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Opinions of Wednesday, 26 April 2017


When fiscal responsibility becomes Economic irresponsibility

Finance Minister, Ken Ofori-Atta Finance Minister, Ken Ofori-Atta

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 prudent or 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 domestic 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 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” and government should manage its finances like a business entity.

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 popular in 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.

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, solve the present macro economic problems and to achieve public purpose programs.

This mainstream version of fiscal responsibility is not an applicable guide for governments who issue their own currency, because, first, Ghana is not currently under gold standard but under fiat money system;

Second, they have wrongly extended the household “budget constraint” to government whereas government finances are completely different from the household or business entity;

Third, the claim that Government finances depend on limited taxes and borrowing, cannot be the case, because logically, taxpayers or financial markets cannot receive the money needed to pay tax or buy bonds from the market unless government, the sole issuer of the cedi, has first spent this money or put it into existence.

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.

Under the gold standard era, government spends its tax revenue and borrows money from markets in order to finance a shortfall of tax revenue.

However, when the gold standard era was abolished in 1973, many countries including Ghana did not change these arrangements and has continued to depend on limited taxes and borrowing to fund government operations.

Some countries still voluntarily adopt gold standard operational restraints even though they are not necessary because there are no gold reserves to defend under fiat monetary system.

During the gold standard period, countries have no choice than to adopt fiscal responsibility rules due to the operational rigidities which include, issuing public debt every time they spend beyond tax revenue, set particular ceilings relating to deficit size; limit the real growth in government spending over some finite time period; construct policy to target a fixed or unchanging share of taxation in GDP; place a ceiling on how much domestic public debt can be outstanding; and target some particular public debt to GDP ratio.

Currently, Ghana is operating fiat currency system, where 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 and therefore, can create an unlimited amount of cedis at any time, which means affordability or financial capacity is not an issue for Ghana government.

Since our Government is the only authority that can issue the cedis and has infinite capacity to issue the cedi anytime, there is no solvency risk and financial risk of default as long as debt-to-GDP is concerned.

However, the only limitation is inflation risk which is a real constrained. The key to spending is limited by the availability of real resources (ie. labor, capital, land), which the nation commands 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 than can be supplied (and 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 idle resources that can support higher government spending without causing inflation.

At the moment, Ghana’s economy is below full employment and we have huge output gap (from GDP growth rate of 14% in 2011, dropped to 3.6% in 2016).

If the economy was able to absorb a growth rate at 14% in 2011 with single digit inflation, then current growth rate of 3.6% in 2016, with 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 without risk of inflation, if the spending is well-targeted, well allocated to productive sectors of the economy.

With this mass unemployment and idle real resources and 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.

The claim that governments must tax or borrow to ‘finance’ its spending is false under a fiat-currency system.

Government finances do not depend on Limited taxes and borrowing from the market as propagated by the neoliberals.

Government being the sole issuer or source of the cedi must first spend via check or transfer (crediting private bank accounts) of recipients before it can tax (i.e. debiting bank accounts) or remove the spent money from the economy which are all done mainly through computer keystroke to mark down or up of account balances at the Central Bank.

By the way, money now has assumed a different form and is more than just the physical paper thing we hold. It is just numbers and very soon, we will be seeing sovereign digital currency all over the place developed by block chain technology.

The notion that taxes and borrowing fund government’s expenditure is obsolete.

Government cannot rely on taxpayers or financial markets to supply the cedis it needs. From the start, the only medium by which one can pay taxes or buy bonds is the cedi and government being the sole issuer and source of the cedi must spend the cedi first, before it can tax.

Taxpayers and financial markets can only supply back to the government the cedi they received from government out of its spending.

That is to say, to be able to pay taxes or buy government bonds, you need the cedi, which has to be spent into the economy first by government.

Government cannot, therefore, tax the cedi that is not spent or not in existence. It is very important to get the sequence right, because government spending precedes taxes and borrowing which is similar to sowing the seed first before it can be harvested.

It cannot be the other way round where taxes and borrowing funds government spending, which is akin to reaping where you have not sown and this arrangement cannot be a financing tool to fund government spending.

Again, most people are not aware that, government finances are different from household or business entity that has budget constraints. To state it in plain terms, the Government is not like a household or business entity as far as money is concerned.

Government is the monopoly issuer of the cedi whereas the household and business entities are the users of cedi and the two are not the same.

The fact is that, all users of the cedis (including you and me and the businesses etc) can’t issue our own cedis and so we face budget constraints.

All users of the cedi must earn, sell an asset or draw down saving and/or borrow in order to spend the cedi.

This means that, all users of the cedis must finance their spending and they cannot spend more than their revenue forever and cannot sustain to live in deficit forever. Because of the limited supply of cedis, the budget choices facing a household are limited and they always have to stay away from perpetual deficits.

Since government has unlimited ability to issue any amount of cedis, it has no revenue constrains and can also sustain long period of deficit.

Therefore, phrases like “we can’t afford it” or “we’re running out of money” or “the Government is broke” or “Ghana Government is bankrupt” or “the deficit and domestic debt is too high”etc are all false and a myth.

When people think money is the constraint on the government’s economic policy, they can be very easily deceived into thinking that fiscal austerity makes sense.

