Budget Deficits and Economic Activity in Asia

Budget Deficits and Economic Activity in Asia The growth and persistence of government budget deficits is causing increasing concern in both developed and developing countries. They have provoked extreme responses: some economists hold that they have devastating effects, others that they have no real impact at all. Budget Deficits and Economic Activity in Asia examines both of these claims in the context of the Asian economies. After testing for the feasibility of the current levels of budget deficits and therefore of the current fiscal policies, the study turns to a quantification of the effects on seigniorage, money supply, inflation, aggregate demand and interest rates. The findings for the ten countries studied are far from uniform, but neither of the extreme positions is vindicated. Budget deficits are monetized to a considerable extent, thus impairing, or at least reducing, the ability of the monetary authority to pursue an independent monetary policy. On the other hand, government expenditures in most of the countries covered unambiguously, though only partially, crowd out private expenditures. The widespread view that budget deficits are inflationary because they increase the money supply receives only partial support. The apparent effect on interest rates is more interesting. It appears to be positive and as the processes of fiscal deregulation accelerate, interest rates seem set to become even more sensitive to the behaviour of budget deficits. The countries covered include India, Indonesia, South Korea, Malaysia, Pakistan, the Philippines, Singapore, Sri Lanka, Taiwan and Thailand. Kanhaya L.Gupta is Professor of Economics at the University of Alberta, Edmonton. He has published widely in the area of Development Economics, particularly on financial issues. His previous publications include Finance and Economic Growth in Developing Countries (Routledge, 1984) and Industrialisation and Employment in Developing Countries (Routledge, 1989).

Budget Deficits and Economic Activity in Asia Kanhaya L.Gupta

London and New York

First published 1992 by Routledge 11 New Fetter Lane, London EC4P 4EE This edition published in the Taylor & Francis e-Library, 2006. “To purchase your own copy of this or any of Taylor & Francis or Routledge’s collection of thousands of eBooks please go to http://www.ebookstore.tandf.co.uk/.” Simultaneously published in the USA and Canada by Routledge a division of Routledge, Chapman and Hall, Inc. 29 West 35th Street, New York, NY 10001 © 1992 Kanhaya L.Gupta All rights reserved. No part of this book may be reprinted or reproduced or utilized in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage and retrieval system, without permission in writing from the publishers. British Library Cataloguing in Publication Data Gupta, Kanhaya L. (Kanhaya Lal) 1935– Budget deficits and economic activity in Asia. 1. Asia. Economic conditions I. Title 330.95 ISBN 0-203-02616-0 Master e-book ISBN

ISBN 0-203-14933-5 (Adobe e-Reader Format) ISBN 0-415-05540-7 (Print Edition) Library of Congress Cataloging in Publication Data Gupta, Kanhaya L. (Kanhaya Lal), 1935– Budget deficits and economic activity in Asia/by Kanhaya L.Gupta. p. cm. Includes bibliographical references and index. ISBN 0-415-05540-7 1. Budget deficits—Asia. 2. Asia— Economic conditions—1945– I. Title. HJ2151.G87 1991 339.5′23′095–dc20 91–13668 CIP

For Carol Marshall

Contents Figures

vii

Tables

viii

Acknowledgements

xii

Introduction 1 A review of the record

1 5

2 Sustainability of perpetual deficits

32

3 Deficits and seigniorage

51

4 Deficits and money supply

91

5 Deficits and inflation

102

6 Deficits and aggregate demand

125

7 Deficits and interest rates

145

8 Conclusions

169

Notes

172

Selected bibliography

174

Index

178

Figures 1.1 Nominal and real federal deficits as percentage of GDP

6

1.2 Government expenditure and taxes as percentage of GDP

11

1.3 Rates of growth of reserve money, M1, and nominal deficits

30

3.1 Estimates of seigniorage

53

4.1 Money multipliers for M1 and M3

92

5.1 Nominal deficits, growth of M1, and rate of inflation

106

7.1 Nominal and real interest rates

146

7.2 Nominal interest rates and budget deficits

149

Tables 1.1 Nominal and real deficits as percentage of GDP

7

1.2 Variances of nd and rd

8

1.3 Components of nominal deficits as percentage of GDP

10

1.4 Central government expenditure as percentage of GDP

12

1.5 Public sector revenues as percentage of GDP

15

1.6 Correlation coefficients between nd and rd

18

1.7 Monetary erosion and inflation tax on public debt

19

1.8 Government debt as percentage of GDP

23

1.9 Variability of the major variables

24

1.10 Mean values of the major variables for different periods

27

1.11 Correlation coefficients between nd, rd, and variables of main interest

29

2.1 Data for analysing the sustainability of public debt

33

2.2 Values of real interest rate minus real growth rate

38

2.3 Values of the condition for instability of the debt/ GDP ratio

40

2.4 Federal debt dynamics

42

2.5 Unit root tests for budget deficits excluding interest payments

48

2.6 Unit root tests for government debt

49

3.1 Table for S1 and S2—alternate estimates of seigniorage

51

3.2 Monetary base growth and the share of government

55

3.3 Budget deficits and the degree of monetization

59

3.4 Estimates of equations (6) and (7)

63

3.5 Increases in reserve money attributable to current and past government borrowing requirements

70

3.6 Contemporaneous correlations between seigniorage and deficit

74

3.7 Dynamic estimates for S1

78

3.8 Dynamic estimates for S2

82

3.9 Test statistics for the null hypotheses for S1

86

3.10 Test statistics for the null hypotheses for S2

87

3.11 Total short-term and long-term effects of past deficits on seigniorage S1

88

3.12 Total short-term and long-term effects of past deficits on seigniorage S2

89

4.1 Money multiplier values

93

4.2 Money growth estimates (M1): the conventional model

95

4.3 Effects of deficits on money growth, M1: the static and the dynamic models

97

4.4 Effects of deficits on money growth, M3: the static and the dynamic models

98

4.5 Comparisons of the effects of budget deficits on monetary base 99 and money growth 4.6 Effects of budget deficit on money growth in other studies for

