Does world agreement to halve deficits fix things or worsen them?

McClatchy NewspapersJune 28, 2010 

TORONTO — World leaders headed home Monday from a weekend summit with a huge question mark hanging over their work: Will their pledge to curb deficit spending help or hurt the global economy?

The International Monetary Fund cheered the promise, saying that it would add $1.5 trillion and 30 million jobs to the world's economies over the next five years.

The economist among the world leaders, Indian Prime Minister Manmohan Singh, joined President Barack Obama in warning against scaling back too quickly, though. Nobel Prize-winning economist Paul Krugman on Monday called the summit's goals a mistake and warned that policy blunders could plunge the world into a depression.

Prodded by European leaders frightened by a debt crisis in Greece, the leaders of the world's top economies met through the weekend in Canada and promised to cut deficits in half by 2013 and stabilize their debt by 2016.

They brushed aside objections from Singh, Obama and others that scaling back too quickly risks choking off a fragile recovery and creating a global recession. They added, however, that boosting growth remains the top priority and built in loopholes for each country to cut spending and raise taxes as it deems necessary.

"This initiative holds out great promise," said Dominique Strauss-Kahn, the managing director of the IMF, who attended the summit.

Growth remains the best way to cut deficits, he stressed, noting that developed economies such as France, Germany and the United Kingdom already are moving to slash spending and raise taxes.

"Fiscal consolidation in advanced countries is unavoidable," he said. "This means putting in place now credible fiscal plans, mostly starting in 2011, since the recovery is still fragile."

In a report for the G20 summit, the meeting of the leading industrialized nations over the weekend in Toronto, the IMF said the summit blueprint would boost the global recovery.

"Global growth would be appreciably stronger," it said, another 2.5 percent, or $1.5 trillion, over five years.

That would help create another 8 million jobs in "advanced" economies such as the United States, Canada and Europe, and 21 million in emerging economies in Asia and the rest of the world. Overall, the IMF said, it would help create 30 million jobs.

India's Singh was among those who wanted the emphasis on growth, not cutting deficits.

"The purpose of G20 should be to ensure that the momentum of recovery is sustained and enhanced in the years to come," he said at the onset of the summit.

"Right now, the danger of deflation in the global economy is, in my view, much greater than the danger of inflation."

Deflation is the decline in prices across the economy. It's pernicious because it leads consumers and businesses to withhold spending amid expectations that prices will decline further. Japan suffered through this in the 1990s, and the trend is arguably visible in parts of the U.S. housing market.

In his column Monday, Krugman warned that deflation threats mean the summit pledge to cut spending was misguided.

"We are now, I fear, in the early stages of a third depression," he said in a warning that drew attention because of his status as a 2008 Nobel winner in economics. "And this third depression will be primarily a failure of policy. Around the world — most recently at last weekend's deeply discouraging G20 meeting — governments are obsessing about inflation when the real threat is deflation, preaching the need for belt-tightening when the real problem is inadequate spending."

Nariman Behravesh, the chief economist for forecaster IHS Global Insight, thinks Krugman has overstated the depression threat.

"He was always a little prone to drama, but the basic point he's making is that this is not the time for countries that don't need to tighten to tighten," he said.

Economists were particularly critical of Germany's recent decision to slash spending amid a European slowdown.

"Why is Germany tightening now, when they could be a locomotive for growth? The only answer they've come up with is to set an example. That's silly," Behravesh said. They should help the other economies (in Europe) grow."

Added C. Fred Bergsten, the director of the Peterson Institute for International Economics, "The Germans put a higher weight on their unquestioned financial stability, even if it costs them some growth. The problem is that it condemns the rest of Europe to slower growth and it has adverse effects on the rest of the world."

Both economists doubt that European spending cuts will bring calamity.

"Even in my worst nightmare ... I don't think it would push us into a new depression or a double-dip (U.S.) recession. It would take a few tenths of a percentage point per year off our growth," Bergsten said.

In the United States, the projected $1.5 trillion deficit this year would fall to $724 billion by 2014 under Obama's most recent budget plan. That's well within the G20 targets adopted over the weekend.

However, the mood in Washington from Republicans and moderate Democrats is to tighten the belt. They fear that deficits will lead investors to demand higher lending rates eventually, punishing the U.S. economy.

Republican senators blocked legislation last week to provide aid to states and to extend unemployment benefits for about 900,000 Americans who've exhausted them. In the most recent jobs report, for the month of May, 6.8 million Americans had been unemployed for longer than 26 weeks, a record.

"I really think the recent debate in Washington ... has just been probably a good example of what not to do," said Robert Bixby, the head of the Concord Coalition, which advocates for balanced budgets. "Things like unemployment compensation — I don't think that's the place for deficit hawks to draw the line. You have enormously high long-term unemployment. ... I think there's a case to be made for extending those benefits."

Bixby long has warned of the unfunded liabilities that are piling up on the U.S. government's balance sheet, but he supports Obama's call for continued stimulus.

"It matters what you are spending it on, and it matters whether you have a credible plan for bringing about a sustainable spending path," he said, adding that curing deficits in entitlement programs such as Medicare and Social Security is essential. "Even if you were to make a lot of heroic spending cuts to the deficit by 2013, they may not be credible if you don't have a plan to keep (entitlement) spending under control."

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