|
 Special Feature
If we were to compare the world to a car, then there is no doubt that the engine that drives it forward has to be the economy. And these days and times, we cannot deny the fact that the engine needs more than just a tuning up. We are, to quote the International Monetary Fund (IMF), in the worst financial crisis since the Great Depression, which – considering the Great Depression took place in 1929 – is quite a remarkable albeit unwelcome achievement. In other words, what is happening at the moment makes all previous post-war recessions and economic slumps look like walks in the proverbial park.
No one should be surprised over the gravity of the problem. After all, we have had five over decades of boom and bust cycles, where we have the papered over the cracks inherent in the system with a poultice of easy credit and interest rate manipulations thus leading to the creation of bubble economies. We have placed concepts like deregulation, free market, and monetarism on the pedestal, and in some cases, have treated them like dogma.
We have sustained ourselves on the concept of ‘speculate to accumulate’ – of spending lavishly, almost blindly, during the good times only to turn to the exact opposite when troubles hit. We have effectively treated the world economy like a large casino – risking our fortunes during a good run of play without any heed of the possibility that Lady Luck will not smile on us forever.
We are living in an ever inter-dependent world, and what happens in Asia has repercussions on Europe and the Americas and vice versa. We can trace part of the problem to the financial meltdown that occurred in the United States and Europe in 2007, but the fact is that the woes of the financial sector are but the catalysts. The real problem is far deeper entrenched than that.
The engine is therefore no longer running as effectively as it should be. In fact, it might even be said that it will not be running at all unless something is done. Around the world, Governments are seeking to restart the engine of growth through fiscal stimuli. Whether they will be successful or not remains to be seen.
The return of Keynes
The period 2008 to 2009 will be marked in economic theory history as the time when the world saw the return of Keynesian economic theories to the forefront of macro-economic policy. Many had thought that the state interventionist policies championed by John Maynard Keynes had gone the way of the dodo after 1979 with the advent of lasseiz-faire Monetarist philosophy as developed by Milton Friedman and put into practice by the likes of Reagan in the USA and Thatcher in the UK.
Although a discussion of Monetarism would take far longer than the number of pages this article is intended to run for, a very basic definition would be that it advocates a policy of markets managing themselves with governments only intervening in monetary policy. In other words, the state controls the flow of money into the system by controlling the interest rates with the market adjusting and correcting itself accordingly. However, as two more recent events – namely the dot.com boom and bust and the US housing market boom and bust – have shown, interest rate manipulation can be said to be a prime cause of economic bubbles. We have seen how low interest rate release liquidity into the markets and cause borrowing levels to increase. With more money in the system, inflationary pressures set in resulting in further interest rates manipulation, resulting in borrowers having to pay back more or face bankruptcy or foreclosures.
And when the bubble has been well and truly burst, and economic growth has turned into economic slowdown; we go through the same routine with interest rates being slashed and a new bubble begins. It is, in other words, a vicious cycle that constantly repeats itself. Of course, there has been hitherto the current situation; the fallout has never been this bad. Perhaps the biggest difference in this current crisis, which is more or less caused by the collapse of the US real estate bubble, is the fact that North American and European banks have been hit particularly hard.
Here we see the problem with this current economic crisis. Whereas in the past, attempts will be made to spend the way out of the crisis by lowering interest rates thus making it easier for people to borrow money, the situation now is that the banks are the ones in trouble. And to where do banks turn in times of trouble? None other than the state, of course.
Of course one cannot ignore the sheer hypocrisy of how the philosophies of J.M. Keynes have come back in the economic principles of Western – i.e. North American and Western European – countries. After all, just more than 10 years ago, during the height of the Asian Financial Crisis, Asian governments were ‘advised’ or more or less coerced into accepting austerity measures prescribed by the International Monetary Fund (IMF), while rejecting interventionist policies.
In other words, affected nations were told to tighten their belts and to let ailing companies fail. Countries that took up the IMF plan such as Indonesia, Thailand, and South Korea experienced economic shocks as companies and even banks were forced to close down. In certain aspects, especially Indonesia, the economic problems caused riots in the streets and the downfall of the government.
Malaysia, under the government of Tun Dr. Mahathir, decided to take the road less travelled by through rejecting IMF policies - much to the derision of many. Instead of letting businesses – especially the banks – fail, Kuala Lumpur introduced measures to rescue ailing financial houses by taking over non-performing loans through Danaharta – an agency set up by the Malaysian government. Controversial at the time, Malaysia’s response – which also included imposing controls on the inflow and outflow of capital – definitely helped it ride out the crisis.
