The Bogey of Fiscal Stimulus

NEW YORK – After the economic disaster of 2008-2009, people are understandably wary of the devastation that yet another financial crisis can wreak. But the likelihood of another crisis is quite small, and its adverse impact would be far less devastating this time around, as there are no more massive credit or asset bubbles to burst. That has not stopped pundits and the media from exaggerating such fears, distracting from greater efforts to overcome protracted stagnation for much of the developed world, which will inevitably drag down economic recovery elsewhere, especially in developing countries. The current favorite bogeyman is public debt. Much is being made of high levels of sovereign debt on both sides of the Atlantic, and in Japan. As the economics commentator Martin Wolf has noted, “The fiscal challenge is long term, not immediate.” Likewise, while Japan has the highest debt-to-GDP ratio among rich countries, this is not a serious problem because the debt is domestically held. And Europe’s debt problems are now widely acknowledged to be due to ill-conceived aspects of European integration. The international community has, so far, failed to develop effective and equitable arrangements for restructuring sovereign debt, despite the clearly dysfunctional and problematic consequences of past international public-debt crises. This prevents timely debt workouts when needed, effectively impeding recovery. High public debt is also being invoked in support of fiscal austerity in many developed countries. But, rather than helping, the rush to budget cutting is reversing earlier recovery efforts. With private-sector demand still weak, austerity is slowing, not accelerating, recovery. It has already reduced growth and employment. And, while financial markets insist on deficit reduction, the recent decline in equity and bond prices – and the loss of confidence that this reflects – suggests that they also recognize the adverse implications of fiscal consolidation at a time of weak private demand. Opponents of fiscal stimulus cynically claim that all such efforts are bound to fail, citing as evidence US President George W. Bush’s tax cuts! Others point out that the US Fed’s “quantitative easing” efforts have been modestly successful, at best. While undoubtedly mitigating the impact of the crisis, Europe’s “automatic stabilizers” are now said to be enough to ensure recovery, despite strong evidence to the contrary. Slower growth means less revenue, and a faster downward spiral. Most major countries’ fiscal deficits nowadays reflect the recent collapse of tax revenues that followed the growth downturn, as well as very costly financial-sector bailouts. And yet many policymakers are insisting on immediate action to rectify not only fiscal deficits, but also trade imbalances and banks’ balance-sheet weaknesses. While these undoubtedly need to be addressed in the longer term, prioritizing them now effectively stymies stronger, sustained recovery efforts. The wrong public policies can induce recessions. This happened in 1980-1981, when the US Federal Reserve raised real interest rates, ostensibly to kill inflation, inducing a global economic downturn as well. This contributed not only to sovereign-debt and fiscal crises, but also to protracted stagnation outside East Asia, including Latin America’s “lost decade” and Africa’s “quarter-century retreat.” Another distraction is exaggerating the threat of inflation. Recent inflation in many countries has been the result of higher commodity prices, especially fuel and food prices. In these circumstances, domestic deflationary policies will only further slow growth – and are helpless to stem imported inflation. Unfortunately, today’s top policy priority is to address remote possibilities, whereas the urgent task at hand – coordinating and implementing efforts to raise and sustain growth and job creation – is being ignored. Meanwhile, cuts in social and welfare spending are only making things worse, as employment and consumer demand fall further. The pressure on employment and household budgets is likely to persist. Strident calls for structural reforms mainly target labor markets, rather than product markets. Growing worker insecurity is seen as the basis for a healthy economy. Labor-market liberalization in such circumstances not only undermines remaining social protection, but is also likely to diminish real incomes, aggregate demand, and, hence, recovery prospects. Moreover, in recent decades, profits have risen not only at the expense of wages, but also with much more accruing to finance, insurance, and real estate compared to other sectors. The outrageous increases in financial executives’ remuneration in recent years, which cannot be attributed to increased productivity, have exacerbated the financial sector’s focus on the short term, while worsening its risk exposure in the longer term, thereby exacerbating systemic vulnerability. Growing income inequality in most countries before the Great Recession only made matters worse, by reducing household savings and increasing credit for consumption and asset purchases, rather than augmenting investment in new economic capacity. What the world needs now are leaders who look to the long-term future. The international financial institutions created after World War II were set up to ensure not only international monetary and financial stability, but also the conditions for sustained growth, employment generation, post-war reconstruction, and post-colonial development. Unfortunately, current policy is justified in terms of “pro-market” – effectively pro-cyclical – choices. But it is counter-cyclical efforts, institutions, and instruments that are sorely needed instead. Global leadership today seems to be held hostage by financial interests and associated media, ideologists, and oligarchs whose political influence enables them to secure more rents and pay lower taxes in what must truly be the most vicious of circles. Indeed, the menace that now confronts us is not public debt or inflation, but a downward economic spiral that will be increasingly difficult to reverse. Jomo Kwame Sundaram, United Nations Assistant Secretary-General for Economic Development, was awarded the Wassily Leontief Prize for Advancing the Frontiers of Economic Thought in 2007. Copyright: Project Syndicate, 2011. www.project-syndicate.org