Stimulus package – to do or not to do?

I had promised to write this week about the role in and implications of the Clico fiasco on the NBS and the NIS.  Unfortunately I am still trying to confirm some information which means that I could not present a full picture. Hopefully I can do so shortly. I apologise to readers for this.

Introduction

During the discussion on the 2009 budget which has all been forgotten in the wake of the Clico meltdown, some members of the private sector had even called for a stimulus package. The call came in the wake of the announcement by the Minister of Finance that Guyana’s real GDP grew in 2008 by 3.1% and projected growth in 2009 was 4.7 %, compared with average growth in the rest of the world of 0.5%. To realise its goal of a 6% growth in 2009 China is now planning a second stimulus package on top of the first package of US$600B. That Guyana can achieve its target without any such package must therefore mean that a miracle is taking place before our eyes. It makes the call by the private sector unnecessary and perhaps that is why we heard nothing further from the sector. So let us look at some other countries.

The new buzz

Stimulus package has become the new term in current economic lingo since President George Bush presented the initial package which was followed by President Obama’s US$800+ billion package after his assumption of the presidency. Using what has already become his legendary skills of persuasion, Obama has been urging world leaders to adopt aggressive, American-sized spending programmes. And indeed if we look at the number of countries that have introduced stimulus packages you would think there is general consensus about the virtues of such packages. In fact two of the greatest recoveries in modern economic history – FDR’s New Deal and the Marshall Plan − are held up as proof of their great virtue.

Those to have adopted such packages recently include Canada, a country which has run a federal surplus for the past twelve years but has announced a sweeping stimulus package of tax cuts and new spending that will push the federal budget into a US$28B deficit; Australia whose package is worth US $27B, while Malaysia’s package of US$16.2B was described as unprecedented in the nation’s history. But both in absolute dollars and expressed in terms of GDP the US, China and Germany in that order are the countries that are investing the most in stimulus packages, some more than once. Interestingly India where politics trumps economics is the big country with the smallest package expressed relative to GDP.

Cynics

With this kind of evidence you would think that everyone would jump on board the stimulus bandwagon. If you do you would be ignoring the politicians and the many-handed economists. It may be unfair to the Republicans to say that they voted almost unanimously against Obama’s stimulus purely on the grounds of partisan politics. Part of it may have to do with ideological differences they share with economists who start with the proposition that there is a range of packages – from the various forms of getting money into the hands of the consumer to direct spending by the government and to monetary policy.

Those who argue the case for fiscal stimulus say that with more money in consumers’ hands, more goods and services would be bought and there would be less need for companies to lay off workers, leading in turn to less demand.

George Bush’s package was based on such a theory. US Republican vice presidential candidate Sarah Palin who temporarily dazzled voters with her charm offered what appeared to be the simplest form of stimulus package: dropping money from the sky into the hands of voters/consumers. That has generally been dismissed because the evidence – or at least this is the conventional wisdom – is that such sums are saved rather than spent, defeating the whole purpose of such a package.

There is now emerging a consensus however that compared with monetary policy, fiscal policy is an ineffective tool in combating recessions. Monetary policy emphasises the ability of the central bank to make more money available − thereby increasing demand − by lowering interest rates. But this too is no guarantee since even with a more liberal monetary policy the banks may still be unwilling to lend and entrepreneurs may prefer to wait out the crisis before retooling or going into new plant and machinery. It would have been good to hear the Bank of Guyana’s views on the matter of interest rate and its role on the level of such rates.

Clash of the Titans

Then there is government spending with the potential to take the budget into (bigger) deficit. As we are seeing with the US, this can pose enormous problems. Obama may be able to convince Americans that his package is necessary, inevitable and the best. But America is the world’s largest debtor nation and no less than the Prime Minister of its major creditor country, China, has just expressed its most direct fears about its trillion dollars investment in US Government bonds and more indirectly about the US’s stimulus package. For the giants it is a clash of culture with the US believing in spending and borrowing while the Chinese are known for thrift and savings.

But it is not only China that has expressed reservations about the US’s approach to the problem. Europe’s position is more contentious with their finance ministers rejecting, ahead of the G20 meeting in London next month, Obama’s call for a two-pronged G20 effort to fix the global economy: stimulus measures and regulatory reforms. In a statement issued through their Chairman, Luxembourg Prime Minister Jean-Claude Juncker, they said the call for more pump-priming by other G20 economies did not suit them.

Juncker noted, “The European recovery programme represents a spending level of 3.4 to 4.0 percent of GDP,” and their “public finances are beginning to suffer.” He could have added that there is no unanimity in the EU either as the differing attitudes to such packages in Spain, England, Italy and Estonia show.

There is a real dilemma since no matter how much is spent domestically if there is no consensus and no uptake in world demand, domestic spending could hardly make up for the slump in exports as world demand evaporates and foreign direct investment (FDI) declines.

Poorer countries

If the big countries cannot come up with the solution then smaller ones are in for a rough ride. No small country can, even if it had the financial resources, spend itself out of this recession. Take Guyana as an example. It has already placed too many of its cards on sugar and rice and does not have many more to play.

Parliament seems to be heading to take on a multi-billion dollar obligation with Clico and our budget deficit as a percentage of revenue is a huge 23%. If we exclude grants the percentage is a staggering 42%. Our public debt is climbing inexorably while internal and external factors threaten our main exports. We face falling FDI and reduced remittances. We are burdened by high taxation and cannot be taxed any more. We will either have to draw down on our international reserves or borrow more. These are not easy options.

It is true that our 2009 budget is unlawfully inaccurate. It has no income from the politically controlled Privatisation Unit/NICIL or the Jagdeo-controlled Lotto Funds. It also excludes the PetroCaribe funds. But it seems that we have to live with such imperious illegalities.

If we look at all the recent budgets we have had essentially the effect of stimulus packages – each year spending well more than we can afford in the hope that we will achieve our goal and see a surplus in the national budget; each year boasting about the biggest budget ever, a trend that now has its own momentum.

Yet, our idea of spending is huge sums on the capital budget much of which goes directly to a handful of contractors and big ticket projects. Physical infrastructure takes priority over education, and even in health unnecessarily large amounts are spent on unlawful drug-purchase contracting.

The Caribbean is suffering badly from the crisis with retailers in the tourist economies reporting a decline in revenue of 15-20%. The energy-based Trinidad is experiencing year-on-year reductions within the same range, affecting the ubiquitous roadside vendors and even the pampers manufacturer. Trinidad which bases its budget on the price of oil has announced two budget cuts affecting in the first instance its capital programme.

No one knows what, if anything the IMF may be saying to the Government of Guyana about stimulus. But the private sector has to be careful what it calls for. To ask a spendthrift to spend more of your money is to invite trouble.

I am sure that is not what we need or they intended. What we need is a tax cut for the poor who in any case are being cheated on VAT, and better financial management.