100

LDCs 5.1 Results of causality tests for the works surveyed

104

5.2 Estimates of equations (9), (10), and (11)

111

5.3 Estimates of equation (12)

114

5.4 Summary of structural models’ results

117

5.5 Contemporaneous relationships of inflation with money growth 118 and budget deficits: equation (14) 5.6 F values for the effects of each money growth term to be zero on inflation (Inf)

119

5.7 Total short-run effect of money growth on inflation

120

5.8 F values for the effects of each deficit term to be zero on inflation

121

5.9 Total short-run effect of deficits on inflation

122

5.10 Long-term effects of deficits on inflation

123

6.1 Estimates of equation (10)

130

6.2 Estimates of the Aschauer model: Version 1

133

6.3 Values of the log-likelihood ratio test statistic: Version 1

137

6.4 Estimates of θ and log-likelihood ratio test statistic: Version 2

138

6.5 Estimates of the modified Aschauer model: Version 3

139

6.6 Values of the log-likelihood ratio test statistic for the Aschauer model: Version 3

142

7.1 India: twelve-month deposit rate

152

7.2 India: money market rate

153

7.3 India: bond rate

154

7.4 India: bond rate

155

7.5 South Korea: twelve-month deposit rate

156

7.6 Malaysia: money market rate

157

7.7 Pakistan: twelve-month deposit rate

158

7.8 Pakistan: money market rate

159

7.9 Pakistan: bond rate

160

7.10 The Philippines: twelve-month deposit rate

161

7.11 Singapore: twelve-month deposit rate

162

7.12 Sri Lanka: twelve-month deposit rate

163

7.13 Thailand: twelve-month deposit rate

164

7.14 Thailand: bond rate

165

7.15 Test statistics for restrictions on the coefficients of deficits

166

Acknowledgements Thanks are due to Daniel Lal and Zheng Wei for their research assistance, to Alan Sharpe for his computing help, to Pat Gangur for her excellent typing of the manuscript, and to Michael Fisher, Cartographic Services, for the preparation of the graphs. Partial funding for the results reported here was provided by the University of Alberta.

Introduction Just as in the developed countries, rising and persistent budget deficits have become a major cause for concern in the developing countries also. But in spite of the urgency and the importance which is being attached to this issue, it is surprising that, except for a very few attempts at the quantification of the possible economic effects of these deficits, there has been no systematic study of this area for many of the developing countries. This is particularly the case for the Asian countries. The aim of this study is to fill this gap to some extent. More specifically, this is a comparative study of the Asian countries, namely, India, Indonesia, South Korea, Malaysia, Pakistan, the Philippines, Singapore, Sri Lanka, Taiwan and Thailand. Due to lack of data, the coverage of Taiwan is not as comprehensive as that of the other nine countries. The experience of all these countries, in terms of economic growth, inflation, budget deficits, and the growth of public debt has been sufficiently diverse to merit such a comparative study. In addition, this approach should allow us to shed some light on the issue of relevance of the experience of newly industrialized countries for others in our sample. Given the vastness of the field and, even more important, the limitations of the data, the treatment is of necessity selective. I shall focus on the following aspects of the budget deficits in these countries: their sustainability; their effects on aggregate demand; the channels through which budget deficits engender these effects; the irrelevance of the mode of financing a given budget deficit; and effects on monetization, money growth, and inflation. These are the aspects which have received the most attention in the literature.1 For example, it is often asserted that in the developing countries, the budget deficits are largely monetized, which lead to higher rates of monetary growth causing higher rates of inflation. If these assertions were true, the implications of budget deficits for the conduct of monetary policy would be serious. And yet, for the developing countries, there is little evidence available on such assertions. Whenever such evidence is available, it tends to be either dated or descriptive with little attention being paid to modelling, measurement and estimation issues.2 Consequently, the aim of this study is to conduct, for each of the ten countries listed, an extensive empirical investigation into the areas identified above and analyse their policy implications as well as the implications of their differing experiences. The basic approach to analysing the above issues is to estimate single equation models using annual time series data. A distinctive feature of the study is the attention paid to the measurement issues, particularly with regards to the estimates of budget deficits, seigniorage and money supply. The importance of this aspect is highlighted below. In order to facilitate comparisons between the results for the ten countries, a uniform methodology for estimation and expectation formation is used. The estimates are used to examine a number of questions: for example, what is the extent of the monetization of the budget deficits? Does it differ across the ten countries? Is the growth in M3 less sensitive to the growth in public debt than in M1? Do public expenditures crowd out private expenditures and if so, to what extent? Is the transmission

