To Spend or Not to Spend?

The immediate question for economic policy revolves around the fiscal stimulus, if any, that should be administered to offset the downward drag that is now manifest in every economy worth the name. Two things need first to be borne in mind.

First, the recession (in the best case) or slump (in the worst) is almost completely self-started. It has no “objective” cause such as an oil embargo or grave balance-of-payments trouble. Discounting the trigger effect of the “subprime” losses suffered by the banking system in 2007—at about $600 billion a fleabite to the world financial structure—the damage to our economies came from the snowballing loss of confidence by which everybody frightened everybody else to behave like wary hedgehogs.

The second preliminary that the makers of policy have to bear in mind is that 2008 has marked the end of the mentality of “fly now, pay later” that has characterised American, British and to a lesser extent other societies. In the modern Anglo-American type of economy, it was the accepted thing to finance consumption by credit card and other debt, household saving hovered around zero as house-owners reckoned that the rising property market was doing their saving for them. The high-spending lifestyle is clearly going out of fashion and looks like being replaced by a more Teutonic culture of caution and thrift. Until very recently, using a credit card was considered by Germans as rather flashy and light weight. It is now becoming just a bit daring everywhere else.

If household saving recovers and corporate investment is frightened off by all the talk about the coming “crisis”, a gap opens up between capacity and demand, and it is this gap that public opinion urgently wants governments to fill by fiscal means. In Europe, the Maastricht rule of government deficits not exceeding 3 per cent of GDP has been explicitly suspended. Had it not been, it would be violated regardless. Various stimulus “packages” have been announced and may well be increased in the coming year. The British package contains a large dose of reduced taxation on consumer expenditure and smaller doses of extra public spending, the whole amounting to nearly 4 per cent of GDP. The public sector deficit will rise to over 8 per cent in 2009. Smaller fiscal stimuli have been announced by most major European countries, the total amounting about 1.5 per cent of European GDP. Some of this is as yet vague and ill-defined, and the part to be devoted to public infrastructure investment can only be spent slowly as projects are approved and work gets going. (Europe’s projected fiscal stimulus of 1.5 per cent of GDP compares with the 2 per cent of US GDP that the Obama administration is thinking of spending on public infrastructure, though it could hardly do all or most of that within a twelve-month).

The European public spending plans would raise the budget deficits of the respective countries by between 1 and 5 per cent of GDP. The British deficit would be brushing banana republic levels. Arguably, Britain can afford it, for its public debt is “only” 45 per cent of its GDP. This compares with about 38 per cent for the USA and Spain, 62 per cent for Germany, 66 per cent for France and 104 per cent for Italy.

It is on the level of the national debt that short and long term arguments about public spending clash against one another. It is plainly a waste to lose 300 billion euros of potential output in Europe (and a comparable sum in America) in a one-year recession, and if near-reckless public spending can avoid this, more glory to it. Contrary to 18th and 19th century beliefs that budget deficits are not only immoral but also practically impossible except sporadically, we now know that there is no technical obstacle to running high deficits if we take care of the balance of payments and national insolvency by import and capital controls. Obviously, such closing of the economy entails severe efficiency losses, but this is the price one must pay for a free hand on the budget. We now know all about the last-resort potential of the printing press and the docility of bond markets.

Against this slightly cynical view, the long-term argument is that if you run deficits even of 3 per cent of GDP, let alone much more, year after year, while your GDP grows by only 1 or 2 per cent, let alone less, year after year, you are in deep trouble before you know where you are. Of course you do not plan to remain profligate year after year, but like drug-taking, it is easier to start than to stop running high deficits. Inflation can boost the growth of GDP in nominal terms and thus help ease the weight of the national debt, but it is an incubator of long-term ills; nor is it easier to cure than drug-taking. Nearly all European states are embarking on fiscal stimulation to save the short term, and nearly all are scolding Germany for refusing to do so. The fear is that Germany is free-riding on their programmes. Their domestic stimulus generates a spillover into the German economy, but there will be no spillover of German demand into their economy. Germany has so far remained unmoved, with eyes fixed on the long-term fitness of the German export machine. Since 2005 Berlin has put its fiscal house in order and corrected the worst features of its labour legislation. It is reluctant to throw away these achievements. With its biggest and strongest economy playing odd man out, European anti-recession “co-ordination” remains the empty slogan it was always destined to be, but that is hardly a matter for great concern. It is easy to forget, too, that without German conservatism and stubbornness, the euro would not be excessively firm as it now clearly is, but would be sliding down the slippery slope (as the pound sterling is doing even though the British programme of spend, spend, spend has not even begun). In this regard, it is indeed hard to tell who is free-riding on whom, Germany on the rest of Europe, or the other way round.

Nor is it sure that it is wrong to accept short-term pain as the price of long-term fitness, or at least the hope of it.

After decades of Thatcherism, Reaganomics and “supply-side” emphasis, the dysfunctioning of a hybrid system of finance and the chill wind of recession have sent the makers of opinion and of policy in the Anglo-American sphere scurrying back to Keynesian certainties. However, for all its admirable originality and inner consistency the Keynesian system has notorious faults. Perhaps the principal one is that it holds out an open invitation to lesser Keynesians to treat the economy as a complex machine made of rigid Meccano parts whose mechanical properties are fixed and known. There is the propensity to consume, the marginal efficiency of capital, liquidity preference and so forth, great impersonal data that make the whole economy move in certain ways when they move—but why do they move? It is all macro and no micro. It is too easy to forget that the data are the sums of human decisions subject to human expectations and they change as expectations change. The eminent Polish economist and statesman Leszek Balcerovicz holds that the authors of fiscal stimulus packages must be taking people for Pavlov’s dogs who react predictably to signals because they live by conditioned reflexes and not by calculating reason. He cites studies showing that when national indebtedness is already high, government spending by further borrowing has no or negative effect on private consumption and investment. Not to spend more, but let the economy freely to find its own way, is a better policy. The best of all policies may well be one that has as few policies as possible.

A generation ago it has been fashionable to detect regular cyclical movements in economic activity like the rhythm of strong and weak tides or the predictable seventh wave. Statisticians discovered long Kondratiev cycles, ten-year cycles and forty-month cycles. The numbers patiently conformed to the findings. Somewhat similar discoveries, though not based on the complicity of numbers, are sometimes made in political history. The political scientist Francis Fukuyama, who earned world fame with his claim that the onset of “liberal democracy” marks the end of great ideological confrontations, has lately found that there is a swinging pendulum that takes us from extreme interventionism to extreme free market practice and back again. He considers that the pendulum is now on its way toward more dirigisme and less reliance on free markets. (He does not go so far as to say that the pendulum is taking us from capitalism to socialism). He may well be right, at least regarding the immediate future for when a movement is clearly discernible, it is a safe guess that it will go on until it stops. The pity is that talk of a swinging pendulum makes a back-and-forth pattern seem inexorable, a Hegelian historical necessity that is destined to sweep all before it. Since theories of history, let alone of historical necessity, have a habit of being falsified by events, let us trust that this minor bit of theory of the policy pendulum will also turn out to be false. It depends on us whether it will.