Is a strategy of fiscal consolidation good for economic growth?
Under the current economic and socio-political circumstances, reacting with the mindset of the 1980s and 1990s is the wrong approach for national economies in Latin America and other emerging markets, and for the global system. In a world of rock bottom interest rates, the whole concept of austerity should be revisited.
In other words, we need a paradigm shift towards intelligent austerity. Take, for instance, Latin America. It is a region with a huge infrastructure deficit that hampers connectivity to regional and global markets. The quality of education is dismal. According to the Programme for International Student Assessment administered by the Organisation for Economic Cooperation and Development, 60 per cent of the region’s 15-year-olds do not have the minimum skills to participate productively in formal labour markets and the knowledge economy. Informality is running wild. For the typical Latin American country, 70 per cent of the labour force is employed by the informal sector, leading to a miniaturisation of the economy with a disproportionately large share of output being generated by very small and unproductive firms.
It would be reasonable for countries to take advantage of historically low interest rates to promote productivity-enhancing investments in infrastructure and human capital, or as professor Ricardo Hausmann of Harvard University suggested, in housing, urban transport and social services to connect informal workers to the complex urban networks where modern production takes place.
Due to the concern of losing the confidence of markets, many countries in the region prefer to opt for caution and forgo these opportunities. It is understandable. We carry too many crises on our shoulders that have caused much suffering. If these opportunities are going to be undertaken, most countries cannot do so by themselves; the international community must play a key role in ensuring that these investments are pursued.
For that to happen, development banks should go back to basics and use their ability to tap cheap resources in global markets and channel those resources to emerging markets, while at the same time they should use their monitoring capacity to ensure that those resources are channelled to socially productive investments.
The International Monetary Fund should ensure that resources are only channelled to countries with a coherent macroeconomic framework. Moreover, it should also ensure that socially productive investments are not computed as regular fiscal deficits. In economic terms they are not. Thus, rating agencies and markets will thus be reassured that cheap and abundant resources are being used intelligently, and only by eligible countries on sound projects.
After all, it is in the emerging world where many if not most of the socially profitable investment opportunities surely lie. If the global financial system is not performing the task of allocating excess financial and capital resources to emerging economies and forcing upon them excessive austerity, international financial institutions should step in to fill the void, either directly or by leveraging up public-private partnerships and private sector investment.
Very low interest rates should not be a licence to spend irresponsibly. After all, even at zero interest rates countries still have to pay back principal. However, the support of the international community for intelligent austerity in emerging markets that combines a credible macroeconomic framework with responsible public spending, would spread the benefits of very low interest rates worldwide and help rekindle global growth.
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Dr Ernesto Talvi is non-resident senior fellow with The Brookings Institution, Â a non-profit public policy organisation based in Washington, DC.
