After the Finance minister’s presentation on the national budget a few weeks ago, the most popular phrase you hear from the media commentators, economist, policy analyst, politicians, is that, government must be fiscally discipline or fiscally responsible. A lot of people share this conventional view and sometimes I ask people, what exactly they mean by “Government should be fiscally responsible”. Today our work is to explain what fiscal responsibility is all about, its impact at the current state of the economy and the way forward.
Mainstream economists define fiscal responsibility in terms of rules and numbers and therefore fiscally responsible budget position is where deficit should not exceed a certain targeted number and also the debt to GDP ratio should not be bigger than a certain figure. For instance, the rule in European Union is that, a budget deficit should be less than 3 % of GDP and Public debt should be less than 60 % of GDP. In Ghana, we have a target to reduce our fiscal deficit to 3% of GDP by 2019 from the current of 6.5% in 2016 and also reduce our debt to GDP below 60%.
This fiscal responsibility concept has nothing to do with cutting waste and inefficiency, eliminating corruption, or discipline in the allocation of resources. Most of our economists, therefore, measure the success or failure of fiscal policy based on how well government budget achieves these targets by way of reducing deficit spending, balance the budget and keep the debt to GDP low. Government is said to be irresponsible whenever the deficit becomes large (it spends more than its tax revenue) and the popular comments you hear is“government should live within its means” because “we are spending money we do not have” and government should manage its finances like a business entity. This is because “you can’t steal from your children and grand-children”; and this government overspending will lead to inflation. These neo-liberals ideas have caught up with almost everybody and so buzz words such as fiscal sustainability, fiscal consolidation, and fiscal austerity etc which virtually mean the same thing are always heard from the media every day. A balanced government budget occurs when the Taxes paid to the government equals government spending (Gov’t Spending=Taxes).In some political circles, fiscal responsibility is when government runs a budget surplus, a situation where government spends less into the economy than it receives in a form of taxes from the private sector.
READ MORE: The Monetary Policy review – here is how the 2% rate cut will affect you
These Apostles of Government Fiscal Austerity and their doctrines of “Fiscal Responsibility” and “sound finance” ideology, interpreted as long-term deficit reduction has a false notion on how to grow post-gold standard modern economy, because they are mentally trapped in gold standard world that no longer exist. This mainstream version of fiscal responsibility is not an applicable guide for Ghana government who issue its own currency. This is because Ghana is not currently under gold standard but under fiat money system. Secondly, they don’t understand that money is not a finite resource and have wrongly extended the household “budget constraint” to government whereas government finances are completely different from the household or business entity. Thirdly, the claim that Government finances depend on limited taxes and borrowing is flawed, because logically, taxpayers or financial markets cannot receive the money needed to pay tax or buy bonds from the market unless government spends the money into existence. Again, the argument that government deficit and domestic debt drives up inflation and crowd out private sector investment is not the case at all times. The people who believe in this fiscal responsibility assumes that, we are still living under gold standard era where Government spending is limited by what the Government Can Tax or Borrow to defend the supply of Gold, and that using this limited resources responsibly, requires balanced budgets or deficit reduction, with the ultimate objective of achieving surpluses.
READ MORE: Ghana included in world’s fastest growing economies
Under the gold standard era, government spends its tax revenue and borrows money from markets in order to finance a shortfall of tax revenue. When the gold standard era was abolished in 1973, many countries including Ghana did not change these arrangements and have continued to depend on limited taxes and borrowing to fund government operations. Thus, such countries still voluntarily adopt gold standard and its operational restraints though they are not necessary since, there are no gold reserves to defend under the fiat monetary system. During the gold standard period, countries had no choice than to adopt fiscal responsibility rules due to the fixed exchange constraints and operational rigidities which include; issuing public debt every time they spend beyond tax revenue, setting particular ceilings relating to deficit size; limiting the real growth in government spending over some finite time period; constructing a policy to target a fixed or unchanging share of taxation in GDP; placing a ceiling on how much domestic public debt can be outstanding; and targeting some particular public debt to GDP ratio. All these arrangements were put in place to defend the gold reserve supply, limit government ability to increase money supply and restrict government spending so it doesn’t devalue the currency.
READ MORE: Budget highlights – Indirect tax policy measures (1)
Currently, Ghana is operating under the fiat currency system with flexibility which is exactly opposite to the way the gold standard works, making obsolete all those operational restraint listed above. Our cedi is not backed by gold and silver but is backed by laws which our government cannot run short. As long as parliament can meet and make laws, we cannot run out of money because the government can create an unlimited amount of cedis at any time, meaning affordability or financial capacity is not an issue for Ghana government. Since our Government is the only legal authority that can issue the cedis and has infinite capacity to issue the cedi at any time, there is no solvency or financial risk of default as long as debt-to-GDP is concerned.
READ MORE: Tax removal will boost investment — Databank
However, the only limitation is inflation risk which is a real constrain. The key to spending is limited by the availability of real resources (labor, capital, land), under the nation’s command and the government can always buy them as long as they are available for sale in cedis. If the Government tries to spend or buy more real resources than can be supplied, (supply will try to expand to meet demand), then the price for that thing will go up and may result in inflation. Ghana has a lot of idle resources that can support higher government spending without causing inflation. At the moment, Ghana’s economy is below full employment and we have a huge output gap (from GDP growth rate of 14% in 2011, it dropped to 3.6% in 2016). If the economy was able to absorb a growth rate at 14% in 2011 with a single digit inflation, then with the current growth rate of 3.6% in 2016 and a lot of output gap, slack and huge unemployment, the government could issue more cedi to hire people who want to work and the economy can absorb all these work force without any risk of inflation; if the spending is well-targeted and allocated well to productive sectors of the economy. With this mass unemployment and idle real resources and excess capacity at this time, we can conclude that the government has no real constraint and can bring those labor and idle resources into productive use through higher spending to expand the economy.
Author: Kwame Ofori Asomaning