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Thursday, August 18, 2016

What should governments spend on when faced with fiscal stimulus?

At the time of financial crisis of 2008-09, we were lucky to have the best monetary policy experts around. They seemingly used their various tools - some conventional and other unconventional. Yet about 8 years after we find we need fiscal stimulus as Mario Draghi put in an ECB statement in early summer. Luckily the US presidential candidates agree with this view. So in all likelihood, we should see some fiscal stimulus coming in.

Yet, the understanding on the fiscal side does not seem to be as well developed as the monetary sides. For one, exactly what Keynes prescribed is still much debated. Second governments don't know what to spend on. Obama famously called for "shovel-ready" projects. Milton Friedman (who died in 2006) would cringe in his grave. There is nothing more dangerous than a government committed to a fiscal stimulus that does not know what to do with it.

Looking at Roosevelt
It is, however, well-accepted that after the World War II, the Roosevelt initiative of building inter-state highway was one of the biggest fiscal stimuli to the US economy. The genesis of this project was the cross-country trip Roosevelt took in mid-1920s which may have given him a hint of its potential. Once it was implemented, its fruits accrued at least till late 1990s. Even in the era when the internet made distance irrelevant, these highways continued to contribute by way of lower transportation cost thereby giving firms advantage in making supply available at lower costs than otherwise. 

If fiscal policy is to be deployed today where can we deploy it? What areas would have as much purchase as did the highway program of 1930-40?

To answer this we need to imagine the economy as a network of value chains. Such a network has some common elements which need government support. These are the areas where fiscal policy needs to be directed. This is the efficiency angle. If any government wants to orient its economy in a certain direction then this would be the time to make investments in the missing parts of the value-chain that can be shared in the new era. 

A few I can think of:
  1. Going green: Reducing Oil-dependance is an option : The very basic pieces of all value chains do contain energy. So an advantage in green energy may be quite advantageous in the long term. Green energy needs a lot of work but could be a potential candidate. It could do with some sort of Manhattan Project 2.0 (the first was for nukes) for making green energy possible. They could standardize the electrical charging stations for hybrids, developing standards and technology to allow smaller wind mill operators to supply into the grid at a time of their convenience. Tesla is looking at this vision through private means.
  2. Going blue: Usable water: Food and water will continue to form part of value chains at a very basic level. While global food production is quite high (we destroy a lot of excess food), same cannot be said of global nourishment.  It is undeniable that whatever food we grow we will need potable water. Many say if we find green energy then we can desalinate the water. But low fresh water has an ecological impact on bio-diversity, food-chain dynamics etc. that cannot be dismissed. In that sense, the bio-diversity advantage may trickle into better nourishment and healthier foods - who knows. So I would focus on water management.
  3. Carbon catchment could be more urgent: In his TED talk Bill Gates made a very poignant statement - we need ZERO emissions, not lower emissions. It is clear that we cannot cut emissions fast enough. But can we trap emissions before they cause global warming? Maybe we should! This is more engineering problem rather than technology problem and may be more beneficial. Alas, its effects are very difficult to quantify.

The nature of fiscal stimulus
The exact quantum of fiscal stimulus is immaterial, though it has to substantial. What matters more is how long is that quantum spread and the conviction behind it. That will decide its efficacy. The fiscal needs to be prolonged, substantial and certain. An uncertain prolonged stimulus or variable stimulus without visibility will have no appreciable impact. 

Ideally, it should also be employment intensive. Higher employment intensity will allow the benefits to spread faster through the economy.

The goal of the stimulus is to increase the certainty of jobs and employment while laying down a basic infrastructure for the future. If it achieves this then such a stimulus will work. With a certainty of income will come spending and further downstream positive economic effects.

Note: the suggestions made are simply most promising areas at the moment as per my reading.