Fiscal stimulus, austerity and sustaining global growth – what does 2017 have in store?

Published: Jan 2017

Monetary easing on an almost permanent basis has led to interest rates that are desperately low, not just in Europe but also in the US, the UK and Japan. None of this has generated enough sustainable growth to cut debts, substantially reduce unemployment and counter voter dissatisfaction. Major trends stoke insecurity, depress the growth potential and/or undermine employment:

  • Ageing populations mean that too few workers have to keep the welfare state alive whereas the costs of the welfare state are rising.
  • Technological progress such as the disappearance of entire job categories due to automatisation alongside technological stagnation (according to scientists such as Robert Gordon the largest breakthroughs are now behind us).
  • Geopolitical and economic power shifting from West to East.
  • Opposition to free trade and other facets of globalisation.

Organisations such as the IMF and the OECD as well as central bankers – who have increased their balance sheets by fourfold or even fivefold – argue in favour of more government stimulus in order to give economies a leg-up. Last summer the US Secretary of the Treasury said: “Today the G20 is no longer debating growth versus austerity, but rather how to best employ fiscal policy to support our economies.” Since then, Americans have elected a president who promised to spend a thousand billion dollars on infrastructure investment. The European Commission has given Portugal and Spain more time to reduce their budget deficits. Meanwhile PM Abe has presented various stimulus packages in Japan.

Public investment has declined markedly in the past decades and years. In other words, there is a lot of catching up to do in terms of infrastructure. Markets are quite sanguine about the combination of investment and tax cuts Trump has promised. This enthusiasm is fuelled by the large sums that Trump has mentioned and the notion that it should not be hard to select fruitful investment projects. A third of US levees and highways are in bad or poor condition. Nevertheless, we believe the prevailing positivism could be too much of a good thing:

  • The power of the purse is vested in Congress so Trump needs the latter to approve his investments and tax cuts. True, the House of Representatives as well as the Senate are in Republican hands but not all Republicans are dead keen on Trump’s plans.
  • Trump’s promises of 3.5-4.0% economic growth are unrealistic. Productivity growth is weakening and the working population decreased as a percentage of the total population after the credit crisis.
  • Not every economist agrees that this is the right moment to invest in roads, ports, and other infrastructure, as the economy is already performing well.
  • Trump’s plans are as vague as they are grandiose. US infrastructure is badly in need of improvements, but opinions differ about the question how, when, and at what price it should be improved.
  • Trump wants the business sector to cough up a large portion of the costs. It remains to be seen whether companies will be prepared to take part as public-private constructions have not proved very successful in the past.

As there is a fairly high chance that the US stimulus measures will fall short of expectations, the question is whether real fiscal easing is possible in other countries. The UK may envisage an end to years of austerity (although the image of draconic cutbacks by the Cameron/Osborne tandem is not completely accurate) as PM May and Chancellor of the Exchequer Philip Hammond prepare to loosen the reins somewhat. The UK’s infrastructure could certainly do with some attention since it ranks 24th on a list where France’s infrastructure is in tenth position and Germany is number 11. However, we do not expect London to come up with big surprises in terms of fiscal stimulus.

Fiscal stimulus in the Eurozone does not really have the wind in its sails either. Southern euro states would like their governments to boost domestic growth but member states like Germany and the Netherlands continue to block these efforts. Still, change could gradually unfold. German Finance Minister Schauble has already presented voters with tax reductions in the run-up to the elections in the autumn of 2017. The Merkel government may want to give away additional presents, particularly as Merkel and her party are losing popularity due to the migration crisis. As Merkel is not prepared to significantly change her views on migration, tax boons are a viable alternative to keep voters happy.

Dutch elections will take place in March. In the Netherlands, too, the fiscal handbrake has been released somewhat while the Finnish government also seems prepared to marginally loosen its grip on the public purse strings. In Italy, an interim government will have to pave the way for a new electoral law as well as for elections. Consequently, few grand gestures will be possible in terms of reform and stimulus. Conditions in France and Spain are not much different. The presidential elections that are due to take place in France in the spring will probably amount to a ‘duel’ between Marine Le Pen and François Fillon. The latter is believed to have the best chances by far. Fillon is not that enamoured of a large and very active government. Therefore, the chance is low that the French government will take the economy in tow. This also applies to Spain, where the government that took office recently after a lot of commotion is no big fan of fiscal stimulus.

Across the Eurozone few left-wing parties are firmly in the saddle. In that sense we should not have high hopes of the will of national governments to stimulate economic growth. Yet, this is offset by the following:

  • The general attitude regarding fiscal stimulus is gradually changing.
  • The traditional left/right dichotomy applies less and less whereas right-wing (populist) parties regularly are in favour of large-scale government spending.
  • The European authorities are taking a somewhat more flexible stance than before.
  • Expectations in Europe are low compared to the prospect of stimulus in the US.

The Japanese government is determined to overcome economic stagnation even though deficits are high and the national debt is huge. Abe has announced stimulus packages worth over US$130bn. The Central Bank of Japan is facilitating the stimulus and PM Abe is in a strong position politically. The coalition parties have won a comfortable majority in the Upper House elections in July and the next Lower House elections are not due until December 2018. The story looks relatively positive at first glance but we should point out that stimulus money that was announced in the past never even came close to the sums that were actually spent.

The Chinese leader Xi Jinping is perhaps even more comfortable on this throne than Abe. Xi has greatly consolidated and expanded his power since taking office. However, he may worry about China’s debt (public and private): it stands at 260% of GDP and economists have been warning against financial bubbles for a long time. Yet, the government can continue to pour money into the economy as its capital account is closed, its reserves are enormous and its debt is almost exclusively denominated in yuan and held domestically. Stimulus measures that entail infrastructure investment are relatively easier to implement than in the West. China lags the rich countries to a considerable degree (it ranks 51st on a list comprising 144 states) and it has grand plans. There is the One Belt, One Road initiative (OBOR) that involves spending worth dozens of billions of dollars and the Asian Infrastructure Investment Bank (AIIB), which has US$100bn at its disposal; Beijing supplies US$30bn of this. We expect China to extend public spending in 2017.

Next year could see a net increase in economic stimulus in the major economies. Japan and China will likely meet the prevailing expectations whereas day-to-day politics in Washington may well belie the optimism about Trump’s plans. We do not expect any stimulus miracles in Europe although the expectations are extremely modest so there is a possibility that the actual level of spending will positively surprise the markets. The large-scale fiscal stimulus that many international organisations would like to see may not materialise but austerity as a mantra seems done and dusted.

The question is will the governments make use of the time bought by central banks to implement (further) structural reforms? Will fiscal stimulus do more than boost near-term demand? It is worth remembering that the European governments have pursued an austerity policy for a long time (and continue to do so in some cases). 2017 may well be the year when this starts to change while the next trend reversal – back towards belt tightening – may unfold just as slowly. Such a pattern would initially be good news for growth. However, the consequences for public debt and inflation could be very serious in the longer term.

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