The reality is that all the renowned Economists (Milton Friedman, Abba Lerner, Paul Samuelson, Joseph Stiglitz etc,), and also the well-known Central bankers ( Ben Bernanke, Alan Greenspan and Mervyn King) know that the deficit and domestic debt mythologies are not true and that a government that issue their own currency and borrow in their currency can never ‘run out’ of money; can never be forced to default in its own currency; can never be forced to miss a payment and is never subject to the whim of ‘ local bond market’.

To quote Paul Samuelson,“the need to balance the budget is superstition…a myth. It’s like an old-religious doctrine that is used to scare people to believe a certain thing”.

The idea of balanced-budget being a myth was a bit like a fairy story we tell to frighten the kids.

It was meant to act as an indirect constraint on politicians not to spend unnecessarily. That’s all well and good when the myth doesn’t cause more harm than good.

The problem is that, what started as something recognized by economists and policy makers to be a “myth”, came to be believed as the truth and an incorrect understanding was developed.

Due to this myth and the belief that government might become insolvent, we are subjecting millions to poverty, denying our people from having good education, good health care and poor quality life, when all that is required is just laws and numbers which the government cannot run short?

Our present monetary system shows that money governs or rules where it ought to serve and many, even the experts, don’t see money as something that is man-made (a tool human beings created for good public purpose),which can be changed anytime we want.

Yet our politicians claim there is no alternative but to impose fiscal austerity measures by cutting budget deficits and reduce domestic debt to GDP ratio.

Of course there is an alternative for Ghana government that issues its own cedi, which is, an effective currency management and significant investment to build the Real Assets base of the economy.

As a country, we can make new arrangements about money and organize our monetary system in such way to ensure that modern money works and functions well to advance public purpose.

Henry Ford said “It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow”.

If unemployment is persisting, then the government has a responsibility to remove the constraints is has placed on its currency that are giving rise to the problem.

Every so often, we turn to forget that, the goal of government economic policy is to provide economic growth, full employment and stable prices rather than being obsessed with deficit number (say 3%) as an end in itself.

Most often, we also, misunderstand that, deficit may be good or bad depending on the state of the economy, and so we cannot have a fixed rule or restrain government deficit number irrespective of whether we have a weak or strong economy.

Sometimes a higher deficit may be unavoidable, good and constructive to ensure that the economy is performing at its potential output level; to close spending gap to achieve full employment; and to increase discretionary public spending to advance public purpose in order to stimulate private investment.

Large deficit spending, on the other hand, can also be very dangerous and damaging when the economy’s output is expanding strongly, nearing full production and full capacity.

We do agree, that, too much government spending generates competition over resources, bottle-necks, and even excessive aggregate demand, all of which can generate inflation.

In such situation we need Paul Samuelson’s fairy tales on balance budget myth to scare politicians from overspending.

However, looking at current macro economic realities, the target 3% budget deficit is misplaced, may not be useful and can become dysfunctional especially when millions are remaining jobless, poverty rates are rising, the gap between the rich and the poor is widening, the lack of access to good health care and education, deteriorating infrastructure and the soaring private sector debt weakening the financial system.

This old-time deficit religion and myth in budget balance makes it impossible to spend on the necessary scale to achieve the public purpose.

Someone should tell me if unemployment will reduce if government taxes more, cut incomes and destroys more jobs which are all fiscal austerity programs.

Infact, whenever you see mass unemployment, widespread fall of income, increased or above normal insolvencies, massive private debt overhang, companies folding ups and GNP falling, is an evidence that the deficit is too low or there is fiscal austerity.

The commentary you hear every day, calling on government to be fiscally responsible (deficit reduction), balance its budgets, living within its means, and warning government about the rising domestic debt is actually the height of fiscal irresponsibility and is prohibitively costly when idle resources are wasted and the economy is performing below capacity.

It is similar to a parent who wants to save, so he stops buying food for his family, stops paying his children’s school fees and refuses to seek medical care for his sick children.

This “fiscal responsibility concept” is economically irresponsible as far as full employment is concerned, because it has been responsible for most of the increasing economic misery and growing idleness, damaging and wasting skills, competencies, and knowledge of our unemployed graduates who want to work.

This bad policy outcome of fiscal responsibility is the cause of decreasing real national wealth compared to what could have created(huge output gap); slowed economic recovery, resulting in economic inequality that many Ghanaians have endured for years.

Again, following deficit reduction plan in isolation is dysfunctional especially when Ghana is experiencing trade deficit, when there is inadequate private investment in productive areas is weak, a situation where both labor and capital are deteriorating, thus, undermining and reducing the productive capacity of the economy.

Therefore, any government that pursue this fiscal rule in the current economic climate described would further undermine growth and denying the private domestic sector the income support, which is essential to reduce its massive debt burden.

In conclusion, the fiscal responsible thing the government should do is to significantly invest enough to building Real Assets, increasing National Capital, advancing Public Purpose (such as full employment, price stability, a first class educational system, Health care for All, practical solution for the energy problems and clean environment etc.) for the general well-being of the people.

A policy proposal targeting Real impacts, Real benefits, and Real results, and fulfilling the needs of Real people is what is called “functional finance”.

This has nothing to do with measure such as debt-to-GDP ratio at the expense of the actual well-being of people, and maintaining and expanding domestic productive capacity.

While pursuing these goals, government must effectively manage the cedi to ensure that inflation does not get out of control.The only real crisis is a crisis of a failing economy, mass unemployment, widespread falling in incomes, and growing economic inequality.