A couple of weeks back (The Other Side, August 18), I had discussed how some economists in the International Monetary Fund (IMF) are now discovering the ill-effects of two macro-economic policies it has been advocating since long: a liberal capital account and fiscal austerity.
The issue of fiscal austerity and the accounting of fiscal deficits is now once again attracting attention. As for the latter, the Greek government recently sued its former chief statistician (an ex-IMF economist) for fraud, alleging that he inflated the fiscal deficit. The European Union authorities are supporting him, but he faces the spectre of being jailed up to 10 years if convicted.
Perhaps the issue of fiscal accounting itself needs reform: should money spent on, say, salaries and wages and that expended on, say, building roads and dams be treated similarly? The external accounts data of an economy provide a useful model: the balance of payments details the flows of income and expenditure (that is, current account) and, separately, receipts and payments on capital account. The statement of international investment position, introduced about a decade back, details the stock of external assets and liabilities. We perhaps need a similar statement of an economy's domestic public assets and liabilities: the latter would include public and quasi-public debt, and the assets comprise government-owned land, roads, buildings, dams, power stations, equity investments, etc - and, in our case, Lutyens' Delhi.
This apart, in a background paper for the recent G20 Summit, the IMF urged policymakers to employ fiscal policies to stimulate slow-growing/stagnant economies. Ahead of the G20 Summit meeting, the US Treasury Secretary was quoted as arguing, "The G20 is no longer debating growth versus austerity but rather how to best employ fiscal policy to support our economies, and increasingly how to make sure the benefits of growth are more widely shared". After the Brexit referendum, Britain has abandoned the goal of balancing its budget by 2020, and Japan has been incurring huge deficits for decades. Even central bankers
(John Williams, the President of the Federal Reserve Bank of San Francisco, and Loretta Mester, his counterpart in Cleveland) have recently given a call for fiscal stimulus.
One key issue in the debate about fiscal austerity is the "fiscal multiplier": does the fiscal deficit increase GDP by more than the deficit? If so, what is the multiplier? Keynes long back argued that the multiplier is greater than unity. It was the believers in "rational expectations" ideology propounded by the so-called Chicago School, which argued otherwise in the 1970s: that economic agents realise that fiscal deficits today would inevitably lead to higher taxes and/or inflation tomorrow, and therefore the deficit would not lead to higher demand but to higher savings. (In other words, the fiscal multiplier is close to zero.)
The IMF has been looking at a different aspect of fiscal deficits: how it affects the ratio of public debt to nominal GDP. For a long time it believed that for each one per cent cut in the fiscal deficit, the GDP is lower by 0.5 per cent: in other words, a cut in fiscal deficit improves the economy's debt servicing ability. (This was the basis of the conditions imposed on Greece at the time of its sovereign debt crisis six years back.) In 2013, the IMF discovered that the ratio is 1.5 - and can be even higher. The implication is that a cut in the deficit increases the ratio of public debt to GDP, as the Greek experience shows!
Perhaps it is time for policymakers to reread Keynes.
A curious case
Since its bailout from the sovereign debt crisis six years back, Ireland has recovered strongly with the highest growth rate in the EU, and low unemployment. For long, Ireland has levied very low tax rates (12.5 per cent) on profits earned by foreign direct investors in the country, to attract them, create employment and growth. One of the large investors is Apple.
Recently, the EU competition regulator has ruled that Ireland's tax policy violates EU regulations, and has levied a tax of €13 billion plus interest on Apple. The Irish government has decided to appeal to European courts: not to increase the levy, but to waive it. The reason is that the ruling would create a precedent and impede Ireland's efforts to attract FDI, and hence future growth and employment creation. Clearly, the Irish government gives greater priority to employment creation and growth than to fiscal balance. That apart, what a contrast to the way we treat foreign investors like Vodafone or Cairn!
The author is chairman, A V Rajwade & Co Pvt Ltd; avrajwade@gmail.com
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
