Mr. AMA Muhith has secured his place in history. For a seventh year in a row, the finance minister has performed the ritual of placing Bangladesh’s national budget – a feat no other predecessor of the octogenarian politician could achieve. During this long period he has raised the budget expenditure from BDT 1016 billion (actual) to BDT 2951 billion (budget) and the revenue earnings from BDT 795 billion to BDT 2084 billion in nominal terms. Expressed in real terms the increase would of course be more modest.
In reply to a question at his post-budget mega press conference the Mr. Muhith said that he was not at all happy with the economy’s growth rate stuck at around 6 percent. He wanted to give a ‘big push’ to the economy to raise it to a higher growth trajectory of more than 7 percent. The ‘big push’ he gave was by way of a 23.1 percent increase in the expenditure budget aided by a 27.6 percent increase in the revenue budget. He neglected to mention that he had tried this approach during the last several years (actually with higher growth targets), but failed to match the growth performance of the earlier years. It seems to have escaped his notice that the economy had achieved the highest ever growth rate during the two-year period 2005-06 and 2006-07 (average 6.9 percent) with the lowest budget of the new millennium (average 12.4 percent of GDP). The fact that a 5 percent (of GDP) increase in government spending is now necessary only to match this growth rate is suggestive of complex processes at work.
Is there a sound logic behind Mr. Muhith’s assumption that the cherished 7 percent plus growth target can be achieved by a large budget? There is actually an intellectual tradition in economic science that supports such a strategy. This goes by the eponymous name of Keynesian economics. It is popular with politicians and governments because of its dirigiste prescriptions.
When the western economy was in a prolonged depression in the 1930’s J. M. Keynes had suggested that it was possible to revive the economy by raising public expenditure, if necessary, by borrowing. Such spending would raise the demand for goods and services which would encourage entrepreneurs to produce and supply more. This would raise employment and income. The higher income would raise tax revenue which would enable the government to pay off the debt incurred initially by deficit financing.
Mr. Muhith has proposed a large increase in both total spending and development spending. The large ADP allocation is meant partly to offset the insufficiency of private investment spending, which has stalled during the last four years. It is anticipated that slightly over two-thirds of the proposed spending could be financed by revenue collection. The rest, amounting to almost nine-tenths of the annual development plan (ADP), will have to be financed by outright borrowing or foreign aid. Thus, investment part of the budget will be financed mostly by borrowed money.
The proposed large increase in tax revenue (27.6 percent) is a transfer of resources from the public to the government. The reduction in public’s disposable income due to higher taxes will reduce their spending while government spending would rise. What would be the net effect on demand? According to an economic theory (balanced budget multiplier) aggregate demand would increase by the amount of the increase in government spending.
While ordinary spending adds to only demand, development spending has a dual character. It adds to both demand and the supply capacity of the future. Here is the catch – while demand increases at the time the investment is done, supply capacity increases only in the future. Hence, there is a possibility that government spending could raise demand beyond the productive capacity of the economy. If this happens, additional government spending does not raise income beyond the productive capacity, it only fuels inflation.
This aspect of government spending became apparent during the 1970’s after the first oil shock. Inflation all around the world soared with increased spending, but output stagnated. The new phenomenon was dubbed stagflation by economists. It took them some time to understand the character of the new situation. Keynesian economics did not have an answer to the new problem, consequently it fell into disrepute. There was a resurgence of (new) classical economics which emphasised the futility of Keynesian pump priming to raise income and employment when the economy was on the trend path. It reestablished (at least for the time being) the efficacy and superiority of laissez faire as against dirigiste economic policies. Some of the leading economists of this genre were rewarded with Nobel economics prize.
The Achilles’ heel of Keynesian solution to economic slowdown is the crucial assumption that substantial excess capacity exists in the economy. If this is not the case pump priming leads to spiraling inflation. Since Mr. Muhith proposes to pump prime the economy out of the 6 percent rut, the important question is whether Bangladesh economy has substantial slack capacity to climb out of it with pump priming.
BBS does not publish information on output gap. Consequently one has to assess the situation on the basis of other available information in a subjective manner. Assessments will differ depending on how the available information is interpreted. Mr. Muhith probably assumes that he can increase government spending by almost a quarter without breaching the capacity constraint. He could be right, but only time will tell.
All this discussion may turn out to be academic if Mr. Muhith maintains his track record. He has consistently set the budget targets high (ambitious?), and has been consistently unsuccessful in implementing the budgets fully. Actual expenditures unerringly fell short of the budget allocations, often by about 10 percent. Revenue earnings mostly fell short of the targets, sometimes by large amounts. ADPs fared even worse with the average rate of implementation at about 85 percent during the past five years. If the same situation obtains in FY 2015-16, a large part of the budget will remain unimplemented. Consequently, the economic growth target may remain unattained again. However, a collateral benefit is that it will avoid excess demand pressure and thereby reduce the chances of stoking up an inflationary spiral in the economy.
Mr. Muhith has, perhaps unwittingly, lent a helping hand to Bangladesh Bank by not implementing the budgets fully. If he continues to do so, both the design and implementation of monetary policy will be made easier. So far there has not been any serious conflict between monetary and fiscal policy which is endemic in so many countries. Such a conflict can easily disrupt monetary policy. Bangladesh Bank should be wishing that Mr. Muhith remains on track so that its monetary policy remains on track.
Higher growth of a developing country can be achieved only by increasing productive capacity, and the latter can be achieved only though productive investment. There is considerable doubt regarding the productivity of public investment due to massive wastages and leakages. Mr. Muhith may be betting on the wrong horse for accelerating growth. The real spurt to growth comes from private investment. It has been on a downhill slide since 2011-12 due to unfriendly investment climate and negative business expectations. The budget does little to address the concerns of genuine business. Unless business expectations turn positive there is little prospect of achieving the high growth the budget promises.
Dr. M. A. Taslim is Professor of the Department of Economics, University of Dhaka.