Now, more than 10 years on, the world is in the midst of another economic crisis. This time though, it is the G7 economies that are feeling the brunt, although owing to the interdependent nature of the world, East Asia has not escaped unscathed. Below, we will look at the situation in the three largest industrialised economies – the United States of America, the European Union – represented by Germany, and Japan.
The American dilemma
The first country we visit is none other than Ground Zero of the global economic crisis –the United States of America. As the story of how the American financial system imploded through the collapse of the housing market and the fallout from sub-prime mortgages is already one that has been repeated many times, we would not repeat them here. Needless to say though that when the world’s largest economy and the world’s largest consumer – two distinct titles that the US holds – falls, its landing is quite heavy and heard (and felt) around the world.
The United States is currently facing a current account deficit of more than US$10.7tr, that is already without taking into account the US$700b pledged by an earlier bank bailout or more recently the US$787b economic stimulus package that was passed recently to boost Government spending in order to jumpstart the economy. Thus when TARP (Troubled Assets Relief Programme) – otherwise known as the bank bailout - and the Stimulus Bill are taken into account, along with an estimated US$3tr spent on military operations in Iraq and Afghanistan, the deficit is more than US$14tr. So, when one looks at the bill that the US Government and its successors will have to foot, one question that is being asked is “Can the United States afford to spend more than US$1.5tr on bail-out and stimulus packages?” We, however, feel that the right question to ask though is not whether the US can afford to spend so much, but whether it can afford not to spend more.
Desperate times, as they say, call for desperate measures. And there is no doubt that what the United States is facing today are indeed desperate times. To summarise, manufacturing output has slumped with the Institute for Supply Management (ISM)’s index standing at 32.4 points – the lowest level since 1980. According to the index, any reading below 50 is a sign of a contraction.
At the same time, consumer demand has also dropped drastically, and in December 2008, consumer spending reached a new 50-year low thus putting more pressure on the manufacturing industry. Furthermore, as of the 19th of February, the US has over 4.99 million people unemployed.
Thus in early February when the US Congress was deliberating over the stimulus package, US President Barack Obama made a speech warning that a “catastrophe” may occur if the stimulus measures were rejected. After weeks of negotiations and talks by both legislative houses, the measures were finally passed albeit with all Republican members of the House voting against it and only three Republican Senators voting in support. Thus, any illusions that Obama or the Democratic majority might have had about a bi-partisan effort has been put paid to.
The stimulus plan
In order to boost consumer spending, the stimulus package – otherwise known as the American Recovery and Reinvestment Act - provides tax cuts worth US$287b with individual workers receiving US$400 in rebates while couples enjoy US$800. Furthermore, the housing market – which has been on a downward spiral since the collapse of the sub-prime mortgage market – was also given a boost with first-time home buyers being provided with tax credit worth 10% of the value of the house with a maximum credit of US$8,000. Those earning under US$19,000 a year will experience tax savings of US$476, which works out as a 95% cut in taxes, while those at the opposite end of the income bracket – namely those earning US2.8m and more – will experience a much smaller tax cut of 1.4%, which works out to savings of US$39,350.
Those claiming unemployment also have a break (pun not intended) as taxes on unemployment benefits have been temporarily suspended. Also small businesses have been given tax breaks in order to encourage new investments on computers and office equipment. A particularly interesting aspect of the Act is a provision that allows consumers to deduct state sales taxes when they buy a new car, which is a move that is clearly aimed at boosting the fortunes of US automakers Ford, GM, and Chrysler.
The same provision also offers higher tax credit of up to US$7,500 for those who buy plug-in electric hybrid cars. All in all, the Act is quite a socially progressive one with US$500b allocated for spending projects and social programmes. For instance, US$95.2b will go to schools, public colleges and universities as well as grants for college students; US$38.4b have been set aside to help the poor and unemployed pay food and rent, as well as for job training, while US$87b will go to help states pay for Medicaid.
The plan also aims to address long-standing infrastructure problems in the United States, and as such US$80.5b has been earmarked for construction projects to repair and build roads, bridges, mass transit lines, and waterways in the country. Furthermore, US$22.2b has been put aside in a bid to boost science and technology, as well as expand the information superhighway to the rural areas, while US$30b will be used to upgrade energy transmission, distribution, and production systems.
