As governments all over the world struggle to revive their economies after the debilitating lockdowns they imposed following their failure to undertake adequate precautionary containment measures to curb the Covid-19 contagion, neoliberal naysayers are already warning against needed deficit financing for relief and recovery.
Deficit financing options
The range of deficit financing options has changed little since first legitimised by Roosevelt and Keynes in the 1930s and used extensively to finance wartime government spending.
First, debt financing has typically involved government borrowing. More recent understandings of sovereign debt stress the implications of the source of borrowing, domestic or external, eg Japan’s total government debt now greatly exceeds double its annual national income, but this is not considered problematic as most of it is domestically held by Japanese.
Second, price controls, general or selective, can cut both ways, and may require subsidies. Price controls on extracted natural resources can also enable governments to capture resource rents to augment revenue.
Third, the widespread use of unconventional monetary measures since the 2008 global financial crisis has forced economists to reconsider earlier monetarist articles of faith about deficit financing by “taxing” everyone via inflation, also giving an unexpected boost to modern monetary theory.
Exchange rate policy
Finally, an overvalued exchange rate has been favoured by elites who travel and purchase abroad wanting strong currencies, which they often portray as cause for national pride. After all, governments collect taxes in domestic currency, but pay for international debt and imports with foreign exchange.
However, a strong exchange rate only provides a temporary solution, worsening balance of payments’ difficulties in the longer term, favouring consumers over producers, and importers over exporters, besides encouraging consumption at the expense of savings. Increasing imports for consumption either deplete foreign exchange reserves or require external borrowing.
Overvalued exchange rates’ potential for fighting inflation is risky as balance of payments deficits cannot be sustained indefinitely. Exchange rate-based currency board and stabilisation arrangements in transition and developing economies are similarly problematic. Economies maintaining overvalued exchange rates have often later experienced severe currency crises.
Quasi-nationalist development ideologies and weak elite opposition enabled many East Asian economies to use undervalued exchange rates to discourage imports and promote exports, with effective protection for import-substituting industries conditional on successful exports.
Deficit spending supposedly responded to “populist” demands by “distributional coalitions” of interest groups demanding higher wages, cheap housing, public healthcare and free schooling. Undoubtedly, their political support was sought by regimes, elected or otherwise, who were typically unwilling or unable to collect enough revenue to sustain such expenditure.
In recent decades, macroeconomic populism has become a catch-all explanation for deficit financing, ostensibly to finance redistributive government spending, regardless of actual expenditure patterns. But rather than populist redistribution, deficit spending was often for “security” (ie the military and police) or physical infrastructure, rather than social expenditure, or corruption.
The narrative implies that regimes could not resist demands for redistribution, presumably the price of retaining political authority and influence. Undoubtedly, government capacities to directly tax incomes and assets have been constrained, with the influential generally better able to evade taxes.
Sovereign debt and fiscal crises, due to borrowing to spend beyond budgetary means, were rarely due to “excessive” populist demands. The actual reasons for budgetary deficits were often multiple as well as historically and politically specific, rather than simply due to regimes succumbing to redistributive claims.
US presidential endorsement of Arthur Laffer’s “supply side” economics’ claim of greater growth due to more investments with lower taxes on the rich fuelled the counter-revolution against progressive taxation. Nevertheless, “macroeconomic populism” became the default explanation for all manner of deficit financing, including “soft budget constraints” in “communist” “command economies”.
Latin American populist fables
Although there have been few truly “populist” regimes in Latin America, most famously Peronist Argentina, “macroeconomic populism” has become a catch-all term, used to explain why governments increase spending and run budgetary deficits.
Undoubtedly, many Latin American regimes pursued import-substituting industrialisation using high tariffs to protect “infant industries” from the 1930s. But high import tariffs augmented, rather than diminished government revenues, in contrast to the tax breaks and subsidies for export growth.
Although precipitated by then US Federal Reserve Bank chairman Paul Volcker raising bank interest rates from 1980 to kill inflation, the Latin American debt crises from 1982 were again misleadingly primarily attributed to preceding populist macroeconomic policies.
Similarly, the significant improvements in popular wellbeing earlier this century in Brazil under the PT, Uruguay under the Frente Amplio, Ecuador under Correa and Bolivia under Morales primarily involved massive employment generation and secondarily, “productive” social protection, rather than the unsustainable transfers depicted by macroeconomic populism.
Neoliberal ghosts return
Macroeconomic populism thus became the default formulaic Washington Consensus “explanation” for deficit financing from the 1980s to explain away all manner of fiscal deficits, and to justify policies imposed by the Bretton Woods institutions, precipitating the region’s “lost decade”.
The International Monetary Fund required short-term macroeconomic (price) stabilisation policies to counter often runaway inflation. The World Bank’s typically medium-term “neoliberal” structural adjustment policies sought to liberalise not only goods and services markets, but also those for finance, labour and social services, previously provided by governments and state enterprises.
Reviving ideological ghosts from the past, neoliberal commentators are once again warning against deficit financing. Instead of recognising the need for consistently counter-cyclical fiscal policies over the duration of business cycles, they dogmatically insist on minimal annual budget shortfalls in the short term, and on balancing budgets by next year, regardless of the recession’s nature and duration.
The stagnation of the last decade was due to the failure to reform adequately after the global financial crisis. Covid-19 recessions are undoubtedly different from recent financial crises, and will need bolder monetary, supply-side and industrial policy measures to catalyse and sustain economic relief, recovery and restructuring measures to address previous maladies and the post-lockdown malaise.
The crisis presents us with an opportunity to do better, to move forward. There is much to learn and do to progress, including abandoning the very modes of thinking which have led to the mess we are in. Exorcising ghosts from the past will be imperative.
Jomo Kwame Sundaram