Column: Fiscal is the new fad

Written by K Vaidya Nathan | K Vaidya Nathan | Updated: May 2 2013, 05:56am hrs
Doomsday predictions for India over its fiscal deficit are necessarily speculative as we havent had any hard landing so far

Finance minister P Chidambaram last Wednesday assured the investors that he has drawn red lines and the fiscal deficit will be below the 4.8% mark in 2013-14. A number of measures have been taken We are determined to go back to the path of fiscal consolidation We have laid out a new path and I have said these are red lines. This will be never, never breached, he said. It is nice to see the finance minister committed to keep the fiscal deficit under control.

Currently, the developed world is reeling under a debt problem, and therefore there is an increased focus on the fiscal deficit figure. It has become fashionable in some way to focus on all the countries that have high deficits, and make all kinds of doomsday predictions. These days, popular discussions of deficits usually take it for granted that deficits are bad for the economy, and perhaps even immoral. Although this view can be defended, its justification is less obvious than one might think. Fiscal deficit wasnt such a big villain a decade ago. The fad is like, when Lage Raho Munna Bhai became a hit, Gandhigiri suddenly became the done thing. Wrongdoers were gifted with roses and if somebody spit somewhere, many started objecting politely, if not cleaning it with a smiling face. All the Gandhigiri was gone by the time the next movie Dhoom 2 got released and then young motorcyclists started racing on roads imagining themselves to be Hrithik Roshan. Fads can be quite short-lived.

Of course, this fad on focus on fiscal deficit is more serious and longer lasting. Most economic debates a decade ago would have argued that fiscal deficit has more benefits than defects. An analogy may be helpful in thinking about the desirability or otherwise of deficits.

Hypothetically, assume that you increase sales tax on cars and decrease it on motorcycles. This law does not benefit or harm the economy as a whole; it merely redistributes benefits among people. The direct effect is to benefit college-goers, young folks and the rural population and hurt the more well-to-do who buy cars. There are also likely to be other effects. For instance, the shift in sales tax from two-wheelers to four-wheeler personal vehicles may raise the demand for motorcycles and reduce the demand for cars, leading to higher sales for the Bajajs and the TVSs and lower revenues for the Toyotas and the Hyundais. These pecuniary externalities sum to zero at the economy level, like the effects of the sales tax in the example.

A policy of running fiscal deficits is similar to a pro-motorcycle sales taxit shifts benefits between groups. Here the shift is not between buyers of different vehicles but between beneficiaries at different times. When the government runs a deficit, it accumulates debt that it must pay back in future. Such a policy just shifts the burden of spending: current generation gains, and future generations lose. Thats what is happening in the developed economies right now. They ran high deficits for ages and the reality is now catching up, as it is pay-back time. However, it is not as bad as it sounds in the Indian context. People often assume a moral imperative that the current generation should sacrifice to ensure that future generations enjoy a substantially higher standard of living. In that sense, whether and why deficits are undesirable requires judgements that are more philosophical than economic.

Economists, traditionally, have not been good at judging redistributions of income. Indeed, they often claim that this issue is outside of the sphere of economics altogether. It is, therefore, somewhat surprising that economists now are decrying budget deficits with such consensus and assurance. One widely accepted standard for judging redistributions is the ability-to-pay principle: redistributions of benefits are desirable if they go from better-off to worse-off people, like in that motorcycle-car example. Car owners, typically, will have higher ability to pay than motorcycle buyers. By this criterion, the redistributions arising from running fiscal deficit are desirable.

Most economists would agree that we are in course of being, at least, the top five economies of the world in the next decade and, may be, the top three economies of the world in a couple of decades. Our path to economic progress, like that of China, is undeniable. Budget deficits shift benefits forward in time, like a college-goer taking a loan to spend now and repaying it when he is earning more. So they benefit, relatively speaking, current generation at the expense of relatively rich future generations. If reducing inequality is a goal of policy, shouldnt budget deficits be applauded

The doomsday predictions for India because of high fiscal deficit are necessarily speculative as we havent had any hard landing so far and they look a bit far-fetched in the future as well. The bottom line is, we dont have to be as much worried about fiscal deficits as the developed world that is neck-deep in debt. Worrying about fiscal deficit in our case, like all worries, is like paying on a debt that may never come due.

The author is a post-doctoral fellow and visiting faculty at Santa Clara University, California