Just lifting aggregate demand is not a development strategy
Both the Treasury and its critics seem to fall short in adequately justifying their arguments with recourse to robust literature
The growing distrust of expertise is a double-edged sword. On the one hand, technocrats leveraging expert knowledge hold considerable responsibility for illegitimately dismissing popular demands that issues of social concern — such as concerns about growing inequality — be addressed. On the other hand, inexpert discourse, such as conspiracy theories, pose a greater threat than before and expertise has an important role to play in refuting it.
A good example concerns the antivaccine conspiracies that are proliferating in the middle of a widespread and deadly pandemic. US immunologist Anthony Fauci said in a recent interview with the Financial Times that the growing distrust of experts is a problem we can’t run away from. One need not fetishise technocracy, nor give it pride of place over popular action, to recognise a role for experts and academics producing analysis relevant to any number of progressive causes.
The dual dangers of expert and inexpert perspectives extend beyond popular debate over health policy into areas such as economic policy. Orthodox dominance of notions of expertise has been used as an instrument to push austerity policies in many contexts, at great social and economic cost.
A prominent example is the highly questionable notion of expansionary austerity, advocated by the recently deceased Harvard economist Alberto Alesina, and in the SA context by Treasury director-general Dondo Mogajane in his recent presentation to parliament. In response to the supplementary budget and analysis such as Mogajane’s, a group of academic economists has rightly offered a vociferous critique. Credit in particular goes to the Institute for Economic Justice (IEJ).
It is increasingly recognised in mainstream spheres that the case against austerity is greater than the case for it, particularly during recessions and depressions. In a sense, SA Reserve Bank deputy-governor Kuben Naidoo recognised this in his recent response to critics, saying the government should respond to the economic effects of Covid-19 and the ensuing lockdowns through a countercyclical fiscal and monetary response.
However, even critics of austerity can and do ask “how confident are we about the level of aggregate expenditure that policy should target?" To address this question it is worth scrutinising estimates of fiscal multipliers, including associated assumptions and implications.
As far as is publicly visible the response to parliament by critics of the budget is based in significant part on a research note written for the IEJ in March. This attempted to calculate the fiscal multiplier for SA using input-output data for 2018, and came to the conclusion that the multiplier averages 1.68 (at other times, the IEJ seems to suggest a multiplier of 1).
Two major caveats to strong use of this research for policy advocacy come to mind, which have not been sufficiently recognised in the advocacy work of the critics. First, while acknowledging prominent accounts of SA macroeconomic performance as constrained by supply side factors such as infrastructural bottlenecks, this research assumes “additional supply is always able to meet an exogenous increase in final demand”.
This is a questionable assumption for an economy plagued by an erratic and constrained supply of electricity (not to mention the effects of lockdown on the supply side).
Second, estimates of the multiplier for 2018 may be less relevant to the indicators for the relevant size of fiscal policy under current demand-side conditions. There are two considerations with competing effects here. While fiscal multipliers tend to be bigger during downturns, the nature of the current shock (which is in part a demand shock delivered by a change in preferences) means the “closed income multiplier” calculation, which includes induced consumption and investment effects, for 2018 is likely less valid as a measure of the multiplier today.
That is to say it’s not obvious whether consumption (or investment) behaviour robustly responds to stimulus as would normally be the case outside of pandemic conditions. Restoring economic wellbeing in the current crisis interacts significantly with control over the spread of Covid-19. A recent working paper by Arslan Razmi provides an interesting formal demonstration.
Both the Treasury and its critics currently seem to fall short in adequately justifying their arguments with recourse to robust theoretical and empirical literature.
What are the implications of the claims in this piece for policy and policy-advocacy more generally? A higher debt-to-GDP ratio seems likely regardless of whether an expansionary or contractionary fiscal policy is pursued. The former might significantly increase the numerator while having a smaller-than-usual increase in the denominator, whereas the latter might keep the numerator from exploding while causing a major contraction in the denominator.
But the debt-to-GDP ratio isn’t an end in itself: policymakers must choose the debt-to-GDP ratio consistent with the highest level of output and employment. A complicating factor is that countries with significant enclaves of hidden unemployment do not have a well-defined short-run full employment target. The “normal” rate of capacity utilisation may be an appropriate short-run target for stabilisation policy.
Will a debt build up lead to “disciplining” by the markets? Given the exogenous nature of the shock — it’s caused by Covid-19, not government profligacy — perhaps SA’s government should invest in a strategy of moral suasion to argue for the debt moratorium relevant to the many developing countries so badly hit by this shock.
In conclusion, identifying the plausibility of dampened effects of stimulus is relatively straightforward in an uncertainty-plagued Covid-19 economy. However, it is imperative that the economy is stabilised in the short run. Importantly, the need for stimulus as a tool for short-run stabilisation must be caveated with recognition that merely boosting aggregate demand does not constitute a development strategy. Recognising these points likely precludes the validity of austerity as an option and does not require overselling the efficacy of conventional fiscal policy during a pandemic.
• Aboobaker is a PhD candidate in the economics department at the University of Massachusetts, Amherst.
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