Correct to redirect spending to boost domestic output
The IMF warns that governments should avoid running high budget deficits for long periods. High deficits require increased borrowings to fund them, so debt rises rapidly each year. Interest on these borrowings increases, reducing government spending on other priorities such as education.
National budgets should also accommodate fiscal “space”. In good times governments should reduce deficits to create future capacity for expansionary policy when a weakened economy requires it. Such an occasion is when an economic downturn is caused by weakening domestic spending. This reduces companies’ profits and the taxes paid on profits. Rising unemployment squeezes personal tax contributions, while reduced household spending hurts VAT collection. This fall in tax revenue makes it difficult for the government to fund its spending obligations.
In such circumstances it is unwise to cut government spending in line with lower taxes, as this would exacerbate the slowdown in economic activity. If the slowdown is especially severe, governments may even increase spending to boost economic activity, widening the deficit further. But it is important that they increase spending only on temporary or one-off activities such as infrastructure or public works. Otherwise, the government will find itself forever locked into higher spending.
When the economy recovers and taxes start to rise, prudent governments avoid increasing spending. Instead, the deficit must be managed down, creating “fiscal space” for future spending increases when the economy requires it.
In looking for ways to boost SA out of its prolonged economic weakness, it is tempting to argue the government should allow the deficit to rise. However, it has chosen the path of fiscal prudence by raising personal taxes, taxes on petrol and VAT.
This is because SA’s budget deficit is already worryingly high and has been for a decade. The government after 2008 did not create the space that future expansionary fiscal policy would require. Its borrowing rose even more, eventually resulting in a creditworthiness downgrade to junk.
Increasing the deficit would be self-defeating. It would prompt a selloff of government bonds and drive up the interest the government must pay on its debt. The result would be less state spending on essentials.
Given the very high deficits since 2008, it is not at all clear that SA’s continued economic weakness is actually caused by inadequate domestic spending. Since 2009, government spending has overrun tax revenue by a cumulative R1.3trillion. SA’s current account deficits with the rest of the world mean that domestic spending consistently exceeds domestic production. SA’s problem is one of inadequate supply. Higher spending now may therefore result in increased imports and an even higher current account deficit.
It is entirely appropriate that the stimulus focuses on redirecting existing spending to boost domestic production. Some commentators are sceptical that the envisaged refocusing of R50bn of spending and the proposed infrastructure fund are adequate. Importantly, they are at least a recognition of the need to grow the economy by increasing output rather than increasing demand.
More is needed. The jobs summit and efforts to attract large amounts of foreign investment are part of a broader attempt to revive confidence. This is to spark increased private production and investment in new capacity by companies confident of growing local and international markets in the future.
Confidence is a delicate thing, much more easily broken than built. Recovery will be slow, but no swifter shortcuts are available to SA.
● Keeton is with the economics department at Rhodes University.