We are all Keynesian now. Or so it seems. After a $145 billion first round of tax breaks, the US is debating a second and bigger fiscal stimulus. China has announced a staggering $586 billion stimulus. Many European countries are out with smaller measures. India has responded with a modest initial package.
The aggressive monetary policy loosening of the past two months through cutting reserve ratios and repo rates along with liquidity auctions appears to have barely pulled the reins on a slowing economy. Fiscal policy measures are the fastest and most reliable way of encouraging short-run economic growth at a time when a serious downturn is under way. Unlike monetary policy decisions which have a greater impact on financial institutions, fiscal measures benefit the poorest and struggling families.
Photo: Rakesh Kumar Singh / AP
However, India is constrained in its ability to indulge in any substantial fiscal pump priming of the economy on account of its soaring current and fiscal account deficits. The massive off-balance sheet deficits such as oil and fertilizer bonds have pushed the combined fiscal deficits of the Central and state governments to beyond 10% of gross domestic product. In the circumstances, it is imperative that any and all fiscal measures end up successful. What are the options available?
Economic theory suggests that the fundamental attributes of an effective fiscal stimulus are that it should be timely, targeted and temporary. Fiscal stimulus spending works by generating a multiplier effect on the economy, thereby boosting aggregate demand. It is important, therefore, that the benefits accrue to those most likely to spend it immediately. It is natural that the poorest and those pushed to the brink of poverty due to the slowdown, the ones who generally do not have a savings cushion, who cannot borrow and are hence forced to cut back on spending at such times, are the major target group.
It is for this reason that tax rebates, which disproportionately benefit the better off, are—contrary to conventional wisdom—relatively ineffective. Examples from Japan in the 1990s and the US recently show that faced with bleak economic expectations, individuals prefer to postpone their consumption and instead save or repay debts with the additional money released by tax rebates. Tax concessions to incentivize corporate investments will come up against the same set of “rational expectations” on depressed economy, which would induce them to postpone investments.
A new study by the Economic Policy Institute in the US shows that tax cuts, especially to companies, are among the least effective and most economically inefficient of fiscal stimulus strategies. It found that food stamps and direct cash transfer schemes to the poor delivered the greatest bang for the stimulus buck, followed by unemployment insurance, infrastructure spending, and assistance to states.
Infrastructure investments— with its manifold attractions of creating much needed permanent capital assets and its multiplier effect on many sectors—though one of the most popular of fiscal stimuli, are fraught with problems. It takes considerable time to conceive, design, source finance and tender them out. Being capital-intensive, they may not be as effective in creating jobs, of crucial importance at such times.
Smaller infrastructure projects such as small village and street roads and drains, community assets, and irrigation structures offer the possibility of reconciling the twin objective of creating capital assets and spending money immediately, besides creating jobs. Other options: swift release of the balance amounts for projects in slow progress for lack of adequate funds and quick completion of projects that are tendered out, but delayed.
Fortunately, some of the ongoing flagship development programmes of the government, such as the National Rural Employment Guarantee Scheme (NREGS) and the Jawaharlal Nehru Urban Renewal Mission, are ideal examples of fiscal-stimulus spending. It may, therefore, be appropriate to step up the allocations for these programmes.
Another effective stimulus strategy is to assist state and local governments which, when faced with perilous finances and a host of populist schemes, are most likely to cut their spending during slowdowns. It, therefore, makes sound economic logic to increase the allocations for matching grant programmes of the Central government, so as to augment the resources of the states, especially for housing, slum development and rural infrastructure.
Ironically, some of the populist steps initiated by the government may end up becoming effective fiscal stimulus measures. The Rs60,000 crore farmers’ loan waiver will leave farmers with more money to spend. The Rs55,000 crore for pay commission arrears and higher salaries are virtual tax credits and direct handouts, though how much gets spent is to be seen. The increased coverage of NREGS will put more money in the pockets of the rural poor.
The one big fiscal stimulus trigger that has the potential to unleash spending in the local economy without substantial government expenditure is a general election! Even the most conservative estimates of election spending by both the political parties and the government runs into several thousands of crores. Most of campaign and election-related spending will be on items which are produced and consumed locally. Finally, elections are a one-off event—and hence have an inherent sunset provision.
Gulzar Natarajan is a civil servant. These are his personal views. Comments are welcome at firstname.lastname@example.org