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.
Growth index has been revised downward but it is till unclear if we are heading towards a double dip recession.
Quote Wall Street....
"The only indicator to recession is from the Economics Cycle Research Institute's Weekly leading Index, the only leading index indicator currently suggesting a double dip. "
I think there is a general slow down. but nobody is going to say is Going Going down as Yet. but certainly all eyes are looking......
Recession or not doesnt matter, Austerity and defending the euro is the right thing to do
Not to mention it good for me too $.$ lol
i feel that they should have let the dollar Crash and the Euro Crash big time so that the world can start from Zero again.
Look at the crisi keep floating from one countries to another now is in Africa......
Is Asia buying Time? there are property bubble in China.....SG property isn't cheap.
Fish is over $1000 a pcs. Very soon we eat Grass.
Well MAS is doing the right thing to be the first of the asian nations to let their currency rise to fight inflation and cool the housing market
China should do the same too to and aggressively revalue the RMB or better yet let it float to stop inflation and property markets but their economy is so much tied to the global economy they cant do it without impunity.
Asia will never have any crisis over the next decades, affected by other economy's crash, yes, but these are short term bear trends, long term decades long bull trend belongs to Asia and it'll be soon and exciting! =) just my opinion though