Austerity the word went so viral that Merriam – Webster has named it the word of the year for 2010. Ardent followers of Keynesian school have always believed in spending more to get out of precarious fiscal deficit situations. On the other hand, the followers of austerity believe that taking the hard way of cutting down on spending and rebuilding always results in prosperity. We are sure that most of us run our households using austerity in times of crisis. We, at ArthaYantra, always believed that Austerity is the go to approach when in trouble. Stimulus is only a way of postponing the much needed tough decisions.
Japan is a classic example of stimulus leading to the lost decade of economic growth. During the period of 1986 to 1991 the asset price bubble expanded at an exponential rate and subsequently burst. Asset prices were on a free fall and had hit the ground in no time. Banks and Financial institutions realized that they had piled up heaps of debt, whose underlying assets has lost most of its value.
To support our case that tough decisions on economy are the way forward, Estonia is a great example. During the 2008-2009 period, when PIIGS were doling out freebies, the government spending was cut down drastically by Estonia; the industries which couldn’t sustain were allowed to go bust.
The austerity measures resulted in high rate of unemployment and fall in GDP growth rates. But the government never resorted to printing money or borrowing. Estonian Govt. focused on the long term goals rather than the short term gains. The hard and painful ways paid off. The economy is back on track and Estonia’s current position is more than promising.
Over the years it has been proved time and again that the stimulus packages can only work as crisis management strategy rather than crisis resolution. Instead, though Austerity is painful and hard, it helps in cleaning up the inefficiencies within the economy. The above graph shows the stagnant nature of the GDP of Japan over the years despite the measures implemented to get rid of the lost decade effect. Estonia’s plans helped it get out of the crisis and record a high GDP growth rate in the times when most failed.
At ArthaYantra, we believe that governments across the globe need to take tough decisions that could lead to closure of inefficient and unproductive entities. This is possible only in a stable political climate. In India, the government was not effective enough to take a stand and make decisions to counter bad economic situation. However the rising fiscal deficit made the government announce some major and welcome reforms. As a first step the long awaited issue of subsidies on diesel has been addressed Govt then followed it with opening up of the retail sector for the Foreign Direct Investments (FDI’s). The cap on FDI’s in the Aviation, broadcasting and power sectors has been revised.
The Japanese government thought of changing the course of its journey by providing cheap money at interest rates close to zero percent. The stimulus spending, instead of making economy productive, aided in increasing the nation’s debt. The businesses, which had got used to the free lunch, started expecting more stimulus packages rather than getting rid of their bad investments and balance sheet deficits. The idea of creating a stable economy by the government went for a toss. Picking up an economy in the current market scenario that faced the situation similar to Japan is not a million dollar question. But, whether the United States and Euro Zone are heading the Japan`s way or the things are going to be different as promised by their respective policy makers still remains a million dollar question!Picking up an economy in the current market scenario that faced the situation similar to Japan is not a million dollar question. But, whether the United States and Euro Zone are heading the Japan`s way or the things are going to be different as promised by their respective policy makers still remains a million dollar question!
These decisions appear to be more knee – jerk reactions than strategic policy decision making. The coming months will show us the reality of where actually the India’s policy making is headed to.In Europe, backed up by the decision of German court, ECB is going on a bond buying spree. Major economic reforms are expected in the Euro zone. US Federal Reserve announced an open ended buying scheme of bonds under the third Quantitative Easing. The revisal of the ground level interest rates has been postponed. The never ending quantitative easing is another leaf straight out of the Japanese story. It’s interesting to see what’s in store for the United States which is also waiting for another political transition. The Chinese are also in 10-yr transition period awaiting a new leadership to define their path ahead.
We at Arthayantra believe, it’s time to address the fundamental issues that are hampering the economic growth across the world. Tough decisions are the need of the hour. Irrespective of the political direction in the near future, all the major economies need tough reforms to get back on track. The countries which take tough decisions will emerge as the leaders of the next growth cycle of the world economy.