In the post below, we observed that the pump-priming government spending encountered significant problems when a nation already had too much debt. There’s another problem with the pump-priming solution, particularly in the world economy as it has evolved over the last two decades.

In the old days, at least the pump you were priming was your own pump. In 1930 in the US, imports and exports were less than 5% of GDP. Today, US stimulus spending creates jobs, but they’re often in China or other low wage exporters. As Niall Ferguson noted three years ago in this space,

France, Britain, America…all belong to the club of developed debtors, with combined current account deficits of $970 billion last year. Other members of this club are Australia, Greece, Iceland, Ireland, Italy, New Zealand, Portugal and Spain. Apart from Iceland, it reads like a list of ex-empires, with the former members of the British Empire (energy-rich Canada excepted) in the lead.

Collectively, the developed debtors had to borrow around $1.3 trillion last year in order to finance the gap between their spending on imported goods and services and their earnings from exports, and the gap between their payments to foreign lenders and their earnings from overseas investments. On the other side of this great global equation is the club of emerging exporters. According to the International Monetary Fund, more than 40 per cent of the developed debtors’ funding requirement last year was met by China, Russia and the Middle East.

The problem for the deficit countries is essentially that their people want to live beyond their means. Accustomed to positions of power, they think the world owes them a living. Their politicians pander to this assumption by making a series of more or less incompatible promises: that expenditure on healthcare and education will always go up; that direct taxation will never go up; and that the assets against which voters borrow will never go down.

Thus, the Keynesian model of pump-priming suffers from at least two flaws in today’s world: (a) government stimulus spending may not create the domestic jobs needed for a self-sustaining recovery; and (b) the countries that finance the borrowing to do the pump-priming may say no, as they have in the case of Greece. Forget Plan B — what’s Plan C?

This entry was posted on Sunday, June 6th, 2010 at 7:03 am and is filed under business, China, Democrats, General, Republicans. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.