STIMULUS VERSUS DEBT REDUCTION: DOMESTIC POLICY AND INTERNATIONAL POLITICS

Globalization has made it increasingly difficult for states to maintain completely independent economic policies. Policy changes in one country cause economic effects that spill over into others. These connections become particularly worrisome in economic crises, when disaster can spread from one economy to the next and one state’s anticrisis measure can undermine others’ economies. In 2010, a dispute emerged among major Western countries concerning the relative importance of stimulating their economies out of recession and containing the growth of their debt. Economic stimulus packages, like those enacted in the United States and many other countries in 2009, are based on fiscal policy: If the government spends more than it takes in through taxes, the net effect is to inject money into the economy, helping end recession. But to spend more than it takes in, the government must borrow. In 2009, many leading industrial states (Japan, the United Kingdom, the United States) agreed that a fiscal stimulus was necessary, while Germany, historically more fiscally conservative, was less convinced. Those favoring stimulus argued that for it to work, governments needed to join together. Globalization meant that the effects of any state’s stimulus would “spill” outside its borders, diluting the effects on the home economy. Thus, if only one or a few states adopted stimulus packages, the effect might be insufficient.

In 2010, however, the tension sharpened as the Greek debt crisis made two things clear. First, financial markets were beginning to doubt the ability of governments to pay back their debts. This could undermine recovery, increase borrowing costs, and lead to debt crisis, as Greece experienced. Second, such a crisis could severely damage the economies even in countries that did not overborrow, because their banks held many of the loans.

In the United States, there was a fierce debate, with President Barack Obama and many liberals worrying that insufficient economic stimulus would prolong the recession, while fiscal conservatives worried more about growing debt. In contrast to past debates, the United States also found itself under considerable international pressure to limit deficit spending. In Germany, the conservative government of Angela Merkel sided with those who saw debt as the major danger. In the United Kingdom, an election shifted power from the Labour Party to a coalition of Conservatives and Liberal Democrats, which also focused on debt and quickly adopted a massive budget cutting program. Both the United Kingdom and Germany urged the United States to bring its deficit under control.

Why did Germany and the United Kingdom care about U.S. fiscal policy? As the largest economy in the world, any crisis in the United States would have a powerful effect on almost everyone else, and especially on major trading partners like the United Kingdom and Germany. Moreover, increased borrowing by the United States was likely to drive up interest rates even if it did not lead to crisis. With a fundamental disagreement about which threat to the U.S. and global economies was greater—debt crisis or recession—it was impossible to agree on a coordinated policy.

The danger emerged that the different policies would cancel each other out. If the United Kingdom and Germany took demand out of their economies through austerity packages, it could offset U.S. efforts to increase demand in its economy. Similarly, the sacrifices that UK citizens were going to make through reduced government services might achieve less effect if U.S. borrowing created a debt problem anyway.

Globalization has brought an increased need for policy coordination, especially in times of crisis, but no way of achieving it. Economies with contradictory policy needs, and societies with contradictory policy preferences, have much less freedom to behave independently of one another.

Why were different governments able to reach some consensus in 2009, but not in 2010, over the merits of further economic stimulus?

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A The primary reason that Germany and the United Kingdom care about United States fiscal policy is because of the potential effects that it could have ... View the full answer