Stimulus spending to revive the economy
THE GLOBAL economy is fragile. The British and German economies are now receiving several doses of cutbacks and austerity programmes to control rising deficits and debts; the U.S. and Indian economies favour a stimulus spending approach to address the deficit issue. The G20 Group of major and emerging economies is meeting over this weekend in Canada, where its common agenda is to secure strong and consistent economic growth in the world economy.

U.S. President Barack Obama consistently argued that the strictness in Western Europe may impede recovery in the global recession. Indian Prime Minister, Manmohan Singh is of the view that these G20 countries should not unleash budget deficits too quickly, but coordinate a policy to attain sustainable recovery. And he feels that the danger of deflation at this time is greater than inflation in the global economy. In fact, both Obama and Manmohan Singh favour stimulus spending. For these reasons, today’s Perspectives will focus on the stimulus approach.

Stimulus packages are part of demand-side economics where the slope of the stimulus curve veers more toward the working class. But before we experiment with this kind of economics, let’s see where we are in this global credit crunch.

The financial meltdown remains a problem for the global economy. Sabherwal (2010) makes the following points in this regard: There is a massive weakening in the quality of the global economic recovery from March 2010; the extent of debt funding will have to occur at a reasonable interest rate, so as not to induce any debt spiral; and the sustainability of U.S. demand relies on income, employment, credit, and asset values, where all are problematic; and the biggest problem being its frail employment picture.

Quote: ‘Stimulus packages are part of demand-side economics where the slope of the stimulus curve veers more toward the working class’

The World Bank forecasts modest contributions to GDP growth for the global economy for 2010 as follows: Private consumption (1.6%); government consumption (0.5%); fixed investment (1.2%); and net exports (2.1%). And the World Bank further noted that excepting China and India, developing countries’ economic growth is likely to be around 2.5% at the end of 2010. And we must assess developing countries like Guyana against a fragile global economy, and not talk about Guyana’s economic health as if it has no impact from the global economy.

The U.S continues to address the credit crisis, a product of irresponsible lending and irresponsible borrowing through cheap loans and 100% guaranteed loans over the last 10 years. Its current financial revamping legislation would become the most significant overhaul of U.S. financial regulations ever since the 1930s. This legislation intends to eliminate the regulatory cracks and abolish the speculative trading practices that were a huge factor in the 2008 financial market crisis.

Perhaps, something good may be emerging out of the financial doldrums, in that this financial meltdown has rekindled the ideas of financial socialism, Karl Marx, and John Maynard Keynes. The real question, however, is: What framework is appropriate to eliminate this financial and economic mess? I merely here want to dabble a little bit with the Keynesian system to see what could come out of its application.

Keynes’ ‘The General Theory of Employment, Interest and Money’ (1936) has stunning relevance to the U.S. credit crunch. Reich (1999) explains Keynes’ theory as follows: In order to sustain full employment, governments would have to operate deficits when the economy decelerates; this is so because the private sector may not have the proclivity to invest as much as necessary. And so, as the private sector markets reach saturation, investments decline, creating a treacherous cycle – declining investment, less jobs, less consumption. And if no government intervention happens, perhaps, there may still be some balance reached in the economy, but this would be at great cost —  rising unemployment with mounting social and economic disadvantage.

In its response to the financial meltdown in the US, it’s interesting to see the Republicans making a u-turn, moving away from Say’s law in classical and neo-classical macroeconomics which focus on the supply side, to more Keynesian and neo-Keynesian thinking that concentrate on the demand side.

Say’s contention, as part of classical macroeconomics, is that under-spending is not a cause of economic recessions. Entrepreneurs will keep on producing goods and services, provided that consumers possess money to spend; and consumers will keep on having money to spend, given that entrepreneurs carry on producing. For this reason, supply generates demand through disbursements to the factors of production like labour, etc. In effect, in classical macroeconomics, output determines spending, signifying supply-side economics. The Keynesian line would be closer to the notion that spending determines output, indicative of demand-side economics.

In fact, Keynes advanced the view that total spending for consumption and investment produces total income. And so, when an economy slows down, it becomes necessary for a government to operate a deficit, to accelerate spending, and in the process, generate employment; demand-side economics.  And this is precisely what we saw happening in the US on October 3, 2008.

On this day, the United States Congress approved the Emergency Economic stabilization Act of 2008, making an allocation of US$700 billion of taxpayers’ money to repair the damage to the frozen credit markets and impaired lending. And President Barack Obama went further.

Obama signed into law $787 billion for tax cuts, job creation, and aid to some States; Obama agreed to make available $275 billion to reduce home foreclosures; Obama, through the Treasury and Federal Reserve, intends to float $2.5 trillion in the financial system; and Obama’s plans would consume about 31% of the U.S. economy. Keep tuned in; there is more spending to come.

Here are a few differences between the Keynesian and classical macroeconomics systems in working out what produces output and as a result, employment: (1) Keynes included the speculative demand for money – liquidity preference; (2) Keynes presumed the prevalence of rigid wages, showing the ineffectiveness of price flexibility; and (3) Keynes presupposed that saving/consumption depends on income and not the interest rate.

It does not really matter if we assume that rigid wages, liquidity preference, or the inconsistency between saving and investment, produce unemployment; for in the end, the most important factor for the size of unemployment and the amount of national income, is consumption.

In the middle of this financial meltdown, we see growing unemployment, we see reduced spending, we see business closures, we see the people without any livelihood; we see a rise in social ills. We now see a revival of Keynesian thinking, where his primary focus was to find out what determined output, and as a result, employment. The supply-side economics did not work effectively when applied in the Great Depression; it will not work today. We need more stimulus spending.

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