Global Trends by Martin Khor
Monday 5 July 2010
Will “austerity” lead to a new recession?
The sudden policy shift in developed countries from “fiscal stimulus” to “austerity budgets” is causing concern that this will stem the economic recovery and lead to a new global recession.
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
These countries quickly announced severe cuts
in government spending and new taxes. Other countries that are thought
to be safe from crisis followed, including
This was a big about-turn from the policy consensus that the threat of 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 or seek a humiliating bail-out from the IMF.
Actually, most governments also have the options of borrowing from their own central banks (or to “print money”) and devalue their currency (so as to expand their exports by making them cheaper).
But countries in the Eurozone such as
A fortnight ago,
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 were adopted in 1931, contributing 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: 600,000 of the jobs lost would be from the public sector and another 700,000 jobs from firms losing government contracts.
The government responded that 2 million new private sector jobs would be created which would more offset the 600,000 lost in the public sector. But this prediction has been met with skepticism.
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
But the investment guru, George Soros, strongly
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.
The Financial Times, in its editorial on 3 July,
warned that the balance of risk has 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
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.