Dr Santosh Kumar Mohapatra
With shrinking revenue, the Union government has reprioritized its spending and taken a slew of new austerity measures to contain the fiscal deficit and overcome the mounting debt burden. The current fiscal, the government banned new public-funded schemes and freezed creation of new posts.
Various states including Odisha have also taken similar steps as the Centre had imposed limits on states’ borrowing capacity in contravention of the principles of cooperative federalism. While the Centre has allowed states to increase fiscal deficit from 3 percent to 5 per cent of the GSDP, fact is also that out of this 2 per cent, an additional borrowing space of 1.5 percent is conditional.
In reality, austerity measures will effect a contraction of the economy, while the Covid-linked lockdown scenario would require perusal of an expansionary policy through higher spending. Since private spending got subdued due to supply disruptions, restriction of people’s movement and business activities, an increase in government spending, more of job creation and new schemes are vital for a revival of the economy facing recessionary trends.
While the world has announced an $1100 billion package for revival, India has come up with around $226 billion, of which fiscal outgo is around $27 billion. Monetary measures like liquidity infusion and lower interest rates are aimed at addressing supply-side problems or supply disruption. But problems are from the demand side, especially a compression of demand. Supply disruption can be eased only when people move around freely.
The present situation is demanding more of expenditure, as opposed to austerity, and has linkages with the concept of the “paradox of thrift” popularised by John Maynard Keynes. The theory has it that if households decide to save more and consume less during a slowdown or recession, then the resulting reduction in aggregate demand will aggravate the economic decline.
In the present Covid-induced recession, people are forced to save more due to uncertainty about the future and the ban on free movement, economic activities and business transaction. As a result, aggregate demand has come down, leading to a further decline in growth. As such, the correct policy response is to increase government spending, and not resort to austerity measures.
No investment will come and no industry will function if there is no demand for products. Hence, spending is vital. Each spending, whether public or private, creates job opportunities. While public expenditure leads to equitable growth, private sector expenditure is inequitable in nature. The government must spend money or have it spent in large quantities to create the demand needed to fuel economic growth.
Hence, steps like a ban on recruitment as also stalling new schemes will have potentially catastrophic consequences. Any spending cut or job squeeze would hurt the economy, hinder recovery, undermine long-term growth, and increase inequality and discrimination.
A major question is whether the implementation of immediate fiscal austerity during a fragile economic recovery is justified and whether it will help in deficit reduction. According to Paul Krugman, Nobel Prize-winning economist and columnist, cutting spending in a depressed economy is a bad idea.
Past experience shows that austerity measures in times of demand compression or recession have backfired or boomeranged. Amid the 2007-08 financial crisis in the US that later spread to Europe, the principle of austerity as a cure was adopted by central banks and encouraged by economists. They believed that a tough fiscal policy was the only treatment for excessive debt and any easing would spell disaster. As countries started to act this way, many realised that such policies were self-defeating and counterproductive. Economies already hurt by the crisis were condemned to perpetual stagnation and shoulder even larger debt burdens. The IMF report reveals that the belt-tightening by the European governments has had a negative effect on the economies of these countries and unemployment scenario became more acute.
An examination of how states fared during and after the economic downturn a decade ago hints that states which preserved or expanded their public sector workforce weathered the recession better and came out with fewer job losses, fewer private sector job cuts, and saw lesser growth in unemployment and faster job growth during the recovery.
It is argued that a country wading in a sea of debt needs to tighten its expenditures. Although the austerity strategy can lead to deficit reduction and prevent insolvency in the case of an indebted individual, this may not necessarily be the outcome in the case of national indebtedness. The problem is accentuated when austerity measures are replicated by other countries or by various states.
It is argued by fiscal hawks that an increase of expenditure without generating commensurate revenues will led to a rise in fiscal deficit; and that large fiscal deficits will cause high interest rates, larger government debts, and inflation. Even if the deficit doesn’t spark high interest rates and inflation, they erode business confidence.
There are also those who argue that deficit should be contained as it hurts the welfare of future generations through a rise in debt. A nation that is heavily indebted needs to implement more borrowings to pay back its lenders. But the problem is not a rising debt. Problem is that beneficiaries of debt-driven growth are not the masses but rich and corporate honchos. This needs to be reversed first.
In general, drastic cuts in government spending increase unemployment and may drag the economy down to a degree that the government’s tax revenues fall. The GDP also declines and as a result fiscal deficit and borrowing as percentage of GDP also rise. This outcome defeats the intention of lowering government debt. It would be equally bad for the government, as a shrinking economy also means shrinking tax receipts.
If the government is reluctant to borrow from market beyond a certain limit, it should resort to monetization of spending through monetization of some parts its deficit or through resort to spread of helicopter money. Central government should provide adequate funds to state governments so that they need not have to cut any spending and schemes, and can sustain jobs and growth momentum.
Does austerity at this point make any sense? This may well be the issue of the moment, but right now a resort to austerity would be a huge mistake. There is need for developing a workable recovery programme. Otherwise, the ‘Great Shutdown’ could take the nation, and the world, to another Great Depression, with enduring low growth and high rates of unemployment. A depressed economy would be a disastrous proposition.
The writer is an Odisha-based columnist and economist.