The road to austerity
Countries facing sudden collapse of growth should not retrench their expenditures, rather should grow their way out.
Caution: experimental thoughts ahead!
Should countries spend their way out of recession and debt difficulties? For many decades now, a creditors orthodoxy has said that the most appropriate response for a developing country’s debt difficulties and recession is to bring discipline to government finances, spend less and tax more to reduce the fiscal deficit and stop a ruinous cycle of borrowing.
This orthodoxy has been enshrined in the numerous IMF programmes since at least the early ‘80s, long before the formation of any ‘Washington Consensus’. Of course, throughout those decades, only developing countries found themselves on the business end of this orthodoxy, and any critiques that emerged of this thinking were easily brushed aside by the powerful cartel of international financial institutions (IFIs) that represents the interests of sovereign creditors.
Pakistan partook greedily from the coffers of these IFIs since the early ‘80s, but because we were useful pawns in a superpower contest, much of the discipline in public finances called for in these programmes could be dispensed with. Our early borrowings from the IMF — two facilities in the early ‘80s — were both criticised within the Fund as being “mere financing” and no reform.
But in the 1990s all that changed. As we signed onto a Structural Adjustment Facility in 1988, at the conclusion of the Afghan war, the demands for discipline in public finances became serious, waivers became harder to obtain, and reform in the structure of government became the policy north star. For all our self-critical commentary on economic matters, we tend to forget that the decade of the ‘90s saw some very important reform measures advanced, when capital markets were freed up, Sales tax legislation was passed, the first privatisations began, and the power sector was opened up to private investment. None of this would have happened had it not been for pressure from our foreign creditors to bring government finances under control.
And we were not the only country pursuing these policies. Throughout the world, the orthodoxy spread like wildfire with the collapse of the USSR. Eastern Europe and Russia were in the cold grip of ‘shock therapy’, and countries in Latin America and Africa, too, stood on the doorstep of the IMF and struggled with the demands to curb government expenditures and raise revenues.
Strong opposition was voiced against this orthodoxy, and the opposition rose to a crescendo in the wake of the financial crisis in East Asia in 1997. One of the strongest defectors from the orthodoxy was Joseph Stiglitz, who in the wake of the East Asian crisis, famously declared that the IMF had prescribed the wrong medicine, that countries facing a sudden collapse of growth should not retrench their expenditures and should not hike up interest rates, but rather should grow their way out of their difficulties by following a “counter cyclical” fiscal and monetary policy.
In short, Stiglitz was telling the world that the right policy for East Asian countries would have been to spend more and pay for it through short-term borrowing, wait for growth to resume and then let the dividends of that growth pay off the short-term debt. Of course nobody listened to him, at least nobody in a position to make a difference, and even when they did listen it was with jaundiced ears, with extreme prejudice.
But the opposition to the creditors orthodoxy that Stiglitz embodied did not go away and today many of them are having their ‘I-told-you-so’ moment. Today, the orthodoxy has come home to bite, as creditors in the Eurozone struggle with another set of countries that has borrowed its way into oblivion, except this time, the set of countries happens to be in their own backyard.
Today, we behold the spectacle of the creditors dithering in the face of a visceral opposition to their agenda on the streets of Athens. This is no longer food riots in Cairo or a general strike in Lima or student riots in Jakarta. This is Athens — the seat of western civilisation, as we were taught in ‘Civ 100’. This is a country that can say no to its creditors safe in the knowledge that if it goes down, they go down with it. And after weeks and weeks of stalemate, this country has finally done what decades of turmoil in the streets of developing countries was not able to do: it has caused its creditors to blink.
The bail out of Greece agreed to in “marathon” talks that dragged on for 13 hours has “closed the door to a disorderly default” according to Christine Lagarde of the IMF. But more importantly perhaps, the agreement opens the door to further debt write downs in the future and that is the important part. Because with this agreement, the creditors orthodoxy that has a pedigree which spans the decades and the continents begins to come unhinged. Quite possibly, for the first time ever, the representatives of major creditors are questioning whether curtailing deficits should be a bigger priority than safeguarding growth for a country in the throes of recession and burdened with debt.
And that is the crux of the matter for us. Since 2008, we have been committed to a path of austerity in the face of collapsing growth and rising unemployment. Of course, we have not delivered on our commitment with any level of earnestness, but the question is: Should austerity even be the yardstick for us? It’s time to revisit this question I think, because one thing the torturous negotiations around the Greek debt debacle have made very clear is that austerity causes growth to drop, which makes debt servicing even more difficult, which necessitates more borrowing. This is exactly what they call a vicious circle, and where creditors in Europe have agreed that austerity alone will not lead Greece out of its difficulties, I would like to know how the same road is expected to lead us out of our present cul de sac.
