The case for fiscal stimulus

LAST week I read with interest the comments to my article, and thought that it would be good to respond to these comments and explain the role of fiscal stimulus, and why it is important for Jamaica. The comments included that I always have a negative view on the economy, irrespective of which government is in power. Commentators also suggested that austerity is needed rather than fiscal stimulus, given that places like Europe have always had stimulus.

With regard to the first comment mentioned, I would only say that I am grateful that the recognition is there that I comment negatively regardless of which government is in power, as it shows impartiality. Secondly on this comment, is there any evidence that our economic development has been improving. If not, then it would seem that my comments are warranted. If however we have been seeing welcome economic development then I would be wrong. I will let the reader make that judgement.

International Monetary Fund (IMF) Managing Director Christine Lagarde recently warned that UK policymakers do more to boost economy. (Photo: AP)

On the second comment, I wouldn't really refer to the waste in fiscal spending during the periods before the recession as the same as the need for stimulus today. The fact is that the reason you need "fiscal" stimulus during a recession, or stagnant economy, is that the private sector will not invest where aggregate demand is low. It is therefore necessary for Government, through fiscal and monetary policy, to provide stimulus to the economy, in order to improve aggregate demand. Without that, then aggregate demand will remain low, and the private sector, because of its profit motive, will not make any new investments. The result is economic stagnation, and increased unemployment, which causes further reduction in aggregate demand.

Only this week there were three reports that showed that the fiscal tightening, in Europe and Jamaica, has caused further declines in the economy.

The first is a report by the Organisation for Economic Corporation and Development warning the Eurozone of a possible severe recession if growth strategies are not adopted, especially since Greece announced that they may be exiting the economic bloc.

The second is where the International Monetary Fund (IMF) has been urging the UK to focus on growth by providing stimulus to the economy, either by direct fiscal spending or reducing interest rates. The IMF's fear is that if Europe does not halt its current decline then the global economy could be negatively affected, and again lead to another global recession.

The third is an affirmation from the IMF that approximately 44 per cent of Jamaicans are living below the poverty line. That is on less than US$2.50 per day. This does not look to me like the IMF projections, and fiscal tightness, we were depending on has worked.

Those who argue against fiscal stimulus say that we cannot continue to live beyond our means, and that the most important thing to consider is the high levels of debt, and that we need to run the country like a business.

The problem with these arguments is that they are simplistic, as they do not consider the social impact of the actions. What we need to remember about a country is that it cannot be run like a business, where if it is not profitable you can shut it down and start a new business. When a business closes then all they will need to do is pay the redundancy costs due and start anew. On the other hand one cannot shut down a country and cannot get rid of human resource (social) problems by merely paying redundancy costs. While the consequence of a business closure may be industrial action, if a country reduces its economic activity severely then you could have industrial unrest.

At the same time, during a recession, the private sector will always seek to cut back on expenditure and activity because of a reduction in disposable incomes. One can always argue that eventually businesses will always start to invest again and economies do recycle and become prosperous again. The problem with that argument is that this cycle can take a very long time, during which period there can be a lot of suffering and social decay.

When this happens in a country we are not talking about lost profits, as a business would consider, but rather we are talking about lost lives. It is the responsibility of Government to ensure that the lives of its citizens are maintained at a certain standard of living, and any Government that fails to do so has really failed in its primary objective of improving the rights and living standards of its citizens.

It is for these reasons that fiscal stimulus is important in times of recession, as when the private sector retreats then the only other source of stimulating aggregate demand and providing the jobs to do so is government. Hence the importance of a programme like Jamaica Emergency Employment Programme.

I would be the first to admit that Jamaica has a serious debt problem, but even more important than the absolute level of the debt is the debt-GDP ratio. Now this ratio changes not only by the numerator (debt) but also the denominator (GDP). In addition, the only way that the debt will be paid off is if the GDP increases — that is if there is growth.

Applying austerity measures will cause the GDP to either decline or remain stagnant, resulting in no growth at best. The debt-GDP will increase anyway because debt naturally increases because of interest costs. In addition, declining or stagnant GDP leads to a loss of the productive base of a country, which makes it more difficult to get growth in the future.

It follows therefore that the path of least resistance, to reduce the debt-GDP, is to increase GDP (grow the economy). In times of recession this can only be done by first practicing short to medium-term fiscal stimulus. A failure to do so will most certainly result in higher poverty levels and Europe-like symptoms.