Sudhir Mulji: Wasteful expenditure

Wasteful expenditure may not be as bad as we imagine

Despite all its drawbacks, I believe in the need for an expanding public investment.

This belief is not simply a Keynesian response on my part to the need to increase effective demand in a slack economy, but flows from the propositions advocated by Adam Smith that "The third and last duty (after that of defence and the judiciary) of the sovereign or commonwealth is that of erecting and maintaining ... .. those public works, which though they may be in the highest degree advantageous to a great society are however of such a nature that the profit could never repay the expense of any individual or small individuals and which it therefore cannot be expected that any individual.. should erect or maintain." (Smith 'Wealth of Nations' book v.1.c)

In this single sentence Adam Smith summarises the duty and obligation of the state to provide and initially pay for the infrastructure that a society needs. Smith has many pages on the method for recovering user costs from the public, but that does not alter the primary obligation of the government to carry out and finance these investments.

Since Adam Smith's time, various avenues for raising finance have been elaborated, but unfortunately in the welter of schemes put forward, the authorities have wished to forget the fundamental obligations that must rest with and only with the sovereign power.

A grave cause for concern has been the inability of governments to spend money without wasting it. Thus it has become commonplace to argue that government expenditure is frittered away and that the real output from this expenditure has not been forthcoming. However one should be careful in measuring the waste of expenditure, particularly in the calculation of economic waste.

A good beginning in these calculations may be the controversy that took place in the nineteenth century between Spence and James Mill. Spence argued that it was the act of spending and not saving which caused wealth to grow.

He wrote: "The prosperity of the country would be as much promoted, if an owner of an estate were to spend in employing 500 men to blow glass bubbles, to be broken as soon as made as if he employed the same number to building a splendid palace. The 500 glass blowers would require as much wealth to be brought into existence from the soil as the 500 palace builders."

Mill countered this argument by making a distinction between productive and unproductive consumption. He defined unproductive consumption as consumption which simply destroys value as in the case of glass bubbles and productive consumption as destroying value but in the process creating goods of greater value like the palace.

Although Mill must clearly be right in his argument with Spence, it seems that the assumption of the permanent value of building a palace leads to another set of complex arguments. For the palace in our story clearly represents investment and there must be some question as to the value to society of that type of investment. Are palaces more desirable than glass bubbles?

In any event, two valid propositions emerge from this argument; first, that any activity stimulated by expenditure is better than no activity. Mill distinguished between productive and unproductive activity and concluded that productive activity was better than unproductive activity but he did not argue that no activity is better than unproductive activity.

Thus, money spent by the government may seem wasteful, but in turn the recipient of income from this wasteful expenditure may spend money on educating his children, which might have a social value somewhat greater than the building of a palace.

This example leads to the second valid proposition that emerges from the Spence-Mill controversy. The concept of productive and unproductive activity needs to be carefully examined and perhaps a final answer emerges only if we are able to trace the impact of the original expenditure through the economy.

This is obviously not an easy measurement; for money circulates between recipients and spenders and it is not simple to detect whether in the final analysis it has been spent socially wisely or not. The government may have spent it wastefully but the recipients may well convert their additional income into useful activity.

These confusing complications have been raised in order to simplify matters. It should be clear that the consequences of government expenditure cannot easily be categorised as wasteful or useful. There just is not sufficient evidence available for calculating social benefits. A government should not be satisfied merely by the direct consequence of its expenditures. It has to consider benefits to society as a whole.

It is of course true that specific policies carried out by the government may not yield the results they expect. It is for this reason that politicians such as Margaret Thatcher concluded that the government was not very efficient in carrying out the business of expenditure.

But that is precisely the mistake of hands-on Prime Ministers. Their policies are influenced by the efficiency of their activity, and they reduce or increase the magnitude of their expenditure according to their analysis of their efficiency in spending.

But in economics this link between efficiency and eventual social benefit is quite remotely linked. The magnitude of expenditure should be related to the potential unused capacity in the economy, particularly to that which could be brought to immediate use.

In attempting to bring about that link it is certainly possible, indeed likely, that government's expenditure would be less efficiently deployed but it may turn out to be socially beneficial. It depends not just on government expenditure but the consequence on investment in general.

In an article in the Financial Express on June 14 Saumitra Chaudhari examined the fluctuations in the rate of growth of fixed investment, particularly in the corporate sector, where it dropped from 50 per cent in 1995-96 to a negative rate of minus 10 per cent by 2001. There seems no rational basis for these fluctuations and those in the investment game feel there are no obvious answers.

In proposing a public investment programme, the main purpose of these miserable Keynesians, of which Ila Patnaik claims (Business Standard 16th June) there are "fortunately few" in India, and who she hopes will not be listened to by Mr Chidambaram, is quite innocent.

If business investment is cyclical, and having spent forty years in the business of investment I know that to be all too true, it seems logical that there should be the sort of state enterprise recommended by Adam Smith, which carries on regardless of cyclical business fluctuations.

The purpose of Keynes and likewise of his disciples is that with their knowledge of the nature of investment fluctuations they wished to insulate the economy from the uncertainties that are central to business decisions. They do so by seeking an alternative purpose for investment than that of getting an adequate return.

It is unfortunate that modern economists have become so enamoured by the miracles of private investment that they are prepared to abandon everything, even their reason, to prevent the state from investing.

sjmulji@aol.com