Reconciling Short-Term Economic Management with Long-Term Growth Objectives

Some may wonder how the observations of the Growth Report, dealing with sustainable high growth patterns over long periods, can be reconciled with policy choices currently facing government decision-makers.  Clearly the food and fuel price spikes earlier in 2008, followed by the financial meltdown affecting all markets, were dramatic challenges, especially for poorer developing economies, but also for emerging market economies generally. This will inevitably be followed by a global recession in 2009, a slow-down that has already started, even in China, the world’s dominant growth engine in recent years.

Policy responses to the food and fuel crisis were limited and most countries resorted to import tax cuts, generalized subsidies (often untargeted), and some preferable interventions, such as increased safety net payments and nutrition programs.  A common feature of these actions was their fiscal cost.  Now there exist financial sector stresses in many countries that may require bank recapitalizations (although hopefully not on the scale of the OECD countries), again entailing a fiscal cost.  And finally, faced with slower exports to world markets, more unemployment, and lower growth, emerging market economies may well consider Keynesian style counter-cyclical spending – again raising the fiscal deficit unless offset by other expenditure cuts.

These fiscal pressures come after a decade of strengthened macroeconomic management in developing countries that had produced significantly lower rates of inflation, stronger growth and some progress in poverty reduction.

Questions:  how to deal with short-term shocks in ways that help shelter vulnerable population without either regressing on macro management or sacrificing long-term policies for sustained growth that the Growth Commission advocates.  The main issue is how to deal with the growing fiscal stress in the near term.  .

Option One:  Expand fiscal expenditures more generally.  Good idea if there is fiscal space to accommodate this, especially if they can be rolled back later and if inflation is not a pressing concern.  Bad idea if it feeds into inflationary expectations or if it rekindles inflation that was hard fought to contain. 

Option Two:  Cut back on investments, perhaps infrastructure.  Bad idea since private flows are simultaneously drying up, start up costs on delayed projects are high and long-term growth is put at risk. 

Option Three: Borrow more, preferably domestically, possibly internationally to generate fiscal resources. Generally speaking, a bad idea since borrowing costs abroad are high (even if market access can be established), domestic markets are stressed and debt sustainability is jeopardized.

Option Four:  Just spend and print money, admittedly a strawman.  Bad idea as it kindles inflation, some of which was already sparked by food/fuel and asymmetries in pass-throughs, and is bad for business and worse for the poor.

Option Five: Temporary tax breaks that can be recalled after say 12-18 months to spur private spending instead of public spending, recoverable if growth picks up and the tax elasticity is reasonable.  Good idea if tax system is effective and fair.  Bad idea if tax system is regressive or tax take is weak or governance concerns exist.

Option Six:  Borrow more from IFIs – World Bank, Regional Development Banks and if needed, the IMF.  Note that the Fund recently made a Short-Term Liquidity Facility available for 3-9 months (up to 500% of quota) but this is too short for fiscal purposes.  MDB terms are more appropriate.  Good idea, but how much additional lending is possible?.  Answer is up to $15 B additional from IBRD alone, much more if Regional Development Banks are included.  Difficulty is global financing needs are huge. 

Do you agree, with these above-mentioned quick assessments?

Please feel free to propose other alternatives.