YOU could be forgiven for believing that a great change in global economic policy has just taken place. Judged by the statement released after their latest meeting, in South Korea on June 4th-5th, the finance ministers of the G20 group of the world’s biggest economies have ditched their collective commitment to Keynesian deficit spending. Unlike earlier announcements, including one as recently as April, the document makes no mention of fiscal stimulus to help struggling economies. Instead it argues that “countries with serious fiscal challenges need to accelerate the pace of consolidation.”
Some politicians, mainly from Europe, hailed the shift. Germany has been calling loudly for greater fiscal prudence. George Osborne, Britain’s new chancellor of the exchequer who is readying his country for fiscal frugality, crowed that the G20 had come round to his way of thinking. Many Keynesian economists are aghast, arguing that savage budget cuts will fell a fragile recovery and condemn the rich world to deflation. Paul Krugman, a columnist for the New York Times, wrote in his blog of the “utter folly” of “madmen in authority”.
In one sense, Mr Krugman’s logic is reasonable. It would indeed be folly for large chunks of the world economy to embark on an immediate and draconian set of budget cuts. In most rich countries recoveries are still fragile. Some show signs of renewed weakness: America’s private-sector job growth in May, for instance, was surprisingly feeble. Although gaping fiscal deficits clearly cannot be sustained for ever, premature tightening can be extremely dangerous, as the experiences of America in 1937 and Japan in 1997 plainly show.
Fortunately, however, the G20’s rhetoric is far tougher than the likely reality. Contrary to Mr Krugman’s fears, there is little evidence from actual budget plans that the world’s finance ministers are embarking on an immediate collective austerity drive. American politicians are still debating a second mini-stimulus. Even in Europe, where the focus on deficit reduction is greatest, the impact will in the short term be relatively modest (see article).
Under pressure from the bond markets, the countries at the centre of the euro-area debt crisis—Greece, Spain, Portugal and Ireland—have no choice but to make tough cuts. But these are mostly small economies. Spain is the only biggish European economy planning fiscal cuts worth more than 1% of GDP this year. Germany is harrumphing loudly about austerity; it unveiled a set of cuts amid much hoopla this week. But look at the details and they are hardly extreme. Thanks to its ongoing stimulus spending, which it is not proposing to trim, Germany’s underlying budget deficit is forecast to rise this year. The plan is to shrink it gradually from 2011, beginning with cuts worth some 0.4% of GDP next year. Not only is the scale relatively modest, the measures themselves (such as cutting military spending and tightening welfare payments) are sensible.
Britain, which awaits an “emergency budget” on June 22nd, will be tougher. Its new government is grappling with a deficit that rivals Spain’s. But serious spending cuts will not begin until next year. And in both Britain and the euro zone, fiercer fiscal tightening can—and should—be countered by central banks keeping monetary policy looser for longer.
Not stupid, but not smart enough
A calm look at the numbers, then, suggests that the odds of a collective G20 blunder towards recovery-wrecking austerity this year are low. The real danger of the current embrace of austerity is not that it is reckless, but that it is thoughtless—missing an opportunity to make the policy changes that will help economies most in the future.
First, most rich-country governments are being insufficiently bold about reforms, such as raising the statutory retirement age, which improve public finances in the medium term without denting demand now. Second, proponents of fiscal austerity are putting disproportionate weight on budget discipline as a solution to the rich world’s ills, underplaying the import!ance of structural, supply-side measures. In Europe regulatory reform is essential to improve growth prospects in prudent and profligate countries alike: Germany needs to boost its underdeveloped service sector, for example; Spain must make it easier to fire its civil servants.
While they are in the mood for tough decisions, governments should broaden their horizon to include the measures that will make their economies fitter, and grow more rapidly, in the long run. Faster growth, after all, is the surest route to a better fiscal outlook.