Unfounded Debt Fears Block Economic Recovery

Anis Chowdhury and Jomo Kwame Sundaram

Debt anxieties are not new, often fanned by political competition. But so is a double dip recession due to premature deficit reduction. For example, to seek re-election, President Roosevelt backed down from his New Deal in 1937, promising that “a balanced budget [was] on the way”. In 1938, he slashed government spending, and unemployment shot up to 19 per cent.

Deficits and debt

Many countries had huge public debts when World War II ended. Despite such anxieties and calls for drastic spending cuts, governments continued to spend. Had they caved in, Europe would not have been rebuilt so soon. As governments continued with massive expenditure to rebuild their countries, economies grew and the debt burden diminished rapidly with rapid economic growth. Clearly, debt is sustainable if government expenditure enhances both growth and productivity.

When the debate about deficits and public debt was raging during the Great Depression, Evsey Domar, growth theory pioneer, noted, “Opponents of deficit financing often disregard … completely, or imply, without any proof, that income will not rise as fast as the debt … There is something inherently odd about any economy with a continuous stream of investment expenditures and a stationary national income.”

After the 2008-2009 financial meltdown brought many OECD economies to a standstill, there was a brief revival of fiscal activism. Many OECD governments initially responded with large fiscal stimulus packages, while bailing out influential financial institutions. Major developing countries also put in place well designed fiscal stimulus packages including public infrastructure investment and better social protection.

Hence, there were sudden increases in debt/GDP ratios, mainly due to large financial bail-out packages and some fiscal activism. But with the first hints of “green shoots” of recovery from mid-2009, fiscal hawks stepped up their calls for winding back, sounding dire warnings about ballooning deficits. They argued that rapid fiscal consolidation would boost confidence, particularly in the finance sector, creating an expansionary impulse.

Thus, the affected countries undertook rapid fiscal consolidation measures with large cuts in public expenditure, especially in the areas of health, education, social security and infrastructure. Yet, their debt-GDP ratios continue to rise as they struggle to reignite growth. Meanwhile, the IMF has admitted that its initial fiscal consolidation advice was based on erroneous ad-hoc calculations.

Overwhelming recent research findings, including from the IMF, indicate that discretionary counter-cyclical fiscal policy in recessionary periods augments and catalyses aggregate demand, encourages private investment and enhances productivity growth, instead of raising interest rates and crowding-out private spending.

Optimal debt-GDP ratio?

The fixation with a particular debt-GDP ratio lacks any sound basis. The 60 per cent debt-to-GDP ratio, used by the European Commission and the IMF as the upper threshold for fiscal sustainability by 2030, was simply the median pre-crisis ratio for developed countries and the median debt-GDP ratio of EU countries at the time of the Maastricht Treaty. Similarly, the 3 per cent budget deficit rule of the EU happened to be the median budget deficit ratio at the time of the Treaty. None of these ostensible bench-marks imply optimality in any meaningful, economic sense.

Public debt in Japan soared to well over 200 per cent of GDP over two and a half decades of deflation. Yet, interest rates have remained low for many decades. In 1988, Belgium had the highest public debt, and Italy’s debt rose above 100 per cent of GDP during this period. Neither of them experienced spiraling inflation or very high interest rates as ‘austerity hawks’ claim will happen when government fiscal deficits rise. Meanwhile, studies of public finance in the United States do not find any significant relationship between debt-to-GDP ratios and inflation or interest rates during 1946-2008.

However, real interest rates may be adversely impacted by whether the debt is denominated in domestic or foreign currencies. In other words, a sovereign country should have the option to monetize debt. The problem arises when that option does not exist, as with countries in the Euro zone. This is clear from the contrasting experiences of Spain and the UK during the recent rapid public debt build-up.

The UK public debt-GDP ratio was 17 percentage points higher than the Spanish Government debt (89 versus 72 per cent) in 2011. Yet, the yield on Spanish government bonds rose strongly relative to the UK’s from early 2010, suggesting that international bond markets costed Spanish risk much more than UK government bonds.

As a member of a monetary union, Spain does not have control over the currency in which its debt is issued, while UK public debt is mostly in its own currency, as in the US and Japan. Therefore, much of the problem in the Euro zone is not really about high public debt or deficits. Rather, it is rooted in the currency union that limits its members’ policy space with regard to money creation and exchange rate policy. Hence, the only way they can improve what is seen as competitiveness is by cutting wages!

Then and now

Since 2014, even the IMF has changed its stance. In its October 2014 World Economic Outlook, it advised that “debt-financed projects could have large output effects without increasing the debt-to-GDP ratio, if clearly identified infrastructure needs are met through efficient investment”.

There is, of course, one difference between now and the 1930s. The finance sector and rating agencies are much more influential and powerful now than then. Democratically elected governments have become hostage to money-market investors who shift money from one place to another in search of quick profits.

Governments should not be driven by superficial diagnoses of complex economic issues by rating agencies. The record of rating agencies before the 2008 global economic crisis was abysmal, and the US Congress has seriously debated whether they should be prosecuted. Trying to win their confidence is futile, and trying to anticipate them is hazardous, but they nevertheless hold finance ministries and central banks to ransom.

