Fiscal stimulus and investment

You cannot solve the problem until you call it by the right name —Mikhail Gorbachev

On November 12, the Government of India (GOI) announced a new package to revive the economy. This includes a fiscal stimulus. It emphasises production and employment. However, it does not pay adequate attention to what is, in the broader perspective, arguably the basic and somewhat persistent issue of low investment and low growth. But at this stage, is it possible or even desirable to address this issue? It is.

It will help to label fiscal policy here under three different heads: Keynesian fiscal policy, re-allocative fiscal policy and redistributive fiscal policy. The first is named after John Maynard Keynes. In a downturn, it is about raising aggregate spending through a fiscal stimulus; it involves a deficit for the government. Re-allocative fiscal policy is about raising some spending and reducing other spending. One example is that the GOI can defer, if not cancel, the Central Vista project and use the funds elsewhere. Next, re-distributive fiscal policy is about raising aggregate spending that is financed by an additional tax such as the wealth tax or inheritance tax. Even in the US, president-elect Joe Biden wants to raise more taxes. Unlike Keynesian fiscal policy, neither the re-allocative nor the redistributive policy involves any deficit for the government. This conceptual framework is useful for exploring the possibility of more government help in these times.

Extraordinary times call for extraordinary measures! This can mean a large deficit or the use of re-allocative and redistributive fiscal policies on a larger scale. Or, we can have a mix. It is important not to rely on a large (monetised) deficit alone because there is a significant risk in India that the inflation rate can jump. Already, the October inflation is at a six-year high of 7.61 per cent; this is also nearly double the 4 per cent inflation target, even though the supply constraints have not been serious and persistent.

Given the overall situation, it helps to plan. The humanitarian spending (including the health spending) is a high priority — more now than at other times. And because it is a high priority, the re-allocative and redistributive policies can be used for such spending. So, the Keynesian fiscal policy can be used primarily for getting the economy back on track. This is, a fortiori, true if the GOI raises funds through sale of some of its existing assets in order to make new investments, which will raise aggregate demand for output!

This brings us to how Keynesian fiscal policy should proceed. The usual argument is that it should focus on putting money in the hands of the consumers and producers who will, directly or indirectly, end up spending on consumption. This will raise the level of gross domestic product. This sounds fine but it can be a soft option and a shortsighted policy. Though such a policy may take care of the level of output in the current period, it does not take care of even the same level of output in the future periods. So, some outside stimulus may be required again, if not repeatedly every now and then.

Indeed, the emphasis on fiscal stimulus in the short-term without paying adequate attention to investment is an important reason why low growth of per capita income has persisted in Japan after the big recession in 1989-90 and even in the US and Europe after the Global Financial Crisis in 2007-08. All this motivates the alternative view.

A simple and stylised version is as follows. Let the Keynesian fiscal policy get more specific and focus on investment spending. This policy raises aggregate demand for output. So far, it is similar to the policy of a general fiscal stimulus. However, the additional benefit now is that the productive capacity rises. If the additional investment has been made in the right projects, then in future there will be demand for the additional potential output. This means that the realised output will be greater in future. Given this growth and given that private investment depends on the growth of and not the level of output, there will be a rationale for greater private investment at a later stage. Thus, that basic concern with the somewhat persistent low investment gets addressed, even if slowly.

Given the revival of more or less adequate private investment at a later stage, the fiscal stimulus can be phased out then. Thus, under Keynesian fiscal policy focused on investment, we will have not only a strong recovery but also somewhat self-sustaining and reasonably high growth. This is meaningful, given that the re-allocative and redistributive fiscal policies take care of the humanitarian needs.

The writer is visiting faculty, Indian Statistical Institute, Delhi Centre