Budget deficits and economic activity in Asia

2

mechanism for the crowding effect via changes in interest rates? If so, do the budget deficits affect short-term interest rates or the long-term interest rates or both and if so, to what extent? Have the deficits been inflationary in each of the ten countries? Are the observed levels of public debt sustainable? More details about these issues are given in the chapters to follow. A brief outline of the chapters is given below. Chapter 1 presents a descriptive picture of the behaviour of the budget deficits over the period covered and the behaviour of the variables of interest in relation to the budget deficits. It starts with an examination of the recent history of budget deficits and the public debt, followed by a study of the nominal deficits and its components, then by a treatment of the behaviour of expenditures and revenues along with their structure. This allows us to say something about the proximate causes of the observed deficits. Since nominal deficits are not always the most appropriate concept for economic analysis, estimates of real deficits are presented and the implications of correcting the nominal deficit for inflation are examined. It then presents estimate of total government borrowing requirements, the monetary erosion and the inflation tax on government liabilities. Having discussed the trends in deficits and debt, I undertake a brief review of the data on deficits in conjunction with the variables of interest identified above. This kind of graphic and descriptive analysis, while not necessarily a proof of causality between deficits and the variables concerned, can nevertheless shed interesting light on the hypotheses to be tested subsequently. Chapter 2 explores the following issue: can the governments in the countries of our sample follow a policy of perpetual deficits, even if they wanted to? In other words, is such a policy feasible or sustainable? There is no consensus in the literature on this issue. It is generally agreed, however, that if the real rate of interest at which a government borrows is in excess of an economy’s real growth rate, the ratio of the public debt to GNP will rise without bounds, so that a policy of perpetual primary deficits will not be feasible. Another way to look at the same issue is to think in terms of the implications of such a policy for the government budget constraint. If the governments, like the individuals, are subject to a present-value borrowing constraint, then following a policy of permanent primary deficits will be impossible because it will violate this constraint. We thus have two ways of testing for the feasibility of fiscal policies practised by the countries in our sample. This chapter presents evidence using both approaches. Chapter 3 starts the process of analysing the implications of budget deficits and the public debt. The issue dealt with in this chapter is that of the monetization of the budget deficits. Monetization of the budget deficits provides the governments with a source of revenue. This process of creating money to provide revenue, called seigniorage, is one of the most important and controversial aspects of deficit financing. This chapter considers four aspects of the issue. First, it provides alternative estimates of seigniorage and examines their importance as a source of revenue. Second, it considers the extent to which these revenues are accounted for by the treasury. Third, it provides estimates of the monetization of the government debt. Fourth, and finally, it presents some quantification of the effects of budget deficits on seigniorage for the countries in the sample. This is done by using alternative modelling approaches. Extensive inter- and intra-country comparisons are then carried out. Chapter 4 turns to the effects of budget deficits on the growth of money supply. The preceding chapter dealt with the effects of budget deficits on monetization or the creation

Introduction

3

of high powered money. However, there is no simple, mechanistic relationship between the growth of high powered money and the growth of money supply. Not only will the outcome depend on whether we are concerned with a narrow definition (M1) or a broader definition (say, M3) of money supply, but also on the underlying structural relationships determining the behaviour of the money multipliers. A stable relationship between high powered money and budget deficits does not necessarily mean a stable relationship between high powered money and money growth, and therefore between money growth and budget deficits. Chapter 4 first presents evidence on money multipliers. The behaviour of these multipliers is analysed to examine their stability across the ten countries. Then a number of alternate reduced form equation models are estimated to examine the effects of budget deficits on the growth of money supply. The sensitivity of the results is examined both with respect to nominal and real deficits as well as to the alternate definitions of money supply. Implications of estimates for monetary policy are then discussed. While it is generally agreed upon that increases in money supply caused by the monetization of the budget deficits lead to higher rates of inflation, it is also argued that budget deficits contributed directly to such pressures. Chapter 5 addresses this issue. Alternate reduced form models based on both structural and non-structural approaches are estimated and evaluated. The chapter also supplies descriptive evidence on the movements of the growth of money supply, deficits and inflation, which provides a background for the econometric work carried in the rest of the chapter. The chapter also provides a brief survey of the literature. Chapter 6 deals with two other contentious aspects. One is the possible crowding out effect of government expenditures on private expenditure. To the extent that such crowding out occurs, the effectiveness of fiscal policy is reduced correspondingly. The importance of the estimates of the crowding out effect is thus obvious for a proper evaluation of the usefulness of fiscal policy. The other aspect deals with the neutrality of the mode of financing such excess expenditures, i.e. budget deficits. The issue is whether the Ricardian equivalence proposition as restated by Barro holds. According to this proposition it is irrelevant whether a given budget deficit is financed by tax increases or by debt issue. This outcome, however, is based on a number of assumptions, so that an a priori resolution of this issue is not possible. Recourse must be taken to empirical estimates. The chapter also presents estimates on this issue. Since the policy implications of both the crowding out effects and the Ricardian equivalence proposition are serious, the evidence presented allows us to discuss these implications in a concrete way for the countries of our sample. The results of Chapter 6 suggest that, although a poor substitute for private expenditure, government expenditure nevertheless crowds out some private expenditure. Given this, the question arises as to the possible mechanism(s) which lead to this result. The most common route is via an increase in interest rates caused by high and persistent budget deficits. Unfortunately, not only is there ambiguity in the theoretical literature, but the empirical results are also inconclusive. Even worse, for the developing countries there is little evidence on this issue. Chapter 7 presents some evidence on this aspect of the budget deficits. The chapter first reports the movements of nominal and real interest rates. It turns out that the two rates have not remained constant over the period covered. Further, the inter-country variations are substantial. The determinants of this lack of

Budget deficits and economic activity in Asia

4

constancy and inter-country variability are then explored with special reference to the role of budget deficits. The results of Chapters 6 and 7 are compared for consistency in terms of their implications for the Ricardian equivalence proposition. The concluding Chapter 8 brings the major findings of the study together and draws broad conclusions.