Facing the critics
Unsurprisingly, the stimulus plan has come under much criticism, especially since it will further aggravate the US deficit. Some however have pointed out that those who attack the plan as being wasteful and full of spending, such as Republicans, were quick to offer their support for the equally wasteful and spendthrift Iraq war.
While Republican opposition to the Bill in Congress did not prevent or delay its passing, thanks in no small part to the three Republican Senators whose support stopped any attempt at a filibuster from taking effect; some Republican governors have said that they will reject the funds. As such, the effectiveness of the stimulus package could be in doubt as states such as Louisiana, South Carolina, Texas, Mississippi, Idaho, and Alaska may opt out of it.
One of the reasons behind the reticence is because of certain stipulations that have been placed into the package. For example, Gov. Haley Barbour of Mississippi told the press. “We will not be accepting unemployment insurance money because it requires us to have a significant tax increase in the future.” Furthermore, there is also concern that the measures will require states to increase costs which would last even after Federal funds run out. However, a clause in the Act allows State legislatures to override the objections of the governor, which incidentally is what the Mississippi State House did.
Criticism of the Act however is not confined to internal opponents alone. America’s trading partners, for instance, have been quite critical of a clause which states that construction and infrastructure projects under the plan use iron and steel made in the United States. They say that this is tantamount to protectionism, while some economists have warned that a ‘Buy American’ policy may cause more harm than good as other countries may retaliate and start off a trade war that the US can very well do without, especially at this time when it needs a boost in exports to spur domestic growth.
Europe (Dis)united
While the United States may be split over the stimulus package with some critics claiming that it is spending too much money while others – such as Nobel Laureate Paul Krugman – saying that it is not spending enough; things are not much different across the Atlantic Ocean.
In fact, the EU may even be more divided than the United States over a stimulus package, owing to the fact that unlike the White House and the US Congress, the European Commission and the European Parliament is not a central executive or legislature. There have been differences between countries that support increasing public spending such as the UK led by Gordon Brown and those that do not such as Germany led by Angela Merkel.
In fact, Germany – which is also the largest economy in Europe – has also emerged as the biggest sceptic of any EU-wide stimulus plan. In early December 2008 for instance, its Finance Minister Peer Steinbruek responded to criticism that Germany was not spending enough as recommended by the Commission by saying that Germany’s spending of 1.2% of its GDP was not that far off from the EU’s recommendation.
He also spoke out against reducing value added tax, and questioned its effectiveness in spurring consumer demand; remarks that analysts believed to be aimed at the UK, which had cut its VAT by 2.5% from 17.5% to 15%. Further acerbic criticism of the UK also continued with his comments on the UK’s GBP20b stimulus plan, which he criticised as doing nothing except to "raise Britain’s debt to a level that will take a whole generation to work off."
On the opposite side of the fence, Germany has come under pressure to increase spending from Gordon Brown of the UK, as well as President Nicolas Sarkozy of France, and European Commission President Jose Manuel Barroso. Furthermore, Joaquin Almunia – the EU’s Economics Commissioner – has also called upon Germany to increase its contributions saying, "As the EU’s biggest economy with a balanced budget, Germany should make a difference with its contribution to give a boost to the economy of Europe."
A battle of the haves and have nots
Another divisive issue that has cropped up is between the richer EU nations and the poorer ones – namely from Eastern Europe. During an emergency meeting on the 1st of March, Hungary submitted a proposal for an emergency bailout of eastern Europe’s banking and finance sector worth Euro180b backed by Poland, Slovakia, the Czech Republic, Bulgaria, Romania, Latvia, Estonia, and Lithuania. However, balking at the high costs and the lack of proper direction, the proposal was shot down by the richer EU nations led by Germany. According to German Chancellor Merkel, a general bail-out of the eastern European countries should be avoided as she believes that each case should be handled individually.
Furthermore, European Commission President Barroso has said that they do not need further bailouts as they are already receiving billions from the EU, the IMF, and the World Bank. However, what probably catches their (east European countries) craw is not the rejection but rather the feeling that the EU haves are not being more forthcoming with aid as they are moving towards more protectionist measures.
For instance, Sarkozy has recently encouraged automakers Puegeot Citroen to close their factories in the Czech Republic and Slovakia, while providing Euro3b in loans to ensure that auto factories in France are not closed down. Naturally, this move has not been greeted warmly by east European nations, and despite Sarkozy’s assurance that it was not protectionist, has set forth fears of tit-for-tat measures amongst EU nations.
