Opinion | Depoliticize fiscal policy to tackle economic challenges4 min read . Updated: 11 Feb 2020, 12:01 AM IST
Politicization of fiscal policy has diluted its effectiveness even as easy money fails to boost growth
An observation of the effectiveness of central banking systems across the world reflects the limited extent to which monetary policy and lower interest rates are able to address cyclical, or even structural, downturns. Whether it is the US Federal Reserve, the European Central Bank, or the Reserve Bank of India, lower costs of borrowing or easier credit requirements introduced with other quantitative or non-quantitative measures have had minimal effects in pumping sustainable cycles of investment-production for higher growth in recent years. This has shifted responsibility to fiscal policy as a tool to boost demand, incentivize targeted lending, and pursue a pro-growth agenda.
For those aware of contemporary macroeconomics, including most monetarists, there is widespread agreement that a well-crafted and fine-tuned fiscal policy, especially in developing nations, can go a long way in filling a hole in the investment-production-consumption processes. However, in understanding the role of fiscal measures, one often understates how deeply politicized fiscal policies have become and hence fail to effectively substitute technocratic central banks that are tasked to ensure short-term economic stabilization.
The nature of politicization may differ from one state to another. In electoral democracies, budgetary spends are often directed towards populist schemes closer to election year knowing that the outcome of such spends may have little to do with driving growth or addressing immediate concerns. A party in power may do so to create a winnable political narrative or for a certain kind of self-projection.
Worse, in authoritarian states, fiscal spends are misdirected towards other overheads (say, defence) vis-à-vis areas of human capital development (education, healthcare, and affordable housing). These can hurt growth and development in the long-term.
Also, fiscal policies today, at least in electoral democracies with a legislature, have not only become politicized because of the involvement of multiple vested interest groups, but also deeply polarized, with decisions to pass budgets being made by razor-thin margins. For example, in the US, while the Democrats may prefer a higher budget spend for social security, healthcare, and other transfers, the Republicans may prefer cutting expenditure and offering tax-breaks to corporate classes. This diminishes public faith in the effectiveness of fiscal policies.
At the same time, polarized political budgets make it extremely hard to take fiscal policy measures aligned with the economic interests of citizens.
A vital question that emerges is: How can polarized fiscal steps hurt a country? Some might argue that budgets in the past have also been subjected to intense political mediations by big democratic governments. While that may be true, it is critical to understand the motives of such mediations—what and whose end they serve.
If the next global economic crisis surfaces from the explosion of a large debt overhang, it may require a more proactive fiscal policy intervention to manage the effects of both national and global responses. In a crisis, an immediate corrective response makes all the difference and, given the time fiscal policy responses can take, the burden of responsibility to act swiftly falls on central banks, as seen in most of the 20th century economic crises. This can no longer be the case.
For states to understand the relative importance of fiscal policies, untying political ends and prioritizing economic goals remain critical. One way to do so is by pursuing so-called activist fiscal policies—which a government implements to achieve its economic agenda—with due clarity and transparency on the motive and by installing certain “automatic stabilizers".
As American economist Kenneth Rogoff argues, fiscal policy interventions might need to institute some form of automatic stabilizers to address or prevent chronic crisis scenarios. In India, which is facing a structural downturn, automatic stabilizers in the recent budget could have helped stall a further slide in consumption demand. These could have taken the shape of increasing unemployment insurance transfers or a Mahatma Gandhi National Rural Employment Guarantee-like scheme, a basic income transfer to farmers and lower-income groups, and targeted spending on unorganized and rural segment of the population—the country’s largest base of consumers and producers.
Unfortunately, the government seems in denial of a slowdown (the finance minister’s budget speech didn’t even mention one), and it failed to ensure this. Instead, what we saw was a reduction in budgetary allocations for some vital social sector schemes. To some experts, fiscal constraints might justify such cuts, but if they lead to austere conditions, or a deeper slump in the economy, the situation may worsen for a large developing nation such as ours.
Activist fiscal policies have thus a critical role in not only crowding-in investment opportunities for long-term growth, but ensuring short-term stabilization by boosting demand. Automatic stabilizers further need to be embedded in activating proactive fiscal policies to not only complement monetary policy measures, but also allow a closer and swifter switching of monetary and fiscal policies in guiding the response to both our economy’s present and evolving macroeconomic needs.
Deepanshu Mohan is associate professor of economics at OP Jindal Global University