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Finance Minister AMA Muhith presented proposed budget for 2015-16 in Parliament on June 4
Finance Minister AMA Muhith presented proposed budget for 2015-16 in Parliament on June 4

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.

M A Taslimis an economist and currently an adjunct faculty at East West University.

5 Responses to “Mr. Muhith’s budget: Spending out of the rut”

  1. sundar swapan

    we are really tired of hearing this folktale of growth ,please stop blabbering on this faltu issue.

  2. Anis Chowdhury

    Dear Taslim Bhai

    I hink you are too harsh on public investment in generalising, “There is considerable doubt regarding the productivity of public investment due to massive wastages and leakages.” If private investments are superior in productivity then why do so many private businesses go down? The recent global economic and financial crisis was mainly due to excesses of the private sector made possible by pushing the government to the margin.

    You also ignore the hostorical facts that much of the large infrasturcture projects were done by the governments and they do have a very strong “crowding-in” effect. Public investments attract private investment through their productivity enhancing effects. We also need to hightlight public investments in social and environmental sectors where private investments are usually shy. That is, we should not lump everything into one big aggregate. Both public and private investments have to be in the right sectors and made in an efficient ways to have better results – the principles are the same – quality of investment (public & private) matters.

    These points are highlighted in recent IMF papers, summarised in its World Economic Outlook, Oct. 2014, which examined the macroeconomic effects of public investment in a large number of countries. Here is what it says, “The findings suggest that in countries with infrastructure needs, now is a good time for an infrastructure push…In many emerging market and developing economies, infrastructure bottlenecks are putting a brake on how quickly these economies can grow.”

    Yes, you are right, the impact of publuc investment depends on many factors. In addition to the factors, such as openness and slack in the economy, it also depends on the binding nature of the balance of payments constraint and real wage resistance. The idea that opening of capital account has made the balance payments less contraining is found to be wanting. The recent expereiences, especially since the 1997-98 Asian financial crisis, have shown that short-term capital flows cannot be relied upon to deal with structural supply side issues.

    Second, the real wage resistance. Public investment, for that matter any investment, causes prices to rise in the short-run due to the gestation gap between spending and productive capacity. This reduces real wage and hence induces more employment. But every-time prices go up, demand for wages goes up too, leaving the real wage unchanged. One way to break this circut is through the public provisioning of basic services, e.g. low-cost housing, transport, basic healthcare and education. The efficacy of the Keynesian policies owe a lot to the welfare provisions in the post-Wolrd War II era. In recent times we have seen this during the “Accord period” in Australia, where wage demand was held back by the increased provising of publicly funded health care and child care.

    Finally, the real wage resitance that I mentioned above is not necessarily due to the arguments of the (new) classical economics, many of which are now found defunct. It happens because of the fact that real wage is already too low for the workers (it has been either stagnating or falling); it can’t fall any further.

    • M. A. Taslim

      Dear Anis,

      Thanks for your thoughtful comments.

      Arguments in favour of infrastructure investment are well known and are not disputed. But consider an investment of $3 billion to build a bridge that will increase the economy’s output by $1/2 billion. If the market borrowing rate is 10 percent the project is very profitable and should be implemented. But if the same project is built with $7 billion, it has a negative net return. With such investment there will be a negative impact on output growth. This is the scenario I am alluding to, not what you are implying.

      The last BNP-led government had a poor record in infrastructure investment, while this government has a robust record. And yet the former managed to push the growth rate beyond 7 percent, while this government is stuck with 6 percent. Where is the higher investment going?

      It is precisely because private investment fails frequently that it is efficient. Inefficient investors/firms simply do not survive. Actually a great majority of start ups fail within a short time in just about every country. Public investment, even when grossly unprofitable, is sustained which adds to the cost. Just look at the record of our public enterprises!

      If infrastructure investment were done efficiently, our growth should have been well above 8 percent. Furthermore the public would not have to make unilateral transfers of money to infrastructure-builders to pay for the wastage.

      • Anis Chowdhury

        Taslim Bhai

        Fair points. I really cannot answer your country specific questions. You are in a much better position.

        However, when you mention about cost differences for an infrastructure project, you also need to refer to all the machinations that the private “entepreneurs” have been designing to siphon off the government – the rental power is an example. In fact, you had an excellent research piece in the 1980s on the lack of enterpreneurship and its link with loan defaults in BD. Has the situation changed much?

        In any case, my comments were on your “generalisations”. I thought they give a very clean bill of heath to the private sector vis-a-vis the public sector. It needs two hands to clap.

        On the question of growth differential between the 2 regiomes, one cannot be sure about the cause. As you know, the World Bank has finally admitted that we don’t know much about what causes growth (Growth Commission Report, 2005, 2008). In the famous growth model of Solow for which he received the Nobel Prize, close to 70% of is explained by the coefficient of ignorance or residuals(lumped into total factor productivity).

        One really needs a country-by-country; period-by-period “growth dianostics” as the causes may differ across countries and over time to identify as precisely as possible what cause growth differences.

        My hunch in this case is the changed global economic situation follwoing the 2008-2009 financial and economic crises that may explain some growth differential. A second factor could be illicit transfer of funds out of BD; the rate certainly shoot up during the last 2 years of the BNP regime and after the interim govts. attempt to clean up corruption (see Global Financial Integrity Report; http://www.gfintegrity.org/wp-content/uploads/2014/12/Illicit-Financial-Flows-from-Developing-Countries-2003-2012.pdf). Bangladesh topped the list of LDCs in this area according to an UNDP report in 2010 (http://www.gfintegrity.org/wp-content/uploads/2014/05/IFFs_from_LDCs_web.pdf).

        Another area to watch out is the obsession with reserve accumulation. This has become a measure of success as if it does not have any opportunity cost. These reserves are kept outside the country (mostly in US treadury bonds) earning almost no interest. Instead of using this resource for domestic investment, BB is in reality financing the US economy what many say capital flows upstrem!

        Finally, I come back to my starting points – my comments are on generailties, and my reply to your response also touches general issues, not specifics; you are in a much better position to analyse the BD economy.

        Warmest regards and thanks for this opportunity to engage intellectually.

  3. Mo Chaudhury

    Thanks to Professor Taslim for a very lucidly written and yet very rich exposition of the bigger picture behind the BD budgets and the state of public finance and economic prospects.

    It is also to be added that the financial health of the nationalized banks is deteriorating at an ominous space in the process of indirectly financing the growing deficits. Meantime, the private sector investment is possibly getting crowded out.

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