness and quality.

British companies and households are hoarding cash. Britain's
unemployment rate of 8.4% compares favourably with that of Spain (23.3%), Greece (21%) and Italy (9.2%) and is only fractionally higher than the US (8.3%). Moreover while the youth unemployment rate in the UK is around 22%, it is around 23% in the US, 30% in Italy and 51% in Greece.

What is really needed is a real boost to the private sector. This is not just about tax cuts. For America, corporation and income tax cuts would increase the deficit. Britain suffers from dependency on Europe for trade, a strong pound and a lost industrial sector. The last problem is one which Britain shares with the United States.

There must be investment in human capital. High value manufacturing €" the kind of thing the West needs €" requires educated minds. But Germany is the only Western country which really makes stuff in a big way and they are going to lose too many workers in the future. The West needs more than austerity. It must make goods which countries like China want.
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