The notion of fiscal discipline in this conventional sense is based on a flawed theory, i.e. neo-liberal economic theory that we teach in our universities. One of the arguments is an increased budget deficit forces the government to compete for funds in the capital markets and as a consequence, the rate of interest will shot up in the market thus ‘crowding out’ private investments.
by Sumanasiri Liyanage
(November 15, Kandy, Sri Lanka Guardian) Even before the Appropriation Bill for 2011 was presented to Parliament, Sri Lankan economists began to talk about the importance of fiscal discipline as a necessary condition for Sri Lanka, for that matter for any developing country, to place the country in the right path of development. Business women and men also opt for fiscal discipline but without an increase in corporate tax and reduction in subsidies to the business sector. Economists who are quite vocal about fiscal discipline appear to be in agreement with the business sector. Fiscal discipline is invariably a main item in WB-IMF conditionality. It is ironic that only uneducated and ignorant poor need a bigger government that violates the norms of fiscal discipline. I tend to think that I also share the position of the latter category for multiple reasons.
Let us first see what is really meant by fiscal discipline. It is customary to define fiscal discipline as maintaining lower fiscal deficit when measured as a percentage of the gross domestic product. There are two parts in budget deficit. The difference between government revenue and expenditure form the first part, while loan disbursement represents the financial deficit. The magic figure for overall business is something like 5 per cent of the GDP. One may question how this magical figure valid for all developing countries is determined. Shouldn’t we take country specificity into consideration when this proportion is established? If we re-read budget speeches in the past two decades or so, almost every finance minister reiterated that his government’s medium-term projection was to reduce the budget deficit to this magical figure. Economists sticking to their disciplinary rules lament as the ministers and their respective governments have failed to achieve this target. I confess I have no tears to be shed and in many instances I am even happy that they failed.
The lower deficit is only one component of the definition, the explicit one. There are many implicit elements in the definition. If we take the history of Sri Lankan budget-making, the late Dr. N M Perera was the Finance Minister who was very much concerned about reducing the budget deficit and government borrowing. As Dr. Jayawickrama of the University of Peradeniya has pointed out, there was a considerable fall in the budget deficit after 1971 and as a result total government borrowing as a percentage of GDP declined (in Dayarathna Banda et al, Sri Lanka Arthikaya (in Sinhala) p. 12). Do economists portray Dr. Perera as a Finance Minister who was committed to fiscal discipline? The implicit meaning of fiscal discipline includes reduction of corporate tax and government expenditure on public entitlement such as health, education and social services. In other words, fiscal discipline implies shrinking government sector in the interests of the market forces and the private corporate sector. Hence, the insistence on fiscal discipline relegates social concerns to the level of by-products of policymaking. Specifically, in pursuit of fiscal prudence, governments in many developing countries place less emphasis on social protection and human security.
The notion of fiscal discipline in this conventional sense is based on a flawed theory, i.e. neo-liberal economic theory that we teach in our universities. One of the arguments is an increased budget deficit forces the government to compete for funds in the capital markets and as a consequence, the rate of interest will shot up in the market thus ‘crowding out’ private investments. Hence, expansionary effect of government spending will be offset by decreasing private investment. About a week ago, an interesting paper on the basis of on-going research was presented at Peradeniya University research session. Authors, Dr. O. G. Dayarathna Banda and A. A. S. Priyadarshinee, have shown that in Sri Lanka, the increased public investment has in fact not led to the reduction of private investment. Studies in relation to Latin American countries have shown similar results. This is the argument advanced by Keynes about 75 years ago. If a country has unutilized resources in various forms, pump priming would contribute in many ways to increasing national product. It may even result in what is called ‘crowding in’. Sometime back, Prof. Budhadasa Hewavitharana stressed the importance of non-monetized capital formation. Public spending and public provision of entitlement can be easily linked with non-monetized capital formation, especially in areas where market is not fully developed. In a recent World Bank publication, (The Day After Tomorrow edited by Octaviano Canuto and Marcelo Giugle, Washington DC, 2010) the WB economists have reluctantly agreed on the ineffectiveness of anti-inflation policies and floating exchange rate regime.
Does the above argument make us believe that fiscal discipline is a useless and ineffective idea? As it has been presented by neo-liberal economists, it is a useless and harmful idea to be avoided in budget-making, unless it is used for a limited purpose of deceiving and/or misleading the visiting experts of the IMF-WB. However, we have to develop our own definition of fiscal discipline. I will focus only on two aspects. First, it is imperative to revisit all items of government expenditure with regard to the needs of post-war situation. In the past, as well in the present, the government has engaged in some totally unproductive and unjustifiable expenditure. The best example for this in recent years was money allocated in the government budget for Mihin Lanka. Three main criteria, in my view, that have to be taken into consideration when government decides to spend money are law and order, development and justice, of course not in the order of priority. First, to what extent, that expenditure can be justified from the perspective of government’s main functions such as maintaining law and order, defence. Secondly, how and to what extent government expenditure is needed for the development of the country i.e. the provision of infrastructure and investment in necessary sectors where private investors are reluctant to invest. This latter category may include heavy investments in important and critical industries. Thirdly, justification should come from its contribution to the provision of public entitlement. The post-war situation has changed the order of priority between these three criteria. Hence, a large amount of money allocated to the Ministry of Defence in 2011 Appropriation Bill cannot be justified. Defence Ministry allocation for the year 2011 is more than double the amount of money allocated for the Ministry of Development. Money allocated for education and higher education, science and technology, power and energy are totally inadequate. These are the areas that the government should focus on in the post-war situation. It is clear that the government’s development effort operates in an ad hoc manner not following a clear and well-structured economic plan. The 2011 budget would have been linked with a six-year development plan. On the revenue side, the dependence on indirect taxes should be reduced and all income should be made taxable. Hence, complete overhaul of tax system is necessary and tax base has to be widened including the government servants, farmers and other income earners.
The second issue of fiscal discipline includes Parliamentary control of government finances. The normal procedure is that all government revenue should go to the Consolidated Fund unless special funds are set up by Parliament. The Constitution has laid down these rules in order to develop and maintain a disciplined financial system. However, statements by two ministers pose some questions. Answering a question by a journalist, Minister Rambukwella said that defence expenditure exceeding 200 billion rupees included loan repayment. Is it true? Can the loan payment be included in specific ministry allocation? Minister S. B. Disanayake in a TV interview referring to low budgetary allocation for the Ministry for the Higher Education claimed that there were more funds for higher education in addition to the budgetary allocations. If this is true, then the question is whether funds come from special accounts. How can such expenditure be made accountable to Parliament? If all other ministries have such special funds that do not come under financial rules and regulations laid down by the Constitution, there is a very serious flaw in the financial and fiscal discipline in the country.
(The writer teaches political economy at the University of Peradeniya,Kandy. he can be reached at sumane_l@yahoo. )
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