< http://www.hinduonnet.com/fline > THE ECONOMY
A case for more public expenditure The management of the economy is seriously flawed: on what the government should, and should not, do in the prevailing situation. PRABHAT PATNAIK THE Bharatiya Janata Party-led Union government's management of the economy gets curiouser and curiouser with every passing day. Here are two examples, one relating to the exchange rate and the other to the fiscal deficit. On January 30, the rupee closed at its lowest ever level against the U.S. dollar, Rs.48.54. Indeed, during the day it had tumbled even lower, to Rs.48.60, but recovered slightly to close at Rs.48.54, which represented a 0.25 per cent drop on a single day. This drop came at a time when India's foreign exchange reserves were growing rapidly and had crossed $49 billion. With burgeoning capital inflows the pressure on the rupee should have been upwards rather than downwards; why, then, should the rupee have tumbled so sharply on a single day? The tumble, it transpires, was an engineered one. It is the nationalised banks, led by State Bank of India, which, under the government's direction, initiated the dollar buying spree, and later, when the rupee fell to Rs.48.60, arrested its fall through heavy dollar selling. The government apparently wanted to bring down the exchange rate to "maintain export competitiveness". But was there any reason to believe that India's "export competitiveness", such as it was, was actually declining? According to the Directorate General of Commercial Intelligence and Statistics, India's trade deficit during April-December 2001 (the latest period for which data are available) was lower at $5,790.30 million compared to $5,876.89 million for the comparable period of 2000. No doubt the country's exports during these nine months increased only marginally in dollar terms, by 0.64 per cent; but imports grew by an even lower rate of 0.3 percentage points. There had been no pressure therefore of a deterioration of net trade performance. And as regards the meagreness of the increase in exports, an important cause no doubt lay in the generally recessionary conditions prevailing in the capitalist world economy; no inference could be drawn from it about a decline in "export competitiveness". Nor could it be claimed that the real exchange rate had increased of late, so that a depreciation of the currency was required to rectify the situation. During the April-December, period when exports in dollar terms increased by 0.68 per cent, the increase in rupee terms was 5.05 per cent, which means that the rupee had already depreciated against the dollar by nearly 4.5 per cent. Between January 5, 2001 and January 5, 2002, however, the rise in the wholesale price index was only 2 per cent, which means that, far from appreciating, India's real exchange rate had depreciated by more than 3 per cent over the April-December period (even if we assume that the rest of the world had zero inflation over this period). The government's deliberate depreciation of the nominal exchange rate therefore cannot be defended on the grounds that it was compensating for the difference between the rates of inflation between India and the rest of the world. Any such difference, if it exists at all, had been more than compensated for already by December-end. OF COURSE it may be argued that India's export performance has generally been so lacklustre that any boost given to it, by whatever means, is always justifiable. But this is a wrong argument. Indeed, any policy that goes about depreciating the currency whenever there is dissatisfaction over export growth is a dangerous one for a number of reasons. First, even if it gives the country's exports an edge over its rivals' exports, this is but a temporary phenomenon, until they retaliate by depreciating their currencies. At that point, not only will India lose the edge, but its foreign exchange earnings, as well as its rivals', are lower than they had been to start with (since the demand for India's exports and its rivals', taken together, is price inelastic, especially in the recessionary conditions that prevail in the world economy). In other words, the attempt of any one country to steal a march over its rivals in this manner invites retaliation and succeeds only in making everyone worse off when the dust has settled. Secondly, such depreciation, by raising the price of imports succeeds in imparting a cost-push inflationary thrust to the economy, whose victims inevitably would be the poor and working people. Thirdly, in a world where finance is highly mobile and pursues speculative gains, an engineered currency depreciation always runs the risk of getting out of hand, if it generates a speculative movement out of the currency. And fourthly, any exchange rate depreciation raises the local currency value of the external debt, and hence the real burden of it: the amount of local goods and services commanded by the external creditors increases, and hence the real cost of servicing the debt. An alternative argument may be advanced in defence of exchange rate depreciation, namely, that it is meant to boost not so much the exports as the domestic level of activity and income. Industry is in recession and needs a demand boost. A range of agricultural prices have crashed, bringing down the income of the peasantry. If a degree of protection is provided to agriculture and industry through exchange rate depreciation (which makes imports costlier and exports cheaper), then