1 A review of the record As a preliminary to the quantitative analysis to be undertaken in the subsequent chapters, this chapter briefly reviews the recent history of the budget deficits and the government debt in the countries of our sample. This is done by examining the recent trends in nominal deficits and its components, followed by a study of the behaviour of expenditure and revenue, along with their structure, to shed some light on the causes of the observed trends in the deficits. Since the nominal deficits are not the most appropriate concept for economic analysis, the real deficits are then examined. This is followed by a look at the history of the public debt which, of course, reflects the history of commulated budget deficits. Having discussed the trends in government deficits and debt, we undertake a brief review of the data on deficits in conjunction with the variables of major interest in this study. This kind of review, while not necessarily being a proof of the direction of causality between deficits and the variable concerned, can nevertheless shed interesting light on the hypotheses to be tested subsequently. Clearly, if certain general patterns were to emerge from this review, they will need explaining.

NOMINAL DEFICITS AND THEIR COMPONENTS Before proceeding with this review, a word is in order about the data used. The data on the deficits and their components as well as the debt are all derived from various issues of Government Finances and the rest of the variables from International Financial Statistics, both published by the International Monetary Fund. The concept of the government deficits used is the national income and accounts one. That this concept may suffer from some measurement problems is by now well recognized (see, for example, Boskin 1988, and Eisner and Pieper 1984, among others). But given the large number of countries in our sample, and the lack of availability of individual country primary sources, it is virtually impossible to make any meaningful corrections. In any event, as a first approximation, the NIAC concept is not a bad start. Similarly, the data on public debt also may not be the best measure, either. This is because the measure we use is based on the par value of the debt rather than the market value, which is the more appropriate one. But once again, such data for the countries in this study are simply not available. However, one advantage of the data which are being used is that they are measured by a uniform methodology and to that extent facilitate inter-country comparisons, which is the major focus of this study. The time period covered in this study was determined by the availability of the data on deficits, its components, and the other major variables.

Budget deficits and economic activity in Asia

6

We can now turn to a review of the record. The recent history of the nominal and the real budget deficits is shown in Figure 1.1. Concentrating on the nominal deficits first, we can see from this figure that the nine countries did not have a uniform experience during the sample period. To take the two extreme examples, Singapore and Sri Lanka; whereas Singapore experienced budget surpluses for most of the period, Sri Lanka, on the other hand, shows high and rising deficits. In between we can see less extreme though still differing experiences. In order to highlight these similarities and dissimilarities more sharply, we can look at Table 1.1 which gives the levels of nominal deficits as a percentage of GDP for different time periods. This table highlights a number of points. The first thing to note is that for India, South Korea, Malaysia, the Philippines, Sri Lanka and Thailand, the experience from the mid1970s onwards differs significantly from the period before that. More specifically, the levels of nominal deficits (again as percentages of GDP) are higher than before. And even within this decade, the deficits were higher in the first half of the 1980s than the latter half of the 1970s. For the other three countries, there are no such similarities. Thus for Indonesia the deficit falls in the late 1970s, then rises. Pakistan’s experience is just the opposite of Indonesia. Its deficit falls in the early 1970s, then rises in the late 1970s, followed by a sharp decline in the early 1980s. Singapore stands in a class by itself. Except for the period 1961–65, it shows a budget surplus, although there is considerable variability over time. Apart from these similarities and

Figure 1.1 Nominal and real federal deficits as percentage of GDP

A review of the record

7

differences in the trends, the absolute magnitudes of the percentage of the deficit also differ widely. Thus, leaving aside Singapore, during 1981–85 the figure was as low as 1.18 per cent for Indonesia and as high as 13.87 per cent for Sri Lanka. In general, using below and above 5 per cent as the dividing line between low and high deficit economies respectively, we can see that for the decade of 1976–85 Indonesia, South Korea, the Philippines, Thailand, and, of course, Singapore fall into the low deficit category and the rest into the high deficit category. A point was made above about the differing degrees of variability in the experiences of the nine countries. A better way to consider this aspect is to look at Table 1.2, which gives variances of the nominal and the real deficit rates. It is immediately clear that only Malaysia and Sri Lanka show the greatest variance in nominal deficits. In order to highlight the role of public debt in the budget deficits, it is useful to distinguish between primary deficits and interest

