Understandably, the discussion now in Bangladesh is dominated by the recently presented 2014 budget. One can identify four broad questions in the debate. The first kind revolves around such questions, as “Is this budget too ambitious?; “Is it implementable?” etc.
These questions are technical in nature and hence could ideally be resolved by doing some modelling exercise once there are some agreements on underlying assumptions about key variables or parameters.
The second type of questions, which are also technical in nature, relate to macroeconomic consequences. The main issues are the level of deficit, government borrowings from the banking sector and their likely impact on inflation and private sector investment. The resolution of this debate requires rigorous research and perhaps international evidence can guide us here.
The third type of questions relate to who wins and who loses. These are questions of political economy. In the ultimate analysis, budget is a political document. Through budget the governing party implements its election manifesto. The citizens get a chance to differentiate among parties and generally speaking, the winners from a budget should be the majority that elects the government. Thus, one cannot really separate the question of legitimacy from political economy questions.
Therefore, the fourth is about the legitimacy of the government that brought down this budget. Is this government legitimate enough to represent aspirations of the people and implement them? Obviously this question does not arise if the mandates of political parties are contested in popular votes.
In today’s commentary, my concentration shall be on macroeconomic and political economy questions. Let me first begin with deficit, borrowings and their macroeconomic consequences.
One must recognise that there is a general aversion against deficit or debt. But we must look at the details before deriving any sensible conclusion. To begin with, there is a golden rule of fiscal policy that we need to adhere to. That is, the recurrent or revenue budget must at least balance; but preferably should be in surplus.
Development budget by its nature cannot be balanced. Of course, how this deficit is financed is crucial. It is better to borrow domestically than externally. External borrowing is risky because of exchange rate movements. If the government borrows from the central bank, i.e. prints money to finance its deficit then it risks inflation. If the government borrows from the banking sector or domestic capital market, then there arises the possibility of competing out private sector investment.
In the end, this is a balancing game and the net result will depend on where the borrowed money is spent. If the government borrows to build infrastructure and to improve human capital that enhances productive capacity and social services that reduces labour cost, then the private sector may still find it profitable even if the borrowing cost rises.
Generally the positive reaction of the business community and various support measures for domestic industries seem to suggest that the private sector is unlikely to be affected adversely by the government’s borrowing from the domestic market. Inflation, too, is unlikely to spike as supply capacity improves with productive government spending complemented by private investment. Also certain tax measures are likely to have overall positive impacts.
It should be pointed out here that rigorous research fails to find any clear relationship between deficit or debt and economic growth or macroeconomic instability. For example, IMF’s 2013 World Economic Outlook observed, “(T)here is no simple relationship between debt and growth. In fact, our …analysis emphasizes that there are many factors that matter for a country’s growth and debt performance. Moreover, there is no single threshold for debt ratios that can delineate the ‘bad’ from the ‘good’.”
Therefore, there is a need to identify and incorporate the transmission channels through which fiscal deficit influences long-term growth. This requires that “attention be focused on the likely growth effects of the level, composition and efficiency of public spending and taxation.” The 2006 Report of the Development Committee of the IMF and the World Bank warned: “Fiscal policy that neglects these effects runs the risk of achieving stability while potentially undermining long-term growth and poverty reduction.”
The issue of public spending and taxation is directly linked to the political economy questions to which I now turn. Who is taxed and where the government spends determine who wins and who loses.
In examining the winners and losers my reference point is the constitution of the country. The constitution is supposed to represent the desires of the citizens. It represents the consensus of a nation regarding who should win from the process of growth.
The country has got back the 1972 constitution which sets out four state principles: (a) democracy, (b) nationalism, (c) secularism and (d) socialism. There have been much debates and fanfare about the reinstatement of secularism principle. Democracy and nationalism are discussed endlessly. But there has been no enthusiasm to discuss about socialism, while this is the most relevant aspect for a budget.
If we take the socialism principle seriously, one pertinent question would be: to what extent can the current budget advance the country towards the goal of equity?
This is an important question given the fact that Bangladesh is one of the few countries in Asia where inequality has risen significantly. The common measure of inequality, the Gini coefficient, has increased from 0.36 in 1973-74 to 0.46 in 2010, a value exceeding the danger mark of 0.40.
According to the Bangladesh Household Income and Expenditure Survey 2010, the share in total income increased substantially only for the top 10% of the households. The share of the ninth decile also did not increase. At the other end, the share of the bottom 40% of the households declined considerably.
Thus, from a reasonably equitable society at the dawn of our independence, Bangladesh has become a highly unequal society despite an explicit recognition of equity in our constitution. Ironically, the process accelerated during the democratic regimes, i.e. since the early 1990s.
Therefore, one should be asking, does this budget has any element that might slow down this unequalising process of our growth? It seems we have some mixed, but hopeful pictures.
The UN-ESCAP’s 2013 Economic and Social Survey of Asia and the Pacific reported interesting findings which are relevant here. First is the negative association between tax-GDP ratio and the Gini (see Figure 1). Thus, the aim to raise tax revenues by increasing the tax rate for higher income earners is likely to dampen inequality.
Figure 1: Higher the tax-GDP ratio, lower is the Gini
Other proposed tax measures that are likely to have some dampening impact on inequality are higher VAT rates on English medium schools, satellite TV channels, SUVs, bigger sized cars, photograph processors, motor garages, imported mobiles, gold, etc. which are normally used by higher income earners. The proposal to tax allowances seems also right. In the same spirit, the budget could have included a special levy on luxury shopping malls, private hospitals, private universities and wealth tax on residents of high-end residential areas.
The decision to reduce VAT on imported raw materials for cancer drugs and other medicines is also laudable. The same goes for VAT measures proposed to reduce cost of everyday groceries. However, here the challenge is to ensure that cost savings are passed on to the consumers.
It is well known that progressivity of tax rates – higher rates for higher income – is a critical instrument to address inequality. However, this itself is not enough. Another key element is where the increased government revenue is spent. Again, the ESCAP 2013 finding is quite informative – a negative association between public social protection expenditure and Gini (see Figure 2). More the government spends on social services, such as public health, public housing, education, etc, lower is the inequality.
Figure 2: Higher the public social expenditure, lower is the Gini
Therefore, we should be examining whether the proposed allocations for education, health, public housing, public transport and income protection are adequate enough. Unfortunately, there has not been enough discussion on this issue.
We can debate on details and ask why items such as diapers should get favourable VAT treatment. We can also differ on exclusion or inclusion of particular items in the VAT measures. Expenditure priorities can also be questioned. But ultimately the budget is a political document and hence involves compromises.
In sum, the proposed 2014 budget seem to be in the right direction, bar the question of legitimacy. Unfortunately a good budget can be undermined by lack of legitimacy. The realisation of budget measures is not a mere technical matter. It depends crucially on legitimacy.
Anis Chowdhury, former Professor of Economics, University of Western Sydney, Australia.