domestic incomes would rise; any such primary increase would stimulate demand further and bring about further increases in income through successive rounds of the "multiplier" effect. An additional argument may be thrown in here: if the exchange rate depreciation does lead to higher inflation, then, with the nominal interest rate given, the real interest rate would fall; and this would stimulate private investment which has been sluggish of late. This argument too is completely untenable. Let us take the second part of the argument first. The inflation directly engendered by an exchange rate depreciation is through an import-cost-push, which reduces the share of wages by transferring purchasing power from the hands of the working masses to the hands of foreigners. If the foreigners do not use the extra command over domestic goods thus made available to them immediately (as is normally the case), then, since the demand from the working masses goes down because of inflation, there is a net reduction of demand. In short, a currency depreciation-engendered inflation has a primary recessionary impact on the economy. And in the face of such shrinking demand, private investment can hardly be expected to increase, no matter how low the real rate of interest. The idea of stimulating the economy through such inflation therefore lacks any basis. LET us now take the second part of the argument. After all, even if not through the inflation route, exchange rate depreciation should generally have an expansionary effect on the economy. Why, then, should one complain about what the government is doing? The complaint is because any expansionary effect that a depreciation can have is achieved much better through other means. Exchange rate depreciation improves the level of activity primarily by increasing real net exports. But while doing so, it has all the four adverse consequences mentioned above. A far better way, however, of achieving an increase in the very same entity, namely real net exports, is by curtailing imports through higher tariffs (even if direct import controls are eschewed). Exchange rate depreciation raises import costs across the board, while higher tariffs can be imposed selectively. As a result, they need not have a cost-push effect, and hence need not hurt the poor and working population. Since they leave the exchange rate unchanged, there need be no fear of panic capital flight by speculators. Likewise there is no question of any increase in the real debt burden. And since they are selective, and would generally be imposed on imports from countries for whom India constitutes a minuscule market anyway, they are much less likely to ruffle feathers and invite retaliation. In short, none of the four dangers mentioned above as being associated with depreciation, attaches to higher tariffs, which nonetheless can be designed to have the same expansionary effect on the level of activity. What is more, nobody in the world can possibly complain about India imposing higher tariffs, since in the case of a whole range of goods the actual tariffs are below the tariff bindings which are legitimately allowed under the World Trade Organisation (WTO) regime. This is especially true of a number of agricultural commodities, in whose case the sufferings of the peasant producers are thus immediately attributable to the voluntarily imposed low tariffs. But if the government's tariff policy was incomprehensible to start with, its persistence with gratuitously low tariffs and its preference for an exchange rate depreciation over tariff increases defies reason. Increasing real net exports, moreover, is only one way of increasing demand in the economy. A far more certain and effective way is through an increase in government expenditure. Since the economy is saddled with massive surplus foodgrain stocks as well as unutilised industrial capacity, especially in capital goods production, an increase in public expenditure that creates demand for these goods, even if financed by a fiscal deficit, would be far preferable to letting the demand constraint persist. What is more, since much of these unutilised stocks or capacity is within the public sector itself, a fiscal deficit-financed government expenditure programme that creates demand for these goods would have absolutely none of the adverse effects usually associated with a deficit, since it would not even increase the net indebtedness of the government as a whole. SEVERAL such proposals have in fact been put forward. One is for a Rs.75,000-crore increase in public investment in infrastructure over a five-year period, financed by borrowings from the banking system. This would overcome recession, remove infrastructure bottlenecks, and use up the surplus liquidity currently lying idle with the banking system. Another fairly obvious one is for a massive employment generation programme, financed by a fiscal deficit which would put purchasing power in the hands of the rural poor. Since much of the money spent on such a programme would flow back to the Food Corporation of India through the purchase of foodgrains by the beneficiaries, or to other public sector companies which would directly or indirectly provide the material inputs needed for the programme, the net indebtedness of the government taken as a whole would increase by a very little extent despite the increase in the fiscal deficit. (And even if there is some increase, that should not be a matter of concern, since it would have contributed to an increase