Table 1.1 Nominal and real deficits as percentage of GDP* India Period

nd

Indonesia rd

nd

South Korea

rd

nd

rd

1961–65

4.93

0.60

—

—

0.56

−1.31

1966–70

4.03

0.71

—

—

0.72

1.26

1971–75

3.87

0.35

2.22

—

1.76

1.99

1976–80

5.67

2.55

0.80

—

1.67

0.81

1981–85

6.65

3.20

1.18

—

2.20

1.94

Malaysia Period

nd

Pakistan rd

nd

The Philippines rd

nd

rd

1961–65

—

—

3.00

2.37

0.36

0.15

1966–70

—

—

7.32

3.81

0.98

0.44

1971–75

7.40

3.41

6.78

3.62

−0.41

0.63

1976–80

8.88

1.91

8.04

3.53

1.31

−0.10

1981–85

13.36

5.69

5.91

3.15

2.76

0.85

Singapore Period

nd

Sri Lanka rd

nd

Thailand rd

nd

rd

1961–65

3.09

1.34

5.49

4.12

0.52

0.79

1966–70

−0.97

6.57

6.64

3.20

2.14

2.10

1971–75

−1.52

4.89

6.69

0.07

0.26

0.56

1976–80

−0.40

7.55

13.26

2.08

3.35

1.42

1981–85

−2.99

8.47

13.87

−0.68

4.49

2.42

Budget deficits and economic activity in Asia

8

Note * nd and rd stand for nominal and real deficits as a percentage of real GDP, respectively. Surpluses are denoted with a negative sign

payments on public debt. Total deficits considered above, of course, equal the sum of these two components. The point is that unless the interest payments on outstanding government debt are, at least, balanced by a primary surplus, there will always be a budget deficit. In order to bring out the significance of this distinction for the nine countries, we present some recent data on these components and the total deficit. These data are given in Table 1.3. This table again shows important inter-country differences. For example, in the 1980s, budget deficits in India, Indonesia, Malaysia, Pakistan and the Philippines largely reflect interest payments on public debt. On the other hand, the deficits in Sri Lanka and Thailand were compounded both by primary deficits and interest payments. The importance of the distinction between these two

Table 1.2 Variances of nd and rd Variance of nd Full sample

Before 1974

Variance of rd Since 1974

Full sample

Before 1974

Since 1974

India

1.72

1.19

1.45

4.83

2.20

6.47

Indonesia

1.32

0.17

1.26

—

—

—

South Korea

1.38

1.59

0.57

4.83

8.22

0.99

Malaysia

15.7

3.34

17.28

12.45

14.97

12.94

Pakistan

5.6

6.10

3.29

83.75

127.03

32.46

The Philippines

2.52

1.84

2.90

1.51

0.48

2.68

Singapore

4.28

6.24

2.11

15.03

21.54

8.62

Sri Lanka

22.42

1.48

28.95

12.19

7.43

14.92

Thailand

3.34

2.64

3.17

2.72

2.39

3.29

components will be brought out further in the next chapter when we examine the sustainability issue.

NOMINAL DEFICITS, EXPENDITURE AND REVENUE The trends in nominal deficits discussed above reflect the trends in government expenditure and revenue. It is not our intention to carry out a detailed analysis of the factors underlying the deficits or to examine in detail the expenditure and the revenue

A review of the record

9

policies of the nine governments. That is a task beyond the scope of any study such as this. However, the aim is to consider the general trends in expenditures and revenues and in particular, consider evidence of some popular perceptions about the causes of the observed deficits. It is often alleged that in developing countries some of the major causes of these deficits on the expenditure side are the expenditures on ‘nondevelopmental’ items like subsidies, defence and administration. On the revenue side the main problem is the relatively small tax base and therefore relative stagnation in the share of direct taxes as a source of revenue. The discussion below is meant to shed some light on these factors. The broad trends in total expenditures and revenues over the period are presented in Figure 1.2. These figures are self-explanatory, except for the fact that once again we notice considerable differences in the experiences of the nine countries. However, one similarity is quite noticeable, namely, that for most of the period, the two move together. To get a better insight, we consider Tables 1.4 and 1.5 which provide a more detailed analysis of the two aggregates for the recent period. Considering Table 1.4 first, we concentrate on expenditure on goods and services, fixed investment, interest payments, subsidies and defence. Comparing 1974 with the latest year for which the data are available, we can draw a number of conclusions. The expenditure on goods and services rose for South Korea, Malaysia, Pakistan, Sri Lanka, and Thailand, whereas the expenditure on fixed investment declined in India, Malaysia, and Sri Lanka. Thus there is suggestive evidence of crowding out of fixed investment expenditure by government consumption expenditure in the cases of Malaysia and Sri Lanka. But in general, the expenditure on goods and services either remained constant or rose for all the countries, whereas the expenditure on fixed investment remained constant or rose for six of the nine countries. Interest payments as a percentage of GDP rose for all countries. Interestingly enough, subsidies and other transfer payments show a rising tendency for only two countries, India and South Korea. In terms of expenditure on defence, rising trends can be noticed in the cases of South Korea, Malaysia, Pakistan, Singapore, Sri Lanka and Thailand. From this brief discussion, it is clear that one of the major reasons for the observed deficits was the rising cost of servicing the government debt and in the case of six countries, also expenditures on defence. But the support for the widely held belief that subsidies and government consumption expenditures were largely responsible does not receive much support. Next we consider the revenue side. The data for the same time period as those in Table 1.4 are given in Table 1.5. Here we concentrate on the inter-country differences in the value of the ratio of direct taxes to GDP and its trend. Broadly speaking, we can observe two major differences. Countries with low ratio of direct taxes also had a relatively constant ratio, while countries with high ratios had a rising rate, the only exception being Thailand. The first category consists of India, South Korea, Pakistan, the Philippines, Sri Lanka, and Thailand, while the latter category includes Indonesia, Malaysia, and Singapore. What is thus clear is that the relatively small and constant contribution of direct taxes to government revenues, ceteris paribus, also plays a role in generalizing the observed deficits for a number of countries in the sample.

