Trends by Martin Khor
Monday 16 January 2012
Fiscal austerity causing new recession
From fiscal stimulus, developed countries have moved to fiscal austerity
which is causing a new global recession, according to a new UN paper.
measures by governments of many developed countries have been criticized
by prominent economists Joseph Stiglitz and Paul Krugman as wrong
policies when economies are weak and unemployment high.
The quick half-recovery from the 2008-9 global recession was largely
due to fiscal stimulus or expanded government spending in both the
developed countries as well as developing countries including China,
India and Malaysia.
Fiscal stimulus became the new orthodoxy. But less than two years
later, the old orthodoxy, based on fears of inflation and budget deficits
‘Fiscal austerity’ involving cuts in government spending has quickly
replaced fiscal stimulus as the ruling paradigm, especially in Europe.
The year 2012 will see which of the two will become reality -- the
policy makers’ expectations of recovery-through-austerity or the Keynesian
economists’ prediction of austerity-led recession.
The UN Conference on Trade and Development (UNCTAD) has recently issued
a policy paper with the stark title, “On the Brink: Fiscal Austerity
Threatens a Global Recession.”
Its chief author, Heiner Flassbeck, warns that fiscal austerity policies
being implemented by countries are driving the global economy towards
‘The vicious circle induced by fiscal contraction, weak financial
institutions and financially fragile households is fuelling a crisis
of confidence and holding back investment and job creation in the
private and public sectors simultaneously’ said Flassbeck, an UNCTAD
Director, and former German deputy finance minister.
‘The countries threatened by recession and deflation should avoid
intensified austerity measures because these are unlikely to produce
the intended outcomes and could propel the world into a renewed bout
of recession, or even into an outright depression.’
The UNCTAD paper warns of a ‘lost decade’ for the world economy that
would risk the development gains achieved during the recent years,
and ‘throw into question the ability of democratic governments to
tackle the most urgent challenges of our age.’
proposes expansionary fiscal policies in key economies. Only these
can open a path towards lower fiscal deficits and falling public debt
Key points in the UNCTAD paper include:
High unemployment is a more pressing problem now than fiscal imbalances.
Fiscal austerity in the current environment will make matters worse,
Contractionary contagion will affect all countries and developing
economies need to prepare contingency plan.
UNCTAD said that in 2011, most advanced economies either suspended
or reversed their expansionary policies. They hoped to bring about
an “expansionary contraction” where fiscal restraint would improve
private sector confidence and spending.
These hopes are rapidly waning as new data points to a fully-fledged
recession. Most advanced countries implementing austerity policies
have experienced, instead, a “contractionary contraction”.
Private sector confidence is reaching new lows, as demand from governments
and from public sector employees falls relentlessly.
A review by UNCTAD of scores of cases of countries (including many
developing countries coming under the IMF’s structural adjustment
programmes) in the past two decades showed that fiscal tightening
did not trigger the sought-after economic expansion but rather had
the opposite effect.
It called for a co-ordinated expansionary policy alternative including
the following elements:
Countries threatened by recession and deflation should avoid intensified
Countries should see fiscal policies as tools for growth and development,
instead of having a fiscal-phobic approach. Instead of asking whether
their fiscal deficit is “too big”, they should consider whether it
is being used in the best way to stimulate the economy.
Fiscal space can be shrunk or expanded according to the mix of policies
that governments choose, with a variable impact on employment, tax
revenues and economic growth.
Tighter fiscal policies have often led to reduced investment, job
losses, reduced fiscal revenues, and stagnant or falling GDP growth.
In contrast, expansionary fiscal policy can boost consumer demand,
increase public investment and stimulate private investment and incomes.
These can lead to higher tax revenues and a lower fiscal deficit.
Social spending in can also promote recovery by sustaining consumption
during a crisis while tax cuts that benefit lower income households
can have a stronger impact on aggregate demand because poorer households
spend a larger share of their revenues.
Fiscal space can protect vulnerable economies against external shocks.
Countries should seek to enlarge their fiscal space through the use
of appropriate tax policies, and by building up a strong fiscal position
in times of economic prosperity.