Higher debts and deficit on the way
While EU regulations set strict guidelines against member countries running up a deficit above 3% of their GDP in order to protect the euro, it has admitted that for the time being it would not be possible to enforce the ruling. For instance, France’s deficit will most likely go up to 4.4% of its GDP in 2009 and may not go back down before 2011, while Germany’s may reach 4% in 2010 and stay there until 2012. Other eurozone members facing rising debts are Ireland, Greece, Malta, and Portugal.
The problem that the EU faces though is that although it has a single currency – with the exception of the UK and some other east European countries like Latvia – it does not have a single cohesive economic system. The lack of a common EU action plan has therefore raised the concern of certain quarters such as IMF Managing Director Dominique Strauss-Kahn who said that this could hamper efforts to restructure banks and financial institutions on the continent.
The need for a leader
With the EU’s US$17tr economy expected to shrink by 1.8% in 2009, the need for leadership has become more urgent. As the largest economy in the grouping, the onus is thus on Germany to be that. Germany though is facing serious economic problems of its own without having to worry about the rest of Europe. However a recovered German economy is vital to pull up Europe.
The economic prospects for Germany however do not look too good. In January 2009 for instance, machinery and factory equipment orders fell by 42%, while production is expected to drop by 7% - the sharpest since 1993. This is expected to result in 25,000 job cuts this year. Furthermore, sales of raw materials and components - which is an indicator of economic production – fell by 4.6% in January 2009 compared to the same period in 2008. In the fourth-quarter of 2008, the German economy contracted by 2.1% - the third straight decline, caused in part by a 7.8% decline in exports. 2009 does not look to be any better with the economy expected to shrink by 2.8%.Therefore, in order to boost the economy, the German Parliament passed a Euro50b stimulus package in late February that will boost spending on infrastructure, provide tax relief, reduce health care contributions, and give money for families with children. Furthermore, car owners who buy new cars will receive Euro2,500 to send their old cars to the junkyard.
To summarise, Euro17b will be allocated for infrastructure projects while tax cuts and relief is expected to be around Euro18b. Furthermore, businesses will get loan guarantees of up to Euro100b.
Not surprisingly, German leaders have played up the merits of the plans with Merkel calling it a "pact for Germany," which will ensure that "Germany does not just overcome this crisis, but emerges from it stronger" Furthermore, Foreign Minister Frank-Walter Steinmeier said, "When I look around in Europe, I can’t see anyone else doing more or taking better steps than we are."
Yet, while the Grand Coalition government of Merkel’s Christian Democratic Union and Steinmeier’s Social Democratic Party pat themselves on the back over the measures, the plan has come under criticism. For instance, the aforementioned Euro100b loan guarantee has been called insufficient based on studies of preliminary requests. The fact that the plan will add an extra Euro37b worth of debt has come under attack by the Association of German Taxpayers, which also cast scorn over the Euro2,500 payment for those scrapping their old cars and buying news ones, saying that it would have been better to provide the auto industry with more tax cuts.
Another measure that has come under condemnation was the allocation of Euro500m to the German armed forces, of which Euro226.2m have been earmarked for the purchase of sub-machine guns, drones, and vehicles from mostly German manufacturers. As such, Defence Minister Franz Josef Jung defended the move by saying, "The Bundeswehr (Germany’s military force) is one of the most important sources of contracts for the German economy so it stands to reason that it will make the most of the possibilities to keep up this support via the economic stimulus package."
However, Inge Hoeger from the Left Party, which favours disarmament, has stated that the German government is using "the cloak of combating the economic crisis to accelerate armament of the Bundeswehr,” and that it is “bogus to claim the purchase of tanks and combat drones represents an economic stimulus programme."
Japan in dire straits
While the US and EU economies are in doldrums, it would not be wrong to say that one comfort they can take is that they are not in the same situation as Japan. The world's second largest economy, Japan reported a shocking contraction in its 2008 GDP of 12.7%, and it is expected – at the most optimistic forecast – to shrink by 11.1% in 2009.
The global decline in trade can be attributed to Japan's problems, with demands for cars, electronics, and machinery dropping sharply owing to consumers tightening their belts as well as a stronger yen. The country is heavily dependent on exports as domestic consumption is usually too low to boost the economy.
Furthermore, investments fell by 17.3% for the last quarter of 2008, while the unemployment rate in January 2009 was 4.1% - a surprising improvement from the 4.4% in December 2008. However, the report which was done by the Statistics Bureau only had a participation of 59.4%, so it may be too early to start popping the champagne cork.
And definitely the Japanese Government is not in a celebratory mood. Prime Minister Taro Aso has expressed pessimism over the economy, saying that, "we have no bottom in sight. It’s clear that the economy is in a severe state."
