How to reduce budget deficit?
THE salaries of government employees should be decreased, the number of government de partments should be reduced, the government should cut its expenditures; these are some of the proposals you will often hear from ordinary people. In the past few days, the same kind of advice was forwarded by some of the experts including Dr Kaisar Bengali, one of the most famous economists of Pakistan. Let me briefly discuss what happens when a government reduces its expenditures. Suppose the government reduces expenditures by cutting the salaries of employees by 50%. We know that the proportion of savings in incomes of people in Pakistan is very low, this means the reduction in the salaries will reduce the consumption. People will purchase less from the retailers and the retailers will purchase less from the wholesaler, the wholesaler will reduce his purchasing from the producer and the producer will find less orders for the goods he is producing. If the producer is finding a small number of orders, he will fire some of the employees to have a balance between his revenue and expenses. These jobless employees will not find enough money to consume and they will start purchasing less, which will again affect the shopkeepers.
In this way a negative spiral effect will start, having multiple levels of reduced consumption. In its first spiral, government consumption gave loss to government employees, to retailers, to wholesalers, to producers and then to his employees, but the story didn’t end here. Reduced incomes of employees of the producers will initiate a second spiral and the process will go on. Reducing the government expenditures just by one billion, the overall reduction in the economy will be several billions. This multiplier effect will be larger for the countries where the ratio of savings to income is very small and Pakistan falls in the same category. On contrary if the government increases its expenditure by one billion, it will boost the economy by many billions through a similar upward spiral. If the economy is already in recession, the reduced government consumption will add to recession, which will in turn reduce the government revenue as well.
John Maynard Keynes, the father of macroeconomics was one of the most influential economists of 20th century. When he was being asked to propose a solution for economy in crisis, he replied, ‘pay the people to dig holes in ground and then pay to fill them up’. The proposal seems stupid; when the economy is in crisis, from where the government will find and resources to spend extra money on digging holes and then filling them up? And secondly, what is the advantage of having no economic feasibility? Third, what will be the advantage to economy when a project is closed without getting anything out of it?
But in fact, the advice of Keynes is filled with very philosophical solution for the trembling economy. When government spends money on such a project, money will go into the pockets of labourers, the labourers will consume the same money and a spiral effect like one discussed above will start. If the government is consuming one billion on salaries of employees or on a development projects, it will actually boost the economy by many billions. And on the other hands if the government is reducing expenditure by one billion, it will actually reduce the size of economy by many billions.
Therefore, in case of economic recession when the economic activities are falling leading to reduced government revenue, the governments don’t reduce their expenditure. The recession is remedied by increasing government expenditure instead of reducing them and it is practiced throughout the world. If government opts to reduce its expenditures, it will reduce the size of economy and everybody in the economy will suffer.
Apart from this philosophy, it is also true that it is not possible to have a significant cut in government expenditure by the austerity measures. In the Federal Budget 2022-23, the total allocation for expenditure of civil government is just 553 billion out of which half of the expenditures are related to salaries and allowances. About 60% of the government employees have very small salaries and hardly meet their daily expenditures. Reducing their salaries will make them more vulnerable. If we impose a cut of 30% on the salaries of remaining employees who are serving in grade 17 and above, a cut of 10% will not be able to make a 15 billion. However, the cut makes a perfect sense on the imported goods. The current economic crisis is driven imports which are currently more than double of our exports. A heavy cut is needed on the imported cars and luxuries and on the petrol consumption by government employees.
Therefore, it is never advisable to cut the salaries and other government expenditures for reducing the budget deficit. Instead of imposing cut on salaries, the cut should be imposed on largest head of expenditure in the budget that is the markup payments. The markup payments are really huge in size and much more than any other budgetary allocation. When the budget for current fiscal year was prepared, Rs 3439 billion were allocated for the markup payments on domestic debt.
In the later months, the policy rate was increased further from 13.25% to 17%, increasing the market payments further high by several hundred billion and it should be about Rs. 4,000 billion only for the markup on domestic that which makes about 44% of the total budget. This allocation is roughly three multiples of the defense expenditures, the second largest head of expenditures in the federal budget. Therefore, in order to reduce the budget deficit what needs to be done is to reduce the market payments which are associated with the policy rate. We need to reduce the policy rate to the level that exists in India, Bangladesh and other peer economies. The austerity in government expenditures will only kill the economy.
—The writer is Director, Kashmir Institute of Economics, Azad Jammu and Kashmir University.