One of the reasons why the US and British authorities were keen on the G20 Leaders meeting on April 2 announcing a large fiscal boost was that it would provide political cover for their ballooning budget deficits. In this phase of the crisis governments will rival their private sector counter-parts in coming up with innovative ways of off-balance sheet financing of the largest fiscal boost on record. When all liabilities are consolidated, US and UK debt to GDP ratios will likely more than double before the crisis is over and could be perilously close to 200% of GDP by end-2010.
That said, despite some hiccups with US and UK government auctions recently, G7 deficits will be financed without much difficulty this year and next. The private sector has been cowered into extra savings and government bonds are the safest thing for them to do with these savings, second only to the flame-proof mattress. The real difficulty for G7 countries will come when the economy recovers and the deficits have narrowed, but governments still need to roll over enormous debts. Then a new generation will learn the meaning of ?crowding out?.
But spare a thought for those countries that do not have capacity for increasing deficits today. Countries that do not borrow in their own currency or countries like India, where deficits are already large and devouring a significant proportion of tax revenues. How do you do Keynesian-style reflation when you have no money? The first thing to do is to pull as hard on the monetary level as possible, but there are limits to this and the weakness in the rupee suggests we are close to these limits already. The most cost-effective thing that can be done is probably to pray and then hibernate for two years. Arguably this is viable for a new government with a mandate longer than the next 2-3 years. But for the brave or foolhardy, there are three other things that can be done.
First, governments need to do the politically impossible task of reviewing current government expenditure and re-orienting spending towards those items that support most employment?while not cutting back on the only productive thing governments do which is education, health and transport. All government spending plans should be assessed in terms of rupee cost per job generated, in the public or indirectly in the private sector. This will doubtlessly yield few gains and will cost much in lost political support. Perhaps the main employment gains will be the civil servants required to carry out the study. Praying is beginning to sound more promising.
Second, the next Indian government could try and get the unions and employers together to agree on a two-year moratorium on labour laws on the basis that the employers promise not to sack anyone and the unions accept less pay for fewer days worked. I don?t generally subscribe to the ?lump of labour? view which suggests that there is only so much work to go around and so it is better to distribute it more evenly, however, there is less work to go around today and distributing it more evenly will reduce unemployment or underemployment which has large social and economic costs. Getting the unions and employers to agree to such a plan is arguably the only thing more likely to fail than re-orienting government spending. But perhaps a new government with an election behind it could afford to do so more than an old government facing an election. Looking for the prayer mats?
The third and most useful thing a government could do is to find the next 20 years of infrastructure spending that is required?not pipe dreams, but real sewage pipes and roads and ports?and do them now, financed by a public-private partnership. The private company that wins the tender to meet the infrastructure requirement, could issues a bond with a partial government guarantee on the principal. Perhaps the guarantee is for the next five years to ride out the current storm, perhaps it is conditional on some performance criteria, but it should be sufficiently partial to get the bonds financed but not to be a permanent and unconditional government liability.
Constructing infrastructure does two things. First, construction employs a lot of people, quickly pushing cash into circulation. Second, better infrastructure improves the supply side of the economy, expanding growth prospects when the recession ends. There is no shortage of good projects. India still desperately needs better transport infrastructure, urban renewal, more modern hospitals and schools. Of course, if these projects are to do more than just create construction jobs they need to be aligned to other public sector reforms?especially in education. New hardware with the same old software does not improve much in the long-run.
The author is member of the UN Commission of Experts and chairman of the Warwick Commission on International Financial Reform. He is a private economic and financial advisor