Has Keynes returned to South America?

In recent years, the news of the economic press in South America seemed to be marked (although with exceptions) by a greater concern about the budget balance, long-term debt sustainability, the reduction of inflation and the recovery of economic freedom .

All these issues have traditionally been linked to economic schools such as the monetarist, but the emergence of COVID-19 seems to have completely changed the landscape.

The response of governments in South America to the economic and health crisis has triggered the debt forecasts that were available at the beginning of 2020. In this context, the authorities of the region face a difficult dilemma: launching stimulus plans to contain the impact of the recession and be mortgaged for the next few years or maintain a balanced budget and let the private sector solve its problems without public support.

Keynesian ideas, in this way, are once again at the center of the debate.

A continent with diverse economies and solutions

As has always happened in the South American continent, there is a great diversity of economic realities between countries, although in this case they all plan to increase their indebtedness. In this sense, the most paradigmatic case is perhaps that of Brazil, whose public debt is expected to reach 100% of gross domestic product (GDP) by the end of 2020.

In this country, one of the most affected by the pandemic in terms of the number of victims, GDP fell by 11.4% year-on-year at the end of the second quarter of the year and as a consequence public revenues have also plummeted. Expenditures have grown strongly, not only due to the health needs of the population but also due to the new social plans (such as a minimum income of 600 reais per month). The result has been an increase in the public deficit, which will have a direct impact on higher debt levels.

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Another country that plans to borrow at a similar rate is Ecuador, where the government has been negotiating an agreement with the International Monetary Fund (IMF) to receive financial aid. In this case, similar to what is happening in Colombia, no major stimulus plans have been implemented in the form of public spending. Instead, the State has guaranteed guarantees for companies that request lines of credit.

On the contrary, the government of Peru has launched the most ambitious spending program in the region. Counting on 4.6% of GDP, plans such as Arranca Perú seek to create jobs through the construction of public works. If these measures are added to the State guarantees for loans requested by companies (Reactiva Peru plan) and the tax extensions, the total amount of the incentives could reach a maximum of 20% of GDP.

Relaunching the economy

The logic of these programs, which, as we have mentioned, are being applied in many countries in the region, is based on the fact that such a sharp drop in GDP requires equally drastic recovery measures. The formula chosen is usually a plan for infrastructure works financed with public debt that can benefit various sectors and throughout the entire geography of each country.

The desired effect is for the construction of these public works to increase aggregate demand, which would reactivate economic activity by creating new jobs. In turn, spending on wages and materials would have an expansive effect since the benefited companies and workers would increase their consumption in other sectors of the economy.

The strategy happens, in this sense, to give an additional boost to aggregate demand that in turn stimulates supply, a phenomenon known as a multiplier of public spending. It should be remembered that these Keynesian-inspired ideas were very popular during the Great Depression of the 1930s, and reached their maximum expression with the New Deal in the United States.

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The supporters of these stimulus plans themselves acknowledge that their implementation could further deepen the state’s budgetary imbalances and pass the cost on to future generations through public debt. However, they tend to maintain that the priority is to recover GDP as soon as possible, since a strengthened economy will have more capacity to face the payment of the debt even if it is higher.

The logic of adjustment

On the contrary, the detractors of these measures consider that their effectiveness is very limited for two reasons. First, issuing public debt today would result in more taxes in the future (or cuts in public spending), thereby reducing the disposable income of the private sector in the long term, slowing down the recovery.

Second, the artificial reactivation of the sectors most directly benefited would not respond to the real needs of consumers. This means that when the programs are over, workers would be laid off and the economy would return to its initial state.

This point of view tends to prefer a recovery more based on Say’s Law, that is, where entrepreneurs readjust their production to new demand patterns. In this way, the new jobs created would be more sustainable since they would be directed to real consumer needs instead of temporary projects.

Offer policies

However, for a reactivation of this type to be feasible, a great flexibility of the factors of production is usually necessary, which means, among other things, a policy of low taxes, respect for private property and deregulation of economic activity and relations. labor. As we have commented in previous articles, the response capacity of an economy to adapt to the changes produced by a shock supply can be critical.

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Naturally, this approach is not exempt from objections, such as the short-term budget lags that a tax cut could entail. Another problematic aspect is often that if companies fail to readjust quickly, unemployment could consolidate at excessively high rates. All this without taking into account the always controversial question about the social consequences of deregulating the labor market and capital movements.

Deciding the future

Most South American governments seem to have adhered to aggregate demand policies, rejecting a recovery based on Say’s Law. In previous articles we have discussed an example such as Ireland where these ideas failed, although many analysts also resort to opposite cases such as the New Deal in which this type of policy had positive effects.

It should be noted, having said all this, that stimulus plans on aggregate demand are more likely to be successful when the increase in debt is used for productive investments and not for transfers. In other words, it is not the same to spend 1 million euros in a subsidy program (transfers) than to spend 1 million euros in the creation of a company to create jobs (productive investment).

It is undoubtedly a decision that can hardly find a unanimous consensus among economists, but that in any case cannot be evaluated with certainty until a few years have passed and the impact of debt on the recovery can be seen. It will depend on whether the region faces a new lost decade or if, on the contrary, it takes advantage of its enormous potential to emerge from this crisis.

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