E – mail address: cythomas@guyana.net.gy
Readers requests
Eight years ago the then SN editor-in-chief, David de Caires, ask-ed me to contribute a regular Sunday column under the general rubric: ‘Guyana and the Wider World.’ Over the years events in Guyana and the wider world have changed so rapidly and dramatically that it has demanded surprising nimbleness on my part just to keep writing about the most pressing issues of the day.
In this regard, last week I had promised to conclude my discussion of the present global crisis, with a discussion on the policy lessons that could be drawn for countries like Guyana in contending with future crises. I had identified three areas for future discussion: 1) the use of stimulus packages 2) innovations in social protection and welfare schemes designed to ease the distressing negative impacts of crises on the poor and powerless, and 3) the implications for future international trade policy and practice.
While several readers have indicated that they look forward to these articles, I have also been bombarded with requests from others to engage two different topics, immediately. One is that, in light of the revelations from the Roger Khan and Robert Simels cases, I should revisit my earlier analysis of the “criminalization of the state” advanced in these columns six years ago (March-September, 2003). The other is for me to evaluate the low carbon development strategy (LCDS).
The truth of the matter is that I had intended to treat with both topics after completing my examination of the crisis; the reason being that these are very contentious topics and will each occupy several Sunday columns. To divert now to deal with them, therefore, runs the risk that I might never get back to concluding the discussion of the global crisis. Most likely, other important matters will emerge during the next few weeks. This type of interruption has happened before, with a similar result.
Instead, what I shall do is to discuss the three topics listed above very summarily, and then proceed to address the two topics suggested by readers, in the order listed. I hope this compromise satisfies most readers, particularly as the two requested topics will be with us for a very long time.
Stimulus packages
The Obama administration’s policy response to the US economic crisis has made the notion of a ‘stimulus package’ one of the most readily recognised economic policy measures globally. Basically, a stimulus package refers to efforts by government to stabilise/stimulate the economy, through manipulation of its overall level of spending and taxation. This differs from the other option available to the authorities of using monetary measures. These latter rely on central bank control of the supply of money and the price credit (interest rate) to influence private expenditure and income flows in the economy in order to stabilize/stimulate it.
Monetary and fiscal policies impact the economy through changes in: 1) domestic consumption and investment, as well as purchases of goods and services from abroad 2) the relative prices of goods and services in order to alter the pattern of resource allocation and 3) the distribution of income between groups, classes, and other categories of income recipients.
Stimulus packages aim at a net increase in government spending. Fundamentally this requires more government spending than government increases in taxation receipts. If the government spends more but finances all the increased spending from increases in taxation, there is no net expansionary impact on the level of economic activity. The combination described here is called budget neutral. There is no net stimulus effect.
Similarly, if government spending increases, but taxation increases by a greater amount, then the net effect on the level of economic activity is contractionary. We have to be careful therefore, always to assess both changes in government spending and revenue from taxation to determine if, and by how much, a stimulus package offers a real stimulus.
In other words, if the Guyana government plans to spend more to stimulate the economy because of the global crisis and at the same time intends to finance this spending from increases in VAT revenues, then the net effect on the level of economic activity from overall spending and taxing will be zero.
Unpardonable sin!
Stimulus packages that intend a net increase of government’s overall activity in the economy are usually associated with deficit financing. To many conservative theorists, as we can observe from the criticisms of the Obama’s stimulus packages in the US, expanding the public deficit is an unpardonable sin. The truth, however, is more complicated than this. While deficit financing expands government liabilities and so poses a number of risks, including the risk of inflation, we must remember not to look only at the government liabilities created by the stimulus. We have also to observe what assets are being created through the deficit spending. If the assets created improve productivity, growth, investment and employment, then the economy can ‘afford’ to increase its liabilities. Indeed, it is made better off because of it.
For most of the years since the late 1970s the mantra preached to poor developing countries has been that, if they were negatively impacted by global crisis, they should pursue contractionary fiscal policies. That is, the budget should operate in the direction indicated by the global crisis. That is, government policy should be pro-cyclical.
Counter-cyclical
Stimulus packages operate against this principle. They seek to stimulate the economy when the global impact is contractionary. Such policy stances are termed counter-cyclical. They seek to expand the influence of the government on the level of economic activity as a counter to recessionary/depressionary influences.
Domestically, recessionary/depressionary influences stem mainly from declines in exports, private consumption and investment expenditures, or a combination of all three. There are therefore two overriding binding constraints on stimulus packages. One is the balance on the country’s external accounts.
All changes in the level of economic activity affect both exports and imports of goods and services. If there is a sizeable deficit between what the country receives from overseas sales as compared to what it spends on overseas products, then its ability to engage in a fiscal stimulus package is severely constrained.
By similar parity of reasoning, if the country planning a fiscal stimulus package already has a large unsustainable budgetary deficit and/or high levels of public indebtedness (external and/or internal) than its capacity to do this is also severely constrained. Unfortunately, the large majority of Caricom economies face one or both of these binding constraints. Their capacity to engage in meaningful stimulus packages is very limited.
In conclusion, we may say that, while the policy space now being afforded to poor countries to pursue countercyclical policies in today’s world is to be welcomed, their capacity to effectively follow this course is severely constrained.
Next week I shall wrap up this discussion on facts and fables behind stimulus packages.