Budget deficits and economic activity in Asia

10

Table 1.3 Components of nominal deficits as percentage of GDP India

Indonesia

South Korea

Year Primary Interest Total Primary Interest Total Primary Interest Total deficit payments deficit deficit payments deficit deficit payments deficit 1974

2.92

1.38

4.30

−0.39

0.55

0.16

0.11

0.35

0.46

1980

−1.25

1.77

0.52

0.04

0.88

0.92

−1.85

1.14

−0.71

1981

−1.03

1.87

0.84

0.03

0.80

0.83

−2.23

1.21

−1.02

1982

−0.96

2.13

1.17

0.12

1.09

1.21

−0.97

1.23

0.26

1983

−0.64

2.29

1.65

−0.47

1.62

1.14

−5.12

1.13

−3.99

1984

−0.04

2.63

2.59

−3.9

1.70

−2.2

−2.30

1.24

−1.06

1985

—

—

—

−1.25

1.69

0.44

−2.08

1.31

−0.77

1986

—

—

—

—

—

—

−2.34

1.31

−1.03

Malaysia

Pakistan Total Primary deficit deficit

Year

Primary deficit

Interest payments

Interest payments

Total deficit

1974

0.43

2.17

2.60

1.30

1.74

3.04

−1.87

0.35

−1.52

1980

−0.18

2.90

2.72

−0.81

2.08

1.27

−1.46

0.87

−0.67

1981

8.41

3.55

11.96

0.86

2.03

2.89

0.32

0.80

1.12

1982

4.60

4.33

8.93

0.70

2.26

1.56

−0.13

1.05

0.93

1983

−0.27

4.98

4.68

0.60

2.93

3.53

−1.40

1.31

−0.10

1984

−3.96

5.56

1.60

−0.48

3.25

2.77

−2.64

1.95

−0.64

1985

—

—

—

0.30

3.33

3.63

−3.15

2.41

−0.70

Singapore

Interest payments

The Philippines Total Primary deficit deficit

Sri Lanka

Thailand

Year Primary Interest Total Primary Interest Total Primary Interest Total deficit payments deficit deficit payments deficit deficit payments deficit 1974

−9.49

1.42

−8.07

4.03

2.44

6.47

−2.45

1.17

−1.28

1980

−9.39

2.95

−6.39

17.73

3.42

21.15

2.93

1.41

4.34

1981

−8.97

2.62

−6.35

10.68

4.54

15.22

2.19

1.76

3.95

1982

−12.44

2.88

−9.56

11.84

5.15

16.99

4.47

1.64

6.11

1983

−13.76

4.38

−9.38

10.16

5.45

15.61

1.63

2.41

4.04

1984

−16.91

4.73 −12.18

6.41

4.38

10.79

1.35

2.50

3.85

1985

—

— −10.87

9.83

4.57

14.40

2.27

2.95

5.22

A review of the record

11

Figure 1.2 Government expenditure and taxes as percentage of GDP NOMINAL VERSUS REAL DEFICITS It is well known that nominal budget deficits do not always accurately represent the stance of fiscal policy (King and Plosser 1985 and Masera 1987, among others). A more accurate measure is the concept of real deficits. This requires adjusting nominal deficits for inflation. This can be done by using the budget constraint. The trends in real deficits are shown in Figure 1.1 and its quantitative aspects are given in Tables 1.1 and 1.2. It is clear from Figure 1.1 that real deficits display greater variability than nominal deficits. Also, in many cases deficits in real terms are lower than in nominal terms. We can see the distinction between the nominal and the real deficits more concretely in terms of Tables 1.1 and 1.2. Considering the extreme example, Sri Lanka, where the nominal deficits were the highest from 1976 to 1985, the situation in terms of the real deficits is quite different. Not only is it no longer the extreme case, but in fact in 1981–85 it enjoyed a budget surplus in real terms. The differences in the variability of the two measures are further highlighted in Table 1.2. The variance of the real deficits exceeded that of the nominal deficits for four of the eight countries for the entire sample period. For the period prior to 1974, this was the case for six countries and for the period since 1974, this happened for five countries. In terms of individual countries’ experiences, the variance of real deficits was on the low side for South Korea, the Philippines, and Thailand for the post-1974 period. Other differences can also be read from this table. Finally, we can get a

