Thursday, November 21, 2013 / By Project Research
Background: What is the origin of the Austerity-Stimulus face-off?
As the 2007-08 financial crisis morphed into a full-fledged economic recession in advanced economies and broke the speed of growth in emerging economies, global policy makers, convinced of the grave dangers the global economy faced in the absence of decisive responses, enacted far-reaching policy thrusts to combat the crisis. Responses took the form of both fiscal and monetary policy, with economic managers implementing a mix of these policy forms in most cases. But that was only at the outset. Five years on since the collapse of Lehman Brothers sent tremors through financial markets and triggered the start of the crisis and the so-called accompanying Great Recession, aggressive, unconventional monetary policy measures enacted in the wake of the crisis are still running their courses, whilst the initial fiscal policy responses have become a casualty of political cum economic policy debate, processes which have blunted their impact on the respective economies gravely affected by the crisis, and by extension, the global economy.
Fiscal policy, specifically expansionary fiscal policy, was deployed in two stages by governments in the wake of the crisis. First, as venerable financial institutions, on Wall Street and across the Atlantic, collapsed one after another, declaring bankruptcies and needing the support of their governments to stay afloat, governments responded with bail-out packages that effectively nationalized these institutions and kept them alive. Instructively, these packages were made available through the instrument of fiscal intervention (and not the monetary role of the central banks of these countries as traditional lenders of last resort). Government essentially doled out these bailouts in exchange for commanding stakes in the financial institutions.
Second, as the financial crisis wrecked the real sectors of these economies (the resultant credit crunch and deleveraging by households and businesses stifled activity) and forced them to go on recess, governments enacted fiscal stimulus measures to prop up their economies. A classic example is the Stimulus 101 package put forward by the then newly-elected Barack Obama Administration in the United States. Other economies had their variants. At a G-20 (Group of 20 top economies in the world) meeting in April 2009, world leaders highlighted the dangers of not responding in proportional measure to the Recession, pointing to the anatomy of the Great Depression of the 1930s and the role of fiscal expansion in the resolution of that great economic setback. Governments adopted the consensus to deploy expansionary fiscal policy to stimulate their economies; many acted in accordance.
The measures worked (or so some would argue). Leading economies of the world – the US, UK, Germany and France – who had fallen into recession by the fourth quarter of 2008, had exited recession by the third quarter of 2009 and returned to the path of growth. Even then, there were concerns about the fiscal ‘costs’ of these extraordinary measures, particularly, broadening of budget deficits and debt positions of these already heavily-indebted economies.
Enter the Eurozone Sovereign Debt Crisis. In the twilight of 2009, it began to emerge that the fiscal books of a number of European nations, particularly Eurozone member nations, were dangerously in the red. The crisis started in Greece; it was not long, however, before it was discovered that Portugal, Spain, Italy and Ireland were equally in trouble. These countries, which economies were still mired in recession, were indebted to very cumbersome degrees. Their debt levels exceeded their nominal Gross Domestic Products by substantial margins, resulting in debt-to-GDP ratios in excess of 100%. Because all of these economies were Eurozone economies (thus sharing the common currency, the Euro), a coordinated policy response by Eurozone member governments was necessitated.
The policy proposals put forward could be summarized thus: in exchange for bail-out packages to help them restructure their finances, the governments of these countries had to agree to severe belt-tightening – massive austerity measures in the form of huge government spending cuts (especially to social and welfare programs) and considerable tax increases that would lead to fiscal consolidation and reverse alleged fiscal profligacy. So then it was that the post-crisis fiscal narrative changed. Focus shifted, even outside the Eurozone, to fiscal consolidation through austerity. General elections in the UK in May 2010 unseated the ruling Labour Party and brought a coalition led by the opposition Conservatives to power. The new government of David Cameron adopted the policy of austerity, thus terminating the expansionary policies that kept the UK from suffering a protracted recession beginning in 2008. Also, rhetoric and political action favouring austerity and fiscal consolidation intensified in the US.
These developments set the tone for the grand debate on the way forward for the economies in trouble. On one hand, there are those who favour austerity and fiscal consolidation over stimulus, thus prioritizing the need for deficit-laden and debt-ridden governments to get their fiscal houses in order and return their fiscal books to sustainable conditions. The initial consensus was that this policy approach would further depress economies still mired in recession or in anaemic recoveries. However, proponents of austerity proposed an argument derided by their opponents as the “confidence fairy”, the belief that markets, firms and households would interpret consolidation measures as striving towards averting fiscal or debt crisis, or alleviating extant ones, thus boosting their confidence and propelling them to rev up activity and consequently, growth.
On the other hand, there were the pro-stimulus economists, Keynesians who believed that with aggregate demand depressed by the crisis, the ideal policy pursuit should focus on stimulus – increased spending and tax cuts to aid households and firms boost their spending, motivate increased business activity and spur growth. They addressed concerns about the fiscal consequences of expansionary thrusts by arguing that since stimulus would lead to growth, it would amount to expanding the tax base and to increased tax revenues, which would then position the country to reduce the deficit and return the her fiscal books to normalcy.
Where does Nigeria fit in?
In sum, the debate over the preeminence and/or suitability of austerity or stimulus derives from the coincidence of a major crisis of economic growth and major fiscal strains in the advanced economies of North America and Europe. So, is there a basis for this debate in the Nigerian context? Put differently, has Nigeria’s experience been identical to those of these economies? The answer is simply NO.
