The G8/20 meeting this week is highlighting the two very different approaches to the fiscal mess that we find ourselves in.
One the one hand we have the deficit hawks calling for cuts and a return to balanced budgets. On the other we have those who advocate increased spending to "stimulate" our way to a recovery.
But ... what if there is a third way? According to Joseph Stiglitz there is.
Although I tend to be fiscally conservative I can very much sympathize with Stiglitz's approach. In simple terms it calls for cutting AND spending. It's all a matter of how the deficit spending money is actually spent.
So what should we be doing? "The lesson is not that you cut back spending, but that you redirect it. You cut out the war in Afghanistan. You cut a couple of hundred billion dollars of wasteful military expenditure. You cut out oil subsidies. There's a long list of things we can cut. But you increase spending in other areas, such as research and development, infrastructure, education" – areas where government can get a good return on the investment of public money. "I haven't done the calculation for Britain, but, for the US, all you need is a return on government investment of 5 to 6 per cent and the long-term deficit debt is lowered."
Taxes also need to be restructured. Osborne has increased capital gains tax for high earners from 18 to 28 per cent. "There's absolutely no reason why you couldn't tax speculative gains [from rising house or land prices] by 40 per cent. There's no social return on it and land is going to be there whether people have speculated or not. But you lower the tax on investment in things like R&D."
Stiglitz has one more practical solution to offer. Governments should set up their own banks to restart lending to businesses and save struggling homeowners from repossession. "If the banks aren't lending, let's create a new lending facility to do that job," he says. "In the US, we gave $700bn to the banks; if we had used a fraction of that to create a new bank, we could have financed all the lending that was needed."
In simple terms look at it this way. What bang for your buck are you getting for your money.
If you spend $100 million in Afghanistan you clearly do not get $100 million back. In fact most of what you spend is wasted, with no return, except a much bigger debt that eventually has to be paid off. In the meantime you have to keep making interest payments.
If you spend $100 million on unemployment benefits, yes people can eat, but there is no "financial return" on the money (although very importantly you do retain social stability). It is clearly better to have the unemployed doing almost anything with a productive outcome. (Of course the real trick is to find "productive outcomes")
If you spend $100 million on high speed rail you have (hopefully) a system that improves economic efficiency (by cutting the use of imported oil and reducing travel times) so this improvement can "pay for" the cost of taking on the debt.
I'll add a few more points:
- Increase taxes on gasoline. The US is sending approximately $30 billion a month overseas to pay for oil imports. Increasing gas taxes will increase conservation, drive a move to more fuel efficient cars, and increase the use of public transport where available. This will also reduce the trade deficit.
- Stop spending "stupid" money on things like housing tax credits. These do nothing to improve the overall housing market for more than the time frame of the credit, but they do add substantially to the deficit, and represent a transfer of wealth from renters to owners (through future tax obligations).
- Tax cuts won't help much. A lot of the money put back into the hands of those receiving the cuts will end up being spent on cheap imported goods (worsening the trade deficit), or just as likely saved (and not put back into the economy).
- The US$ as the world's reserve currency definitely provides some benefits to the US, but it also means that it is very hard to retain/regain competitiveness through a currency depreciation.
- Stiglitz's approach to banking/lending is an interesting one. One of the big mistakes made in this crisis was letting the banks that screwed up continue to exist. They are now "hobbled" with bad loans and now feed at the trough of the Federal Reserve to slowly try to regain their strength. They are not interested in making loans to business because that entails taking on risk. For the moment though there does not seem to be a big backlog of businesses wanting to borrow to expand (as new customers are not coming through the door, so no expansion is necessary).
The Key: Of course a lot of this is what the advocates of stimulus spending have been saying BUT what has been missing from the equation is the cutting of wasteful things, like defense. There are two sides to the equation. Increase spending on the productive enterprise side and cut spending on the wasteful side.
On a household level this is a bit akin to a family that is spending more than it is making each month. Included in this spending is regular meals out. If the family cut the meals out (which were just adding to their credit card debt) and instead used the money to finish their basement so that it could be rented out. Yes there would be a short term hit to the credit card (it costs more to finish a basement than go out to eat), but the rent received (and the meals forgone) would eventually lead to reduced debt and ultimately higher income.
Of course what we really need are good investment ideas and the guts to cut wasteful spending.