As Canadians sparred overÂ fake lakes, budget-bustingÂ security, and theÂ global capitalist conspiracy, the worldâ€™s twenty most influential leaders convened in Toronto this past June to negotiate a response to the worst financial crisis in generations. At issue was anÂ age old debate between two economic philosophies: stimulus as a life vest versus stimulus as a straitjacket. The pro-life camp was championed byÂ consumerist America and itsÂ global supply chain. The pro-restraint camp was led byÂ conservative Germany and itsÂ regional demand chain. At risk were millions ofÂ jobs, trillions inÂ debt, and quite possibly the fate of our modernÂ political economy.
With so much on the line, the G20â€™sÂ vague andÂ non-committal communique was particularly troublesome, since a crisisÂ this big requires a coordinated and comprehensive response. Instead, the worldâ€™s two largest economies spent the weekend channeling theirÂ biggest historical fears — a wave ofÂ premature austerity in America that prolonged the Great Depression, and debt-fueled GermanÂ hyperinflation that gave rise to National Socialism and sparked a continental war.
This failure to build consensus might have been expected but it wasnâ€™t inevitable. Stimulators and Austerians already agree that governments, businesses and households have each spentÂ decades borrowing and spending well beyond their means, leaving future generations a legacy of their grandparentsâ€™ debt. They are both aware of the structural dangers of excessive leverage, and admit that it was only allowed to proliferate because nobody wanted to take away theÂ punch bowl while the party was still going. Their only two fundamental disagreements involve dealing with the resulting debt hangover and charting the least painfulÂ path toward fiscal sobriety.
Coordinating an emergency response was a much easier sell during the global panic of late 2008. Now that most major economies have stabilized, the timing and scale of stimulus withdrawal has evolved from an exercise in economic triage to a debate about theraputic recovery.Â Exit too soon and we could tip back into recession. Exit too late and aÂ cascade of debt default couldÂ fracture the global banking system and plunge the world economy back into the abyss.
To put the G20â€™s challenge inÂ context, nearly three years after the onset of the recession, Americaâ€™s economy — the worldâ€™s largest — stillÂ hasnâ€™t emerged from its slump.Â Persistently highÂ unemployment has devastatedÂ consumer confidence and removed any hope of a quickÂ housing recovery. At the same time, aÂ shell-shocked banking sector has slowed criticalÂ business lending. Without a resurgence inÂ demand a viscousÂ deflationary trend will likely cause the nascent global recovery toÂ stall.
Despite these considerable headwinds, the US remains one of the few countries withÂ enough debt capacity to fund another round of stimulus — unlikeÂ Japan,Â Italy,Â France or even theÂ UK — fueling calls for more shock therapy. The Stimulators are worried about aÂ pulling the plug too quickly, claiming that recessions are the worst possible time for the public sector toÂ retrench. As Nobel Laureate Paul KrugmanÂ suggests: â€œYes, America has long-run budgetÂ problems, but what we do on stimulus over the next couple of years has almost no bearing on our ability to deal with these long-run problems.â€
In contrast, Germanyâ€™s economy — the worldâ€™s fourth largest — seems to be firing onÂ all cylinders. Unemployment is relativelyÂ low and falling, manufacturingÂ output is at pre-recessionary peaks, and a lower euro is helpingÂ boost sales to key Asian markets. However, the countryâ€™s exporters are still heavily exposed to other struggling trading partners, many of whom are inÂ much worse shape. Moreover, after the trillionÂ euro bailout announcement this past May, Germanyâ€™s financial system is now tied even more intimately to the fiscal health of its neighbours. Given years of profligate spending, these sluggish regional economies are now a dangerous liability for the fragile German recovery.
The typical AusterianÂ response calls for a strong dose of fiscal consolidation, trading off near-term economic pain for a more sustainable long-term recovery. Globetrotting economist Jeff SachsÂ puts the argument in perspective: â€œIt is wrong in this context to believe that the only choice is further fiscal stimulus versus a repeat of the Great Depression. Further short-term tax cuts or transfers on top of Americaâ€™s $1,500bn budget deficit are unlikely to do much to boost demand, while they would greatly increase anxieties over future fiscal retrenchment.â€
Outside of the irony of capitalist America and socialist Europe swapping policy playbooks, theirÂ compromise at the summit did little to resolve the inescapable tension betweenÂ hair-of-the-dog stimulus andÂ cold turkey austerity. One reason thisÂ increasingly popular debate has been so difficult to resolve is that it involves fundamental beliefs about the role of public debt in a free market society.
Put simply, debt allows borrowers to â€œpull demand forwardâ€ and consume today what they would otherwise have to wait to consume tomorrow. Such borrowing can help entrepreneurs start-up businesses, governments build roads and schools, and young families buy their first homes. More recently, however, it has allowed individuals, businesses, and governments in developed economies to consume wellÂ beyond their means with little of value to show for it.
Rising American public debt over the lastÂ three decades provides a useful illustration. Populist programs likeÂ tax cuts,Â mortgage subsidies, andÂ cash-for-clunkers have predominantly supportedÂ retail andÂ residential consumption while the nationâ€™s highways, bridges, power grids, schools and health systems have beenÂ left to decay, causing trillions in lostÂ productivity andÂ competitive disadvantage. Similar trends in Europe have pushed some of the regionâ€™s more egregious borrowers likeÂ Greece andÂ Spain to the brink ofÂ default. Had Western governments followed the example of centrally-plannedÂ China or emergingÂ Brazil and invested public borrowing in criticalÂ infrastructure rather thanÂ pet projects or plump payrolls, there might be less debate over theÂ merits of additional stimulus and more toÂ show for trillions in government spending.
After the last double-dip recession in the early 1980s, one of Jimmy Carterâ€™s economic advisersÂ observed that “it is not the wolf at the door but the termites in the walls that require attention.” This time around, both near termÂ relapse and longer-termÂ default represent clear and present dangers to the fledgling global recovery. Additional stimulus will only work if it is strategic and surgical, and austerity only if it includes a credible plan to promote longer-term growth. But neither approach alone can heal the global economy without Stimulators and Austerians collaborating on a sustainable path to prosperity. In that respect the summit in Toronto was a missed opportunity, one with potentiallyÂ painful repercussions if global recoveryÂ fails to bloom.