Monday July 5, 2010
THE STAR ONLINE
With developed countries announcing severe cuts in
government spending and new taxes, there is concern a new global
recession may be in the making.
A DEBATE is raging among economists and policy-makers whether
the recent sharp shift in economic policy from “fiscal stimulus” to
“fiscal austerity” will help the global recovery or cause a new
recession
It is more than an academic debate. Depending on what the answer
is, there could be a continuation of the recovery or a slip into a
“double-dip recession” or even a depression.
The rush to austerity started in Europe, when the near debt
default in Greece quickly created fears of contagion of sovereign
debt crises to Portugal, Italy and Spain.
These countries quickly announced severe cuts in government
spending and new taxes. Other countries that are thought to be safe
from crisis followed, including France and Britain.
This was a big about-turn from the policy consensus that the
threat of a depression must be fought by the Keynesian policies of
increased government spending, through higher budget deficits and
low interest rates.
It is widely acknowledged that the re-discovery and
implementation of Keynesian policies in the past few years saved
the world from a prolonged recession or even a Great
Depression.
But the Greek crisis has struck fear into governments, that if
their budget deficits are too large, they may not be able to borrow
enough at a reasonable rate of interest, and may be forced to
default.
Actually, most governments have the options of borrowing from
their own central banks (or to “print money”) and also devaluing
their currency (so as to expand their exports by making them
cheaper).
But countries in the Eurozone such as Greece don’t have this
option as they cannot lend to themselves and don’t have their own
currency to devalue. Thus, Greece had to rely on the market to lend
to it. When the market demanded interest that was too high, Greece
had to be bailed out by loans from Europe and the IMF.
A fortnight ago, Britain was the latest country to go for
austerity. The new Tory-Liberal government cut spending by £83bil
(RM406.8bil) and raised taxes by £29bil (RM142bil). As Britain is
not in the Eurozone, it has more options to continue with fiscal
stimulus, but the government chose instead an austerity budget.
Well-known economists and media commentators like Robert
Skidelsky, Martin Wolf and Will Hutton have been critical.
Skidelsky, the biographer of John Maynard Keynes, criticised the
“conversion to austerity” for being caused by the need to restore
“confidence in the markets”.
“If markets have come to the view that deficits are harmful,
they must be appeased, even if they are wrong,” he wrote about the
change in policy.
He pointed out that in a parallel situation in 1931, a British
government committee recommended a drastic cut in government
spending in order to balance the budget, and this was supported by
almost all politicians and the business sector.
Keynes was one of the very few who opposed it. He commented that
deficits are “nature’s remedy for preventing business losses from
being ... so great as to bring production altogether to a
standstill”.
The austerity policies adopted in 1931 contributed to a long
recession, and Skidelsky noted that there was never a complete
recovery until the war.
Commenting on the present situation, Skidelsky wrote: “We are
about to embark on a momentous experiment to discover which of the
two stories about the economy is true. If, in fact, fiscal
consolidation proves to be the royal road to recovery and fast
growth then we might as well bury Keynes once and for all.”
“If, however, the financial markets and their political fuglemen
turn out to be as ‘super-asinine’ as Keynes thought they were, then
the challenge that financial power poses to good government has to
be squarely faced.”
There was a public uproar last week when The Guardian
reported on leaked Treasury documents showing the austerity budget
could cause 1.3 million job losses by 2015-16, of which 600,000
would be from the public sector and 700,000 from firms losing
government contracts.
The government responded that two million new private sector
jobs would be created which would more than offset the 600,000 lost
in the public sector. But this prediction has been met with
scepticism.
Germany, whose finances and economy are in strong shape, has
been criticised by the United States and those who advocate
expansionary policies for insisting that Greece and other countries
take on austere policies to qualify for bail-out loans, and for
itself cutting its deficit.
Its finance minister Wolfgang Schauble replied to the criticisms
by saying that Germany was attempting an exit strategy from the
present large fiscal stimulus with laying the foundations for
future growth.
But the investment guru George Soros strongly attacked Germany
for insisting on pro-cyclical policies and on strict fiscal
discipline for weaker Eurozone countries. He said this was in
conflict with the lessons of the 1930s’ Depression and was liable
to push Europe into prolonged stagnation or worse.
In the United States, although the federal administration is in
favour of further fiscal stimulus, it is facing opposition from the
Republicans and some Democrats in Congress, and a Bill to assist
state governments and the unemployed has been stalled.
Most of the states are in deep deficit and since they face
problems getting loans, they are now cutting their spending. This
will affect jobs and demand, and more than offset the expansion in
federal spending.
The economist Paul Krugman has written scathing columns
attacking the new emerging consensus in policy circles favouring
immediate fiscal austerity. He argues that there is no evidence for
the belief that fiscal contraction is actually expansionary because
it improves confidence.
For example, Ireland has implemented savage spending cuts, and
its reward is a Depression-level slump, and financial markets
continue to treat it as a serious default risk.
The Financial Times, in its editorial on July 3, warned
that the balance of risk had shifted towards renewed recession.
Noting that the world economy is heading for a period of tightening
fiscal policy, it reports on estimates that the big advanced
economies will tighten their government budgets by 1.9% of their
output this year, and that the United States will cut its deficit
by 2.7% of national output next year.
If the Keynesian economists and media commentators are right,
the contraction in public spending will have an adverse effect on
the private sector and there will be overall economic slowdown or a
new period of recession.
The developing countries will be affected through the trade
channel as their exports slow down due to the cuts in spending and
the rise in unemployment. These countries are also following the
debate on fiscal stimulus versus austerity budget, as they also
face the same policy dilemmas.