The reader will agree that loss cannot be the path to profit except in special circumstances. Companies, for example, come out with introductory offers and sell their goods at a loss for a short time in order to capture the market. They soon increase the price and try to make profits. This applies to government as well. Fiscal deficit can be beneficial only for a short time. Governments across the world would have printed money to success if that were possible in the long run.
The most notable example of successful use of fiscal deficit is of America in the 1930s. The economy was booming till 1929. Then the share markets collapsed suddenly and the economy entered into a recession. Mainstream thinking at that time was that governments should follow the policy of balanced budget. They should make only so much expenditure that is backed by income. Recession led to reduction of revenues of the government and was thus followed by reduced expenditures. The economy was caught in a cycle of recession, lower government expenditures and yet deeper recession. At this time famous British economist John Maynard Keynes wrote a letter to the US President that he should increase expenditures by printing money. Keynes said that the public had developed a fear complex and had clammed up like a tortoise. People were not willing to spend their incomes. This mentality had led to deepening of the recession just as a healthy man may take to bed if he is told that he has paralysis. The US Government must print money and increase expenditures and invest in making of highways etc. This will generate demand for steel, cement and labour, generate incomes in the hands of people and break the mentality of fear.
The President accepted the advice of Keynes, increased expenditures and the recession was broken by the end of the thirties. At this same time the Second World War had started. Huge demand for military equipment was generated from European countries. The atom bomb was invented during the war and was followed by the development of nuclear energy. Oil deposits of West Asia also came to be known. Availability of oil at a low price led to the automobile culture. Thus America came back to the growth path, courtesy fiscal deficit.
Two conditions for success of fiscal deficit can be noticed from above narrative. One, that there exists a short term problem like the fear complex among the American people. Then fiscal deficit works like a tonic. Second condition is that a new source of demand, like military equipment for the War should be visible on the horizon. Fiscal deficit can be resorted to bridge the time till the demand fructifies just as a sinking man is thrown a rope.
The first condition is clearly not fulfilled in our present situation. There are no indications of a fear complex among Indian consumers. Indian economy is growing at a respectable level of six-seven per cent. The lack of demand is mainly from exports. Trying to increase domestic demand to make up this loss is like making the runner run faster by giving him steroids. This cannot go on for a long time. The side effects of steroids have but to appear soon.
The second condition of successful use of fiscal deficit is that a new source of demand should be visible on the horizon. In my reckoning this was the main factor that led to end of the recession in the United States. It would be okay for India to use fiscal deficit to bridge the time till the export demand is revived. I have doubts about this happening, however.
My assessment is that the global recession will be long and deep. Main reason of the recession is that developed countries are unable to invent new products that they may be able to sell to the developing countries at a high price. A news report tell us, for example, that the Office division of Microsoft made a profit of $9.3 billion on sales of $14.3 billion-a profit of neat 65 per cent. Developed countries were able to pay huge salaries to their workers on the back of such monopoly profits. Their workers, in turn, were willing to consume basmati rice and garments produced in India with these incomes. This situation appears to have come to an end perhaps permanently. We have not seen any great invention since the internet in the nineties. American companies will not be able to pay high wages in absence of such inventions and the people, in turn, will not be able to buy Basmati rice. Thus our exports are likely to face continued pressure. This will turn the fiscal deficit into a problem. Prices will increase due to the deficit but growth will remain flat because new source of demand is not seen on the horizon. We are likely to be caught in twofold problems of inflation and stagnation.
There is yet another reason for the fiscal deficit becoming troublesome. The purpose of fiscal deficit is to generate short term demand to tide over a small period till new true demand is created. It follows that expenditures should be such that it can be turned off when required. The expenditures should be like a tonic rather than bread. For example, US President George Bush made a one-time refund of income taxes to encourage Americans to spend more. Or the Indian Government had made a Voluntary Disclosure Scheme to bring out black money. Or expenditures can be increased for making highways. They will automatically reduce once the highway is built. The expenditures made by the Government do not appear to be of such type. Former Economic Advisor Shankar Acharya writes: “The bulk of the massive expenditure increase is due to interest payments, defense, subsidies, salaries and pensions, and major social programmes such as NREGA and Bharat Nirman. The notion of a temporary fiscal stimulus assumes that it can be readily reversed when the need for the stimulus goes. None of the expenditure categories mentioned above looks very reversible to me.” It follows that even if the policy of fiscal deficit was justified, the expenditures increased by the Government are not of the right type. The Government has made long term increase in expenditures behind the smokescreen of temporary stimulus to break recession.
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