With the global economy doing so poorly, the central question on the G20 agenda should be the revival of growth. In a globally integrated economy, mistakes by any large country or region have global consequences.
There are massive externalities associated with the macroeconomic decisions being made in Europe, America, and elsewhere. But it is evident that those making the decisions typically don’t take them into account. The G20 provides a framework where leaders can and should be reminded of this growing interdependence.
Of particular concern at this juncture is the euro crisis. The mistakes Europe is making in addressing that crisis are not just an internal matter for Europe. They are of concern for the world.
Several simple economic propositions should inform their discussion:
The key problem facing the world today is lack of aggregate demand. The focus should, accordingly, be on restoring aggregate demand. Supply side reforms are important for long run growth; but poorly designed and timed supply side reforms - especially those that lead to lower wages - can actually weaken the economy in the short run.
Lectures about fiscal responsibility, no matter how well intentioned, won’t help. And some of these lectures are misplaced: Spain and Ireland had budget surpluses and low debt levels before the crisis.
No large economy has every recovered through austerity. There are some instances of small economies where exports compensated for reduced government spending - but that requires strong growth in one’s export partners, and with the global economy in the doldrums this is unlikely to happen.
The economic framework of the Eurozone was flawed from the beginning. Given the free flow of capital, it makes little sense for anyone to keep their deposits in a weak Spanish bank, knowing that the government has little capacity to bail it out of its trouble, and knowing that it is under pressure to buy risky sovereign Spanish bonds. But the flight of money from Spanish banks will weaken lending capacity, aggravating the downturn. This is only one of several vicious circles built in the euro-framework.
It is voodoo economics to think that Spanish banks can finance the Spanish government, and the Spanish government can bail out the banks. Such bootstrap endeavors are doomed to failure.
There is a viable growth and stability program - but it’s not based on austerity, and it can’t rely on just structural reforms. It entails a European wide banking system, and a European budgetary framework - and by that, I don’t mean the suicide pact of mutual austerity.
Euro bonds (or the ECB borrowing, and relending to the periphery) would provide room within their fiscal constraints for these countries to spend more in ways that would stimulate their economy today and provide the foundations for future economic growth.
Both the UN Commission investigating the sources of the financial crisis and the IMF have identified growing inequality as one of the foundational problems behind the crisis. But the way that many countries have managed the crisis has exacerbated inequality, weakening the recovery. Thus austerity programs that increase inequality - which most do - have doubly adverse effects.
In a world of globalization, monetary policy works in a markedly different way than in a closed economy. Liquidity can and does flow all over the world, looking for where returns are highest, often in countries already experiencing a boom. Thus money goes to where it’s not needed, and doesn’t go to where it’s needed. This means that just as there are large externalities associated with budgetary decisions (austerity), so too for monetary policy.
QEII was rightly seen in many quarters as (in part) a competitive devaluation; it set off a currency war; and it led, into the end, to a variety of interventions that had consequences just the opposite of what American has been working for for so long; it undermined globally integrated financial markets.
And yet, for all the potential adverse effects in emerging markets, for all the risks in creating asset bubbles, for all the threats to price stability that come from these commodity booms, QEII did little to rekindle growth in the US, at least in a sustainable way. QEIII is unlikely to be any more successful, and the belief that it might be reduces pressure on governments to come up with effective fiscal policies.
These are the principles that ought to guide the discussions. More likely than not, leaders will, instead, be focused on their own countries and (in the democracies of the G20), their voters. Political stances and ideology will rule. Germany sees its surpluses as virtuous, doesn’t understand why others don’t follow its course (but of course, by definition, not all countries can run a trade surplus), and won’t admit that surpluses contribute to the lack of global aggregate demand. The UK and Germany won’t acknowledge that austerity is at the center of Europe’s double dip recession. America won’t admit that its conduct of monetary policy - or its irresponsible lack of regulation - imposes costs on others. In a world dominated by conservative leaders, no one will even broach the notion of the balanced budget multiplier - if the government raises taxes and spends the money, the economy is stimulated, and often by a multiple of the amount of taxation.
So the leaders almost surely will end their meeting with fervent commitments to restoring global growth and balancing the budget, with most fervently committed to the notion that virtue - restoring fiscal balances - will miraculously restore economic growth. They - and the world - will be sorely disappointed.
Joseph E. Stiglitz is the winner of the Nobel Memorial Prize in Economics and former chairman of President Clinton's Council of Economic Advisers and chief economist of the World Bank. His new book is “The Price of Inequality: How Today's Divided Society Endangers our Future,” out this month from Norton and Penguin/Allen Lane