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Austerity’s deepening shadow

Austerity’s deepening shadow
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First Published: Mon, Jul 05 2010. 09 06 PM IST
Updated: Mon, Jul 05 2010. 09 06 PM IST
The debate on whether or not a “double-dip recession” is around the corner is bound to get stronger: A slew of economic data seem to be pointing to a slowing of the growth momentum in a number of major economies. In June, manufacturing output was lower across large parts of the world, including some of the countries in the developing world that had put the downturn firmly behind them. But what is perhaps more worrisome is that some of the industrialized countries are showing signs of stuttering, leading to speculation that the indifferent performance of the manufacturing sector can be attributed to this fact.
Joblessness in these countries is certainly on the rise. The US department of labour, reporting on the employment situation in the country in June, has painted a very bleak scenario indeed: The size of the US labour force has shrunk since May by 652,000, the second highest fall in a month since 1995. The shrinkage in the labour force points to the fact that a sizeable number of able-bodied workers are no longer looking for jobs, an indicator of the slump in the confidence in the economy. And, in the 27-member European Union, the unemployment rate maintained the 12-year high level of 10% that it had reached in April for the third straight month.
The unemployment figures are consistent with the decline in consumer confidence in all the major economies, with Europe suffering the sharpest slump in May. Sagging consumer confidence has put in shade the somewhat better numbers of consumer spending that were registered in recent months.
What role do policymakers have in such circumstances? The focus here has been on a proactive government that should play a more decisive role in stimulating demand in markets that are clearly losing their momentum. This was clearly the message that Prime Minister Manmohan Singh gave in his statement during the Group of Twenty summit in Toronto, where he emphasized that governments which have been providing stimulus packages to bolster their economies in the wake of the recent downturn must desist from withdrawing it too soon.
Singh’s statement has assumed more significance, given that cuts in public spending have become a key feature of crisis management in several countries. The euro zone has entered into a fiscal austerity mode with a number of countries committing to substantial reduction in their fiscal deficits in the next couple of years by slashing public spending. The zest for “fiscal consolidation” has now spread westwards, with the new coalition government in the UK deciding to reduce its fiscal deficit by 10 percentage points in five years—a decision with potentially far-reaching implications. And, calls for reducing public debt have grown in the US, whose Senate has in recent weeks refused to allow the government to increase spending that adds to public debt.
It is difficult to fathom how the contractionary policies being adopted by these governments— measures to cut expenditure and raise taxes could be contractionary—would bring their economies back on track in the near term. Many countries from the developing world, which had to put in place such policies in the 1980s and 1990s, would tell us that the probability of a quick rebound is extremely low. These countries would also tell us that what is more probable is that countries would have to undergo a prolonged period of adjustment before they get their growth momentum back. In other words, there is considerable risk for the global economy stemming from these contractionary policies that needs to be avoided, especially at the present juncture.
An important point that is often missed in the discussion on the importance of public spending to stimulate the economy is the quality of such spending. In most cases, governments have done little to ensure that public funds are deployed in the areas leading to the creation of assets that result in investment in long-run concerns such as innovation or education. Since 2008, the major economies in the developed world have failed to manage their public funds efficiently, and as a result they are unable to see an early end to the economic uncertainty.
The starkest example in this regard is the US, the largest user of public funds for providing economic stimulus. The US decided to pump in $700 billion to rescue rogue financial institutions that had precipitated the economic crisis, on the basis of an assessment made by the then secretary of treasury Henry Paulson that it was “absolutely necessary to stave off an economic catastrophe in which unemployment could have exceeded the 25% level of the Great Depression”. Such assessments gave substance to the “too-big-to-fail” argument, which resulted in unabashed support for “Wall Street” at the expense of “Main Street”.
Perhaps developed countries need to take a cue or two from the experiences of some of the developing countries, which have been able to cope with the downturn much better through effective use of public spending.
Biswajit Dhar is director general at Research and Information System for Developing Countries, New Delhi.
Comments are welcome at theirview@livemint.com
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First Published: Mon, Jul 05 2010. 09 06 PM IST