G-20 splits asunder
By Hossein Askari and Noureddine Krichene
At the Group of 20 summit in Toronto last weekend, the "G" in the G-20 all but
disappeared. Irreconcilable differences that were apparent before the gathering
were the highlight of the summit, namely, the effectiveness of growing fiscal
deficits in restoring global economic prosperity.
Three years into the financial crisis, policymakers and citizens in some G-20
countries have become disillusioned and dismayed by the worsening fiscal
picture and the lack of efficacy of unorthodox monetary policies. If the fiscal
picture deteriorates much further, it may be almost impossible for a number of
countries to climb out of the deep hole without social upheavals.
During much of the past decade, demand policies, supported by large fiscal
deficits and negative real interest rates, were blindly implemented in a number
of industrial countries. The objective
was to increase demand as the preferred policy of boosting employment. And in
spite of the worst financial crisis since Word War II, widespread bankruptcies,
and trillions of dollars in government bailouts, demand policies garnered
strong and unanimous consensus among the G-20 in the London and Pittsburgh
summits and were envisaged as the best way out of the financial and economic
crisis, with most of the G-20 countries embracing monumental fiscal deficits
never seen before in peacetime, near-zero interest rates, and massive
injections of liquidity through the purchase of toxic assets.
This blind unanimity came to a screeching halt before Toronto. Confronted with
deepening economic crisis and ruinous public debt, policymakers in Europe have
finally questioned the wisdom of these policies. Is granting large salary
increases to public servants a sound policy for increasing demand? For some,
economic waste, bank solvency and financial safety have had little or no
importance. The presumed virtue of demand policies pushed by the US seems to be
promoting short-run growth and employment, no matter how disastrous the long
At long last, European policymakers have discovered that rapidly mounting
public spending and fiscal deficits may not be sustainable and could in the end
be ruinous for a number of European countries. The public sector cannot simply
assume the bad debt of the private sector, and add bailout expenditures to its
ongoing fiscal obligations and expect that this would have with no effect on
its ability to borrow.
Such expenditures may have to be maintained for many years into the future
before full-employment can be reached. All the while, the distortions caused by
runaway government spending could be onerous and the financing of government
spending could be a challenge: resort to money printing or more and more
borrowing, at what cost and what for?
Proponents of Keynesianism see Keynes’ model as the easy way out of a
recession, with bigger and bigger fiscal deficits required in the chain of
financial and economic crisis that emerge.
In a recent Wall Street Journal article, titled "our agenda for the G-20",
White House economic adviser Larry Summers and Treasury Secretary Timothy
Geithner praised the success of Keynesianism in fighting the latest economic
recession in the US and in the rest of the world and urged their G-20
counterparts to continue down the road to nowhere that they had charted in
London and Pittsburgh:
In London last spring, the G-20 embraced an
unprecedented and coordinated strategy to end this crisis. In Pittsburgh last
fall, we established a new framework for global growth, and we designated the
G-20 as the premier forum for international economic cooperation. In Toronto,
we will take steps to ensure that the current recovery is self-sustaining.
Thanks to strong, decisive and coordinated action, President [Barack] Obama and
the other G-20 leaders have achieved significant progress since the London
meeting. The global economy, which was then contracting at an unprecedented
rate, is now expanding, and world trade has increased by more than 20% over the
last 15 months.
This turnaround has been especially dramatic in the United States. At the time
of the London summit, the US economy was shrinking at an annual rate of 6%. Now
it is growing at a rate in excess of 3% - the largest swing in US growth in 50
years. At the start of last year, the US was losing more than 700,000 jobs a
month, and today the private sector is generating new jobs. Recovery was only
possible because we took action to repair our financial system, driving down
borrowing costs for homeowners, consumers and businesses, and put in place the
Recovery Act, which increased demand by cutting taxes for families, helping
unemployed workers, and investing in public infrastructure.
To maintain the momentum of the US recovery, we need strong, balanced and
sustainable global growth. Global growth will help double US exports over the
next five years, supporting several million American jobs, a key goal of the
president's export initiative. The G-20 is critical to ensuring that global
growth. The G-20 must continue to work together to secure the global recovery
it did so much to bring about. We must ensure that global demand is both strong
While the US was the major source of demand for the world economic growth
before the crisis, global demand must rest on many pillars going forward. That
is why the G-20 must support Europe's reform program and the financing that
Europe and the IMF [International Monetary Fund] will provide to countries
facing acute fiscal challenges. We must demonstrate a commitment to reducing
long-term deficits, but not at the price of short-term growth. Without growth
now, deficits will rise further and undermine future growth. Emerging economies
can help strengthen the global recovery by strengthening domestic sources of
growth and by allowing more flexibility in their exchange rates.
