A6 OPINION Friday 20 July 2012 Shanghai DailyHow to end recession:Austerity vs spending Editor’s note: Should governments increase spending to maintain economic growth in recession years? Renowned economists Paul Krugman and Richard Layard say yes in “A Manifesto for Economic Sense” late last month. Shawn Mesaros, managing director of Pacific Asset Management, disagrees in a statement sent to Shanghai Daily. The following is a condensed account of their arguments.❛ Manifesto: More than four years after the The condi- financial crisis began, the world’s major ad- vanced economies remain deeply depressed, intions for crisis a scene all too reminiscent of the 1930s. Andwere created the reason is simple: we are relying on the same ideas that governed policy in the 1930s. Theseby excessive ideas, long since disproved, involve profoundprivate sec- errors both about the causes of the crisis, its nature, and the appropriate response...tor borrowing The causes. Many policy makers insistand lending, that the crisis was caused by irresponsible public borrowing. With very few exceptionsincluding by — other than Greece — this is false. Instead,over-lever- the conditions for crisis were created by excessive private sector borrowing andaged banks. lending, including by over-leveraged banks.The collapse The collapse of this bubble led to massive falls in output and thus in tax revenue. So theof this bubble large government deficits we see today are a consequence of the crisis, not its cause.led to mas- Shawn Mesaros: Government, not con-sive falls in su mers, is responsible for effectively “subsidizing” the poor behavior of consum-output and ers. Banks are nothing more than recipients Illustration by Zhou Tao/Shanghai Dailythus in tax of the Federal Reserve policies. In fact, these policies created a self- many future generations with debts in order — the countries with the biggest budget cutsrevenue. reinforcing policy response at the state to provide appropriate solutions to what is have experienced the biggest falls in output. and local level to where tax policies favor clearly a crisis of too much debt. Mesaros: The Manifesto authors are accurate— Manifesto the trend in rising home prices, rising home here. The IMF studies are most centered on equity, lowered borrowing costs, thus much Manifesto: The big mistake. After responding emerging economies and smaller countries. higher retail sales which policy-makers knew well in the first, acute phase of the economic And using the same 173 case studies, the was poor policy, but now, having bitten the crisis, conventional policy wisdom took a wrong manifesto authors fail to also admit that apple, they could not resist the temptation turn — focusing on government deficits, which these studies demonstrate the largest decline❛ Govern- to throttle the market with more leveraged are mainly the result of a crisis-induced plunge in GDP resulting from absolute reduction in products. After all, leveraged transactions in revenue, and arguing that the public sector government spending occurs in countriesment, not have the capacity to create GDP numbers. should attempt to reduce its debts in tandem where government makes up a very large Then we see Fannie Mae and Freddie Mac who with the private sector. As a result, instead percentage of GDP. Embrace big government,consumers, were again, set up in the “Great Depression” of playing a stabilizing role, fiscal policy has and then never let them stop spending or you as a lender of last resort, yet these same ended up reinforcing the dampening effects of get a big drop in GDP.is responsible entities became the dumping ground for private-sector spending cuts... Both Greece and Spain had about 7 percentfor effective- everything toxic during an economic boom. unemployment before the financial crisis. Federal policy drove these failures. Deeper and deeper in debt The result of “austerity” aka “less governmently “subsidiz- Mesaros: When the government goes deeper spending” was truly astonishing.ing” the poor Manifesto: The nature of the crisis. When and deeper in debt, taxes go higher and higher About 25 percent unemployment in just real estate bubbles on both sides of the since taxpayers pay for everything govern- 36 months. Did non-government demandbehavior of Atlantic burst, many parts of the private ment does. The Manifesto authors would have drop off that much? NO. What was the causeconsumers. sector slashed spending in an attempt to pay us believe that when we go deeper into debt, of that rise in unemployment? Government down past debts. This was a rational response we recover faster. This is false. sponsored businesses and governmentBanks are on the part of individuals, but — just like One cannot invest and save more when one employees no longer received free credit cardnothing more the similar response of debtors in the 1930s is continuously paying off ever larger moun- cheese. They were fired or the businesses, long — it has proved collectively self-defeating, tains of debt. We would suggest that the laws since without economic benefit, disbandedthan recipi- because one person’s spending is another of physics continue to apply in economics. If for the epic failure of capitalism that theyents of the person’s income. The result of the spending you want to see a faster growing economy in would have represented. collapse has been an economic depression real terms, the first rule is to save and investFederal Re- that has worsened the public debt. more at the consumer level. Manifesto: ...as spending rose between 1940serve Policy. The appropriate response. At a time when and 1942, output rose by 20 percent. So the the private sector is engaged in a collective Manifesto: Moreover past experience problem in the 1930s, as now, was a shortage effort to spend less, public policy should act includes no relevant case where budget cuts of demand not of supply.— Mesaros as a stabilizing force, attempting to sustain have actually generated increased economic Mesaros: The Manifesto authors forget that spending. At the very least we should not be activity. The IMF has studied 173 cases of between 1929 and 1942 consumer credit ac- making things worse by big cuts in govern- budget cuts in individual countries and tually contracted for about 11 years before ment spending or big increases in tax rates on found that the consistent result is economic bottoming ahead of World War II. Consumers ordinary people. Unfortunately, that’s exactly contraction. In the handful of cases in had saved money, they had invested money, what many governments are now doing. which fiscal consolidation was followed by and it set the stage for a wonderful period of Mesaros: The Manifesto authors continue growth, the main channels were a currency economic expansion in the United States. asking government to give away money, depreciation against a strong world market, As we would expect, the Manifesto authors soak up all excess capacity, and stabilize not a current possibility. The lesson of the explain this 20 percent rise in output as the bloated system by borrowing against IMF’s study is clear — budget cuts retard “government spending” only and not actual the same taxpayers who will be harmed for recovery. And that is what is happening now taxpayers working and producing anything.