Published in The Express Tribune, February 23rd, 2012.
Should countries spend their way out of recession and debt difficulties? For many decades now, a creditors orthodoxy has said that the most appropriate response for a developing country’s debt difficulties and recession is to bring discipline to government finances, spend less and tax more to reduce the fiscal deficit and stop a ruinous cycle of borrowing.
This orthodoxy has been enshrined in the numerous IMF programmes since at least the early ‘80s, long before the formation of any ‘Washington Consensus’. Of course, throughout those decades, only developing countries found themselves on the business end of this orthodoxy, and any critiques that emerged of this thinking were easily brushed aside by the powerful cartel of international financial institutions (IFIs) that represents the interests of sovereign creditors.
Pakistan partook greedily from the coffers of these IFIs since the early ‘80s, but because we were useful pawns in a superpower contest, much of the discipline in public finances called for in these programmes could be dispensed with. Our early borrowings from the IMF — two facilities in the early ‘80s — were both criticised within the Fund as being “mere financing” and no reform.
But in the 1990s all that changed. As we signed onto a Structural Adjustment Facility in 1988, at the conclusion of the Afghan war, the demands for discipline in public finances became serious, waivers became harder to obtain, and reform in the structure of government became the policy north star. For all our self-critical commentary on economic matters, we tend to forget that the decade of the ‘90s saw some very important reform measures advanced, when capital markets were freed up, Sales tax legislation was passed, the first privatisations began, and the power sector was opened up to private investment. None of this would have happened had it not been for pressure from our foreign creditors to bring government finances under control.
And we were not the only country pursuing these policies. Throughout the world, the orthodoxy spread like wildfire with the collapse of the USSR. Eastern Europe and Russia were in the cold grip of ‘shock therapy’, and countries in Latin America and Africa, too, stood on the doorstep of the IMF and struggled with the demands to curb government expenditures and raise revenues.
Strong opposition was voiced against this orthodoxy, and the opposition rose to a crescendo in the wake of the financial crisis in East Asia in 1997. One of the strongest defectors from the orthodoxy was Joseph Stiglitz, who in the wake of the East Asian crisis, famously declared that the IMF had prescribed the wrong medicine, that countries facing a sudden collapse of growth should not retrench their expenditures and should not hike up interest rates, but rather should grow their way out of their difficulties by following a “counter cyclical” fiscal and monetary policy.
In short, Stiglitz was telling the world that the right policy for East Asian countries would have been to spend more and pay for it through short-term borrowing, wait for growth to resume and then let the dividends of that growth pay off the short-term debt. Of course nobody listened to him, at least nobody in a position to make a difference, and even when they did listen it was with jaundiced ears, with extreme prejudice.
But the opposition to the creditors orthodoxy that Stiglitz embodied did not go away and today many of them are having their ‘I-told-you-so’ moment. Today, the orthodoxy has come home to bite, as creditors in the Eurozone struggle with another set of countries that has borrowed its way into oblivion, except this time, the set of countries happens to be in their own backyard.
Today, we behold the spectacle of the creditors dithering in the face of a visceral opposition to their agenda on the streets of Athens. This is no longer food riots in Cairo or a general strike in Lima or student riots in Jakarta. This is Athens — the seat of western civilisation, as we were taught in ‘Civ 100’. This is a country that can say no to its creditors safe in the knowledge that if it goes down, they go down with it. And after weeks and weeks of stalemate, this country has finally done what decades of turmoil in the streets of developing countries was not able to do: it has caused its creditors to blink.
The bail out of Greece agreed to in “marathon” talks that dragged on for 13 hours has “closed the door to a disorderly default” according to Christine Lagarde of the IMF. But more importantly perhaps, the agreement opens the door to further debt write downs in the future and that is the important part. Because with this agreement, the creditors orthodoxy that has a pedigree which spans the decades and the continents begins to come unhinged. Quite possibly, for the first time ever, the representatives of major creditors are questioning whether curtailing deficits should be a bigger priority than safeguarding growth for a country in the throes of recession and burdened with debt.
And that is the crux of the matter for us. Since 2008, we have been committed to a path of austerity in the face of collapsing growth and rising unemployment. Of course, we have not delivered on our commitment with any level of earnestness, but the question is: Should austerity even be the yardstick for us? It’s time to revisit this question I think, because one thing the torturous negotiations around the Greek debt debacle have made very clear is that austerity causes growth to drop, which makes debt servicing even more difficult, which necessitates more borrowing. This is exactly what they call a vicious circle, and where creditors in Europe have agreed that austerity alone will not lead Greece out of its difficulties, I would like to know how the same road is expected to lead us out of our present cul de sac.
Published in The Express Tribune, February 23rd, 2012.