The main worry in this context is that these crisis measures all imply increasing public sector deficits and hence increased public indebtedness. This is particularly the case in the US and the UK, as the funds disbursed to rescue the banks and other financial firms are astronomic, implying a deficit of over 10% of GDP in 2009, and in Japan and Italy where the deficits are more limited but the public debt is already alarmingly high (not to mention Ireland and Iceland). But more generally, the perspective of increased government debt is sounding alarms everywhere.
And rightly so. Increased debt means that an increasing part of the government budget in the future will go to interest payments, particularly when interest rates return to a more normal (and higher) level. This will put a pressure on other public spending, which inevitably will affect the social spending (education, health, social benefits). It could mean the end for the welfare state as we know it.
Back in the nineties, some liberal ideologues, frustrated by the lack of willingness of even right-wing governments to scale down the welfare states in Europe and cut taxes, argued that tax cuts should be implemented anyway, even if they were not accompanied by a cut in public expenditures. That would build up government debt and finally make it clear to everybody that the welfare state was not viable any more, opening the way for a dismantling of this social-democratic creature. The present crisis has the potential to make this happen.
It therefore matters a lot how the crisis packages are put together. Generally, the choice has been between increasing government spending and cutting taxes (temporarily), but also a third sort of measures has been including: subsidizing certain forms of private consumption or investment (e.g. the cash-for-clunkers to prop up the car industry).
The tax cut option has unsurprisingly been favoured by the political right. The argument has been that it works fast and thus has an immediate effect on production and employment. Furthermore, it prevents “big government”. Apart from its limited effectivity in a crisis (part of it will probably be saved, not spent), it is, however, a dangerous way to go, particularly if the crisis continues for several years as it is likely to do. It will imply that government debt increases, and unsustainable debt-based private consumption is simply substituted by unsustainable tax-stimulated consumption.
Public spending in infrastructure is potentially a better option. What should be done is in reality to bring forward the coming years' planned infrastructure spending, so that the increased government debt in the future will be accompanied by an improved infrastructure. This means that even if there will be a future burden of paying back the debt, there will also be a minor burden of investments in new infrastructure, as part of these investments will already have been carried out. Thus, the long term viability of the public sector is not threatened.
Of course, preparing good investments in infrastructure takes time, unless these have been planned in advance, and these projects can simply be brought forwards. This seems to be the case of China, where the impact from a hugh public sector investment programme has been much bigger and faster than pessimists (including myself) had expected just half a year ago (and where the need for improved infrastructure is enormous).
The risk is the often cited Japanese experience from the nineties, where it is claimed that many infrastructure projects turned out to be meaningless (“bridges to nowhere”). The risk for many European countries is that it will simply mean more investments in highways and bridges, thus perpetuating an unsustainable consumption pattern.
Apart from the repair and renewal of the existing social infrastructure (mainly hospitals and schools), which in many developed countries has suffered from years of underinvestment, the main challenge for the developed countries is to change their pattern of energy production and consumption. This will require enormous investments in the future. Some of these investments could be brought forward by increasing investments in energy saving and renewable (or less polluting) energy and thus reduce the burden we have to shoulder anyway sometimes in the future. And some of them could be carried out relatively fast, mobilizing also private capital by a mix of public investments and incentive schemes. The menu is obvious: upgrading and expanding the public transport system (China is for example creating an impressive country-wide network of high-speed railways that will rival Western Europe and Japan), incentives for investments in renewable energy, incentives for making buildings more energy-efficient, a mix of taxes and incentives to make cars more energy-efficient etc., etc.
But of course, brain-dead tax cuts and cash-for-clunkers schemes and other short term measures may be easier and less politically controversial, so the story may well end there.
