The great debate
IN the wake of the Great Recession, a fascinating policy debate is under way across much of the world.
From the podiums of the presidential debates in the US to the streets of Europe, and from the hallowed halls of the IMF-World Bank fall meetings to the studios of the BBC, political leaders, economists, central bankers, journalists, public-sector employees, farmers and trade unionists, among others, are all passionately debating essentially a single proposition: how best can countries gripped by high debt levels and a once-in-a-generation economic downturn navigate their way out of the crisis as quickly and as ‘painlessly’ as possible.
This debate has resonated in Pakistan as well, and has crystallised, wrongly in my view, into a ‘growth’ versus ‘austerity’ question — engendering a widely held misconception that an inevitable trade-off exists between the two.
In Pakistan’s rich but chequered history of brief trysts with macro-economic stability, growth has been a casualty in the short run on quite a few occasions — but this has more to do with the effects of the self-inflicted crisis preceding the attempt to stabilise, as well as the wrong use of curtailment of development spending as the policy tool of choice for stabilising the economy.
As with any debate, however, how the question is framed is extremely important. In the animated discussion on ways to clamber out of the economic crisis, almost the entire focus is on ‘securing the present’, i.e. on reviving growth in the economy in the short term.
If, on the other hand, the question is framed as ‘how best can countries gripped by high debt levels and a once-in-a-generation economic downturn secure their future’, it will inevitably produce a different set of policy prescriptions.
The fundamental difference essentially lies in two things. First, in the durability of any economic recovery brought on by fiscal stimulus under existing conditions of a high burden of debt. And secondly, extremely important in my view, in the distribution of pain (or, the ‘burden of adjustment’) — both horizontally (i.e. across different segments of society at any one point in time) as well as temporally (i.e. across time).
Hence, while it is possible in a relatively short period of time to kick-start moribund economies mired in debt — such as those of Europe, or the US or Pakistan — through fiscal stimulus that adds even more to public debt, these short-run solutions will temporarily relieve the pain of today’s population or workforce at the expense of the next generation. There is no escape from this Ricardian equivalence — someone will have to pay for the additional stimulus via higher taxes, and/or via less spending because of higher debt servicing, and ultimately through lower growth and a reduced quality of life for all.
The relatively short-term effects of even a powerful fiscal stimulus are amply demonstrated by the experience of a range of countries in the past two to three years. In response to the global recession, various countries injected stimulus into their economies through heterodox policies — a combination of fiscal and monetary stimulus. And yet, many of these economies are standing on the brink of a second major, back-to-back recession (the so-called ‘double-dip’ recession) as the effects of the stimulus have worn off.
Japan offers the most extreme example of how a reliance on stimulus alone, without undertaking the requisite structural reform, can only produce one outcome — a ‘lost generation’. Greece is in an even worse position, or perhaps, depending on which side of the debate one is on, a better position — it doesn’t have the money even for a stimulus. This may force it to undertake the painful reform of its economy that has now become inevitable after decades of postponement. Pakistan, like Greece, has been a ‘serial’ non-reformer for decades — and its day of reckoning is here.
Not surprisingly, however, the ‘austerity’ camp is short of members. The Germans are holding the fort for fiscal conservatism in Europe (with German Chancellor Angela Merkel deliciously dubbed the “ayatollah of austerity” by the Financial Times), while the Republicans are a force in the US.
The Tories have also implemented fiscally conservative policies in the UK. In fact, to their credit (and to that of their coalition partners, the Liberal Democrats), the Conservative party had run — and won — the elections on essentially an ‘austerity’ agenda for the UK.
Beyond these countries, however, there are few takers for fiscal conservatism. A big spending government that is easy on taxation is the ‘natural’ or the preferred state for any electorate. And yet, in an attestation of the fact that the current crisis is unprecedentedly severe, and in recognition that the party is over and the ‘punch bowl’ will have to be removed, not one but three new incoming governments in Europe — in Spain, France and Greece — have opted for a surprising degree of fiscal austerity even as their voters have been protesting on the streets against the measures. The only remaining question is the one which the IMF has formally brought up — that of timing. While it is now widely recognised that budgets will have to be balanced and the free-spending ways of the past reversed, the level of adjustment proposed by the Germans on Greece, and the magnitude of social pain it is inflicting, is clearly intolerable as well as politically unsustainable. Hence, the view that the Greeks should be allowed a few more years to balance their books is gaining ground. The only danger with this approach is that, as experience has shown in all parts of the world, any back-loading of reform into a distant future doesn’t work as it invariably leads to permanent postponement.
One interesting dynamic that is emerging from the severe protracted economic slump in Europe and other parts of the world is the effect on sub-national regions. The Great Recession has unleashed centrifugal secessionist forces in Spain (Catalan), Belgium and the UK (Scotland). The same dynamic also appears to be underpinning the secessionist movement in Balochistan.
The writer is a former economic adviser to government, and currently heads a macroeconomic consultancy based in Islamabad.