Growth isn’t an option

At a lunch to celebrate the 125th anniversary of the Scottish Investment Trust a few weeks ago, I sat next to a man who noted in passing that the core problem with those on the political left in Britain is that they have far too much faith in capitalism. They appear to be convinced that however much you tax it, regulate it, criticise it and generally interfere with it, it will continue to churn out the cash you think you need to finance big government.

It is a theme Janet Daley picked up in the Sunday Telegraph this week. The idea of European co-operation was not doomed from the start, she says. It is true that continent-wide unity was never going to be easy "the ancient hatreds and unforgivable sins of the past" were always bound to cause frictions along the way. However, "what has made the system unworkable is the insistence that the EU be a vehicle for democratic socialism". The impossible dream? Not unity, but "unfeasibly enormous social security and entitlement promises made on the basis that the free market would always provide".

In building up these entitlements, the assumption was always that growth would somehow provide. No one stopped to ask if it were possible that the promises might one day outgrow the ability of the market to pay up, or what might happen when Europe's economy went through a prolonged bad patch (as economies always do).

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It turns out the answer is not a good one. But the extraordinary thing about our current crisis is the idea that, having utterly failed to live up to the extreme expectations of politicians about its abilities so far, the market is now somehow expected to step into the breach again: Europe's managers and populations "demand" growth.

If you look at the history of financial crises you'll see that probably isn't an option. Mostly you need to deleverage before you grow. A study out from McKinsey Global Institute earlier this year proves the point. It looked at 32 episodes of post-financial crisis deleveraging around the world from America in the 1930s and 1943 to Argentina today and found there are four paths out. There is rapid economic growth; there is massive default; there is high inflation (which increases nominal GDP and causes automatic deleveraging); and there is austerity.

The most common are the third and fourth (25% of the time and 50% of the time respectively). And the least common? It's growth. There is only one example in which an economy has grown away its problem (the States from 1938 to 1943). And that growth didn't exactly come from the best of sources.

So for those of you still wondering how all this ends, history has given you something of a hint. You can't grow your way out of a financial crisis. You have to work your way out of it with austerity, inflation or a combination of both. Expect the latter.