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Tuesday, June 29, 2010

Structural reform, please

Stimuli Won't Cure All G20 Nations
Prime minister Manmohan Singh warned the G20 at Toronto that deflation was a greater threat than inflation, so countries should not prematurely withdraw their financial stimuli introduced during the Great Recession of 2007-09.

This was a bit rich, coming from a country with 10% wholesale price inflation and 14% consumer price inflation. Dr Singh covered himself by adding that exit from the stimulus should be calibrated to country conditions, and one size would not fit all.

This is a sensible formulation, but partially contradicts the case for maintaining the stimulus. Keynesian stimuli have often failed. Greece is a good example where two years of stimulus produced little growth but huge fiscal deficits, driving the country towards sovereign default.

Portugal and Spain are in fiscal trouble too, and if contagion spreads to Italy — where public debt is already 120% of GDP — the European financial system could be paralysed.

Dr Singh said countries should not be bulldozed into premature withdrawal of their stimuli, but can it be called premature in countries where sovereign bonds are crashing and being downgraded to junk?
Keynesian economics requires fiscal surpluses in good times no less than deficits in recessions. Countries that don't create surpluses in boom times may fail with deficits in bad times.

Markets have learned the lesson, but politicians remain reluctant to do so. One exception is UK Chancellor of the Exchequer George Osborne. He is clear in his mind that the British fiscal deficit is structural, not cyclical, and requires austerity to restructure the whole pattern of saving and spending.

He does not think the economy can be fixed by desperately hoping that continuing deficits will produce growth faster than they produce bankruptcy. Many other G20 countries have structural deficits too.

India and some other developing countries have strong growth prospects, and can grow out of high deficits.

But mature economies have weak growth prospects and cannot afford high deficits in the manner India can. Structural adjustment is not a remedy for spendthrift developing countries alone: it is a remedy for spendthrift rich countries too.

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