Fiscal stimulus the way forward

  • Nation
  • Tuesday, 10 Mar 2009

AMID the global economic crisis, countries are turning on the fiscal tap apart from maintaining an expansionary monetary policy to arrest their deteriorating macroeconomic conditions.

Deficit spending that generally involves excess of government expenditure over its revenue, termed fiscal deficit, could represent an optimal policy response to the current harsh macroeconomic realities.

It is a deliberate action by a government to take up the slack in the private sector demand for goods and services.

As far as Malaysia is concerned, there is much leeway to count on fiscal spending due to prudent fiscal management in the past that generally involved prepayments of external debts, preference for domestic non-inflationary sources of financing against external borrowings, low external debt service ratio of the Federal Government and operating surpluses.

Deficits in the past arose from development rather than operating spending. At this juncture, the immediate concern should be with economic growth rather than price stability.

Raising public sector investment may support private sector growth if both public and private sector investments are complements.

Fiscal deficits arising mainly from development as opposed to operating expenditure could enhance the productive capacity of the economy.

In this respect, fiscal deficits sustained currently could be future growth-promoting, especially if it entails more private sector investments.

This could imply a larger tax base in the future, thus yielding more revenue for the government. Thus fiscal deficits could augur well for the economy’s long-term prospects.

The fiscal gap could be bridged eventually as tax proceeds grow with economic recovery and as fiscal consolidation subsequently takes place.

Debts incurred currently from higher fiscal deficits may then be repaid thus the burden of pursuing the fiscal deficit may not fall significantly on future generations.

The pursuit of a deficit fiscal policy may be welfare-enhancing to the present and future generations, particularly if it involves judicious spending and capacity-building and contributes to environmentally sustainable development.

In no way could a fiscal deficit thwart private capital accumulation that could be inimical to economic growth, given the present economic climate. Higher interest rates that could crowd out private sector investments may not be witnessed as a consequence.

The threat of inflation from the deficit may also be ruled out as the global economy is under deflationary pressure.

Neither should there be any fear for the adverse current account consequences of a fiscal deficit as large current account surpluses have been recorded over the years.

Generally, deficits are not invariably bad as the opposite could be worse.

Going on an austerity instead of a spending drive could in fact dampen business and consumer sentiments as expectations could then be formed that the government is willing to let the economy remain depressed.

Fiscal deficits could hence inspire confidence amongst firms and consumers.

Moreover, Malaysia is not alone in running up fiscal deficits. This would not place Malaysia in a negative light in the eyes of international portfolio investors which could be the case in normal times.

Fiscal rather than monetary policy could also be more effective when banks and firms are hesitant to engage in lending-borrowing transactions.

To enhance the efficacy of the fiscal deficit while maintaining it at a manageable level to allay possible concerns about its magnitude, perhaps the deficit should be sustained via tax cuts in order to boost disposable income and thus consumption and by increasing Government expenditure in ways that could bring long-term economic benefits to the nation.

Even if tax cuts fail to stimulate spending, it may to a certain extent curb reduction in spending, thus arresting a worsening condition.

This could provide greater mileage than offering incentives to business establishments for their expansion.

Malaysia is essentially confronted with a demand- rather than supply-side problem. Its financial system remains robust.

In fact, if the magnitude of the fiscal deficit is indeed a cause for concern, there is scope for containing it by beefing up tax administration.

Hawkers and other petty traders with lucrative businesses that generally thrive in the informal sector ought to be subjected to income taxation.

The economy could be worse off without any pump-priming. Even if fiscal measures do not translate into impressive growth figures, at least they could partially offset the recessionary pressure.

The prospects of economic recovery could be brighter as nations undertake concerted fiscal stimulus measures. Malaysia is not the only country that treads the path of fiscal expansion.

·Prof Tan Eu Chye is with the Faculty of Economics and Administration, University Malaya.

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