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Home / Analysis / Budget 2020: Fiscal expenditure is the way out | Opinion

Budget 2020: Fiscal expenditure is the way out | Opinion

Go back to Keynesian principles. Spend money in key areas, and see the multiplier effect across the economy

analysis Updated: Jan 29, 2020 19:56 IST
Rohit Azad
Rohit Azad
The criticism against enhanced government expenditure is misplaced. Take the blinkers off
The criticism against enhanced government expenditure is misplaced. Take the blinkers off(Sanjeev Verma/HT PHOTO)

The Indian economy is currently like a ship caught in a whirlpool. The only way to avoid sinking is to apply force in the opposite direction — and to do it now. In the arsenal of the government, there are two such devices: Credit injection and fiscal expenditure. The first has been tried exhaustively but hasn’t quite provided the much needed force to revive the economy. Budget 2020 is, perhaps, the only opportunity left before it’s too late.

John Maynard Keynes, arguably the greatest economic thinker of the last century, had argued that fiscal expenditure is a sure shot way out of a slowdown. The way it works is very simple. Let’s say the government spends ~100 on any programme of its choice, which generates income in the hands of the people who get it. If people in general consume, say, half of their income, it further generates ~50 worth of demand for consumption goods, of which the sellers of these goods consume ~25 and so on. So, an initial increase in government expenditure of ~100 has not only increased the economy’s GDP by that amount but much more, a process which he aptly called a “multiplier”. Despite the simplicity of this argument, it is perhaps one of the most contested ideas in the field of economics.

One, it is argued that this spending will not increase the overall income, because when the government borrows to finance the initial ~100 from the people, an equivalently less amount is left for private investment. This is erroneous on at least two counts. Firstly, this increased expenditure also simultaneously increases the total savings. So, in the example above, when ~50 out of the ~100 was consumed, the other ~50 is obviously freshly saved and ~25 thereafter and so on. Secondly, if government borrowing were to be ineffective for this reason, so should private borrowing be, and if so, then no economy can ever grow. It’s like saying that if the Airports Authority of India borrows to build an airport, it doesn’t increase the income of the economy, but when a private company builds it, it does.

Two, the critics argue that an increase in public debt as a result of this increased expenditure can increase the cost of domestic borrowing (interest rates) while bringing the international ratings down for the economy. This again is erroneous. Increased government expenditure need not necessarily raise public debt since it also increases tax revenues. In the example above, if the tax rates are, say, 20%, then the government also receives additional revenue as the income rises. In fact, a government can plan tax-financed expenditure, in which case, public debt remains the same. Even if public debt were to rise, that need not increase the cost of borrowing, because both the demand and supply of loans have increased simultaneously.

As far as international ratings are concerned, they can balance out if such an expenditure is accompanied by higher growth.

Three, it’s argued that if instead of public borrowing, this increased expenditure is financed by printing money, it will lead to inflation because more money is chasing the same goods. The error in this argument is that more money is not chasing the same goods. As argued above, new goods have been produced in the very process of such an expenditure.

Four, there’s a fear that this may widen trade deficit since imports rise with income, thereby, affecting the value of the rupee. While this may be true and indeed could be a problem for countries with limited capital inflows from abroad, it depends entirely on the nature of government expenditure. If the expenditure is on activities and goods which are primarily produced domestically, say, for example, pushing up rural demand or incomes of the poor people in the country, this will not pose a problem.

An additional factor, which is almost missing in these arguments, is that far from curtailing private investment, government expenditure might provide impetus to the latter by generating demand for goods produced by the private sector. No wonder, corporate houses are recommending relaxation of the fiscal deficit targets in this budget.

Take it together, and the criticism of government expenditure is not very persuasive unless your vision is blinkered by the “invisible hand” of the market. There is no dearth of avenues of government expenditure, for example, introducing an urban employment guarantee act or an Indian new green deal or public health and education.

What’s missing, instead, is the willingness to take the blinkers off.

Rohit Azad teaches economics at Jawaharlal Nehru University

The views expressed are personal