Budget Deficit And GDP Growth

On the eve of the Sinhala and Tamil New Year the Central Bank (CB) ceremonially presented its Annual Report of 2010 to the President. At this occasion the President used some statistics in the report and said that Sri Lanka achieved 8% of GDP growth in 2010. Further it was said that per capita income rose to USD 2400 in 2010 from $2053 in the previous year; unemployment decreased to 4.8 from 5.9%. He assured that this decade will be a decade of economic prosperity and will double per capita income by 2016.
Only a die-hard opposition member might grudge the optimism expressed by the President. The overwhelming majority of Sri Lankans from all ethnicities must be happy if Sri Lanka could win in the game of economic development or at least become a kind of runner up as our cricketers did in their game recently.
Yet, being a honest researcher, I want to send a message of caution to the President and the administration in general. The parameters cited above by the President has nothing to do in assuring continuing economic progress.
Let us take an example to explain my point. GDP or Gross Domestic Product is a measure of the goods and services produced in the country; in fact it is a relatively good measure of economic output. GDP is calculated in adding up four quantities namely C+I+G+(NE). Here, C=private consumption, I= investment by industry excluding investments in stocks and bonds, G= government expenditure again excluding interest and capital paid on loans and NE= net exports (exports – imports).
So, the  government expenditure is represented in GDP. If the government spends Rs. 100 the GDP should increase by Rs. 100, if the government did not pay any interest and capital. Similarly if the government increased its expenditure by 8% over the budget which is known as deficit spending, then the GDP should be increased by 8%. According to the statistics deficit spending of 2010 was 8% of GDP (or to be exact it was 7.9%).
We all know that budget deficit (or deficit spending) is bridged with borrowing. Does this mean that the total GDP growth we achieved in 2010 was from borrowing from the government? No, the case is not that simple but we can understand it.
CB reported that some sectors in real economy like agriculture, tourism and exports posted a growth in 2010. Should these figures contribute to increase GDP? Yes, they should. That means even though the deficit spending has come to 8% of GDP the effective contribution to GDP from government expenditure should be less. How has this become less than the nominal value? If a good part of government expenditure goes for the payment of interest and capital, that expenditure of the government does not contribute to GDP. What does this mean?
In answering the above question let me generalise it since I do not know of any plans of the government economic planners and the IMF. If deficit spending is ‘ x%’ and the increase of GDP is less than ‘x’ then the country is heading towards a national debt crisis or unwanted inflationary situation. If deficit spending is ‘ x%’ and the GDP increase is greater than ‘x’ then the country is far from having a debt crisis. I would suggest the President to keep an eye on this matter before it is too late.
Let me bring up another matter here. According to the Central Bank the rate of unemployment has decreased to 4.8%. It is expected to reduce further if we sustain the same level of growth which is the expectation of the CB. If huge productivity improvement did not take place or retirement age is not increased we are heading to maturity of our economy before we double per capita income to USD 4000 in 2016.
When any economy reaches maturity it possesses certain characteristics which I summarise as follows.
At economic maturity “If the private consumers are not in significant debt then the government should. And if both the private consumer and the government are not in debt significantly then the system gap must be filled from the income derived from the stock market which means there should be a bubble in the stock market with heavy debt on holders/ or holding companies of stocks. If nothing of the above is happening then it must be an immature economy which is expanding by reinvesting the expanded capital and producer credit mostly producing goods and services of higher order goods.”
“In all former scenarios except the last scenario the economic system should crash due to heavy debt sooner than later if partial debt cancellation does not take place pro-actively to ensure the continuing filling of the system gap. In the later case the economy would fall into any one of the former scenarios as the economy grows.”
“The only other possibility that a producer country does not have a ‘debt’ crisis is when it continues to have an excessive (I mean excessive) trade surplus; but all countries in the world cannot record ‘trade surpluses.” (above quotes are from an essay written by the author of this article).
As we noticed above there is a certain underlying order in economic behaviour. The recent economic crashes that happened in the developed world, proved it. Japan had a good foreign reserve surplus but the economy crashed in 1990; the decade of 1990’s is now called by the Japanese as the lost decade.
The U.S. had a continuing trade deficit but had the lowest rate of unemployment (around 4%) and highest rate of home ownership, high productivity and a stable dollar before the economy crashed in late 2007 due to a debt crisis.
Is such a crisis possible before we hit per capita income of USD 4,000 in 2016? I would suggest the President to be mindful on this point again before it is too late. Because the restructuring of state enterprises, reducing budget deficit and cutting social welfare programmes etc. are simply no solution to prevent such crises happening.
Hema Senanayake