As a guiding principle for any profession or career, “first do no harm” is hard to beat. The Hippocratic oath comes to mind amidst reports that economists are rethinking orthodoxy about debt and public finance. After decades of warnings about unsustainable debt levels and a resulting push for austerity programs that inflicted untold harm on already suffering countries, the paradigm is shifting: A new consensus is emerging among academics that stimulus should be preferred to austerity.
This reassessment predates the COVID-19 crisis and is, in important ways, a reaction to the victory of austerity economics after the Great Recession of 2008-9. That crisis was extended because many Western governments embraced restraint rather than stimulus, and national economies sputtered as a result — an outcome that may have produced even more damaging political consequences.
Since the 1980s, economic orthodoxy has been defined by neoliberalism. That concept rests on two pillars: increased competition, achieved through deregulation and opening domestic markets to foreign competition, and a smaller role for the state, which typically means privatization programs and limits on the ability of governments to run fiscal deficits and accumulate debt.
Neoliberalism was the cure when countries suffered economic crises and had to turn to international institutions for help. Government expenses — typically in the form of support programs — were cut to the bone. Invariably, unemployment skyrocketed, as did inequality within the country. While theory argued that austerity would increase output and jobs by raising private sector confidence and investment, evidence proved otherwise.
The seeds of heresy were planted in 2013 by Olivier Blanchard, who, when he was still chief economist at the IMF, offered a grim assessment of the austerity package forced on Greece in the wake of its economic crisis in 2009. (Despite projections that deep cuts would quickly turn the country around, after two years, the economy continued to shrink and unemployment hit 25%.) Blanchard drily noted that “Forecasters significantly underestimated the increase in unemployment and the decline in domestic demand associated with fiscal consolidation.”
A 2016 article by three IMF economists showed that the Greek example was not unique. “On average, a consolidation of 1% of GDP increases the long-term unemployment rate by 0.6 percentage point and raises by 1.5% within five years the Gini measure of income inequality.” The authors concluded that theory failed to appreciate the short-run costs, high unemployment in particular, and the ability (and desirability) of having countries “with ample fiscal space of simply living with high debt and allowing debt ratios to decline organically through growth.”
Blanchard has since preached his case with the energy of the newly converted, challenging orthodoxy from a variety of positions, even when standing at the highest altars of the economic priesthood. In his farewell address as president of the American Economic Association in 2019, he warned that his profession had gone too far in warning about debt, and failed to understand the longer term and more corrosive effects of high-levels of unemployment.
That view has gained adherents, and the profession is contemplating a paradigm shift. Vitor Gaspar, head of the IMF’s fiscal policy unit, now insists that the main role of fiscal policy should be to help restore economic growth, reduce unemployment and beat COVID-19. Laurence Boone, chief economist of the OECD, the club of developed countries that has long championed austerity, agrees. She argues that governments should abandon short-term targets for public debt and instead focus on long-term sustainability, accepting that public debt will rise during crises and focus on returning to normal debt levels when, well, things return to normal.
In a sense, the arguments are academic. Governments have not hesitated to pour money into their economies. The IMF estimates global fiscal support for COVID-19 aid at $14 trillion, with advanced economies pumping in $11.8 trillion. This has meant an increase in debt: Global public debt will reach 98% of GDP at the end of 2020, up from the 84% that was forecast for that date in October 2019.
The battles continue. The IMF still demands austerity when less developed countries want help. Among developed nations, domestic politics is the chief hurdle. Japan is contemplating a fourth stimulus package after passing three worth $3 trillion in total, about two-thirds of its GDP. Expect resistance.
U.S. President Joe Biden wants a $1.9 trillion stimulus package, one that Treasury Secretary Janet Yellen said in her confirmation hearing would help get the economy back on a sustainable growth path. (Given the role of the U.S. in creating demand, all countries have a stake in its recovery.) She too dismisses concern about total debt and prefers to focus on interest rates and returns that will be generated. That makes sense when “The interest burden of the debt as a share of GDP is no higher now than it was before the financial crisis in 2008, in spite of the fact that our debt has escalated.”
Yellen, along with Jerome Powell, her successor as chair of the Federal Reserve Board, learned painful lessons from the response to the 2008-9 recession: Half-hearted measures draw out the pain and prolong the time until recovery. She warned that inaction “would likely leave us in a worse place … than taking the steps that are necessary and doing that through deficit finance.”
Republicans in the U.S. resist that logic and have rediscovered the perils of red ink. After four years of indifference during the Trump presidency — U.S. national debt grew $7 trillion during his tenure — they again worry about debt, with one GOP leader intoning that the party will be “getting back to our DNA.”
It’s time for gene editing. First, emphasis must change from debt to interest rates. If borrowing costs are low — an important “if” — governments should add debt when their economies are in a hole. Gaspar, the IMF expert, makes this point by pointing to the doubling from 60% to 120% of the public debt of advanced economies as a share of GDP over the past three decades at the same time that interest payments were cut in half, from 4% of GDP to 2%. Countries can grow out of their debt burdens.
Second, central bank decision making needs to be more attuned to political consequences. I don’t mean “politics” as in helping (or hurting) the party in the White House. Rather, it means that the subordination of employment to inflation as a central bank priority has political consequences. Austerity uses high interest rates to throttle price increases and attract capital, ignoring the impact on main street. This has fueled the rise of populist movements among long-suffering populations. The relationship is impossible to quantify but the connections are clear. It is no coincidence that there have been waves of populism across the Western world in the wake of the global financial crisis — and the imposition of the austerity orthodoxy.
This new thinking puts Japan’s experience in a new light. This country has steadily accumulated red ink for decades and has the world’s highest levels of indebtedness: No.1 when measured by public debt as percentage of GDP (237%) or when tabulated as public debt per capita ($91,768).
Foreign analysts long bemoaned the country’s “Mt. Fuji of debt,” while policy makers insisted that there is no problem since virtually all of it is domestically owned. Don’t bet against the house: The debt has grown in a low-interest rate environment. Japan invented the zero interest rate policy in the 1990s. Sluggish growth is a problem but Japan remains a comfortable, well-functioning country, and has avoided the divisive polarization of other developed nations. Given investor confidence, that debt will be sustainable — until it isn’t. But that is likely to be further into the future than expected, given this new mindset among economists. Uncertainty will continue, but analysts would do well to remember the Hippocratic oath as they do their jobs.
Brad Glosserman is deputy director of and visiting professor at the Center for Rule-Making Strategies at Tama University as well as senior advisor (nonresident) at Pacific Forum. He is the author of “Peak Japan: The End of Great Ambitions” (Georgetown University Press, 2019).
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