The rise of finance capital affects the ability of governments to
undertake deficit spending even directly. Finance capital is wary of the
possible inflationary consequences of deficit-financed expenditure, since
such inflation affects the real value of financial assets and the real
rate of return on such assets. It is also wary of the possibility that
governments resorting to deficit-financed expenditure may manage interest
rates in a manner aimed at keeping down the cost of their borrowing
requirements. Not surprisingly, financial agents constantly run down
deficit-based spending and often respond by pulling out of economies
characterized by high deficits on the governments' budgets. Fear of the
destabilizing effects this would have puts direct pressure on governments
to abjure deficit-financed spending.
The reality is that inasmuch as this fear of deficit
spending afflicts each and every government, we should expect the adoption
of a more deflationary stance across countries that could result in an
overall slowing of global growth. The shift to a more deflationary stance
did, in fact, occur. As Chart 3 shows, government fiscal balances in the
1990s reflect a sharp reduction in the level of deficit spending in the
principal developed countries, with the exception of Japan, where the
level of deficit spending increased sharply. In fact, by 1998, the fiscal
balance in the US and the UK had turned positive.
Chart 3 >>
It cannot be denied that this shift to a deflationary stance in fiscal
policy across the major developed countries would have had an adverse
impact on growth. To start with, in all these countries the stimulus to
growth afforded by government expenditure would have been considerably
dampened, since deficit spending relative to GDP fell in a period when tax
rates were being substantially reduced to spur private initiative. This
would have been aggravated by the global effects of reduced deficit
spending in the world's leading economy, the US, whose currency serves as
the world's reserve currency and is therefore considered 'as good as
gold'. In the decades immediately after World War II, America used its
hegemonic position and the fact that it was home to the world's reserve
currency, to function as though it faced no national budget constraint. It
could finance expenditures worldwide, including those on policing the
world, independent of whether it had a surplus on its current account or
not. It did not have to earn foreign exchange to sustain such
expenditures, since the dollar was accepted in any quantity worldwide.
The willingness of the US to undertake such
deficit-financed expenditures based on its strength as the world's leading
power obviously meant that the United States served as an engine for
global growth. The post-War boom in the world economy is attributable in
no small measure to this tendency. Conversely, the decision of the US
government to move out of a regime in which it sustained a high and
persistent deficit on its budget to one in which its budget showed a
surplus must have substantially worsened the deflationary tendency in the
world system. The consequent tendency towards deflation is reflected in
price trends worldwide (Chart 6), which point to a significant and
continuous decline in inflation rates across the major industrialized
nations throughout the 1990s.
Chart 6 >>
These circumstances render the picture of de-synchronized economic
performance during the 1990s even more puzzling. To start with, we have
the counter-intuitive trend wherein the US, which saw a dramatic
transition from deficit to surplus budgets, turned out to be a remarkable
performer growth-wise precisely in those years in which that transition
was occurring. Next, barring Japan, growth in many of the developed
countries, especially the UK, was not very much worse in the 1990s than it
was in the previous decades, despite the dampening effects of their own
deflationary fiscal stance and that of the US. Finally, we have the
unusual fact that despite the consistent effort of the Japanese government
to pump-prime its economy through a series of reflationary packages, the
Japanese economy performed poorly right through the 1990s, except for a
brief episode of growth around 1996.
The first step in unravelling this puzzling set of
circumstances is to recognize that in the era of finance, the stimulus to
growth has to come from the private sector. Since private investors need
some inducement to invest, private sector-led growth in any economy must
be stimulated by a rise in consumption expenditure either in the domestic
economy or abroad, which translates into increased demand for domestic
firms. There is reason to believe that the rise to dominance of finance
does contribute to such an increase in private expenditure. Financial
flows and financial liberalization can make a self-correcting contribution
to neutralizing the deflationary bias resulting from reduced government
expenditure in two possible ways: (a) they can permit a burgeoning of
debt-financed consumption and housing expenditures that help sustain
private and public spending so long as borrowers and lenders coexist; (b)
they can trigger financial developments that increase the financial wealth
of households, which in turn, through the 'wealth effect' encourages
consumption and even dis-saving.
