THE NEW MANTRA

Over the past three months, several global central banks have stressed that monetary policy can only buy time but other actions are needed. In its last quarterly bulletin, the Bank of England strikingly demonstrated that the money multiplier, which justifies the intervention of central banks, does not work. In those circumstances, the ball is in the governments’ court. In a dramatic turnaround, all the international organizations, especially the IMF, and the G20 Summit of Beijing have called for more public spending to push economic growth close to its pre-crisis level. There is no doubt that this quarter, fiscal spending will be on the top of the agenda for investors all around the world.

Once-in-a-lifetime opportunity

The context is actually very favorable for higher public spending. Economic liberalism, that has exerted an overwhelming influence on policymaking over the last thirty years, has been discredited by the emergence of the global financial crisis. There is no dominant economic ideology anymore. Moreover, the role of rating agencies, which have acted as the guardians of fiscal orthodoxy, is now much less important for investors. However, the real incentive to make public spending is linked to historically low borrowing rates on financial markets. Global credit conditions are close to the loosest it has never been with average yield on global government bonds (all maturities included) evolving around 0.9% which is well-below its 10 years average of 2.30%. In some cases, the situation is even more unusual, like Germany where more than 80% of the sovereign bond market is with negative rate.

China and Japan are leading the way

In terms of fiscal stimulus, Asia is leading the way. The investment of public companies has increased by 24% since the beginning of the year in China in a move to offset the deceleration of private investment. The aim is to avoid an abrupt downturn of the economy but it also accentuates industrial overcapacity and the deflationary spiral (which has however slowed down since the start of the summer due to higher global commodities prices). To limit the negative effects, promising measures have recently been taken consisting in granting equal access to private investors in education and medical care, sending out inspections teams to make sure projects are carried out on the ground and investing in infrastructure in rural area, where it is really needed. If implemented, those decisions could certainly help fixing the economy.

Similar impact can be hardly expected from the stimulus package worth about 28 trillion yen (but direct spending only represents 7.5 trillion yen) that was approved last August by Japan. Compared to previous packages, it is not really impressive. It will probably lead to a temporary burst in industrial production but the effect will quickly vanish once again due to the deflationary mindset of companies and households. There is no easy trigger to switch their mindset. Until now, nothing has worked. A similar situation occurred in the USA in the 30 and, actually, only war solved it.

The last Japanese fiscal package worth 28 trillion yen mostly consists in infrastructure spending and cash handouts to poor family.

Europe: the end of austerity and of the 3% rule

Unlike Japan, risk of deflation is not the main issue in Europe. Despite very weak underlying inflationary pressures, there is no change in household and corporate behavior resulting from low inflation for a prolonged period of time.  In this context, fiscal policy can still be effective.

Europe hasn’t waited for the green light of the IMF to push for fiscal stimulus. In April 2015, the Juncker plan got underway. It is on right course since 20.4 billion euros worth of projects (one quarter of this amount for the benefit of small business and startups) have been approved on a three year target of 60 billion euros by the EFSI Investment Committee. However, it does not fulfill its initial promises in terms of growth. Therefore, to speed up the process, more than one third of the EU countries have recently launched or plan to launch some sort of fiscal stimulus in the coming weeks (e.g. UK and Hungary). Yet, only three countries have sufficiently strong public finance to do so: Germany, Sweden and Austria. The elections and referendums that will take place in the coming months in Italy, Spain, Austria and France in April 2017 will inevitably favor the spur of populism and weaken appetite for austerity (or fiscal consolidation). For the moment, Keynesian-style stimulus programs have not been embraced, with the exception of UK that may opt for a strategy of infrastructure spending to overcome uncertainty in the aftermath of Brexit. In most cases, the measures mostly consist in lower corporate tax to prevent delocalization to Ireland and to stimulate investment. Britain’s vote has also been a strong near-term catalyst for fiscal cuts in many countries. However, significant tax cuts or tax credits for households, to offset the important increase that has happened over the past years and, why not, direct cash handouts to poor families like in Japan could occur more frequently close to the election date.

The comeback of expansionary fiscal policy put a definitive end to the 3% deficit rule. As the saying goes, promises only bind those who believe in them. Italy, whose GDP at constant prices has not increased one iota over the past 15 years, Spain and Portugal are expected to miss their deficit reduction target in 2016 and 2017. As far as it concerns France, considering the economic program of the main presidential candidate from the right and the left, the outcome election will be, in any case, the break of the 3 percent deficit pledge, as it happened in the early 2000s. Due to the absence of European coordinated fiscal policy, it is the reign of "every man for himself" that prevails.

The US government frozen by key election

In this debate about public spending, the noticeable absent is the United States. The honorable performance of the US economy and the upcoming presidential election do not push for fiscal stimulus. However, we can easily anticipate that if Hillary Clinton wins, she will not hesitate to use the fiscal lever when signs of economic slowdown will appear. She may be inspired by the Bill Clinton stimulus package of 1993 that put US growth back on the right track. However, it is more difficult to assess the decisions that Donald Trump could take in these circumstances. His economic program contains interesting measures, such as lowering corporate tax to 15%, but also absurd and dangerous proposals like ripping up existing trade agreements and imposing heavy taxes on imports.

 This quarter will be the opportunity to discuss (again) the role of the state in the economy. Unfortunately, it is a debate that is systematically flawed because it is influenced by ideology whereas pragmatism should prevail. Public spending is neither bad nor good, and it is certainly not a miracle solution, as shown by the example of Japan. Its effectiveness depends on the economic diagnosis and on its implementation. However, it is quite a good news that governments finally step in and that monetary policy does not substitute to fiscal policy anymore, which has been the case since 2008. 

Traditionally, the debate is about big government versus small government but this opposition does not make any sense in a globalized world where the state needs to further regulate finance and faces the challenge of climate change. We should better talk about smart government: a government that relies on new technologies to reduce operating costs, that tackles the issue of declining productivity and that develops a real industrial policy, which have never done in the past 25 years in most of the rich countries. My message to governments: in any case, stay away from old-fashioned protectionism and understand that it is a waste of money and time to support industries that are doomed to decline. Those strategies have zero chance of success.