To spend or not to spend

Governments are habitually profligate and gladly eat into an ever-larger share of GDP growth. The United States, the richest, big country in 1990, spent 40.6 percent of GDP on government expenditure. By 2011 its government was spending even more at 43.7 percent of the GDP. Countries which went in the opposite direction were rare- such as Demark, which reduced government spending from 62 percent to 57 percent of GDP. 

By doing so, Denmark- an oft cited exemplar for good governance- lived up to its reputation. But low and lower middle-income countries, like India- with a low tax base, large populations, poor infrastructure and low levels of publicly provided social protection- have developmental needs far exceeding their public fiscal resources. 

Plutocratic China – Small budgets but big collaborative outlays on infrastructure

It is curious that, in comparison, China – a communist country albeit well on its way to implementing “capitalism with Chinese characteristics” by 1986 should have a share of government expenditure in GDP of just 21.2 percent.  By 2011 the share increased marginally to 24.4 percent despite a 7x growth in per capita GDP. The global average was 1.5x. Clearly, economically effective government is different from big government.

China, is a centralized plutocracy with features of highly decentralized functioning versus, say India, which is a living democracy, with unitary characteristics. The single party system in China is the cornerstone of unified (centralized) near absolute control, albeit democratized through a highly meritocratic, public examination-based access to the party “system”. Contestation, within the Party by factions, for control of the nine-member Politburo, adds further checks and balances. Democracy- with Chinese characteristics- is however marred by a pervasive system of efficient and often draconian, controls by the Party and a tendency for mission creep versus citizen and corporate rights. 

Democratic India – Low budgets spread across populist public outlays

In contrast, Prime Minister Modi labelled India as the “Mother of Democracy” recently in his address to the UN General Assembly. The UK, US and France could contest the meme. Nevertheless, India is certainly the most populous and competent child of the global democratic spirit, relative to its economic and social constraints.

East and South Asian governments, in general, are parsimonious about public spending. In India, government expenditure as a share of GDP increased marginally from 31.5 percent in 1990 to 31.7 percent in 2011, despite a 2.4x growth in per capita GDP. Compare this with Brazil where a 1.5x growth in per capita GDP resulted in government spending increasing from 14.9 percent to 43.3 percent of GDP, over the same period. 

Private versus public spending

There is a trade-off between leaving money in the hands of citizens versus filling government coffers using the “cost-of-services” model, as opposed to the “value” of services provided. Other than the question of who is best placed to spend – government or individuals- there is also an issue with respect to the governance incentives unleashed by plentiful public resources. 

Unless the flow of public finances is completely decentralized by design and decentralized governance deeply embedded in a country’s architecture- as in Germany- boosting government revenues generally results in centralization of power and decision making – particularly in democracies, where fiscal flows are a significant lever for political control. The practice of leaving the bulk of the income growth in private hands and moderating public debt are well aligned with the tenets of good governance. A good example is Germany, where government public debt is severely constrained and yet the share of government’s spending in GDP is just 47 percent. 

Low public debt levels and constrained government expenditure are virtues, which India could well emulate. There are two reasons for this. First, governance capacity and the efficiency of public spending is low. Clearly, it is lower than China, where despite a vastly lower share of government spending in GDP, the government has managed to roll out infrastructure at a staggering scale, through productive partnerships with the private sector, albeit bankrolled by state banks and financial enterprises. 

Growth with equity is the core objective

Rapid growth, as in China, is the magic wand which enables larger government spending on infrastructure without increasing its draft on private savings or private consumption. Consider that double-digit growth in India of 10 percent, instead of 5 percent per year, can, over a five-year period, generate an extra Rs 11 trillion in tax revenue in constant terms on 2018-19 GDP, at the 2017-18 level of tax collection (17.62 percent of GDP). More importantly, growing the GDP sustains a higher volume of deficit financing, within fiscal stability norms.  

The “growth or bust” strategy is facilitated by the availability of vast amount of cheap finance sloshing around the globe. Fast growing, well managed sovereigns can access larger volumes at better prices than corporates, so it makes perfect sense to run a fiscal deficit within sustainability constraints. India targets a fiscal deficit of 2 to 3 percent of GDP. Germany worships its “black zero” policy of a balanced budget – relaxed to accommodate a 4.2 percent fiscal deficit (FD) during the pandemic. Our “report card” conscious government, is being Germanic, in its zeal to reduce the FD this year itself, though it had budgeted for 6.8 percent of GDP. 

Doing so, could impact much needed expenditure in the second half of the fiscal year. The government is being a bit harsh on itself and possibly more so on those who need public support. Till August 2021 this fiscal, total spend by the Union government was 37 percent of the budget against the pro-rata share of 42 percent. Growth and equity inducing outlays on renewable energy, power, petroleum & natural gas, rural development, space and social justice lag well behind the average expenditure outcome.

Bolstering consumption through temporary, targeted fiscal support is pro-growth in a downturn

Reducing the FD should be linked to sustained reductions in unemployment and the recommencement of economic activity. CMIE reports an employment level of 406 million in September 2021 equal to the 2019 levels and admittedly, the economic trends are positive. 

But isn’t it a mite optimistic to hope that the economy will snap back immediately if covid-19 restrictions are relaxed? Also, what are we “snapping back” to? Growth in 2019-20 was just 4 percent in constant terms. Two years later, normal economic functioning should be defined as a sustained trend taking us well above the 2019-20 rate of growth. We have yet to reach there, even though agriculture has done well, ssand industrial growth and consumer sentiment is recovering. 

Most crucially, the debts incurred or savings exhausted, by the bottom 40 percent of the population, during the pandemic, can only be liquidated/rebuilt over time. Ending the special support mechanisms too early, could stymie consumption and in turn, demand growth, to feed an across-the-board industrial recovery. Caution is advised.

Also available at TOI Blogs October 2, 2021

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