It’s not about debt, it’s about stimulating an economy in crisis
Many economists and analysts have fixated on the Treasury’s borrowing prospects, neglecting the bigger picture
A submission by more than 100 economists, policy analysts and academics, calling on parliament to reject the supplementary budget, has drawn public criticism from the Treasury, business editors, Reserve Bank officials and the minister of finance himself.
Many of these responses fail to take seriously the underlying arguments of the submission. Many also uncritically accept the Treasury’s position, which should be taken seriously and scrutinised against existing evidence.
The overriding concern of the budget appears to be the rising level of debt, a growing budget deficit and the cost of repaying the debt. These are all extremely important. Together with economic growth, employment, tax revenue, the balance of payments, inflation and our exchange rate, they are key macroeconomic indicators.
Contrary to the caricatures, economists such as myself are not in favour of ever-rising debt and deficits, or wanton spending. At the heart of Keynesian “countercyclical” fiscal policy is the notion that a country should borrow and spend during a downturn, and that this should taper off during periods of economic growth.
Two questions arise. First, in the current context, should debt be the overriding concern? And second, does the Treasury’s plan represent a viable path for reducing SA’s debt and containing deficits and debt service costs?
Tackling the second of these, the Treasury presents its budget as a path to containing borrowing and spurring economic recovery.
For this to be true, reduced spending must not cause a contraction in GDP and tax revenue, or lead to a small enough contraction that the net effect on debt is positive. The concern is not the absolute level of debt, but its size in comparison to GDP — the deficit in a given year or the amount we pay for our debt in relation to our tax revenue.
Indeed, this appears to be the Treasury’s position: in its presentation to parliament it says, “SA’s fiscal multipliers are very small (and possibly negative before the crisis)”. This implies that a change in spending has little impact on economic growth. A multiplier of one means that for each rand spent (or not spent), GDP will increase (or decrease) by one rand. A multiplier of zero means no impact on GDP, and a negative multiplier means that cutting spending actually increases growth.
The Treasury provides no evidence to support its claim.
Despite how the Treasury persistently tells us that budgeting involves “trade-offs”, it is the Treasury that wishes these away. In the macroeconomic view of the world presented, there are no costs to reducing spending to slow borrowing. This is not what the available evidence suggests.
Using generally accepted methodologies based on observed historic relations in the economy, Stellenbosch economists show, between 1980 and 2010, a multiplier of 1.6-1.8. Former Treasury economist, Konstantin Makrelov, and colleagues show a fiscal multiplier of 2-3 post the 2008 financial crisis (not all conditions then hold today). Using insights from both, Schröder and Storm calculate a multiplier of 1.68 for 2018. This means for every rand spent (or cut,) GDP increases (or decreases) by R1.68.
Working with the evidence we have at hand, therefore, a cut in spending will lead to a fall in GDP. This fall in GDP will lead to a fall in tax revenue.
Input the current level of debt, size of the economy, tax-to-GDP ratio and interest rate on debt, and a reduction in spending of the magnitude proposed over the next two years leads to a rise in debt-to-GDP and a rise in debt service costs as a share of revenue or budget spend.
Similarly, the high deficit, largely a consequence of a collapse in revenue, cannot be closed by growth- and tax-reducing measures.
The Treasury’s plan will, therefore, fail to achieve its primary objective.
Various conditions will affect the size of the multiplier. That SA has a large “output gap” — our economy is producing less than it could — and falling inflation, is likely to raise the multiplier. Rising debt and a relatively high level of imports are likely to lower the multiplier.
The size of the multiplier from expanding fiscal spending over the next two years might be lower than 1.68. One reason for this is that households and businesses are, in the crisis, accumulating debt and so a larger-than-normal share of additional income may go towards paying this down, rather than to spurring new economic activity.
However, the contractionary impact of cutting spending in the near term is likely to be far higher than in normal times. This is because, in the midst of a crisis, government spending is a vital lifeline to the economy. If businesses go bust now, the impact on economic growth is enormous.
Because government spending is a component of GDP, the only circumstance in which a reduction in spending would not lead to a contraction in GDP is if the private sector increased spending by a commensurate amount. The multiplier can only be less than one if the private sector steps into the breach. Given the widespread economic collapse we are witnessing, this is highly improbable.
The potential of budget cuts to cause a meaningful fall in borrowing costs is equally unlikely. Borrowing costs are being shaped by the global crisis, and market players have viewed the budget as “unimplementable”. They are also equally (or more) concerned with the prospects (or lack thereof) for economic growth and resolving underpinning structural constraints.
For all these reasons, in the midst of potentially the country’s largest economic contraction ever, and against the stated position of the IMF, making debt the overriding concern of the budget is counterproductive.
This leaves two last lines of defence for the Treasury view; that given corruption and inefficiency, the state is unable to spend effectively, and that even if everything argued here is true, there is, in fact, no money available anyway.
In the Treasury’s favour, state capacity is something that analysts such as myself, who see an important role for a developmental state, must more deeply incorporate into our policy prescriptions. The abject failure of the state to effectively implement the Covid-19 rescue package is a salutary illustration.
However, this does not rescue the Treasury’s position. First, it doesn’t change the underlying statistical reality that the multiplier is in fact larger than one — even stolen money is partially spent in the local economy. Second, it doesn’t mean we need a smaller state with less money. It means, in the medium term, we have to invest in fixing the state, and in the short term, we need to supply economic support through channels that are simple and effective, for example, wage support via the SA Revenue Service.
That there is not endless money is true, but the Treasury does not currently face a borrowing constraint. In June, despite the credit ratings downgrade and global crisis, money returned to SA bond markets. And while they are high, interest costs are still below those of the late 1990s and early 2000s.
If the Treasury can demonstrate a sustainable path for borrowing now and reducing debt later, this can be sold. This plan is not the theme of this article but is the topic of current work.
We have to begin by appreciating that, given the evidence we have, the Treasury’s logic doesn’t pass muster. Insufficient rescue measures now and budget cuts in the near future will almost certainly cause a fall in GDP and tax revenue as well as a rise in debt levels, accompanied by the deficit and debt service costs.
Only if the Treasury — and its defenders — accept this, can we begin a sensible conversation. This must be premised on the need to rescue and stimulate the economy in the short term, requiring additional borrowing and spending, complemented by a 10-year growth-led plan to draw down the debt, primarily in the second five years.
Perhaps we won’t “find the money”, though there appears little evidence of that. But the point is that the Treasury has already admitted it isn’t looking very hard. And this is because it has wished away the tradeoffs involved, believing — and it is mere belief — that we can cut spending without tanking the economy.
• Dr Isaacs is the Co-Director of the Institute for Economic Justice and lecturer at the School of Economics and Finance, Wits University. He is a signatory to the submission by economists to parliament.
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