The "success" of these policies cheerfully touted by Summers and Geithner for
the US and the world economy has been achieved through fiscal deficits in the
US exceeding 13% of gross domestic product (GDP )in 2008-2010, a temporary
bandaging of the financial system and bank bailouts to hide the real problem
(growing debt), and driving down the borrowing costs for homeowners, consumers
and business (near-zero interest rates and massive liquidity injections by the
What will happen when gigantic stimuli spending are phased out, when deficits
become overwhelming, and the burden of debt crushes the hopes and aspiration of
future generations? The answer has been provided by Keynes himself: in the
long-run, we are all dead, or apres-moi, le deluge.
In Europe, people are still alive and the consequences of fiscal follies are
unfolding. In the United Kingdom, elections brought to power a government that
is committed to rein in fiscal profligacy. Germany has firmly decided not to
stimulate its economy further. France has introduced austerity measures, with
Greece, Portugal, and Spain doing the same. Although steps in the right
direction, in time, these measures may be seen as insufficient.
Most poignantly, Jean-Claude Trichet, the European Central Bank president, has
recently deserted the Keynesian camp. He has argued that tighter fiscal
policies are the best way to foster growth in industrialized economies. Firm
control of government spending and a rational tax policy were essential for
restoring the confidence of households, business and investors. Trichet told
the European parliament: "We are in a situation where a lack of confidence is
operating against recovery. A budget policy which from a certain point of view
you might describe as restrictive is in fact a policy which we would call
confidence building." Trichet also urged eurozone governments to beef-up the
policing of fiscal policies in the 16-country region and impose tougher
sanctions earlier on countries that broke fiscal rules.
The gulf between US and European policymakers has become an ocean. European
policymakers are abandoning fiscal profligacy under forced conditions. No
matter what they have said to the US, Europeans cannot toe the US line anymore.
The US policy design is being rejected.
The US administration is contemplating another stimulus package. Besides
stimulating domestic demand, US policymakers have needed to propel exports,
which has been promoted by calling on other countries to maintain large fiscal
deficits. The US has been urging European countries to show commitment to the
G-20 London-Pittsburgh strategy and keep public and private spending rising.
Greece and other European countries with large deficits have been urged by the
US to maintain their deficits with financing from European countries that are
in stronger fiscal positions and the IMF. President Obama has stated that
withdrawals from London-Pittsburgh spirit would stall global economic recovery.
Summers and Geithner are politicians. They are only interested in the very
short-run. They have been urging G-20 countries, including those who suffer
large deficits and debt crises, to maintain fiscal expansion with support from
surplus countries and the International Monetary Fund (IMF). Fiscal
consolidation should be considered only in a very long run. They want to prove
that large government spending is working in creating jobs and full employment
will be secured.
The extent of cost, inefficiencies, and distortions of unorthodox fiscal
policies did not matter to them. How government debt is to be repaid, what will
be the inflationary implications, what will happen when at some point in time
when trillions of dollars of government programs are phased out? These issues
seem almost irrelevant to Geithner and Summers. European policymakers would
hardly be fooled by Summers-Geithner arguments. They have belatedly lost
confidence in fiscal extravagance and disavowed the London-Pittsburgh
prescription. The markets had lost confidence in G-20 policies much earlier by
rapidly deteriorating financial risk measures (the worst since the collapse of
Lehman Brothers) and sending gold to record levels in 2009 and recently to
close $1,300 an ounce.
The newly emerging market economy countries had to wake up in the 1990s and
learn that industrialization based on import-substitution and government
protection and subsidies caused decades of economic stagnation. It will take
G-20 policymakers years of stagflation before they will admit that large fiscal
deficits only accentuate distortions and economic inefficiencies. By trying to
fight deflation in August 2007 through large interest rates cuts and massive
liquidity injections, the US Federal Reserve pushed the US economy from
full-employment at about 4% to mass-unemployment at about 10% in 2009. By
forcing interest rates to near-zero bound, the US Fed is encouraging the
government to borrow and consume.
The G-20 meeting in Toronto was clearly different from previous G-20 summits.
Some governments have awakened to the damage caused to their economies and
financial systems by unorthodox fiscal and monetary policies and cannot afford
to continue down this path any longer. Exorbitant fiscal deficits and near-zero
interest rates are digging their economies into a deeper and deeper hole.
Some economies may crumble when governments withdraw their stimuli or when
interest-rates begin to climb. In time, some G-20 countries may discover that
they could have gotten out of recession in a shorter time and without incurring
huge costs of distortions if they had left the real estate bubble to burst and
considered fundamental financial reforms by reducing the role of debt (risk
shifting) and leverage in favor of equity financing (risk sharing). For as long
as financial institutions assume asset-liability risk, financial crises will be
a part and parcel of our economies.
Hossein Askari is professor of international business and international
affairs at George Washington University. Noureddine Krichene is an
economist with a PhD from UCLA.