(Two boats, a lot of waves, and one Mount Fuji)
There’s a new law of global economics: the deeper you are in a crisis, the emptier the policy tool box becomes. And the emptier the policy toolbox is, the more similar the measures become in practice. (Global economics starts its life in a very odd way…)
Before the credit crunch, we all thought that monetary policy was rapidly converging towards flexible exchange rate based inflation targeting, while fiscal policy keeps being all around the place. The size of the state relative to the economy, the structure of the tax system, the principles governing the government’s actions, as well as the source of legitimacy and relationship with the population, all varied tremendously. It was not only that the mature economies were following very different paths, the US and Sweden being the two different poles, but also emerging markets started to display a very varied set of behaviour. The logic of high resource revenue - weak manufacturing wealthy emerging markets is drastically different from the logic of manufacturing export-based rapid structural change countries, or even from the logic of commodity exporting but poor economies. The world of the mid-2000‘s was dominated by monetary policy convergence and fiscal policy divergence.
This picture changed dramatically a year ago. As the monetary transmission mechanism disappeared, suddenly central banks were at a loss, and governments found themselves in shock, imagining the picture of total collapse. And there came the surprise: there was more homogeneity among the panic policies than any time during the past two decades. As the world economy was nosediving towards the abyss, the fiscal solutions employed around the world were all being read from the same book. In the course of the past two years, for example, the average budget deficit of the advanced economies shrunk from -0.5% to the the staggering -4.5%. As a consequence, the average OECD gross debt per GDP measure, for instance, is jumping 26 percentage points to 100% between 2007 and 2010.
Which is funny, for probably, the way governments started to spend as well as the magnitude of the fiscal stimuli was far from optimal. However, wanting to appear as proactive during the crisis, most governments ended up doing the same as others, and against their best protectionist wishes they ended up providing the world economy with a decent fiscal push. As an example, the total increase in budget deficit of the advanced economies (using the IMF’s categorisation), amounts to 5.2 percent of the global GDP. Add to these the gigantic government boost in a host of emerging markets, China, India, Brazil being the prime examples.
Curiously enough, now that the recovery seems to be under way, the policy space seems to be opening up again. Some of the badly hit countries, like Japan (expected to reach 197% in 2010 from 172% in 2008), Italy (to 127% from 112%) or Hungary (to 82% from 73%) were already in a tight spot, while Iceland (to 62% from 34%) or the UK (to 91% from 54%) or Ukraine (to 35% from 20%) had started off from relatively good debt positions (although the premia varies tremendously of course). Clearly, some will find it easier to restart their economies than others.
The variation in the upcoming fiscal constraints does not stop with countries in trouble. While Germany and France already see the signs of recovery, they are way out of the Maastricht bounds, and thus they will have to combine the management of slow recovery (and possibly a jobless one, see previous posts on jobless recovery and the role of technology dynamics in jobless recovery) with getting back into the limits they never supposed to have left. Compare that to Sweden’s 46.6% that was virtually unchanged from 44% in 2008, which -- combined with the fact that they reduced it from 80%, where it was a decade earlier -- shows real discipline. (Or take the Czechs, Denmark, Finland, all expected to be under 40% in 2010.) -- Check out the OECD's "Beyond the crisis" report.
The consequence of this might shape the global economy’s dynamics the post-crisis years. We might find that the combination of the new primacy of fiscal policy and the variation of fiscal capacities might have a long-lasting effect. If the 2000’s can be taken as an indication, the next decade we’ll see new global structures emerging, and activist governments might just give a crucial competitive edge.