Saumitra Chaudhuri &=
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Economic Advisor
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26 K G Marg,
Saving the Economy from the Savio=
urs
As the world’s economies creak painfully and=
the
planet’s 6.7 billion soldier on, economists are busily engaged in doi=
ng
what they do best, i.e. arguing: How to get the lumbering giants of the
developed world to move forward instead of sliding back. Leading the charge,
are the most recently minted Nobel Laureate who writes of the “edge o=
f an
abyss”, joined by one of a slightly older Laureate vintage, and anoth=
er
illustrious one who is believed to have given the bad advice that Yeltsin t=
ook
leading to the collapse of Russia’s economy in the early-1990s. The
objective is to upend the
It has been argued by others that much of the prop=
osed
expenditures would never have passed muster in normal times; that barely 20=
to
30% of the total fit the criteria of a fiscal stimulus; most of the rest are
for expanding government. That most of it would not be spent now, but over =
the
next several years. “Fiscal stimulus” is now become a mantra, ever-so convenient for tho=
se so
inclined, to slip in items that no thinking person would approve, especiall=
y in
straitened times. In the crudest “Keynesian” construct, any and=
all
expenditures are good enough – “dig holes to fill them up”=
; as
some of us may have heard in class. In a recent column the economist Alan
Blinder prays for a fiscal stimulus “with intelligent design” a=
nd
expenditures that happen now, i.e. in the next six months, not over the next
three years. It is the sensible prayer, but perhaps in vain.
Before we get to the “stimulus” part, =
let
us remember that in the US, unemployment benefits acts as a built-in stabil=
izer,
protecting to a great extent the spending power of people (some 3.6 million=
so
far) who lose their jobs, even as there is little doubt that increase in job
losses on this scale is undesirable and exacerbates business and consumer
confidence. There was no such stabilizer in Keynes’ time. The most
obvious thing to do is to extend the unemployment insurance, i.e., more
generous terms – which is part of the 20 to 30%.
***
One way of looking at cyclical downturns is to see
them as representing a collapse of private sector demand (where growth turns
negative) or a shrinkage in its rate of expansion (where growth slows down,=
but
remains positive). So, government can step in with off-setting expenditures,
which reduce the magnitude of the downturn, and thus function in a counter-=
cyclical
fashion. But why does private sector demand slow in the first place? For the
most part, because firms caught up in the headiness of the previous upturn
created too much capacity, took on too much debt, i.e., got ahead of the ac=
tual
pace of economic growth and in the face of declining margins, begin the pro=
cess
of ramping back investment plans and reducing debt, i.e., they de-leverage.=
This
is why empirical analyses of data show that it is investment demand that ta=
kes
the biggest hit in an economic downturn and the opposite in an upturn. If
businesses are going to demand less debt, then when government steps in to
borrow in order to finance the fiscal stimulus, no “crowding-out̶=
1;
effect will occur in the loan/bond market. Thus this scheme appears to be
internally consistent.
But matters are more involved. First, it is not th=
at as
if governments show fiscal restraint in the good days and thus accumulate e=
lbow
room to accommodate fiscal expansion in hard times – through either t=
ax
cuts or additional outlays. In fact, governments spend as much as they can =
when
things are good. So, when the economic downturn happens, they face the pros=
pect
of reduced buoyancy in tax collections, while their normal expenditures =
211;
salaries, interest, subsidies/transfer payments, defence and other purchases
– continue to grow, causing a rapid expansion in the deficit and the =
size
of their borrowings. Second, in this situation where governments operate wi=
th
soft-budget constraints, there is hardly a worthwhile project that fails to=
get
funded. Therefore, the belief that there exist numerous projects with good
economic and/or social returns collecting dust on the shelves because they
failed to get past flint-eyed fiscal conservative practice is entirely misp=
laced.
The stock of clearly identifiable projects that are “shovel-readyR=
21;
thus may not be significant. In fact, that perhaps, more than any other rea=
son,
is why infrastructure accounts for just $70 billion of the $800-odd billion=
The debt taken on, in order to fund the stimulus h=
as
to be paid off over the next decade(s) along with interest. If money is spe=
nt
with inadequate regard to the efficacy of the expenditure, it will add to t=
he
burden on general tax revenues at all future times, without providing
equivalent benefits in the current period. Let us take some examples. Suppo=
se government
plans to purchase 25,000 trucks over the next two years. Seeing the depress=
ed
conditions in the truck business, it brings forward orders for 10,000 truck=
s to
this year. This additional order is a boon to the hard-hit trucking industr=
y in
the short-term without actually increasing government expenditure over the
medium term. Major infrastructure projects however take years to complete, a
year or two to even get preliminary design and clearances completed. They m=
ay be
worthwhile in themselves, but clearly they do not fit into the narrower
category of “stimulus”, that is, by definition ad hoc. Indeed th=
ey are
a part of the regular business of government. Raising general outlays like
taking on more staff or constructing new buildings, increases the baseline =
for budgeting
future government expenditure; thus they tend to become permanent. Finally,
there is the option of reducing taxes.
Bringing forward infrastructure spending in the few
instances where it may be possible, providing temporary expanded social saf=
ety
benefits and cutting taxes to bolster the investment and consumption climate
are what is needed. Not swelling the already swollen government system: Tha=
t is
the reason for Blinder’s prayer for a stimulus with “intelligent
design”. In the final analysis, “fiscal stimulus” can only
alleviate the pain, by putting a floor under the downturn; it cannot substi=
tute
for the natural economic buoyancy that drives the growth process forward. F=
or
that business confidence and private investment has to come back into play.=
***
There are other serious flaws in seeing a massive
“stimulus” as an economic elixir. The most important one being =
the very
difficult conditions that American, British and some European banks, find
themselves in. This is a problem entirely separate from a retrenchment in
private sector investment and consumption demand. A collapse in the financi=
al
system causes serious disarray and dislocation in the real economy. Just see
what the failure of a single major entity, i.e. Lehman Brothers, has wrough=
t all
across the globe. Then there is the aggravating matter of very high levels =
of
household debt in the USA and the fact that much household spending is fina=
nced
not from current income, but from loans – a state of affairs that Key=
nes
could surely not have foreseen. In this situation, where banks are not in a
position to lend to customers who in any case have borrowed probably too mu=
ch
already, in a context moreover, where the genesis of the crisis lies in
millions of mortgages that have or are likely to be in default, a workable
solution to the crisis in the financial system is the first and most import=
ant step.
No dollops of fiscal “stimulus” can substitute for this.
We in
[Total number of words excluding title: 1,370]
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