The quality of Government expenditures

Dr Bharat Jhunjhunwala
Finance Minister Arun Jaitley has claimed with some justification that the NDA Government has been successful in keeping the fiscal deficit under control. High growth rates will follow, he says. The global development mantra today is that low fiscal deficit signals good governance and can help attract large foreign investments. However, it also limits the capacity of the government to make investments in ports, highways and e-governance which, in turn, hurts both domestic and foreign investment.
More importantly low fiscal deficit means fewer jobs. Economists have found that there is direct relationship between inflation and employment. More inflation means more jobs and vice versa. The underlying idea is that when government prints notes to make highways and ports or to make expenditures in MNREGA, it leads to two consequences simultaneously. More notes in the economy leads to inflation. At the same time, demand for labour is created in the making of highways and ports. Thus an increase in the rate of inflation comes along with creation of jobs and a reduction in unemployment. Thus, control of fiscal deficit is anti-poor. They are deprived of jobs that could come from increased government expenditures.
Control of fiscal deficit, therefore, has two consequences simultaneously. On the one hand it helps attract private investment. On the other hand it leads to loss of jobs. The latter negative impact of fiscal deficit is ignored by mainstream economists who peddle the views of the World Bank and the IMF. They ignore that a lower fiscal deficit may not bring in more investment. They also ignore the fact that this increase in investment may not translate into creation of jobs. Our experience since the NDA Government has take over indicates that control of fiscal deficit is not bringing in investments but it leading to loss of jobs. This is why wage rates of daily labour are stagnant and businesses are down today.
Economist John Maynard Keynes gave the mantra of jumpstarting growth by increasing fiscal deficit in the thirties. Mainstream economists say exactly the opposite today. Was Keynes wrong, then? Let us examine his sayings. The American economy was in deep depression in the late thirties. The US economy started to enter the recession in 1929. President Truman continued to follow the policy of zero fiscal deficit for almost a decade. The slowdown in the economy led to reduced tax receipts. President Truman cut government expenditures in the same proportion. This reduction in government expenditures further reduced the demand in the economy and pushed the economy into a deeper recession. The economy was caught in a vicious cycle of reduced production, reduced revenues, reduced government expenditures, reduced demand, and, as a result further reduced production. Both private- and government demand were declining and there was a steep increase in unemployment. In this grim situation Keynes suggested that the American government must print notes and increase demand in the economy just as a dying person is put on the respirator. President Truman accepted Keynes’ advice and soon the American economy started looking up.
This is exactly what is happening in India today. Prime Minister Modi has cut government expenditures to control fiscal deficit. This reduction has reduced the demand in the economy and pushed the economy into a recession. The Indian economy is today caught in a vicious cycle of reduced production, reduced revenues, reduced Government expenditures, reduced demand, and, as a result further reduced production. This is happening because control of fiscal deficit is not actually leading to an increase in private investment. As a result the economy is slowly sinking into recession. I must say here that I am not convinced about the increase in growth rates that are claimed in government data. There is nothing on the ground that indicates of a vibrant economy.
My understanding is that both an increase and a decrease in fiscal deficit are harmful. Increase in fiscal deficit leads to inflation and repels private investment. Decrease in fiscal deficit leads to deflation in the economy and to loss of jobs and production. The true issue is that of quality of government expenditures. A fiscal deficit translates into inflation when the quality of government expenditures is poor. Printing of notes does not lead to inflation if the notes are used for making roads and ports and for establishing factories like the Bhilai Steel Plant. Such expenditures lead to increased production. This does not lead to inflation. Or, if the government provides assistance, for example, to rickshaw pullers to buy e-rickshaws, the benefits to the economy will accrue almost instantly. Passengers will reach their destination quickly. They will be able to produce more. These increases production will nullify the increase in fiscal deficit. Say the government prints notes of Rs 1000 and fiscal deficit goes up by this quantity. There is a pressure on prices because there are additional notes worth rupees 1000 circulating in the economy while the quantity of goods produced remains unchanged. But the people have saved time because of the use of e-rickshaws will help people produce more.
Let us say the Government prints notes of Rs 1000 and finance e-rickshaws. People reach their destination quickly. They produce more in the time that is saved. Now, if they produce an additional Rs 1000 worth of goods then there will be no inflation. The newly printed notes of Rs 1000 will be chasing the newly produced Rs 1000 worth of goods. The prices will remain unchanged.
The situation would be entirely different if the government used the newly printed notes, say, for paying higher salaries to government servants. The government servants, in turn, invest the money in gold or in property. No additional production takes place while Rs 1000 worth of new notes have entered the economy. The prices will increase as a result. Thus fiscal deficit will not be harmful if the Government makes productive investments.
Finance Minister Jaitley is obsessed with control of fiscal deficit. Indeed this may help control prices. But there is a danger of our slipping into a regressive cycle that President Truman had led America into. A better approach is to let the fiscal deficit rise but ensure that expenditures are made in productive assets. Jaitley should adopt this approach so that the economy can be pulled out of the continuing slowdown quickly.
(The Author was formerly Professor of Economics at IIM Bengaluru)

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