Nigeria did experience a home-grown banking crisis in 2009, but that was after the crisis had simmered in advanced economies, and the causes were largely not related to the crisis. Unlike in the case of the advanced economies, ingenious intervention was carried out in Nigeria. The model employed to restore health to the banking system was remarkably developed only with indirect government support (the FGN acted as guarantor for bonds issued by the Asset Management Company of Nigeria, which was created to absorb distressed banks’ toxic assets and help recapitalize them).
Further, although the Nigerian economy was hit by external shocks resulting from the global crisis (forced Naira devaluation, heightened inflation, revenue shortfall and dip in external reserves as oil prices plummeted), output growth did not suffer significantly. Indeed, the slowest rate of growth recorded in the peak period of the crisis was 5.01% in Q1 2009, which was substantially higher than the economy’s growth rate in the corresponding quarter in the previous year (Q1 2008), when the financial hurricane had not made landfall in Nigeria.
Some theoretical insight might also be useful. Convention on fiscal policy dictates that it ideally ought to be countercyclical – essentially expansionary when the economy is recessionary (and/or deflationary) and contractionary when the economy appears to overheat. This is the theoretical underpinning to pro-stimulus, expansionary arguments in the wake of the crisis. Keeping with this convention in the Nigerian context would require countercyclical responses to the mechanics of the Nigerian business cycle. There is a paucity of literature on the business cycle in Nigeria and there is not much to suggest a history of systematic coordination of fiscal policy intended to modulate the hardly identifiable business cycle.
Again, Nigeria presents a special fiscal case, being a mono-product (oil) economy. A huge proportion of government revenue and foreign exchange earnings that accrue to the country are proceeds from crude oil sales. This condition, coupled with volatility of oil prices (one might add production) in the international market, necessitates a special form of revenue management. The applicable model includes the crucial factor of saving some of the revenue earned in a fiscal year for the rainy day even whilst committing a statutorily determined portion to annual expenditure. In material terms, based on reasonable anticipation of the vicinity of average crude oil prices in a given year, a benchmark that represents the upper limit on oil revenue per barrel available for expenditure is set, with the surplus going into the country’s investable savings pools – operationally, the Excess Crude Account and external reserve holdings.
The implication of this arrangement is that the decision to run a fiscal deficit in the Nigerian case is on some level, a self-imposed decision, since the country retains the choice, to retain more of its oil revenue in a given year in order to balance the budget or run a fiscal surplus. The government might as well radically raise its expenditure profile to make it more proximate to earned revenue, in spite of the associated risks. These hypothetical scenarios serve to underscore how markedly different the fiscal configuration in Nigeria is from those of the economies that have formed the centre-stage for the austerity-stimulus debate and why it may not be wholly accurate to define Nigeria’s fiscal stance in terms of the prevailing fiscal balance.
One final dimension that highlights the structural disparity between fiscal dynamics and those of the predominantly advanced economies caught in the austerity-stimulus dilemma is that many of these countries run statutory elaborate welfare or entitlement programs – technically defined as transfers – by proportions that far exceed the commitment of the Nigerian government. There’s no effective social security program in Nigeria as in the US, or government-financed universal health care coverage as in the UK and most other nations in the industrialized world.
It is relevant, however, to state that the fates of these entitlement programs are at the heart of the austerity-stimulus debate and policy actions. At least in Greece, there is a consensus that the growing cost of entitlements was largely responsible for the implosion. The absence of such programs in Nigeria’s case, whether desirable or not, again confounds any attempt to box Nigeria into the categorical space shared by these economies in investigating the propriety of austerity or stimulus.
What direction then for fiscal policy in Nigeria?
Consideration of the direction of fiscal policy in Nigeria should be conditional on the recognition of certain roles of policy. Fundamentally, the conduct of fiscal policy is one of the paradigms from which any government derives its legitimacy and integrity – the legitimacy of government is preserved as long it retains the ability to meet its (fiscal) obligations.
Further, the demands of fiscal activism are proper and legitimate. Governments typically work to guarantee the greatest good for the greatest number of their citizens. In the Nigerian context, these ‘greatest goods’ would be most met to the extent that fiscal policy helps fast track the nation’s march to industrialization and welfare enhancement for the citizenry. Fulfilling these objectives requires that fiscal policy be expansionary in the long run, although prudent.
It is fair to say that Nigeria’s current fiscal policy structure subsidizes its own entitlement (not necessarily welfare) programs – in vast import subsidies (for food and fuel, both consumables) and high cost of governance (especially immense benefits for political officeholders leading to high recurrent overheads). This is largely where the chronic problem of dominance of recurrent over capital expenditure derives. There is also the challenge of immense leakages resultant upon the hydra-headed monster called corruption, bloated bureaucracies and inefficient structures. These factors, if not eliminated or reduced to the barest minimum, make otherwise benign expansionary fiscal policy dangerously inflationary and counterproductive. Hence the undue focus by policy makers on fiscal consolidation at the expense of an ambitious fiscally supported industrialization and human capital development agenda!!!
Therefore, the challenge for Nigeria is not to conjecture over whether we should toe the path of either austerity or stimulus. The economy is currently experiencing neither a fiscal crisis nor a major activity shock nor a coincidence of both, which might necessitate such debate. The task is to get rid of the systemic leakages that inhibit allowing fiscal policy the necessary latitude to bolster Nigeria’s quest to industrialize and develop her human capital endowments.
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