The G-20 Stimulus Split: A False Debate

As the G-20 leaders prepare to meet on April 2 in London, the issue of a coordinated fiscal stimulus response to the global economic crisis is one of the most important items to watch in terms of summit results. Much has been made of a split between some G-20 leaders about the need for a more aggressive fiscal stimulus response to revive growth and trade. Yet, this stimulus split is a false debate and the numbers show that the overall economic response to the crisis by the G-20 countries actually already exceeds the 2 percent target pinpointed by the International Monetary Fund.

First, it’s important to distinguish between the two types of economic responses pursued by countries. There are discretionary measures, which include elements such as tax cuts, public investment and expenditure increases, and automatic stabilizers, which are economic mechanisms used by countries to deal with unemployment compensation, health care, poverty, and other social needs that increase in periods of economic downturns. The Europeans have made the case that this full basket of measures, including automatic stabilizers, count towards reviving economic growth and they are correct. What matters when we look at the economic data is the total economic response from both of these elements. To look at only discretionary measures to the crisis without looking at automatic stabilizers is like looking at the world with one eye shut.

The International Monetary Fund recently provided estimates on both types of economic responses in a document it prepared for the G-20 finance ministers in mid-March, and what stands out from this data is that there are not significant differences between the U.S. and Europe when we look at the combined total of discretionary measures and automatic stabilizers. The U.S. average annual rate of stimulus for the period of 2008 through 2010 will be 3.2 percent, as a percentage of 2007 GDP, compared to 2.8 percent for the EU.

It is true that when we look at just discretionary measures alone, the U.S. is making an average annual effort over the three years of 1.6 percent of 2007 GDP as compared to 0.6 percent for Europe. But Europe’s tradition of stronger welfare state mechanisms is revealed by the fact that automatic stabilizers in Europe contribute 2.2 percent of GDP over the three years with respect to the 2007 base, as compared to 1.6 percent for the U.S.

The real contrast can be seen when we compare the U.S. and Europe together against the G-20 emerging market economies. It is not surprising that emerging market economies cannot provide as many social welfare mechanisms given that their capacity to respond to economic crisis is more limited, and we see the data bear that out. For example, whereas the 10 G-20 emerging market economies are utilizing discretionary responses to the crisis at a similar level to the G-20 advanced industrial countries (1.2 percent average annual ratio to 2007 GDP for both groups), the emerging market economies automatic stabilizers only contribute 0.8 percent of GDP as compared to 1.9 percent for the advanced economies.

Finally, when we look at the sum of the parts, the IMF figures reveal that 19 countries in the G-20 (all but the combined EU seat) provide an overall impact on aggregate demand, including discretionary measures and automatic stabilizers, at an average annual rate of 2.6 percent of 2007 GDP for 2008-2010. This is well above the 2 percent of GDP fiscal stimulus target identified for the G-20 London Summit. In fact, Europe’s combined share is actually more than the G-20 average at 2.8 percent of GDP for the three years, as compared to the overall G-20 average of 2.6 percent.

So, what does this really mean for the man on the street trying to recover from the crisis? The bottom line is that for citizens of the G-20 countries who are struggling with unemployment, health care costs and other economic burdens, it makes little difference if you receive a check in the mail for a tax rebate, a tax cut or an unemployment compensation program. To him, stimulus is sustenance. Therefore, the debate should shift away from the false dichotomy between discretionary measures and automatic stabilizers and focus instead on the overall real economic response to the crisis.

My bet is that the protestors on London’s streets care more about the scale and scope of response and how it will affect them rather than how we split the difference.

Sources: IMF (2009), Global Economic Policies and Prospects, Note Prepared by the Staff of the International Monetary Fund, Group of Twenty Meeting of Ministers of Finance and Central Bank Governors, London, UK, March 13-14, 2009.