ECONOMIC STIMULUS MAY NOT BE A PANACEA FOR ALL ILLS

BY INVITATION

The boldest stimulus packages that governments all over the world have poured into their economies do not seem enough to bolster the economic cycle, which has entered its worst post-World War II recession. Also, central banks have delivered news of the worsening state of the real economy notwithstanding widely expected cuts in interest rates.

The figures are staggering. The United States Senate and House of Representatives recently agreed on a US$789.5-billion stimulus package. Economic safety nets worth billions more dollars have also been announced by many of the world's leading economies - $586 billion for China, $164 billion for the European Union (EU), $51 billion for Japan, $38.8 billion for the United Kingdom (UK), $26.5 billion for Australia, $13.7 billion for Singapore, and $12.9 billion for Hong Kong.

Meanwhile, the worries and caveats coming from central banks and financial institutions keep painting a bleak picture of economic fortunes. These include falling industrial orders, contracting industrial production, collapsed export demand and deteriorating labour markets.

The US Federal Reserve, for instance, warned that "downside risks to growth remain" following the passage of the record stimulus package. Singapore Finance Minister Tharman Shanmugaratnam said that "the resilience package will not get us out of recession. But it will [only] help avert an even sharper downturn and more lasting damage to the economy".

Experts also worry that the measures that governments announced to bail out business and industries will have limited impact.

"Our big concern is that today's measures will not actually provide much boost to the economy," said James Knightley, an economist at ING Financial Markets in London.

Likewise, Chua Hak Bin, research head at Citigroup in Singapore, said: "Unfortunately, Singapore is the most open economy in Asia. Its fortunes are tied to global growth and trade. So the budget is not going to make that much of a difference."

A textbook analysis provides hints that explain why stimulus packages may not help reverse the current economic decline.

In normal circumstances, when the rest of the world works well, fiscal and monetary stimuli revive the economy in two ways. First, the interest-rate channel - a plunge in interest rates - induces spending on consumption and investment, thereby magnifying gross domestic output. Second, and perhaps more importantly, the exchange-rate channel - depreciation of the domestic currency - beefs up employment and production for the export and import-substitution sectors.

The latter is particularly vital for a city-state, which has a highly open economy that depends heavily on trade, as do the economies of most OECD and newly industrialised countries.

Now let us turn to the currently prevailing, anomalous state - the global slowdown - in which all countries compete to ease policy simultaneously.

"An onslaught of horrific economic data around the corner," said Alex Patelis at Merill Lynch in London, inflicts uncertainties intimately on the lives of people.

The worsening economic outlook tempts consumers to defer consumption of durable goods such as properties, electrical appliances and cars. A slump in business sentiment, in addition, affects investor risk appetite and thus prompts many companies to slash investment in new equipment and factories, which has been a key driving force of economic growth. The eroded spending ultimately shrinks the multiplier effects of the interest rate channel.

Neither does the exchange-rate channel work now that all countries cannot export at the same time. A country always needs a bigger stimulus plan than that of the others in order to keep the domestic currency depreciated.

The lack of international collaboration on budget deficits that fairly slices export shares, therefore, traps all countries in the "prisoners' dilemma" outcome. The result is stagnant export growth.

Governments around the globe now open the door to welcome an additional stimulus package - raising a natural question: How much could we spend to rescue the countries from dire economic straits?

Size doesn't matter. "The word of the day is confidence. Confidence in our markets, confidence in lending, confidence in our financial institutions," US House Speaker Nancy Pelosi said recently.

The key to reviving the economic growth engine lies with reducing uncertainties and restoring upbeat consumption and business confidence. Sentiment-lifting measures, like tightened financial regulations and well-established financial market restructurings, are by all means indispensable for securing an economy at a time of unprecedented global economic turmoil and are therefore in dire need of being put in place.

Aekapol Chongvilaivan is a fellow at the Institute of Southeast Asian Studies (ISEAS), Singapore.