On the eve of a general elections, the national debate which has been taking place since October is very commendable. The tone and substance of the debate on how to remedy Barbados’ fiscal crisis and build a platform for growth are exact what is needed as both political parties make their case to the public. The discussion of privatisation, renewable energy, tax policy etc. has been rather constructive.
Now that the US presidential election is over the focus has correctly shifted to presidential and congressional negotiations aimed at achieving a compromise deal to avert the so called “fiscal cliff”. Since the outcome of these negotiations has significant implications for the global economy, I would like to take the opportunity today to discuss the prevailing global economic context. Before I do so, it is salient to reflect succinctly on the policies pursued by various countries in response to the 2008-2009 Great Recession.
Countries such as the United States, Canada, the United Kingdom, Germany, China, Australia and Brazil pursued an economic stimulus programme of some form, size and duration. Other countries either adopted austerity programmes or sought to ride out the adverse international economic climate. Of course it is important to note that the recession impacted countries differently. For example, the United States and the United Kingdom were the epicentres of the financial meltdown due to their banks’ over exposure to sub-prime mortgage backed securities.
Consequentially, their economies spiralled downward, leading to economic contagion and the now infamous Great Recession of 2008-2009; the worst economic recession since the 1930s Great Depression. Canada’s recession was relatively mild. Like many other countries, Canada was largely affected by the economic slowdown of its major trading partners. Similarly, Barbados was impact by the global economic decline rather than any direct exposure to the international financial crisis.
It is now a fact that those countries which pursued expansionary fiscal and monetary policies (stimulus) recovered more quickly from the recession than those that did not. Moreover, those countries which have been pursuing aggressive contractionary fiscal or monetary policies (austerity) have prolonged the recession or achieved lower rates of post-recession economic growth.
Stimulus, also referred to as counter-cyclical policies, takes the form of lower taxes, increased government spending (typically infrastructural spending), and/or lower interest rates. In some jurisdictions, stimulus programmes also included extending unemployment benefits, increasing provision for welfare and new investment in higher education, innovation and alternative energy. Austerity took the form of slashing government spending and raising taxes and user fees.
Why was stimulus, followed by balanced, measured fiscal consolidation the best policy response to the Great Recession? The recession was caused by the explosion of a housing bubble that brought over leveraged financial institutions to their knees. The result was a financial crisis characterised by a credit crunch as banks sought to reduce their debt levels, write-off bad debts and hoard cash.
The consequence was a downward spiral of private construction activity and a significant reduction of household and corporate access to credit. As access to money dried up, private consumption and investment were stymied; the makings of the Great Recession. Therefore, as businesses and households deleveraged, it was imperative that governments fill the gap in productive spending while giving impetus to private consumption.
That’s what stimulus is all about. It is imprudent and premature for a government to double down on economic decline caused by private off-loading of debt by doing nothing (a wait and see approach) or pursuing austerity to reduce public debt on the basis that a pretty fiscal position will magically create the conditions for growth.
Once health has been restored to the finances of consumers and businesses, private economic activity will rebound. It is at that time that government should withdraw public spending and or raise revenue in order to reduce the public debt and put public finances on a sustainable footing.
What’s the evidence? Canada pursued stimulus and its recession lasted for only nine months. The United States emerged from its deep recession since 2010, though growth has been uneven and modest. Most economists advocated a stimulus larger than what the Obama Administration was able to secure politically.
Emerging economies strived and Europe; austerity central, prolonged its recession and experienced anaemic growth before the advent of a double-dip recession.
Most of the current global uncertainty is due to a weak Euro-area economy, the prospect of a collapse of the Euro, and dangerously high debt levels which have been compounded by a contracting economy and declining revenues due to overzealous, ideologically driven austerity. The rest of global economic uncertainty largely surrounds the prospect of the United States’ fiscal cliff.
What is being referred to as the fiscal cliff is the cumulative effect of the expiration of the George Bush tax cuts and previously legislated automatic and substantial federal spending cuts set to begin on January 1, 2013. It is reckless, austere deficit reduction. The resulting withdrawal of money from the economy would be so significant that it would push the United States back into recession and result in a significant loss of stock market wealth and higher unemployment.
US politicians are now scrambling to compromise on a better approach to reducing the deficit without putting the economy in peril. The Obama administration and his allies in Congress are correctly pushing for a balanced deal that would credibly achieve the reduction of the federal debt while investing in the future. Republican legislators are promoting spending cuts without tax increases. As you could appreciate, if the US economy, the world’s largest, goes back into recession, a global recession will follow.
Barbados’ approach to the global downturn was perhaps most similar to that of the UK. Initially the Barbados Government rejected the idea of stimulus, opting instead for a “wait and see” approach. Though the former Labour Government in Britain pursued stimulus policies in response to the Great Recession, the succeeding Conservative-Liberal Democrat Coalition government in 2010 pursued misguided, ideological heavy-handed austerity in the form of VAT and income taxes increases, as well as severe spending cuts.
The result has been a shorter 2008-2009 recession due to the stimulus followed by paltry growth, high unemployment, a double-dip recession and declining revenues. Just last week, it was announced the UK’s public sector borrowing requirement is expected to be higher this year than forecasted as the fiscal deficit widens. Unfortunately Barbados’ approach has also been to increase taxation, thus dampening demand and yielding stagflation.
Though the global recession ended two years ago, its effects still linger. The global economy, particularly the industrialised economies, has entered a period of slow growth which is likely to continue for another two years. Notwithstanding the international environment, the next Barbados administration will have to find a way to reduce the fiscal deficit responsibly while building a foundation for sustainable economic growth and development. Both political parties must audition comprehensive economic plans to the people of Barbados during the upcoming general election campaign as the nation yearns for a brighter tomorrow.
Carlos R. Forte is a Commonwealth Scholar and Barbadian economist with local and international experience. C.R.Forte@gmail.com