After two wasted years, the G20 pivots back towards fiscal sanity
The G-20 has come (almost) full circle. In April 2009 in London, the communique set out leaders' commitment to a massive coordinated fiscal stimulus:
We are undertaking an unprecedented and concerted fiscal expansion, which will save or create millions of jobs which would otherwise have been destroyed, and that will, by the end of next year, amount to $5 trillion, raise output by 4 per cent, and accelerate the transition to a green economy. We are committed to deliver the scale of sustained fiscal effort necessary to restore growth.
While the degree of coordination was somewhat exaggerated, there was a genuine collective determination to do what was necessary to ensure the financial crisis did not become a prolonged depression.
And it worked - perhaps too well. By June 2010, in Toronto, it appeared that recovery was indeed underway. The new priority was fiscal consolidation: the communique noted approvingly that:
"Sound fiscal finances are essential to sustain recovery, provide flexibility to respond to new shocks, ensure the capacity to meet the challenges of aging populations, and avoid leaving future generations with a legacy of deficits and debt... Advanced economies have committed to fiscal plans that will at least halve deficits by 2013 "
For the UK government, this was a diplomatic triumph; not only did the G20 endorse the UK's approach to fiscal consolidation, it commended it to other countries:
"I think the British budget has been noticed here in the G20 and has been appreciated," finance minister George Osborne said. Citing the summit communique, he said the group had formally recognized that "countries with serious fiscal challenges need to accelerate the pace of dealing with them, and of course that is exactly what the budget did."
Others were less positive; Paul Krugman's reaction:
"The deficit hawks have taken over the G20. The right thing, overwhelmingly, is to do things that will reduce spending and/or raise revenue after the economy has recovered — specifically, wait until after the economy is strong enough that monetary policy can offset the contractionary effects of fiscal austerity.
But no: the deficit hawks want their cuts while unemployment rates are still at near-record highs and monetary policy is still hard up against the zero bound. Utter folly posing as wisdom".
And indeed it is now clear this premature "pivot" to fiscal consolidation, as the IMF described it, was a huge mistake, both for the G20 as a whole and for the UK. The supposed commitment to halve deficits by 2013 has been quietly (and rightly) forgotten, derailed by weak growth. Indeed, in the UK, most of the deficit reduction so far has come through cutting public investment; belatedly, the government has recognised the folly of this approach, and is trying to think of ways to reverse it without admitting that it got it wrong, as I explain here.
Meanwhile, in the eurozone, matters are even worse. Austerity has proved self-defeating even in its own terms, with fiscal contraction leading to lower growth and higher unemployment, in turn exacerbating deficits and leading to further losses of credibility, both political and economic.
But the good news is that at this week's G20 in Los Cabos the message does seem finally to have got through to world leaders. Although most press attention has focused on the rather inconclusive discussion of the eurozone crisis, it is worth noting the communique text on fiscal policy:
All G20 members will take the necessary actions to strengthen global growth and restore confidence. Advanced economies will ensure that the pace of fiscal consolidation is appropriate to support the recovery, taking country-specific circumstances into account and, in line with the Toronto commitments, address concerns about medium term fiscal sustainability. Those advanced and emerging economies which have fiscal space will let the automatic fiscal stabilizers to operate taking into account national circumstances and current demand conditions. Should economic conditions deteriorate significantly further, those countries with sufficient fiscal space stand ready to coordinate and implement discretionary fiscal actions to support domestic demand, as appropriate. In many countries, higher investment in education, innovation and infrastructure can support the creation of jobs now while raising productivity and future growth prospects. Recognizing the need to pursue growth-oriented policies that support demand and recovery, the United States will calibrate the pace of its fiscal consolidation by ensuring that its public finances are placed on a sustainable long-run path so that a sharp fiscal contraction in 2013 is avoided.
As usual, there is something for everyone here. But the change of tone is marked. Instead of the mistaken and damaging view of 2010 that immediate fiscal consolidation was urgent to sustain recovery and boost confidence, there is a recognition that cutting deficits too fast could damage growth; that higher investment would boost both output and jobs now and productivity over the medium term; and that further stimulus may well be necessary, given the continued depressed state of much of the world economy. All this is welcome; it is a pity they didn't say this two years ago. Let us hope it translates into policy.