Budget deficits and economic activity in Asia

12

better feel for the relationship between the two concepts of the deficit by considering their correlation coefficient given in Table 1.6. The coefficient is very low, even negative for India, Pakistan, and the Philippines. On the other hand, it has changed remarkably over time for some countries, for example India, South Korea, Malaysia, Sri Lanka, and Thailand. In short, nominal deficits may not always reflect the situation about the real deficits. It is possible to examine the implications of correcting nominal deficits for inflation further. This can be done by following Masera (1987). In order to carry out his approach, we can rewrite the government budget constraint as follows: (1) where D is nominal government debt, d is real debt, Y and y are nominal and real GDP respectively, and π it is the rate of inflation as measured by the rate of change of the GDP implicit price deflator. In this equation, ∆D/Y represents total government borrowing requirements which equal ∆d/y plus (D−1/y)π, where the first term represents the change in real debt as a proportion of real GDP and the latter term represents monetary erosion or the loss of purchasing power of initial nominal debt as a proportion of nominal GDP. Table 1.7 presents estimates of total government borrowing requirements, the monetary erosion and the inflation tax on government liabilities. Inflation tax was calculated as the differences between interest payments on public debt minus the monetary erosion, both expressed as percentages of nominal GDP. The most interesting aspect of Table 1.7 is that none of the countries experienced high inflation tax rate. If anything, the period covered was dominated by periods of net transfers from the public sector to the rest of the economy. Further, such periods have been more the rule during the 1980s than the 1970s. In spite of these

Table 1.4 Central government expenditure as percentage of GDP 1974

1980

1981

1982

1983

1984

1985 1986

Current expenditure

11.61

12.48

12.27

12.92

12.81

14.08

—

—

Export on goods and services

(4.96) (4.06) (4.13) (4.27) (4.19) (4.40)

—

—

Interest payments

(1.38) (1.77) (1.87) (2.13) (2.29) (2.63)

—

—

Subsidies and other transfers

(5.27) (6.65) (6.27) (6.52) (6.33) (7.05)

—

—

2.31

—

—

(1.36) (0.48) (0.55) (0.56) (0.58) (0.73)

—

—

15.11

16.39

—

—

(1.17) (2.88) (2.90) (3.02) (2.90) (3.11)

—

—

India

Capital expenditure

3.50

Fixed investment Total expenditure a

General public services

1.66

14.15

1.83

14.10

1.88

14.80

2.00

14.81

A review of the record Defencea

13

(3.39) (2.80) (2.99) (3.08) (3.04) (3.14)

—

—

Indonesia Current expenditure

11.55

11.89

—

Export on goods and services

(5.65) (5.99) (5.51) (5.54) (5.18) (4.83) (5.06)

—

Interest payments

(0.55) (0.88) (0.80) (1.09) (1.62) (1.70) (1.69)

—

Subsidies and other transfers

(5.35) (5.74) (5.53) (4.57) (4.61) (4.24) (5.14)

—

Capital expenditure

5.60

Fixed investment Total expenditure a

General public services Defence

a

12.61

—

17.05

21.62

—

— (7.92) (7.11) (6.47) (7.14) (6.17) (7.55)

—

— (3.21) (3.12) (3.01) (2.61) (2.48) (2.29)

—

1980

1981

21.72

10.78

10.77

(4.34) (9.78) (8.79) (8.36) (5.97) (4.63) (6.67) 24.51

10.52

11.41

—

23.82

12.67

11.20

9.73

1974

11.21

11.84

22.19

8.42

19.19

1982 1983 1984 1985 1986

South Korea Current expenditure

10.97

14.88

14.74 15.68 12.41

Export on goods and services

(5.64)

(7.81)

(7.86) (7.94) (7.57) (6.92) (7.18) (6.92)

Interest payments

(0.35)

(1.14)

(1.21) (1.23) (1.13) (1.24) (1.31) (1.31)

Subsidies and other transfers

(4.98)

(5.93)

(5.67) (6.51) (3.71) (6.67) (6.77) (6.70)

2.63

2.43

(1.47)

(1.35)

(1.16) (1.64) (1.41) (1.30) (1.29) (1.30)

13.60

17.31

17.11 19.12 14.93

(2.82)

(1.73)

(1.89) (2.01) (2.02) (1.75) (1.86) (1.84)

(3.99)

(5.94)

(6.62) (5.98) (5.58) (5.19) (5.24) (5.05)

19.45

19.17

24.07 25.44 23.18 22.01

Capital expenditure Fixed investment Total expenditure a

General public services Defence

a

2.37

3.44

2.52

14.83 15.26 14.83

2.41

2.40

2.45

17.24 17.66 17.28

Malaysia Current expenditure Export on goods and services

(10.15) (10.84) (14.09)

—

—

—

—

—

—

—

Interest payments

(2.17)

(2.90)

(3.55) (4.33) (4.95) (5.56)

—

—

Subsidies and other transfers

(7.13)

(5.43)

(6.43)

3.95

9.90

(3.28)

(2.78)

(1.92)

23.04

Capital expenditure Fixed investment Total expenditure a

General public services Defence

a

—

—

—

—

—

15.38 10.04

8.20

5.38

—

—

—

—

—

—

29.07

39.45 35.48 31.38 27.39

—

—

(3.95)

(1.55)

(1.77)

—

—

—

—

—

(4.18)

(4.23)

(5.79)

—

—

—

—

—

—

Budget deficits and economic activity in Asia

1974 1980

1981

1982

14

1983

1984

1985

1986

Pakistan Current expenditure

14.19 14.47

17.28

—

Export on goods and services

(8.13) (8.31) (10.78) (9.40) (10.93) (10.97) (10.94)

—

Interest payments

(1.74) (2.08)

(2.03) (2.26)

(2.92)

(3.25)

(3.33)

—

Subsidies and other transfers

(4.32) (4.08)

(3.54) (2.62)

(2.50)

(3.11)

(3.01)

—

2.92

3.12

2.43

2.32

—

(1.67) (3.04)

(2.61) (2.83)

