On cliff’s edge

What is not fully recognised is the manner in which the eurozone economies have taken immense pain through 2011 and 2012. The head of the European Financial Stability Facility (EFSF), Klaus Regling, told this writer some time ago that the eurozone will surprise everyone by bringing down its combined fiscal deficit to 2.5 per cent of the GDP by 2013 end. After the austerity measures undertaken by Spain, Italy, Portugal and Ireland, many of them are on the path to recovery. Only Greece remains a bit of a problem, but the damage has largely been contained in Europe.

If the eurozone achieves a fiscal deficit of 2.5 per cent of GDP, which it is likely to, it will be a historic achievement. Though Obama is also attempting a medium-term fiscal correction, the US deficit will remain around 7 per cent for some years to come, if one goes by the grand bargain over the fiscal cliff being worked out between the Democrats and the Republicans.

Therefore, the eurozone economies have done far better in terms of controlling incremental public expenditure in the post-global economic crises period. The tendency all over the world, including in India, has been to just let the fisc go haywire in the name of rescuing the economy. The subtle skill of applying the brakes on an ever-expanding fisc has rarely been tested anywhere in the world since 2008. The possible exception is the eurozone, which has managed to scale down its deficit quite dramatically.

In some sense, the bulk of the world economies have preferred to lazily hurtle towards the fiscal cliff in the four years after 2008. For instance, China's GDP was around $4 trillion in 2008. After the global economic meltdown, Chinese banks decided to pump another $4 trillion (100 per cent of its GDP) of new investment in housing and manufacturing as a special stimulus. Obviously, no one can keep such a high level of incremental investment going forever. So Chinese policy-makers are now saying they have had enough investment-led growth and it is time to move to a relatively consumption-led model. This is a clear recognition of the fact that China cannot afford government bank-led stimulus on the same scale as before. Indeed, China may be facing its own version of a fiscal cliff. It is trying to soft land from its fiscal cliff by scaling down its GDP growth projection to 7.5 per cent over the next five years, down from an average of 9.5 per cent in the previous five years.

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