DELVING INTO THE FISCAL STIMULUS PACKAGE

ECO CAFE

Thailand has joined a worldwide trend in increasing its fiscal spending. Prime Minister Abhisit Vejjajiva recently put forward three important fiscal bills for parliamentary debate: two for the 800-billion-baht loan package and the other for the 2010 budget.

The 800-billion-baht borrowing plans are part of Mr Abhisit's 1.43-trillion-baht stimulus programme for 2009-12, also known as "Strong Thailand 2012". The stimulus is aimed at getting Thailand out of recession by 2010 by adding 1.5 percentage points of growth to the economy per year. More than 6,000 development projects, including rural and urban infrastructure, are set to benefit from the stimulus, creating more than 400,000 jobs a year.

Across the world, recent statistics from March 2009 put the sum of announced fiscal stimulus plans in 43 countries at US$2.18 trillion, or 3.5% of the world's GDP, mostly in higher income countries. Most of these recovery packages contain measures to stimulate firms, consumers and public investment in infrastructure.

The thinking behind the stimulus packages is simple: if companies attempt to save more by consuming or investing less, they will all fail. The solution is for governments to do the opposite. That is, to "dis-save" even more heavily than the private sector is trying to save, thus maintaining the targeted level of nominal aggregate demand.

It is also widely perceived that conventional monetary policy, which acted as a first line of defence against the crisis, appears to have reached its limits. Policy interest rates in many countries are now close to the zero. Also, the collapse of many countries' financial systems made monetary transmission mechanisms much less effective. Fiscal policy has, therefore, become necessary to restart the global recovery quickly and to prevent global growth from declining further.

Given the urgency of spending our way out of the crisis, how well thought-out are current stimulus plans? Policymakers worldwide have underestimated the depth and breath of the financial crisis, and their decisions have often resulted in expensive quick fixes, leading to many debates regarding the usefulness of fiscal stimulus packages.

There are three important issues to consider when launching stimulus packages. First, stimulus spending may be ineffective if banks are not willing to lend, but try to improve their balance sheets and distrust their counterparties.

Second, investment in infrastructure, often the major component of stimulus plans, only has an impact in the relatively long term. Third, lowering taxes and interest rates may not be effective when people are worried about losing their jobs, pensions and homes. As a result, money may be put instead into savings or paying off debt, rather than consumption.

A much larger proportion of government spending should, therefore, be spent on creating jobs, or generating a permanent stream of income, for everyone in the economy. As people become more secure of their future cashflow, they will be more willing to spend, effectively stimulating overall demand. As firms see more profitable opportunities they too are more willing to invest, while banks are more interested in financing their projects, generating further jobs and income.

We should take note that the popularity of fiscal stimulus or discretionary fiscal policy came only recently. "Discretionary" fiscal policy is an explicit change in government expenditure and/or tax policy, normally through legislation, in response to prevailing economic conditions. This is in contrast to "nondiscretionary" or "automatic" policy, in which expenditure and tax revenue only change as a result of changes in economic activity without any action on the part of policymakers.

In the past, the consensus view in mainstream economics was that such discretionary fiscal policy actions were undesirable. This consensus has recently begun to reverse - discretionary fiscal policy is now deemed effective and potentially more immediate than monetary policy in reversing economic crisis.

A recent IMF study provides new evidence that, on average for all economies, a discretionary stimulus package equivalent to 1% of a country's GDP is associated with an increase in GDP of about 0.1% to 0.2%, but the longer-term effects are typically negative in emerging economies.

To make sure that discretionary fiscal policy yields longer-term positive results, governments need to ensure that they improve fiscal positions during good times and that stimulus packages are only temporary. The packages should not be about returning the world to where it was - with widespread income inequality - but about bringing redistribution to the policy agenda.

Redistribution could boost economic growth in a sustainable way by promoting domestic demand and internal markets, and by enhancing human capital through better education and health care for all.

There are legitimate concerns about the effectiveness of fiscal stimulus. But given the weakening economic situation and the lack of other tools, we can only hope that the money will be spent wisely here in Thailand. After all, the economic cost of doing nothing is probably more enormous.

Dr Tientip Subhanij holds a PhD in economics from the University of Cambridge, and currently has a career in banking as well as academia. She can be reached at tien201@yahoo.com