Monday, 29 June 2015

Growth by Spending

Growth is the main target of the policymakers. If growth is inclusive then the benefits of growth are distributed among all the groups of society. However in case of non-inclusive growth the redistribution of benefits will trickle down effect of growth. Nevertheless, the trickle down effect is insignificant in the short run.
Several policies have been made by the government and then affiliated departments support government to achieve that announced level of growth. Among those several departments Federal Board of Revenue has significant importance. Every year an impossible task is given to the FBR which sabotage the reputation of FBR.
Along with taxation, the other significant part is expenditures which everyone wants to do without any restriction. However, everyone faces the income constraint which at macro level comes from the revenues government generated from people and the income from the investment they have made. Unfortunately, government entities are not in habit of earning profits thus subsidized heavily by revenues collected by FBR.
Government invests where markets fails, for example it involves in services industry such as PIA and Railways in our case which provide facilities to the general public because private sector does not invest in non-profitable or lesser profitable ventures. Despite these two sectors, government invest in all those activities which are used by general public or in other words which can be called a public good such as parks, defense, police etc. Public goods are provided without considering the profits to all segments of the society. It is worth to mention that Metro Bus service is a public good, which is subsidized by the government and used by the general public. Although in more technical terms this kind of public good is known as club good since it is not totally free. However, since it is used by few people in the society that is one of the reasons it is highly criticized by the opposition, though the beneficiaries are praising it.
Coming back to the main point that growth is the target agenda of policymakers then why are we following lower inflation (stabilization) and lower fiscal deficit policy (fiscal consolidation) from the last several years. Although several seminars and reports prepared by Institute of Policy Reforms suggested that growth is necessary. Dr Pasha repeatedly said that the stabilization is achieved and now its time to shift to higher gears of growth. But unfortunately IMF’s agenda is above the wail of national economists and think tanks.
A recent paper by PIDE suggested number of things. One of the major findings it has is that fiscal consolidation leads to growth which is in accordance with the IMF agenda. However, how it should be achieved is very interesting.
There are several components through which fiscal consolidation is done. As discussed earlier the two major components are revenues and expenditures. Thus it can be done by increae in revenues or decrease in expenditures. For the last 25 years several ineffective policy measures are taken to increase tax revenues but tax revenues as percentage of GDP had declined from 13 percent in 1990 to less than 10 percent in 2014.
Literature on fiscal consolidation explicitly says that consolidation is only effective when it is done by cutting down expenditures. A noteworthy question is what expenditures? These can be classified into capital/development as well as current expenditures. Capital expenditures or development expenditures are those which will payback in future while current expenditures, although very important but are those those expenditures which do not pay back in future. The definition may be debatable because employee’s salaries are current expenditures. However, if school/college/university teachers are paid then it is also known as investment because government is investing in existing knowledge to produce further knowledge (students) which is the crux of endogenous growth theory of Paul Romer.
One of the important conclusions of PIDE’s paper is to reduce interest payments. In the current budget Rs.1328 billion is the estimated budget deficit and Rs.1280 billion is interest payments. If interest payments are zero, which is almost impossible with the high debt and high fiscal deficit, then the total budget deficit comes to Rs.48 billion. In this way government can spend rest of the money to produce further knowledge, i.e. spending on Research and Development, which is low to an embarrassing level. The interest payments can only be curtailed by reducing the overall debt, which is close to impossible, in the current scenario.
It has also been revealed that higher growth episodes are strongly related to the higher capital/development spending. Nonetheless, the trend of capital spending has been declining for the last 2 and half decades. This implies that fiscal consolidation, if it is followed in few years, is done by cutting in development expenditures. This is the worst form of fiscal consolidation. It affects the growth negatively.
It is high time to identify the leakages in the system, which will give us more fiscal space to invest in development projects. Finding an efficient way of doing the mega projects is very necessary. The recent worst example is metro bus system which according to Dr Farrukh Saleem cost us Rs.2 billion per KM. This cost is 8 times of the cost of building Indian Metro and more than double the cost of building Turkish Metro (0.88 billion per KM).

In conclusion we may say that since we are facing huge debt and deficit problems and we are scarce in resources to fund our development projects thus (i) leakages and over spending should be avoided by carefully examining every project, thus we may have more fiscal space to allocate funds on other development projects (ii) prioritize the projects according to the need of public (iii) give importance to Paul Romer’s theory of endogenous growth and allocate sufficient fund for research and development.

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