It should be noted that while other countries have the option of slashing interest rates in order to spur borrowings – a move that the US and European Central Bank has taken – Japan does not have that luxury. Its interest rate, after all, is already at 0.1%. It was only last year that the rate rose from 0% after Japan had seemingly beaten off deflation. Low interest rates did not exactly help stave off the Lost Decade – the period of economic slump which occurred after the collapse of the asset price bubble in the 1990s, and it doesn’t look to be the answer now.
In order to spur the economy, the Japanese government announced a US$270b package in December 2008, a sharp increase from the US$50b package it had earlier planned in October of the same year.
Around Yen2tr (US$20.5b) has been set aside to encourage domestic spending through tax breaks and incentives. Furthermore, another Yen2tr has been earmarked to revitalise the financial sector. However, indications are that the amount may rise up to Yen10tr (US$102b) as the government has experienced losses of up to Yen650b (US$6.65b) from its shareholdings in 10 domestic banks. Furthermore, in order to encourage job production, Yen1tr (US$10.2b) will go to local governments, while an additional Yen1tr will go to the unemployed. Japan hopes to pay for the stimulus by tapping into emergency reserve funds, as well as from issuing bonds. However, such a move may just mean an increase in the budget deficit. Furthermore, Aso has also come under criticism for introducing a measure that will see each Japanese citizen with a registered address receive around Yen12,000 (US$120) as a cash handout. It should also be noted that permanent residents will also benefit from this, as well as infants who were born before the 1st of February.
With a general election looming, the move has been labelled a corrupt move by opponents of Aso whose record low popularity may lead to the Liberal Democratic Party (LDP) losing power which they have had a near monopoly on since the end of the Second World War. In his defence though, Aso said that the measure is a good and effective way of stimulating spending.
Looking to the Dragon
One development that has arisen from this crisis is the transformation of how China is viewed as far as its role in the global economy is concerned. Whereas, even very recently, it was seen as a producer and exporter of goods; China’s booming economy and large population is increasingly being seen as a potential market for goods especially with traditional markets such as the US and EU suffering from a lack of consumer confidence.
However, given the fact that China is itself a major exporting nation, the same decline in global trade has affected it. As such, its economy grew by just 6.8% in Q4 of 2008 – the slowest rate in more than seven years, whereas only a year ago, it was boasting GDP growth of 8% and higher. The slump in export demand has been quite devastating on the country’s manufacturing industry with 670,000 small and medium-sized companies closing down, while 20 million domestic migrant workers have been made unemployed.
The faltering economy has also caused much unknown open domestic discontent in the country with one recent incident being a clash between workers and police at a textile factory in Sichuan province. As such, while the Communist Party maintains an iron grip on power, there is concern among its ranks that its star may be waning.
Thus, the Chinese Government has launched a stimulus package of its own worth Yuan4tr (US$585b). Aimed at confidence on the home front and to shore up industries in the wake of the decline in demand, the plan mostly centres on infrastructure development. For instance, US$219b will go towards building and upgrading roads and railways and US$146 has been set aside towards disaster recovery, while US$58 has been earmarked for rural development. A further US$54b has been allocated for upgrading technology and innovation in Chinese companies, US$30b for energy saving and anti-pollution measures, and US$22b for health care.
Despite rumours in early March that China will increase the amount it is spending on its stimulus, Premier Wen Jiabao announced to the National People’s Congress – China’s Parliament – that there has been no change. Unofficially, the word is that China’s leaders are not all that happy over being expected to help pull the world out of the quagmire with Zhou Xiaochun, the Governor of the People’s Bank of China saying, "What we are waiting for is, what will happen in the country where the crisis originated. If you can explain what that country will do, we can say what we will do."
The USA, the EU, Japan, and China – these are the four largest economies in the world, upon whose economic well-being hangs much of the world’s hopes for economic recovery. If any one of these above-mentioned stimulus packages work, then perhaps that country may help pull the world out of the quicksand that it is now in. The situation has become more dire with the World Bank warning that the world economy will shrink for the first time since 1945. Yet one must ask, will radical Keynesian measures help or will they – as the nay sayers predict – just cause more public debts that future generations will have to pay back? Definitely, the hundreds of billions in these stimulus packages will have to be accounted for eventually. Monetarism has shown that it is not the way forward. Are Keynesian theories any better or is there a viable third solution? These are the questions that need to be answered, and answered quickly. |