Originally published by Inter Press Service.

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What We’re Writing, What We’re Reading

What We’re Writing

Bofeng Cai, Xin Bo, Lixiao Zhang, James K. Boyce, Yanshen Zhang, Yu Leif, Gearing carbon trading towards environmental co-benefits in China

Martin Khor, A toast to the right to development

Sunita Narain, Redefining gender issues and conservation

Matias Vernengo, On the Recent Productivity Slowdown (at the Rick Smith Show) (audio)

Tim Wise, Rules, Rights, and Resistance: The Battle Over TPP and TTIP – Session 3: Health and Food (video)

What We’re Reading

Stop Austeridad, Ending austerity policies to open a new time in Europe

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Robert Pollin, The Green Growth Plan to Climate Stabilization

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Enforcement of Puerto Rico’s Colonial Debt Pushes Out Young Workers

“Compromise” protects vulture funds, not Puerto Rico

José A. Laguarta Ramírez

At least 23 of the 49 people killed in the mass shooting that took place at Pulse nightclub in Orlando on June 12 were born in Puerto Rico. While the horrendous hate crime targeted LGBT people of all ethnicities, the large proportion of island-born casualties is not surprising, as the central Florida city has become a preferred destination of Puerto Rican migrants over the past two decades. Steadily growing since the onset of the island’s current “fiscal” crisis in 2006, yearly out-migration from Puerto Rico now surpasses that of the 1950s. The island’s total population has begun to decline for the first time in its history.

Nearly a third of the island-born victims of the Orlando massacre were 25 or younger, most of them students employed in services or retail. This is the population group that will be hit hardest when the ironically named Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA) comes into effect. Among its other “promises” for working-class Puerto Ricans, PROMESA will cut the minimum wage in Puerto Rico for those under 25, from the current federally mandated $7.25 to $4.25 per hour, and scale back the federal nutritional assistance program on the island. Purportedly aimed at “job-creation,” these measures will likely intensify the outflow of able-bodied “low-skilled” workers. Ongoing out-migration has already decimated the number of available healthcare and other professionals on the island. Puerto Rico’s 2013 median household income of $19,183 was barely half that of Mississippi, the poorest U.S. state (at $37,479), despite a cost of living that rivals that of most major cities in the United States. Inequality on the island is also greater than in any of the states.

The U.S. House of Representatives approved PROMESA on the evening of June 9, following a strong endorsement by President Barack Obama. The bill, which would also impose an unelected and unaccountable federal oversight board and allow court-supervised restructuring of part of the island’s $73 billion debt, now awaits consideration by the Senate. Its advocates hope the president can sign PROMESA into law before July 1, when $1.9 billion’s worth of Puerto Rico general obligation bonds will come due. Unlike those issued by public utility corporations and certain autonomous agencies, general obligation bonds, under Puerto Rico’s colonial constitution, must be repaid before any further public spending for the following fiscal year is authorized. Puerto Rico’s government has partially defaulted three times within the past year, but not on general obligation bonds. Puerto Rico is not the only place, under the global regime of austerity capitalism to face predatory creditors and the imposition of unelected rulers —as illustrated by cases like Argentina, Greece, and post-industrial U.S. cities such as Flint, Mich.— but its century-old colonial status has made it particularly vulnerable and defenseless.

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The Global “New Normal” Is Not New– But it is still a real concern


C.P. Chandrasekhar and Jayati Ghosh

Many different explanations have been proffered for the “new normal” of “secular stagnation” in the global economy ever since the Great Recession. This is supposed to be exemplified by low growth, verging on stagnation, in the advanced economies, now combined with slower growth in the developing world.

Certainly the recovery from the Great Recession of 2008-09 has been anaemic at best, even as it has failed to generate much employment outside of the US (and even there it has created mostly casual, part-time and poor quality jobs). Deflation has persisted in Japan for many years now, and has become evident in the Eurozone and the US as well. Financial markets are febrile and display nervously erratic behaviour, often without proximate cause – such as in the recent collapse in bond yields across the advanced economies.

But purely in terms of GDP growth, are the last five years really so very different from past patterns of global capitalism, even compared to the supposedly more dynamic period of globalisation? Chart 1 tracks annual GDP growth in developed and developing/transition economies from 1990. The period from 2002 to 2007 does show acceleration of growth across economies, but that came to end in the collapse of 2008-09, and since then GDP growth rates have been similar to those of the 1990s.

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Facing Up to the World’s Health Crises

Martin Khor

The global health situation is facing many critical challenges, and urgent action is needed to prevent crises from boiling over. This is the impression one gets from this year’s World Health Assembly (WHA) in Geneva last week.

The WHA is the world’s prime public health event, attended by 3,500 delegates, including Health Ministers from most of the 194 countries.

In her opening speech, World Health Organisation director-general Dr Margaret Chan gave an overview of what went right and what is missing in global health.

First the good news: 19,000 fewer children dying every day, a 44% drop in maternal mortality, the 85% cure rate for tuberculosis, and 15 million people living with HIV now receiving therapy, up from just 690,000 in 2000.

