Friday, July 02, 2010

Austerity vs. Stimulus

Paul Krugman has reignited the debate about proposed austerity and continuing stimulus. I think we need to understand one more side to the argument. 

The problem 
The economic problem relates to creating jobs and businesses. Basically, we need avenues for people to start earning. Once people earn, they will pay taxes and spend a little from the surplus. This will make the economy self-sustaining. This has two steps. First, we cannot increase the burden of the people further. Second, what we spend should be big enough to generate incomes large enough to pay for it. This is essentially the dilemma. This is the reason why we need stimulus.

But the stimulus is not yet efficient
Though we have been living off stimuli for past two years, the mechanics of stimulus is not fully developed.

To reiterate my earlier position, this crisis has its roots in the certainty of income. A stimulus is efficient if it improves the certainty of income. The certainty is more important than the amount of income. The certainty of income will come from jobs (created by businesses large and small) and small businesses. It is clear that small businesses are critical link as they reduce the owners and few other people from list of those who want jobs. This is where stimulus should reach. But the stimulus is not reaching the intended location - able and potent small businesses and individuals.

The flow of money is such that the beneficiaries of the stimuli are not actually the ones who need it. Sadly, the reverse is also true. Those who are supposed to pay for the stimulus are not actually the ones who can. This is a double blow to the effectiveness of stimulus. But the fact that stimulus is misdirected does not mean that it is not needed.

Austerity won't help either
Austerity will severely constrain the opportunities of the masses. It will definitely aggravate the problems. Worse, at this point, austerity will wipe out any gains from earlier stimuli and render them useless. The prior stimuli will now appear as a burden without any gain or impact. When we have a fire we need water. The fact that some people wasted water should not stop us from bringing more.

What it means
At the start of the crisis, I had mentioned that either approaches may work if we fully commit ourselves right at the beginning. At the beginning we started with stimulus approach. Now we should fully commit to it. Our commitment issues may make the situation even worse. We will end up with larger liabilities and no jobs to pay them. It will push the world over the edge. 

We need to get two things done:
  1. Examine what is preventing the earlier stimulus from working. Get the efficiency of stimulus going IMMEDIATELY.
  2. Get more stimulus to where it is needed, FAST.