A galaxy of well-known economists is pondering the vexed question of the preferred policy option in the context of world economic recovery — fiscal consolidation or not, and if not now, then when? The recent G-20 meet has agreed on ‘growth friendly’ fiscal consolidation plans for the advanced economies, going forward. And yet, in view of serious concerns about the pace of economic recovery, economists and others are slinging mud at each other on the issue of what exactly is ‘growth friendly’, and whether it is as yet time to withdraw the fiscal stimuli in advanced and other economies.
What do the two sides in apparent opposition assert?
Economists supporting extension of the fiscal stimulus believe that the fact of low long-run Treasury rates, in both the US and the UK, reflect confidence in these economies; that there is as yet no indication of inflationary trends; that the growth rate of most economies is far below any plausible level of peak economic activity; that unemployment figures continue to be high; that there is continued shortage of demand; that scope for utilisation of monetary policy for promoting growth is limited; and that the recession may worsen if private spending does not go up.
Those advocating fiscal austerity have wondered whether it is possible that government spending in itself is a weak lever to counter economic cycles. Also, could debt-fuelled government spending be destroying the confidence of markets? Finally, are rising fiscal deficits contributing to private sector fears of future fiscal crises and tax increases?
Given this background, what is the preferred policy option at this juncture, and, is deficit spending always the preferred option in a recessionary or low-growth situation? If yes — the answer provided by John Maynard Keynes — how long should it be continued? Or, are there situations of slow growth in which measures other than deficit spending can work equally, if not more effectively?
Peering below the surface of the Keynesian remedy of deficit spending and counter-cyclical policy to boost demand provides scope for reflection. While Keynes is identified with fiscal prescriptions as a remedy for unemployment, what is perhaps often overlooked is why he prescribed this. Was it simply a mathematical identity that he was trying to ensure, and thereby suggesting public spending to meet the shortfall in private spending, when there was a shortfall of total demand in an economy?
Or was public spending playing some other less visible role, perhaps akin in some indirect way to the ‘invisible hand’ of the market? Was this expenditure, even through deficit spending where necessary, contributing in some way to holding, perhaps indirectly, the invisible but occasionally doddering hand of the market?
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In case the answer to this question is in the affirmative — which appears to be the case, as understood through reference to some of Keynes’ own works — then his prescriptions have to be viewed in the light of the role that they are expected to play. Keynes pointed out that his prescription for unemployment was designed expressly to counteract the growing threat of socialism and communism. Therefore, his prescription was clearly more than a simple device to enable balancing of a mathematical equation, where total demand was the sum of public and private demand. Public demand was intended to step up private demand by building up faith in markets, and not by substituting private spending with public demand.
If in today’s situation, private demand, in the form of both consumption demand and investment demand, is refusing to respond to the stimulus in the form of public spending, then before pumping more money into the system, there is need to examine in greater depth why this is the case. Perhaps the role that Keynes in his brilliant treatise expected it to play is not being played out.
In fact, reference to the original work of Keynes on this subject, while shedding light on the possible role of public spending, also helps in reconciling the apparently contradictory viewpoints with respect to the need for fiscal expansion versus fiscal austerity, or put differently, on the timing of the fiscal withdrawal, which is a relevant concern at this juncture.
Before arriving at the remedy of deficit spending to counter unemployment, Keynes elaborated at great length, and in a profound manner, on the important role of short- and long-term expectations of firms, while they take the decision to invest or not. He emphasised the crucial role of confidence in shaping the schedule of marginal efficiency of capital. However, he added that nothing could be said a priori about the state of confidence. Our conclusions must depend on actual observation of markets and business psychology. Keynes also emphasised that recovery required revival of both — of lending institutions towards those who seek to borrow from them, and the confidence of those who needed to borrow.
The two apparently contradictory positions mentioned earlier also come close to reconciliation, when public spending is viewed, as a means, not merely of boosting volumes of expenditure and resultant demand, but by trying to understand the role that public spending can play in holding the invisible hand of the market. If the role of public spending is understood as that of building confidence in the ability of markets to function freely, then public spending will need to convey that message suitably, and in a manner where it does not convey the opposite by over-extending itself.
Possibly, what is needed is to carry forward the analysis in the General Theory of Keynes to discuss the nature of public spending that would build confidence of businesses and firms in their own abilities and in that of markets and economies. A new theory of the ‘invisible hand of government’, somewhat akin to the invisible hand of the market, which would define how far and in what manner governments can and should go in order to build confidence of markets, so as to enable them to function on their own without disturbing their ‘integrity’, is the need of the hour. The invisible hand of the market combined with the invisible hand of the government can then go on to provide the Midas touch to economies and lives across the globe.
Capitalism would then have been preserved, perhaps without the undue volatility and cyclicality that it is at present associated with. Questions on how much to spend and for how long would also get answered as part of the extended theory that one hopes will get propounded. One hopes that the Institute for New Economic Thinking, about which this writer has written earlier on this page, would be working towards the magic wand, and the Midas touch!
The writer is a civil servant. The views are personal