In defense of the Holy Fiscal Deficit: Accounting and economics
Part III: Fiscal discipline and responsibility or nation building?
By Jesus Felipe and Mariel Monica Sauler
(Last of three parts)
WE END with a plea to all the sectors that believe that fiscal deficits damage the economy. While this might be true in some special circumstances, these do not apply to our economy in general. Moreover, our monetary system and overall conditions are very different from those of the 1980s. Let’s abandon once-and-for-all the orthodoxy that has prevailed in the country for decades.
The business community should understand that a deficit increases the net worth of the private sector, as it receives more than it pays in taxes. Don’t shoot yourself in the foot. Also understand what terms such as “debt” and “interest payments” really mean for you when you purchase T-bills. The fiscal partner can be a great partner if you understand her.
Government officials should understand the economics behind the sectoral balances, gain a holistic view of what all relevant agencies and the Bangko Sentral ng Pilipinas (BSP) do, and understand that their job is not to match spending and taxes. Bond issuance is part of it. Bond dealers in the private sector will purchase the bonds that the Treasury offers them. As a consequence, lowering the fiscal deficit to 3% of GDP is not a meaningful target as it will reduce the nation’s policy space, as long as we run a current account deficit.
Finance professionals should go beyond the financial side of the economy (interest rates, exchange rates) and understand the role their sector plays when the Treasury and BSP auction T-bills, the reason why their institutions buy T-bills, and what these do on their balance sheet.
Economics journalists have a responsibility to gather, verify, and report accurate, unbiased, and timely information to the public. Tell those who watch your programs or read your newspapers that the average Filipino does not owe P130,000 to anybody.
Fellow academics must stop using models that do not correspond to reality, in particular those based on the idea that the government has a budget constraint like that of a family. The neoclassical intertemporal budget constraint framework, an accounting identity in reality, that we all learned, appears to be rational, reasonable, and consistent with development, when in practice it has been used so often in irrational, unreasonable ways that have frequently stunted growth and made existing recessions worse in many countries.
If all the above contribute, the average Filipino will have a better understanding of the state of the economy and this will be a great step toward progress.
Myths about budget deficits and debt have damaged our economy for a long time. We need a fiscal deficit because our economy does not have firms that export (we export people instead), hence we run a current account deficit. The only way for the domestic private sector to run a surplus and to avoid a crisis, is for the government to run a deficit, like many other economies. The only solution, if we do not want to run fiscal deficits permanently, is to change the structure of our economy and try to run current account surpluses. Easier said than done.
Double-entry accounting tells us that a fiscal deficit is an increase in the net worth of the private sector. We also have to understand how governments spend and tax. Government spending is needed for nation building: this requires infrastructure, schools, hospitals, and to eradicate malnutrition, without financial returns considerations. Certainly, the government can financially afford them if they are denominated in pesos. The recent corruption case does not imply that government spending must be curtailed. What we need is better governance. Debt in pesos is just an accounting record of the Treasury bills in circulation in the hands of the private sector, and issued as an interest maintenance operation, not for government borrowing.
Unless we understand these, and use them for nation building, we will continue facing headwinds in our development quest. It is a mistake to think that developed countries waited to get basic public goods until they reached a high income.
We have shared these views with all kinds of audiences and have written about them. Many have started understanding them but they fear eating the forbidden apple. Under the standard view, policy makers, the public, the voters, authoritarians… all of them… will destroy the economy if they begin the policy design process from the point of view of a correct operational understanding, like we propose. So, to make sure nobody will ever “bite the apple,” the neoclassical framework used by academics, and the textbooks written for millions of economics students, pretend that the apple does not exist. If somebody does come to understand that “the apple exists,” the neoclassical response is to invoke fear (of economic consequences like hyper-inflation), or pass the knowledge off as irrelevant (“pay no attention to the man behind the curtain”).
The economic argument must be understood: What is the cost of building a school, a hospital, or a flood control project? Public goods such as these cost “nothing.” They are paid for in pesos as described earlier — if the project requires foreign currency, this has to be earned or borrowed. While a government cannot be forced into default on debt in its own currency, it is true that it might be forced into a default on its foreign obligations. Public goods like these must be valued in terms of the real resources the country dedicates to building them. What are these resources? The workers, machines, and materials used. These are real resources that the nation has, possibly underutilized. The real cost of building additional infrastructure through a government-sponsored employment program is the extra consumption that formerly unemployed workers could enjoy and the extra capital equipment that the workers would use in their productive pursuits. These projects generate income and employment. This is their value. Government programs have to be appraised by how they use real resources rather than in terms of the nominal money values involved. If the government and society at large continue thinking about them as a cost, we will always be behind.
How much can the government spend? The answer is a policy choice: does the government want to eliminate poverty and malnutrition, build schools and hospitals, or does it believe in fuzzy terms like fiscal discipline? None of our arguments contradict the idea that government spending has to be judicious. We are not saying either that the national budget has to triple next year. What we argue is that fiscal responsibility must be about addressing the pressing concerns of our society (isn’t this the role of the government?), then the government can use its power as the issuer of the national currency (together with the BSP) and pay for them. The private sector will certainly benefit because construction companies, for example, will be awarded contracts, again corruption aside. A currency-issuing government can have “monetary sovereignty,” though there is a spectrum. Certainly, the Philippine peso does not play the role of the US dollar (or of other reserve currencies) in the international payments system. But to claim that we cannot afford the basics is technically and morally wrong.
There are only two limits to this. One is inflation. Government spending will contribute to improving our economy and, ideally, we should move in the direction of full employment of the nation’s resources. Inflation will appear then. This is a simplification but no further spending is needed. That’s the time to tax. Our proposal is to bind the government deficit to outcomes like an inflation target rather than to a debt ratio value. Such a strategy would call for a smaller primary fiscal deficit (or a larger primary fiscal surplus, depending on the circumstances) if inflation were above (or projected to be above) target. Second, the economy may face bottlenecks of different kinds, for example no Philippine company is able to supply materials to build schools (a real constraint), hence they need to be imported; or lack of public sector capacity and capabilities to implement projects. These are acknowledged but they do not undermine the thesis we have developed.
Read Part 1 and 2 here: https://tinyurl.com/22orcztj and https://tinyurl.com/285b94uw
Jesus Felipe is a distinguished professor and research fellow at the Carlos L. Tiu School of Economics, De La Salle University. Mariel MonicA Sauler is an associate professor and chair of the Carlos L. Tiu School of Economics, De La Salle University. The authors are grateful to Eunice Gerenia, economics student, De La Salle University, for her excellent research assistance.
