Brexit drove me to review the European Union and see if there are lessons to be learnt, especially in light of the economic challenges some of the member states have faced. The conclusion I have come to is that it is frighteningly easy to make well-meaning mistakes that can destroy an economy.
It is instructive to compare the United States and the European Union and see what light it sheds on how the UAE might make decisions about its economy. A full analysis would require a book; I will focus on a few directional ideas that might inspire.
When facing a financial test of the economy, conventional wisdom points to four solutions. The first is to inflate the economy out of it. This requires the ability to print money, something the US Federal Reserve is able to do but no EU member state can, as they gave up that ability when they adopted the euro. The UAE is closer to the EU in this respect, as the dirham is pegged to the US dollar.
The second method is to devalue. For similar reasons as above, neither the EU nor the UAE can do this.
The third method is to inject massive amounts of liquidity by lowering interest rates, something the Fed has done so often that it has gained the name of the “Greenspan Put”. The ECB on the other hand does not normally conduct open market operations for long term liquidity, and the UAE’s Central Bank is not authorised to do so – though the UAE’s sovereign wealth funds can repatriate large amounts of assets. Furthermore, the UAE Central Bank keeps its rate in lockstep with the Fed because of the dollar peg.
The more advanced Toxic Asset Relief Program had the Fed transfer banks’ toxic assets to its own balance sheet. The ECB certainly does not do this. The UAE does a form of this but does not use the central bank’s balance sheet, instead usually using sovereign wealth funds.
The final method, and the one preferred by the EU, is austerity. I think that when austerity destroys a member state’s GDP by 30 per cent in four years one should take notice and review this option.
Austerity means the government cuts its budget so that it remains balanced. As we saw with many EU countries, cutting the budget led to a further contraction of the economy, which led to lower tax revenue, and the vicious circle is refusing to end. This challenges the concept that introducing taxes will help balance government budgets as taxes put a brake on business. The EU experiment reinforces such an idea.
In the UAE’s case the budget cuts and large layoffs are largely driven by oil price drops. So there is no vicious circle from a tax point of view. But as the government is such a large part of the economy, the vicious circle is manifesting itself in an ever-decreasing economy.
There is worse to come.
We are seeing an increasing amount of borrowing from foreign markets to finance a contracting economy that is driving large numbers of expatriates, with their savings and spending, out of the country. This leveraging, usually through the banks as intermediaries, is happening at a low cost because of the implicit sovereign guarantee of the government of Abu Dhabi. Think about it – if Abu Dhabi were to firmly state that there was no implicit guarantee, what would the banks have to pay in a true competitive market? What about Dubai Inc?
This lack of a competitive credit pricing mechanism based on the efficiency and effectiveness of institutions removes incentives to act in any capitalistic manner. It also drives the whole economy to over leverage. If investors hold off from deploying their funds, we could move to ever greater leverage, the liquidity trap that fuelled the Great Depression.
What to do? First is to understand that austerity should have happened when the times were good. That is when we should have worked to become more efficient. When times are difficult is the time to actually have an expansionary budget. We created jobs when we did not need to and are now cutting jobs precisely when we need to do the opposite.
The second is to understand that the goal of the economy is not austerity, it is consumption. Frightening people with no hope of getting a job ends spending and exasperates the slowdown.
Austerity sounds good: we are doing something. We are being sensible. We are being responsible. But history has shown us this path is not the most effective. The EU is struggling while America, which has been under almost constant quantitative easing for the past seven years, is doing great.
This is the time to invest and spend. This is the time to focus on the domestic private sector and not the balance sheets of state-owned entities and government-related entities investing abroad or on marquee projects. This is not the time to think of how many jobs we can cut – it is the time to think of how many jobs we can save and create.
Increasing employment is like planting seeds that grow and nourish our economy. Decreasing spending is like not watering our economy and leaving it to wither. Increasing employment, not decreasing spending, should be our aim.
This article was originally published in The National.