It is right and important that governments take on their responsibility to cushion the present crisis with a) programs to get banks to lend again and b) with demand-stimulating programs in order to lessen the impact of the recession on citizens and businesses. Orthodox economists and some policymakers in their vain are still fighting rear-guard actions, but empirical experience and “Zeitgeist” are working against them.
A number of questions arise, however:
1. The size of the programs announced so far is quite unusual: the EU just announced 1.5% of GDP, the US up to 5%, the UK 4%-5%, Kazakhstan 4%, Russia 3% – and so on. Previous programs were smaller by a factor of 10.
Do we need such massive response? It is clear by now that both the type of the crisis and the way it has evolved from the housing sector in the US to the global economy, are unprecedented. Policymakers’ response in this case is: the larger, the better. So far it is unclear whether the first packages for the banks, though very large, have been successful. The repeated efforts by the largest economy, the U.S. to follow up with new directions, new money, new instruments attest to a muted response, at best, so far by the banks: instead of easing loan conditions, they are tightening them. Consumers and businesses (especially SME) get no credit at all or only at short tenor and high costs.
2. The EU leaves the largest part of its recently proposed program to its member states. This means, in effect, that each state creates its own program, according to its political necessities, instruments, preference for tax or expenditure policy, etc. Only 30 bill € out of 200 bill € will come out of EU’s “own” budget resources, targeting innovative investments into environmental and energy-saving areas.
It does make sense to have a coordinated EU program, since this reinforces its effectiveness. Since 85% of EU trade is within the EU area, a co-ordinated program will reduce each country’s leakages into imports. A rough rule-of-thumb states that for the average EU country only around 1/3 of extra expenditures would benefit the own country, if it is the only one to increase spending.
However, it may well happen that the EU member states come up with very diverse stimulus programs, some even with contradictory aims: the UK’s reduction in VAT, for instance, may not reach customers, if retail business does not pass on the reduction in prices; if they pass it on, it will benefit also foreign importers of goods; help to the ailing construction industry in some countries will maintain overcapacity and will help immigrant (often illegal) labor from other countries: this is something we see already very strongly in Russia and Kazakhstan; help to the automobile industry will again cement overcapacity – and will reward managers who have blatantly disregarded the decades-old calls for more energy-efficient cars: this is especially true of the U.S. and Germany.
If packages should exert their maximum short-term effects on effective demand, targeted public expenditures (for teachers, hospitals, anti-poverty measures and transfers) should take precedence over tax reductions, since the former will all be spent, while tax reductions in VAT might not be passed on to consumers and income tax reductions might largely be saved by households, in preparation for the continuing dire times expected.
It is also clear that crisis-related packages should not only look at the short-term (however important), but create a double-benefit by tackling medium- to long-term problems: climate change, health care reform, education and training, innovation, second-generation immigrant integration into society, poverty alleviations, etc.
The extraordinary size of the packages proposed now calls for very close scrutiny and bold deliberations where the additional money is to be spent. Long-term effect should take precedence over the power of lobbies of sectors in trouble.
3. Any responsible policy must take into account how these packages will be financed. In the short run the packages will increase the deficit ratios and public debt which countries incur, since most of the packages will be short-term financed by public borrowing. This, incidentally, puts again pressure on financial markets and increases the danger of crowding out private-sector borrowers.
But these programs are not self-financing, as some politicians would like us to believe. At best they will cushion the ongoing recession, both in depth and duration, but they will not increase economic growth over the previous (very good) years. Thus taxpayers will have to pay in the future. In the EU debt service levels might increase back to 5% of GDP, as they were a few years ago, or even higher. This means that public money for more socially productive purposes is crowded out and that higher taxes will be levied in the future. Thus, after a few years, when the crisis is hopefully history, public expenditures will be lower and taxes higher than today. This makes perfect sense economically, but citizens should be told this right now. They must be told that the additional funds for these packages (both those for the banks and those for the real sector crisis) do not fall like manna from heaven, but will have to be financed by the citizens themselves.
4. The irresponsible, credit-financed boom of the last years – from which many of us profited – has come to a crushing halt. Governments and national banks have reacted swiftly and created a plethora of high-volume programs both in order to stabilize the banking sector and, more recently, to lessen the impacts on the “rest” of the economies. There are some first steps at international coordination of crisis response, so far mainly among industrial countries. Emerging and developing economies, which are suffering disproportionately, are only marginally included into these coordination efforts.
The programs go into the right direction. However, stronger co-ordination would be warranted, in order to maximize the stabilizing effect. Beggar-thy-neighbor policies need to be avoided.
Crisis programs, however, need to be frank about how and by whom they will be paid for. And, they must avoid to answer predominantly to the lobbying efforts of the loudest shouters, but must rather tackle short-term crisis response together with addressing some of the more pressing medium-term problems: poverty in poor and rich countries, social cohesion, pension security in the face of ageing populations, health care and climate change.