Twin deficits: Spending beyond means

Published : 19 Oct 2011, 03:12 PM
Updated : 19 Oct 2011, 03:12 PM

A local daily recently organised a meeting with several economists to discuss what most of them regarded as an emerging economic crisis in the country. The crisis was viewed as gradually deepening and assuming an elephantine shape. Some described the crisis in terms of excessive credit, money and inflation, some regarded the reckless spending on rental power plant as the major factor contributing to the crisis. Some focussed on subsidies, budget deficits and the ever-increasing debt burden, and others brought out the worsening balance of payments and exchange crisis.

The speakers seemed to have described the economic crisis (that is a sick elephant) in a truncated manner, from the view or feel they had of the beast from their particular position. Thus, the elephant appeared as a serpentine trunk, or a pillar-like leg or a truncheon tusk. It is difficult to visualise the shape or the nature of the elephant from a description of its limbs.

The ring master must know the true nature of the elephant itself if he is to successfully manage its performance in front of a viewing public. A successful performance involves the movement of various limbs in a choreographed manner such that each limb has an important role in the overall performance of the elephant. The ring master must ensure that the elephant is in such a fit state of preparedness of health and training that all the limbs work together to produce a performance to the satisfaction of his audience.

A little reflection will reveal that the source of the crisis is the excessive spending by both the government and the private sector. Most of the problems mentioned above are essentially offshoots or manifestations of the nation's spending beyond what prudence would dictate. If the masters of the economy are to manage the emerging crisis in a manner so as to ensure a reasonable performance of the economy, they have to tame the runaway spending.

The government as well as every household has a budget, which is simply a statement of the income (revenue) receipts and expenditures. When expenditures exceed income receipts the budget is in deficit, conversely it is in surplus. A deficit can be financed by either borrowing or selling assets, while a surplus may be lent out or used to acquire assets.

It is not difficult to convince the illiterate housewives of the poor farmers and workers of the country that their households will be in serious strife if their budgets are persistently in deficit. Indeed, most of them are acutely aware of the unpleasant consequences of deficits without anyone having to tell them. Unfortunately, it is extremely difficult (thanks to Keynesian economics) to convince a government, especially that of a liberal variety, that large and persistent deficits are eventually harmful to the nation. If anyone needs convincing, just look at the economy of the USA and an almost-bankrupt Greece.

The governments of these countries (and many others) have allowed large deficits for decades without any regard for the consequences. Finally, the deficits have come home to roost with a vengeance. These countries will have to go through a painful process of restructuring to bring the economy back to health, a process that has already started.

The cruel part of this sordid saga is that it is not the government and business leaders or the perpetrators of the crisis who will bear the brunt of the pain. The hapless ordinary people are forced to pay for most of their excesses. Indeed, many of the perpetrators even profited from the misery of the people. Many of the Wall Street supremos (aided by government functionaries) who brought such a disaster upon the USA and the rest of the world in 2007 and 2008 received massive bonuses from their bankrupt companies and these companies received hundreds of billions of dollars of bailout money from the government. This perverse incidence of benefits and costs of a crisis might be a reason why those who control government and finance are impervious to the deficit problem until it has assumed a crisis proportion and can no longer be swept under the rug.

The US citizens are understandably angry and have finally woken up against the perpetrators of their misfortune. A US spring of sorts seems to have broken out in many cities to protest against the excesses of the financial wizards of Wall Street. Not since the Vietnam War era anything resembling this was witnessed in the USA. The US spring seems to have spread in many other developed countries.

While it is easy to find data on the government budget balance, it is difficult to get information on the balance of the private households or firms. Fortunately, a national income accounting identity (an equation that is always true) permits us to derive the private sector balance as a residual. Students of intermediate macroeconomics will be familiar with the important identity that the government budget deficit is equal to the current account deficit and the private sector saving-investment balance.