Then Chan described how health has become a globalised problem, with air pollution becoming a transboundary health hazard, and drug-resistant pathogens being spread through travel and food trade.

The recent Ebola and Zika outbreaks showed how global health emergencies can quickly develop. The world is not prepared to cope with the dramatic resurgence of emerging and re-emerging infectious diseases.

Chan said the global health landscape is being shaped by three slow-motion disasters: climate change, antimicrobial resistance and the rise of chronic non-communicable diseases.

She described these as man-made disasters created by policies that place economic interests above health and environmental concerns.

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And Now, Price Deflation in India and China?

C.P. Chandrasekhar and Jayati Ghosh

Ever since the Global Financial Crisis, advanced economies have been grappling with the spectre of deflation. While this was very clearly a reflection of the downswing in economic activity in the aftermath of the crisis, such price deflation has proved remarkably impervious to the most expansionary monetary policies and liquidity expansion that the world economy has yet seen. This has had adverse consequences in terms of producers’ expectations, which in turn have kept investment low. It has not benefited working people because wages have stayed low or continued to fall. And it has generated tendencies of the debt deflation-type that Irving Fisher had warned against, whereby the real value of debt and of debt servicing keep rising because of falling prices, and make it harder for debtors to deleverage or to increase their spending.

All this has been true of the developed economies at the core of global capitalism for some years now. But in general it was presumed the developing countries, especially the more prominent emerging markets, were less prone to such tendencies. Indeed, because the developing world as a whole continues to grow faster than the North, and because some large emerging economies like China and India continue to experience recorded GDP growth rates of 6 to 7 per cent, it was perceived that they would also have inflation rates that would show rising or stable prices. In countries such as India that are still hugely affected by agricultural cycles affecting food prices and other forms of sectoral supply bottlenecks, there seemed to be no reason for prices to fall, beyond the secondary impact of the global fall in prices of primary commodities like oil.

However, it now appears that this too was a misconception about the new economic patterns emerging in the Global South, including in economies like those of China and India. Recent trends show a remarkable – and worrying – convergence of producer prices in these countries with those in the advanced economies, where price deflation has become rampant.

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What We’re Writing, What We’re Reading

What We’re Writing

C.P Chandrasekhar, No Clue to the Furture

Martin Khor, Facing Up to the World’s Health Crises

Sunita Narain, Garbage is About Recycling

Léonce Ndikumana and Mare Sarr, Capital Flight and Foreign Direct Investment in Africa

What We’re Reading

Pablo Bortz, A Novel Capital Controls Proposal

Arthur MacEwan, Do Trade Agreements Foreclose Progressive Policy?

Robert Pollin, The Green Growth Path to Climate Stabilization

Argeo Quiñones-Pérez and Ian Seda-Irizarry, Politics, Primaries, and Crisis in Puerto Rico

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The Trans-Pacific Shell Game

Jomo Kwame Sundaram

The Trans-Pacific Partnership (TPP) trade agreement is being portrayed as a boon for all 12 of the countries involved. But opposition to the agreement may be the only issue that the remaining US presidential candidates can agree on, and Canada’s trade minister has expressed serious reservations about it. Are the TPP’s critics being unreasonable?

In a word, no. To be sure, the TPP might help the US to advance its goal of containing China’s influence in the Asia-Pacific region, exemplified in US President Barack Obama’s declaration that, “With TPP, China does not set the rules in that region; we do.” But the economic case is not nearly as strong. In fact, though the TPP will bring some benefits, they will mainly accrue to large corporations and come at the expense of ordinary citizens.

In terms of gains, one US government study on the topic projected that, by 2025, the TPP would augment its member countries’ GDP growth by a meager 0.1% at most. More recently, the US International Trade Commission (ITC) estimated that, by 2032, the TPP would increase America’s economic growth by 0.15% ($42.7 billion) and boost incomes by 0.23% ($57.3 billion).

But TPP advocates have largely ignored these results, preferring to cite two studies by the Peterson Institute of International Economics, a well-known cheerleader for economic globalization. In 2012, the PIIE claimed that the TPP would boost total GDP in member countries by 0.4% after ten years. In January, it declared that TPP would augment total GDP by 0.5% over the next 15 years. In a World Bank study released the same month, the authors of the PIIE research projected a 1.1% average increase in GDP in TPP member countries by 2030.

Something is clearly amiss.

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Societal Involution in the North

Jayati Ghosh

The term “involution” – which means to turn into oneself, or to shrink, or to reverse a process of evolving – may seem like a strange one to apply to societies. Yet that is the term that increasingly comes to mind when considering recent social and political trends in the United States and in some parts of Europe.

Consider the United Kingdom, currently in the throes of a heated debate before the referendum that will be held about whether or not Britain should stay in the European Union. Many issues and concerns have been raised on both sides, and politicians and business leaders inside and outside the country, from top financiers to US President Obama, have pitched in with their own views and warnings about the implications of “Brexit”. But within the country, public discussion appears to be focussed essentially on only one issue: immigration.

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