in employment and incomes.) Such an employment generation programme, in other words, would kill several birds with one stone: it would alleviate poverty and malnutrition; it would get rid of foodgrain stocks whose persistence currently threatens the very continuation of procurement operations that are so vital a source of support for the peasantry; and if properly conceived, it would generate rural infrastructure and contribute to an increase in agricultural growth and an improvement in the quality of life. And it would do all this without any adverse effects on the economy. We could in short get a bonanza for nothing. But the government has steadfastly refused to undertake any such ambitious programme of public expenditure. (The Prime Minister's announcement of an employment generation programme in his Indepen-dence Day speech, even if fully implemented, would use up no more than five million tonnes out of the current surplus stocks of about 45 million tonnes.) On the contrary, it has repeated the well-worn cliches, propagated by the Bretton Woods institutions, about the need to curb the fiscal deficit, which effectively mean a curtailment in public expenditure. (The latest visitor from there, Anne Krueger, currently the First Deputy Managing Director of the International Monetary Fund, trotted out exactly the same cliches in a speech in New Delhi on December 20.) Paradoxically, however, despite the government's obsession with restraining the fiscal deficit, it has shot up dramatically in recent months. The overall fiscal deficit during the first nine months of the current year has been Rs.89,014 crores, which is 76.5 per cent of the annual target; by contrast, the fiscal deficit during April-December 2000 was only 58.1 per cent of the target. The deficit in November 2001 alone was Rs.15,000 crores and in December Rs. 10,000 crores. The reasons for the burgeoning deficit are: first, disappointing tax revenue collections (only 52.1 per cent of the annual target had been collected in the first nine months), and, secondly, a sharp increase in non-Plan expenditure. While non-Plan expenditure increased by Rs.21,579 crores in November, the increase in plan expenditure was only Rs.6,629 crores; the corresponding figures for December are Rs.23,573 crores and Rs.9,537 crores. The increase in non-Plan expenditure must be attributable, to a significant extent, to the steep rise in defence expenditure on account, inter alia, of the mobilisation of troops on the border. What is striking, however, is the fact that the government which had been so chary of enlarging the fiscal deficit to finance development expenditure, has not hesitated to do so to finance defence expenditure. To be sure, defending the country has a priority. But is alleviating poverty a non-priority area for the government? What is even worse than the government's reluctance to enlarge expenditure on employment generation and infrastructure is that now, in the name of curbing the fiscal deficit, this expenditure is going to be curtailed further! In other words, while the fiscal deficit may turn out to be higher than the target for the year as a whole, this increase would have been on account of items of defence and other non-Plan expenditure rather than welfare-augmenting ones. And what is more, since the impact of the former kind of expenditure on domestic demand generation is likely to be much less than that of the latter, and perhaps rather limited anyway (owing to the fact that defence expenditure tends to be more import-intensive), the domestic demand recession, which could have been overcome through an increase in expenditure of the latter kind, is likely to continue despite the rise in fiscal deficit. Assessing the necessity of the level of defence expenditure that is being undertaken is not this writer's concern here. But the point is that a fiscal deficit is better used to finance development expenditure, where the commodities whose increased demand it gives rise to are actually or potentially readily available. On the other hand, more import-intensive expenditure items such as defence-related ones are better financed through the taxation of the rich, since that releases foreign exchange. The government's policy, however, has been the very opposite: not to use a fiscal deficit for development expenditure but to do so for defence expenditure. To eschew using the fiscal means to enlarge demand but to try doing so through an exchange rate depreciation; to be concerned with the deficit when it comes to employment generation or public investment (where in fact it is harmless) but to use it to enlarge non-Plan expenditure such as that on defence (where it may not be harmless); to use an exchange rate depreciation where higher tariffs would serve the purpose better and can be legitimately used even within the WTO framework: all these show the government's economic policy in a very poor light. The impression is that of a government floundering about without any coherence of understanding or clarity of purpose. Marxism sees economic policies as being dictated largely by class interests. That no doubt is so. But within the broad parameters defined by class interests, a surprisingly large proportion of these policies appears to flow, as the current Indian experience testifies, from the sheer mindlessness of the policy-makers, their utter theoretical confusion and consequent floundering about. Prabhat Patnaik is Professor of Economics, Jawaharlal Nehru University, New Delhi.
