Messages from ‘fiscal space’
Jayati Ghosh
Among the many inequalities revealed by the COVID-19 pandemic, one of the most striking is the dramatic divergence in governments’ fiscal responses. Economic activity has collapsed worldwide as a result of lockdown measures to contain the coronavirus. But while some developed countries have been able to deploy fiscal stimulus on an unprecedented scale, most have not.
Since March, the US government has announced additional spending amounting to over 14% of GDP. In Japan, the figure is over 21%, compared to nearly 10% in Australia and around 8.4% in Canada. In Europe, lack of agreement on a strong joint stimulus effort has led to more varied responses, from additional spending ranging from 1.4% of GDP in Italy and 1.6% in Spain to 9% in Austria, with Germany and France in the middle, at 4.9% and 5%, respectively. Rigid EU budget rules continue to limit government spending in precisely those countries that need fiscal stimulus the most.
Meanwhile, monetary-policy responses have expanded the fiscal capacity available at sub-national levels of government in many advanced economies. By cutting interest rates, buying up municipal and provincial bonds, and introducing new lending facilities for specific sectors and enterprises, the US Federal Reserve and other major central banks have used all means at their disposal to keep borrowing costs low, and to maintain public agencies’ liquidity.
By contrast, the fiscal response across most developing economies has been underwhelming, but not because the economic conditions facing these governments are any less challenging. If anything, the lockdown measures and disruption of global trade and investment have already inflicted even greater damage on developing and emerging economies than on the rich world.
In India, for example, it is estimated that 122 million people lost their jobs just in April. Worse, despite lockdown measures, the number of COVID-19 cases in the country continued to rise rapidly. Declining remittances and sharply falling export and tourism revenues have battered many other developing economies as well, even those with less stringent lockdowns.
Yet, despite large-scale job losses and declining household incomes, there has been relatively little fiscal response. While Prime Minister Narendra Modi just announced a package amounting to 10% of GDP, this includes earlier allocations and the expected impact of monetary measures. Additional public spending will comprise only a miniscule fraction of the total amount.
These differences are evident even within the G20. By the end of April, new public spending by the group’s emerging economies averaged around 3% of GDP, compared to 11.6% among the advanced economies. And even within that cohort, there was wide variation, with South Africa increasing spending to 10% of GDP, while India’s new public spending was less than 1%. Not surprisingly, outside of the G20, low-income countries have struggled to marshal even tiny rescue packages, let alone anything sufficient to combat the virus and avert economic collapse.
Much of this difference in fiscal responses across countries can be explained by longstanding systemic inequalities in the global economy, in which developing countries must borrow in internationally accepted reserve currencies. As a result, they simply do not have the fiscal freedom enjoyed by countries that issue such currencies. That is why a new issue of the International Monetary Fund’s reserve asset, Special Drawing Rights, has become such an urgent priority.
Moreover, many developing economies were already being crushed by a mountain of external debt before the pandemic struck. For example, African countries (as a group) were spending more on debt service than on public health. Though many bondholders and other creditors remain in denial about the need for substantial debt relief, the imminent implosion of global debt makes this outcome inevitable.
After all, the widespread cessation of economic activity means that tax revenues are plummeting just when governments need to increase spending. For developed-country governments that can borrow directly from the central bank, this isn’t really a problem. But for most developing countries, the calculus is more difficult. Even those without immediate debt-repayment concerns are showing little inclination to raise public spending to anything near the levels needed to prevent a broader economic collapse.
The reason is simple: most of these countries fear capital flight. Already, more than $100 billion has poured out of developing countries since the pandemic began. Aside from debt denominated in foreign currencies more than a quarter of developing countries’ local-currency debt is held by foreigners, and liberalized capital-account rules in many countries have made it easier for domestic residents to shift their funds abroad. All of this leaves developing countries exceedingly vulnerable, so much so that the fear of financial markets acts as a major constraint on even the most obvious and urgently needed policies.
In India, for example, a top finance ministry adviser justified the pathetically small size of the government’s stimulus package by raising concerns about the country’s sovereign rating. Never mind that an inadequate response increases the likelihood of a major economic collapse in which hundreds of millions of Indians will face poverty and hunger. Equally revealing, in South Africa, the deputy finance minister created controversy for making the perfectly reasonable suggestion that the central bank should buy government bonds directly.
In this self-imposed climate of neoliberal fear, the very idea of instituting capital controls is dismissed as crazy, on the grounds that it would frighten away foreign investors. Yet the economic fallout from the pandemic has made a substantial increase in public spending essential for most developing economies. Besides, how many foreign investors (other than those interested in snatching up assets on the cheap) will be attracted by economies that have been left completely devastated in the absence of fiscal countermeasures?
Well before the pandemic arrived, it was evident that the financialization of the global economy was fueling massive levels of inequality and unnecessary economic volatility. In this unprecedented crisis, the need to rein it in has literally become a matter of life or death.