Stimulus goes global. Will it be enough?

The key is how well nations manage the spending.

By , Correspondent of The Christian Science Monitor

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    Closed: The US recession has already forced car dealers, like this one near Detroit, out of business. Businesses globally are bracing for more contraction.
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    Protests in Japan: Unemployed workers and supporters rallied in Tokyo Jan. 5 amid announcements of factory closings and big job cuts.
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Think 2008 was rough? Most indications are that 2009 will be even rougher for the global economy.

For the first time since World War II, the world's advanced nations – representing 80 percent of global output – will all see their economies contract simultaneously. Smaller economies will see slower growth and even dynamos like China, whose economy is still expected to grow by 8.5 percent, worry about social unrest from the slowdown.

And that's the optimistic scenario, painted by the International Monetary Fund and others. While the IMF back in November forecast that the US economy would contract by 0.7 percent while Japan's and the European Union's would fall by 0.2 percent, pessimists see larger declines, especially for the US.

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As a practical matter, one of the only certainties for the year ahead is that government deficits will balloon as nations try to stimulate their economies and restart the cycle of growth.

How deeply the global recession cuts, analysts say, will be a function of how well they manage this spending.

If mismanaged and if the direst economic predictions are borne out, a storm that began on Wall Street could have profound political and social effects, particularly in the most vulnerable economies.

What are the ways out of the current crisis?

In one word, "Keynesianism" – the idea set out by economist John Maynard Keynes in the 1930s that governments lower interest rates (which has already happened) and increase spending (which is about to happen) to jump-start their faltering economies.

At the heart of the theory is the expectation that massive new outlays on roads, bridges, and other infrastructure will create jobs and stimulate consumer spending, cushioning the downturn at first and eventually stimulating economic growth.

The theory holds that if managed correctly the economic benefits of this spending will eventually be a multiple of the cost, allowing for the deficit accrued to be paid back later through higher tax revenue.

In practice though it's hard to know when you're spending too little to create the needed economic boost and when you're spending so much that you've generated a crippling, rather than manageable, debt burden. Getting that balance right will be the main task.

All eyes are on the United States. With an economy three times the size of its nearest competitor (Japan), it still sets the global tone for consumption and growth.

President-elect Obama has indicated that he will seek a nearly $800 billion government stimulus program to create jobs, pump money back into consumers' pockets, and thereby set the stage for recovery.

If such action isn't taken, a recession could "linger for years," he warned on Thursday. "I don't believe it's too late to change course, but it will be if we don't take dramatic action as soon as possible," he said in prepared remarks for a speech at George Mason University in Fairfax, Va.

Is stimulus the right move?

Although dissenters are easy to find – both those who think it's too large and those who think it's too small – far scarcer are those who think spending by global governments shouldn't expand at all. No economists or governments are predicting job gains in 2009, and most large companies are bracing to fire workers and cut costs to prevent themselves from drowning in red ink.

"How much room is there for more fiscal stimulus? Probably not much," says Simon Johnson, former chief economist at the International Monetary Fund and currently a senior fellow at the Peterson Institute for Economic Research. "Stimulus is not going to be enough by itself. We need an aggressive housing program to limit foreclosures, a more expansionary monetary policy, and a bank recapitalization."

Mr. Johnson says the Obama administration must find a way to recapitalize banks because they have few other ways to access new cash with the current weakness of the stock and bond markets. If, as he suspects, credit remains locked down and defaults rise in the coming year, then the banks will need another source of funding to keep credit flowing. "You get into this situation when losses wipe out their capital and you need to nationalize your banks."

But it's expensive. The Congressional Budget Office forecast a deficit of $1.2 trillion for this year on Wednesday. And few are expecting a quick turnaround, one reason that Obama warned earlier this week that "potentially we've got trillion-dollar deficits for years to come." That comment in perspective? The federal deficit in the last fiscal year, which ended on Sept. 30, was $450 billion.

All of this means more job losses for now. In the last two months of 2008, the US lost 1 million jobs, according to an estimate by payroll company ADP and the US unemployment rate was at 6.7 percent in November. On Tuesday, the Congressional Budget Office warned that the unemployment rate could rise above 9 percent by the end of the year – its highest level since 1983.

Will nations work together?

Although the US stimulus package, if passed, would be the largest – about 5 percent of output as measured by gross domestic product (GDP) – it's not the only one.

The European Union – with a combined economy that is slightly larger than that of the US – has recommended that its members enact a stimulus plan amounting to 1.5 percent of their combined GDP, or about $220 billion.

Australia's Prime Minister Kevin Rudd warned in piece published in Wednesday's Financial Times that much of the fiscal stimulus so far announced by world governments will not be released until 2010.

He called for international coordination of spending plans to create a cycle where "stimulus measures from one country spill over into their trading partners" and said he's worried about the emergence of "beggar-thy-neighbor policies" like the re-creation of trade barriers. Resetting the table for economic growth "will require unprecedented cooperation among governments. If we fail, the consequences will be grave," he wrote. 

"The United States isn't the only country right now that's talking about massive fiscal stimulus programs, almost everyone is," says Curtis Dubay, a senior policy analyst who focuses on tax issues for the Heritage Foundation. "But of course the US is going to lead the world out of recession."

Mr. Dubay hesitates to put a precise figure on what the right amount of stimulus is, but he argues that if current proposed and scheduled stimulus proposals fail, more government spending will probably fail as well.

Conservative groups like his believe deep, across-the-board tax cuts are what's needed, though that's something they acknowledge is unlikely with an incoming administration that is signaling it favors tax cuts targeted at the middle class, not permanent tax cuts for all corporations or individuals.

"How much is ever enough? No one knows," he says. "But we're getting up to almost 10 percent of deficit spending already. Massive federal government spending problems are not likely to work."

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