Spend, spend, spend for prosperity

Nobel Laureate Joseph E. Stiglitz offers fine advice to debt-ridden nations.

In an article titled ‘The Way out of Debt? Spend, Spend, Spend’ to the Newsweek Special Edition of December 2010, he suggests that the debt-ridden West should spend more, and not less, to get out of debt and into eventual prosperity.

This piece of advice is in sharp contrast to what these nations had been following ever since they were hit by an unprecedented debt trap: introducing bold, but politically unpalatable austerity measures.

Stiglitz, the rebel

Stiglitz, the rebel in economists’ family, has been famous, sometimes notorious too, in suggesting nonconventional prescriptions to global economic maladies. After a short stint as the Chief Economist at the World Bank, he disagreed with his colleagues and even went to the extent of suggesting that the Washington Twins, the World Bank and IMF, have been infested with economic fundamentalists who acted as if being oblivious to emerging ground realities.

The subtitle of the article ‘Spend, Spend, Spend’ would have been borrowed from the traditions of the East. It is the Eastern way to spell something thrice so as to emphasise its importance and make it eventually happen.

Stiglitz’s prescription

Stiglitz’s argument is simple enough.

Global interest rates, driven by the excess global liquidity, are at their lowest today. Hence, the countries should borrow more, spend it on wealth creating projects which they may have postponed earlier due to high borrowing costs and create wealth, jobs and economic prosperity. Any cut down in expenditure, at this juncture, would harm the ongoing job creating initiatives and thus prolong the economic recovery.

To support his argument, he draws a parallel from a private business person.

A private business person, he argues, may find himself in an advantageous position if he could borrow substantial sums of money at a low long term interest rate, say 2.5 per cent. If he had a backlog of projects which could have earned him, on average a rate of return of 20 per cent, he would be foolish to pass up the opportunity. Even if he had been pressed by considerable debt already, his financial position would definitely improve if he starts new projects that yield him high returns.

Kautilya’s advice: Use wealth to create more wealth

Hence, to attack debt, get into more debt, but with a difference: debt that pushes up the borrower’s financial position making him able to repay even the old debt.

A conservative economist may find this prescription to be outrageous. But, the third century BCE Indian economist, Kautilya, has said in his treatise on economics, ‘The Arthashastra,’ that “just like elephants are used to catch more elephants, wealth should be used to create more wealth”.

But, Kautilya’s wealth was not borrowed wealth. It was the wealth accumulated through austere means: Spend less and save more. In Kautilya’s time, budgets were surplus budgets and it was only through surplus budgets that a king could build up his treasury and become a powerful monarch.

Global debt problem

But today, domestic as well as global capital markets have enabled the world nations to borrow, spend more than the revenue and still live without getting into serious debt problems. That was how many world nations were able to raise their public debt portfolios to significantly high levels compared to the size of their domestic economies and continue with deficit budgets.

According to projections by IMF, the debt levels of leading nations would rise further if allowed to grow unchecked. The following numbers give some flavour of the extent of the current debt problem in leading nations by end 2011: France, 88 per cent of GDP; Germany, 77 per cent; Greece, 139 per cent; Italy, 120 per cent; Japan, 234 per cent; UK, 82 per cent; USA, 99 per cent; and India, 71 per cent. The comparable figure for Sri Lanka in 2011 is closer to 80 per cent.

Despite the above high debt profiles, Stiglitz has concluded that there is no harm in these countries continuing to borrow and spend such borrowed funds on high yielding projects. It would generate new revenue and that would be the way to get out of the current high debt problem.

Why Stiglitz may be wrong

In my view, Stiglitz’s logic suffers from the following shortcomings.

It is like advising a diabetic who has got into his problem by consuming sweets excessively in the past that he should consume more sweet now because it will help him to retain his energy level, work harder and get out diabetes eventually. The root cause of the problem, in this case sweet, has been viewed as the solution too.

The question is whether a nation can borrow-spend into prosperity when it is hit by an economic recession.

The ghost of Keynes

Yes, according to Keynesians and some of the leading policy makers advocating stimulus packages. The logic is that a country is in recession because its output is not demanded by consumers. So, give money to citizens by way of direct cash subsidies, tax cuts and tax refunds and expenditure through government projects.

The citizens will use that money to buy goods and services thereby creating an increased demand for the output. The producers, observing the new opportunities available to them, will step up production and in the process generate employment, wealth and economic prosperity. Since this is a ‘quick-fix’ method, it is naturally sweet music to politicians, policy makers and economic theoreticians. Hence, in the post second world war period, many countries, in both developing and developed world, pursued it as the best way to generate economic growth and improve the living conditions of their people. For instance, Sri Lanka which had budget deficits on average of 7.5 per cent of GDP year after year in the whole of the post independence period except 1954 and 1955, has offered continuous stimulus packages to its citizens by borrowing and spending.

The objective was to lead the country out of poverty. But, the result has been the opposite: low economic growth, less than five per cent on average and high inflation above 11 per cent throughout this period.

Singapore’s Rejection of Keynesianism

But some countries did not consider Keynesianism as the way out. The best example comes from Sri Lanka’s neighbour to the East, Singapore.

