Mar 14 - 20, 20

Government overspending, besides creating other economic and social problems, inevitably results in fiscal deficits which in turn have to be financed through public debt. One may come across divergent economic opinions on deficit financing, ranging from totally dismissive to overly optimistic. Ron Paul says: 'Deficits mean future tax increases, pure and simple. Deficit spending should be viewed as a tax on future generations, and politicians who create deficits should be exposed as tax hikers. When a country embarks on deficit financing and inflationism, you wipe out the middle class as wealth is transferred from the middle class and the poor to the rich.'

Joseph Stiglitz speaks from the opposite side of the aisle: 'Financial-sector deficit hawks said that governments should focus on eliminating deficits, preferably by cutting back on expenditures. The reduced deficits would restore confidence, which would restore investment and thus growth. But, as plausible as this line of reasoning may sound, the historical evidence repeatedly refutes it. When US President Herbert Hoover tried that recipe, it helped transform the 1929 stock market crash into the Great Depression. When the International Monetary Fund tried the same formula in East Asia in 1997, downturns became recessions, and recessions became depressions. The reasoning behind such episodes is based on a flawed analogy. A household that owes more money than it can easily repay needs to cut back on spending. But, when a government does that, outputs and incomes decline, unemployment increases, and the ability to repay may actually decrease. What is true for a family is not true for a country. More sophisticated advocates warn that government spending will drive up interest rates, thus "crowding out" private investment. When the economy is at full employment, this is a legitimate concern. But not now: given extraordinarily low long-term rates, no serious economist raises the 'crowding out" issue nowadays.'

A report puts forward the following argument: 'Deficits aren't always bad: excess government spending can help alleviate the pain of an economic downturn by encouraging business and curbing unemployment (this is the theory behind New Deal and Obama's stimulus package). But, that doesn't mean that deficits are good, either. The US covers the shortfall by issuing more government bonds, which can drive up interest rates and inflation.'

The said arguments, on the face of it, would appear to be relevant to the US economy and one may argue that what is good for the leading world economy, may not be good for a developing economy like Pakistan. But, the point made by Joseph Stiglitz that interest rate hike and private sector crowding out takes place when the economy is at full employment surely concerns us. Pakistan's economy is far from being at full employment. We have seen its potential during the period 2002-07 when it grew at an average annual rate of 6.75 per cent. The later years saw it going into recessionary mode in the wake of rising policy rate. Given the robustness of our economy, we should not call into question the mounting up of our public debt so long as the funds raised through debts are spent on genuine economic projects.

The idea of stimulus spending works in the following way: every new project (say project B) during its implementation phase puts new money into the economy through payments, for example, to the seller of project land, to the suppliers of local machinery, appliances and equipment, to the constructors, to the suppliers of vehicles and furniture and fixtures, to its employees and to the providers of allied services. This new money in the economy is utilized to buy the output of another project (say project A) which, after completing its implementation phase, has started commercial production. The money required to purchase the output of completed project B is supplied to the economy by yet another new project (say project C). This process continues as long as new money gets pouring in to the economy on a regular basis. This new money is provided in continuum by the new government debts raised to finance its fiscal deficits.

Fiscal deficits are normally financed through domestic debts in the absence of any external resources. A portion of fiscal deficit may be financed through printing of new currency which possibility is obviously subject to certain monetary policy restraints. Major portion of the deficit is financed through additional domestic debt raised through bank and non-bank borrowings. For bank borrowings, the government approaches the central bank which in turn sells its new commercial papers to the country's banks. These new commercial papers comprise the amount required by the government and the amount required to redeem any maturing past issues. Non-bank borrowings include money raised through direct sale to the public, business, and corporate bodies of government bonds and certificates under various national saving schemes. The money required to redeem these bonds and certificates is raised through fresh issues on a continual basis. One can imagine the external debt being reduced to zero at a certain point in time but the domestic debt is never fully paid off. Its size grows with the size of the economy. Increase in an economy's debt size is triggered by persisting fiscal deficits.

In the modern economics, controlled fiscal deficits are recipe for sustained economic growth. Whenever governments tried to balance their budgets through cut in government spending or by resorting to loans pay-off to reduce interest burden, the economies went into recession.

The rationale for increase in the size of public debt is embedded in the basic imperative of sustained economic growth. The economy gets a bad shock when the funds raised through public debt are utilized for unproductive purposes. This is what we have witnessed during the last three years rising fiscal deficit, mounting public debt and shrinking economic growth. Instead of worrying about the size of public debt, we should learn to monitor government spending, not by stifling them but by channelizing them to the most productive sectors of economy. Government spending should be used to create future assets and not liabilities. Investment in economic projects related to agriculture, energy and infrastructure and social sector projects namely education and public health can create future assets of great value. The return from these assets could be more than sufficient to take care of our public debt.