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Premature fiscal tightening endangers global recovery – UN report

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A report by the United Nations Conference on Trade and Development (UNCTAD) has warned that the consequences of fiscal tightening pose a danger to the recovery of the global economy.

UNCTAD´s Trade and Development Report (TDR) 2011 notes that fiscal tightening only addresses the symptoms of the problem, leaving the basic causes unchanged.

“A shift from fiscal stimulus towards fiscal tightening is self-defeating, especially in the most developed economies which were severely hit by the financial crisis. In such a situation, a restrictive fiscal policy may reduce GDP growth and fiscal revenues, and is therefore counterproductive in terms of fiscal consolidation”, argues the report released September 6, 2011.

The report emphasised that the reduction in growth-promoting fiscal expenditure may lead to a decline in future government revenues that will be larger than the fiscal savings obtained by retrenchment – with negative consequences for long-term fiscal and debt sustainability.

The report slammed the International Monetary Fund (IMF) fiscal tightening programmes implemented by some countries during the 1990s and 2000s.

“Countries that put fiscal tightening packages in place during the 1990s and 2000s as part of IMF-supported programmes have failed to consider these dynamic effects. In countries where fiscal tightening was expected to reduce the budget deficit and restart growth, deficits actually became worse while GDP growth stalled. In the present situation, the current fiscal tightening policies adopted by some countries are likely to deliver similar negative results.”

According to UNCTAD, a fiscal policy that supports growth is more likely to reduce fiscal deficit and to curb public debt ratios than a restrictive fiscal policy.

The main argument that is usually advanced in support of fiscal tightening is that it is indispensable in order to restore the confidence of financial markets, which is perceived as being key to economic recovery.

But the report said “in light of the irresponsible behaviour of many private financial market actors, which has required costly government intervention to prevent the collapse of the financial system, public opinion and policymakers should not trust again those institutions, including rating agencies, to judge what constitutes sound macroeconomic policies and sound management of public finances.”

The TDR shows that increases in spending on infrastructure, social transfers, or targeted subsidies for private investors tend to be more effective in stimulating the economy than tax cuts, because they directly lead to job creation, purchases, and demand.

By Ekow Quandzie

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