Its first Finance Minister, the late Dr. Goh Keng Swee, has explained why Singapore’s leaders did not succumb to the then popular Keynesianism when they crafted their economic development strategies in late 1960s.

In an article titled ‘Why a Currency Board?’ in the Silver Jubilee Commemorative Volume of the Singapore Currency Board, Swee explains their position as follows: “None of us believed that Keynesian economic policies could serve as Singapore’s guide to economic wellbeing. Our economy was and is both small and open. Financing budget deficits through Central Bank credit creation appeared to us as an invitation to disaster. There was no effective way of exchange control in an open trading economy like ours to deal with inevitable balance of payments troubles.”

Swee then goes on to explain the hard truth. “Another contributing factor was the world outlook of my colleagues – the old guard as they are now called. We grew up under difficult conditions and did not believe anybody owed Singapore a living. The way to better life was through hard work, first in schools, then in universities or polytechnics and then on the job in the work place. Diligence, education and skills will create wealth, not Central Bank credit.”

Stiglitz recommends borrowing and spending

The only difference in the Stiglitz’s prescription is that he has substituted capital market borrowing for central bank credit. But, then can all nations borrow simultaneously from the capital markets and create economic prosperity?

Cost escalations may need more borrowing

The answer to this question has two sides. While a private business person can borrow-spend into prosperity without distorting his cost structure, not all private business persons or a nation can do it simultaneously. A nation may have a backlog of projects as Stiglitz has argued. But, when you start all of them together, there is a big competition for inputs – skilled labour and natural resources – pushing their prices up.

The cost structure goes up requiring the project implementers to borrow continuously to keep the projects afloat. If for some reason funding dries up, the much valued projects have to be abandoned midway. In Thailand just before the East Asian economic crisis of 1997, there were many such projects – skeletons of partly-constructed sky scrapers and theme parks – scattered all over Bangkok.

Does ‘supply create its own demand?’

On the other side, Stiglitz’s prescription has not taken into account the demand side and its significance to the continuity of the projects. It has simply assumed that the consumption of the project’s output is automatic, a belief similar to the dictum of J.B.

Say that “supply creates its own demand”. In a restricted national economy, this may be true. But today’s economies are integrated to the global market and the demand for the output of one project will come from the consumers of a different nation.

If those consumers have not got the required purchasing power, the project may just sit waiting for the appearance of its clientele. Even the new incomes generated by the borrow-spend projects will leak out to other nations by way of increased imports, a malady about which Singapore was very worried, according to Swee.

Mexican debacle

Mexico did this mistake in the 1970s when interest rates in the capital markets were low. Looking at its rich neighbour to the north, USA, Mexico went on an infrastructure project spree by borrowing and spending.

It built modern ports, thinking that US ships that were liberally sailing the Gulf of Mexico will call. But ships did not call at the new ports at the expected rate and according to one cynic, “Some of the new ports were visited only by sea gulls.” By the early 1980s, signs were visible that Mexico could not repay its loans without borrowing more and in 1982 it had to default its foreign loans for lack of economic capacity to repay them.

So, the demand side of the projects is as equally important as the supply side, specifically when they are built out of borrowed money. If a nation does not get the capacity to repay foreign loans, the whole nation will have to default its commitments, paving way for creditors to impose much harsher conditions. At that time, austerity imposed on the nation by its creditors would be totally unbearable. This is exactly what happened to Greece and Ireland just six months ago.

Global excess liquidity needs to be burnt out

Interest rates are low today, as Stiglitz has noted, because there is a global excess liquidity. Global liquidity is created by nations like USA which have the responsibility for creating reserve currencies by following imprudent fiscal and monetary policies. They are called imprudent because they create new money and enjoy spending it but unwittingly pass its cost on to the nations which have to use their currencies as reserve assets.

The result is the inundation of the global markets with excess liquidity causing a gradual decline in the value of the currency and a fall in interest rates. This is like injecting the body of global economy with an alien virus paralysing its performance. So, the solution is not to inject it with more viruses, but to burn out the viruses already within the body causing it to ill perform.

A new meaning for hard work

The way to prosperity, as Swee has pointed out, is hard work. In my view, hard work today is multidimensional. On one side, it is stimulated by innovations brought about by expenditure on research and development. On the other side, it is facilitated by skills and competencies of the work force.

If a nation’s skills and competency base is low, no matter how much its government would borrow and spend, it cannot attain a sustainable growth. Since there is razor-edged competition among the global producers, the ability to produce at the lowest costs is a further dimension of hard work today. That comes from maintaining low inflation within the domestic economy, an output produced by prudent fiscal and monetary policies.

Hence, borrow and spend, as argued by Stiglitz, will act counter to creating an environment conducive for hard work by citizens. The main economic malady in many developing countries, including Sri Lanka, is this inability to maintain costs at competitive levels.

Hence, in my view, the Western nations have adopted the appropriate policy by going for austerity measures.

(W.A. Wijewardena practiced economics, taught economics and wrote on economics for more than three decades. He is a free lance writer and a consultant on economic matters. He could be reached on [email protected].)