The cycle, the trend and Budget 2016…and beyond

Part 1

Before budget day 2016 there had been several calls for boosting government spending to stimulate the economy for the purpose of job creation. This is an old Keynesian idea which says if private sector investment and external demand for exports are weak, the central government should intervene by increasing its spending to stimulate the economy. For an economy such as Guyana, government stimulus can at best increase economic activity in the non-tradable sector of the economy. The non-tradable sector represents those businesses which do not export to earn foreign exchange. Stimulating the tradable sector that earns foreign exchange requires structural or long-term policies as one would have under an agreed economic development strategy.

development watchIn other words, the yearly budget implements short-term economic activities of government spending and taxation. Another way of thinking about the short run is to see it as a cycle. Each cycle has a trough, expansion, peak and recession.

The forces driving these short-term business cycles are completely different from the forces determining the long-term trend. In good years – depending on global demand for Guyanese products – there will be an upswing in the cycle. In bad years the cycle turns downward and pessimistic sentiments of investors and consumers take hold.

The long term is the trend rate of growth of GDP. In a recent letter Dr Ramesh Gampat calculated the trend rate of GDP growth from 1960 to 2014 is a paltry 1.2% per year. Some years the observed rate of growth of GDP will be greater than 1.2% and in other years it will be below 1.2%, thus the cycle around a long-term trend. An expansion of government spending could cause GDP growth to rise above the 1.2%, but that multiplier effect will eventually peter out and the economy will revert back to its long-term trend. And if the government stimulates too hard it can cause a foreign exchange crisis or a serious shortfall, thus resulting in growth falling below the 1.2%. This means government spending could itself result in cycles around the low 1.2% long-term trend.

The forces driving the long-term growth rate since 1960 are very different from the forces causing the cycles. In my academic research, I have argued that the low long-term trend results from natural and environmental constraints, small dispersed population, and antagonistic politics in which the opposition party is incentivised to not cooperate with (or even sabotage) the agenda of the government of the day.

The academic literature also gives clues as to what are needed to change the long-term trend from the lacklustre 1.2% to about 5%. To sustain the new trend of 5% requires that some years growth exceeds 5% and of course sometimes growth will fall below the 5%, but overall the economy would have transcended to a higher growth path. Some of these clues are structural production transformation, strategic infrastructure, protection of private property rights, a smart developmental state (public service) in the Amsden-Evans-Wade sense, education (especially tertiary levels), political freedoms, political stability, physical security, macroeconomic stability and technological innovation.

The task of this column and the next one is to identify the proposals of Budget 2016 that are merely helpful in pushing growth above the mediocre 1.2% trend and those that could possibly result in a transition to a higher long-term average. It should be noted that reducing structural unemployment is tied to transitioning to a higher rate of trend GDP growth. As a matter of fact, it is the only way to reduce structural unemployment. Stimulating government spending in the short run can only reduce temporarily the cyclical aspect of unemployment that will eventually increase back to its long-run structural trend. If Guyana had good quarterly labour market statistics we would have been able to observe the high structural unemployment trend (associated with the 1.2% long-term GDP growth) and the fluctuations around that trend associated with budget spending.

We should bear in mind that yearly budgets are usually focused on short-run issues. These often get the most media attention, possibly because of their political implications. However, let’s not lose sight of the longer term implications of the budget; and moreover whether the annual budgets are tied into a consistent long-term development framework whereby aspects of the development agenda will be financed on a yearly basis.

The budget also deals with several moral issues that cannot be reduced into the economic long term or short term. These include spending to take care of pensioners and the elderly, and direct subsidies to eradicate poverty in urban, rural and hinterland settings.

Nevertheless, the only sure way to permanently dent poverty is to lift the long-term economic growth rate from 1.2% through focusing on high quality growth initiatives.

The APNU+AFC government obviously thought a Ministry of Economic Development and Planning was not necessary. Nevertheless, Budget 2016 outlines five core principles or pillars that are consistent with President Granger’s vision. These are: (i) National Unity, (ii) National Infrastructure, (iii) National Institutions, (iv) National Security and (v) Public Services. Past budgets had a theme which changes from year to year. But Budget 2016 is underpinned by core principles. One can ask whether these core pillars will still stand in next year’s budget. Should they not be the guiding principles for multi-year government spending and taxation?

No reasonable person would disagree with these core pillars. Infrastructure is needed not only to propel economic growth, but also to increase human capabilities. This is one pillar that opens the possibility of cooperation with the PPP. It is not necessary to bring the PPP into government in the name of national unity, but it should be necessary and sufficient to work with the PPP to flesh out an infrastructure agenda for the next 20 years. The understanding should be if PPP wins the election they will continue to implement the agreed infrastructure programme. Hopefully it will significantly minimize the need for tit-for-tat political destabilization that can be traced back to the1960s, 1970s and just after 1992.

It would be interesting to observe which aspect of the APNU+AFC government would be responsible for distilling President Granger’s core pillars into realistic and implementable economic agendas so as to solve the numerous coordination and market failures inherent in Guyana. Just privatizing state entities and passing legal reforms will not do the trick as history has shown in all countries except Hong Kong and Great Britain. We know the Ministry of Finance does the financing, but who does the distilling? No doubt Minister Jordan and his Ministry would have to take on this added responsibility given the government has already overextended its size.

In the next column, I will discuss some of the specific proposals of Budget 2016 so that we can position them into cyclical and trend components. I hope by doing so we can peel away pure political noise so as to view the kernel of the long period.