A more compact version of the identity is that the current account deficit is equal to the national deficit, i.e. the overspending by both the government and the private sector. Thus one deficit is simply the identical twin of the other deficit. Since Bangladesh ran mostly (positive) current account balance during the last one decade, a more convenient representation of this equality is that the current account balance is equal to the national income-expenditure balance.

It may seem strange, but even after three and half months of the passing of the 2011-12 budget by the Parliament, the much vaunted Ministry of Finance of the Digital Government, putatively the most skilled ministry, is yet to reveal on its website the final outcome of the budget of the previous fiscal year 2010-11. Hence, the actual revenue earnings and expenditures of the last fiscal are still not known to the public.

The 2011-12 budget documents had estimated a budget deficit of only 0.5 percent of GDP for 2010-11. The actual deficit was most likely greater than this amount since the Government went on a borrowing binge during the last months of the budget. If the actual deficit was double the forecast, it was in the vicinity of 4.3 percent of GDP, i.e. an increase of about 1 percent of GDP over the previous fiscal year (2009-10). Hence, only about a billion dollar reduction in the current account balance between 2009-10 and 2010-11 is explained by the increased budget deficit. Since the current account balance deteriorated by $2.7 billion during this period, the reduction in the private sector balance must have contributed the remaining $1.7 billion.

A large part of this reduction must have been due to the sudden spurt in investment in rental power plants as the Government outsourced power generation to the private sector in a bid to solve the power crisis quickly and the consequent sharp increase in oil import. Investment in other industries was constrained by the power crisis, and is unlikely to have increased substantially.

The Government has undertaken to pay enormous subsidies to profitably run these gas and oil guzzling monstrosities. Hence, the budget will undoubtedly go farther in the red in the current fiscal. The Government has the option of reducing the subsidy payments by raising oil and electricity prices, something that IMF is pressing for. But this will prove politically very uncomfortable for this Government, especially since its political capital appears to have dwindled considerably during the last year or so.

Another concern is the plummeting growth rate of remittances from 33 percent in 2008 and 19 percent in 2009 to only 2 percent in 2010. While remittances in 2011 might improve somewhat, it is unlikely that these will keep pace with import requirements. The current account balance is most likely to go into the red by a substantial amount this fiscal implying that the nation will run up a deficit for the first time since 2004-05.

As far as the current account problems are concerned it is immaterial whether the money was spent on import of power generation plants or food or any other commodity. As long as the nation is overspending, the inexorable outcome will be a current account deficit, and the greater the national deficit, the greater will be its twin the current account deficit. Until the sickness of the elephant is cured its limbs will remain wobbly.

The budget deficit can be reduced by either raising revenue or reducing government spending. The NBR is already operating at a high gear and has succeeded in raising revenue substantially. Pressing it harder for greater revenue may be counterproductive.

Hence, any substantial reduction in the budget deficit must entail a substantial reduction in expenditures. The Government should consider trimming down its mega ventures. It should bear in mind that it can spend excessively in a sector (such as power) only at the expense of depriving some other sectors. Private spending may also need to be curtailed to minimise overheating. This can be achieved through a judicious choice of monetary and fiscal measures.

If budget deficits are financed by borrowing from the central bank, the monetary base of the economy increases causing a rise in the money supply. This fuels the inflationary spiral. If money is borrowed from the market, the private sector is crowded out by a credit crunch and a rise in the interest rate. The consequent outcry of the aggrieved private businesses may force the hands of the central bank into easing the money market. The increase in the money supply eventually feeds the inflationary spiral.

Notwithstanding what has been said above, the budget is still not entirely out of whack and the economy is still not in a serious crisis. The problems that have emerged are manageable with appropriate policy changes and a significant improvement in economic governance. The sickness of the elephant is curable. However, for this to happen the Government will have to wake up to the fact that the realisation of its 'dreams' and 'visions' must be circumscribed by resource affordability and leakages through mismanagement must be stopped if it wants to avoid inflicting long-term damage on the nation.

The Government still has room to be reckless, and if it chooses to be so it will only deepen the economic crisis.

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M A Taslim is a professor of the Department of Economics, University of Dhaka.