(3.07)

(2.42)

(2.31)

—

16.62 17.52

19.21 17.20

19.48

19.76

19.60

—

(1.33) (1.26)

(1.49) (1.41)

(1.56)

(1.43)

(1.54)

—

(5.70) (5.37)

(5.48) (5.76)

(6.79)

(6.39)

(6.64)

—

9.05

8.98

7.96

9.08

—

Capital expenditure

2.52

Fixed investment Total expenditure a

General public services Defence

a

3.05

16.35 14.28

2.86

16.36

17.33

The Philippines Current expenditure

9.27

9.15

8.59

Export on goods and services

(5.27) (7.43)

(7.11) (6.71)

(6.72)

(5.41)

(5.97)

—

Interest payments

(0.35) (0.87)

(0.80) (1.05)

(1.31)

(1.95)

(2.41)

—

Subsidies and other transfers

(3.37) (0.85)

(0.68) (1.29)

(0.95)

(0.60)

(0.70)

—

2.94

2.71

1.81

1.44

—

(0.99) (1.27)

(1.93) (1.31)

(1.29)

(0.90)

(0.52)

—

10.48 12.32

12.75 11.99

11.69

9.77

10.55

—

(0.93) (2.47)

(2.36) (2.59)

(2.30)

(1.56)

(1.44)

—

(1.95) (1.93)

(1.81) (1.63)

(1.59)

(1.17)

(1.25)

—

1974

1981

1983

1984

Capital expenditure

1.21

Fixed investment Total expenditure a

General public services Defence

a

3.17

1980

4.16

1982

1985 1986

Singapore Current expenditure

11.74

Export on goods and services

(9.58) (11.53) (14.57) (12.85) (11.91) (13.52)

—

—

Interest payments

(1.42)

(2.95)

(2.62)

(2.88)

(4.38)

(4.73)

—

—

Subsidies and other transfers

(0.74)

(1.10)

(1.14)

(0.96)

(0.77)

(1.23)

—

—

1.94

4.45

4.96

4.62

5.46

6.67

8.47

—

Fixed investment

(1.43)

(4.02)

(4.46)

(4.16)

(5.10)

(6.46)

—

—

Total expenditure

13.68

20.03

23.29

21.31

22.52

26.15 27.46

—

General public servicesa

(2.05)

(1.96)

(3.12)

(2.84)

(2.76)

(2.91) (3.87)

—

(4.50)

(5.09)

(5.10)

(4.92)

(4.16)

(5.25) (6.17)

—

Capital expenditure

Defence

a

15.58

18.33

16.69

17.06

19.48 18.99

—

A review of the record

15

Sri Lanka Current expenditure

17.78

24.74

19.72

17.82

18.83

17.96 20.68

—

Export on goods and services

(7.96) (12.92)

(8.35)

(7.02)

(7.36)

(7.95) (9.33)

—

Interest payments

(2.44)

(3.42)

(4.54)

(5.15)

(5.45)

(4.38) (4.57)

—

Subsidies and other transfers

(7.38)

(8.40)

(6.83)

(4.65)

(6.02)

(5.63) (6.78)

—

4.65

16.62

12.88

15.46

13.39

12.58 12.73

—

(2.91)

(7.22)

(4.23)

(4.74)

(4.55)

(3.32) (3.57)

—

22.43

41.36

32.60

33.28

32.22

30.54 33.41

—

(3.05)

(3.92)

(2.81)

(3.83)

(2.65)

(2.52) (3.20)

—

(0.72)

(0.69)

(0.56)

(0.49)

(0.81)

(0.83) (2.84)

—

Capital expenditure Fixed investment Total expenditure a

General public services Defence

a

1974

1980

1981

1982

1983

1984

1985 1986

Thailand Current expenditure

10.69

16.83

—

Export on goods and services (7.66) (10.03) (11.00) (11.81) (11.56) (12.16) (12.32)

—

Interest payments

(1.17)

(1.41)

(1.76)

(1.64)

(2.41)

(2.50)

(2.95)

—

Subsidies and other transfers

(1.86)

(2.55)

(1.52)

(2.08)

(1.63)

(1.24)

(1.56)

—

2.64

4.21

4.12

4.53

3.90

3.43

4.00

—

(2.25)

(3.32)

(3.48)

(3.82)

(3.38)

(3.00)

(3.57)

—

13.33

18.17

18.40

20.06

19.50

19.33

20.83

—

(1.57)

(1.56)

(1.49)

(1.77)

(1.79)

(1.80)

(1.89)

—

(2.62)

(3.94)

(3.71)

(3.19)

(3.78)

(3.83)

(4.21)

—

Capital expenditure Fixed investment Total expenditure a

General public services Defence

a

13.96

14.28

15.53

15.60

15.90

Note a

indicates both current and capital expenditure

Table 1.5 Public sector revenues as percentage of GDP 1974

1980

1981

1982

1983

1984

1985

1986

India Current revenue

18.74

12.48

13.03

13.44

12.97

13.62

—

—

Direct taxes

(4.58)

(4.56)

(4.98)

(4.87)

(4.51)

(4.34)

—

—

Indirect taxes

(4.78)

(5.31)

(5.23)

(5.10)

(5.46)

(5.42)

—

—

—

—

—

—

—

—

—

—

0.07

0.15

0.23

0.19

0.19

0.18

—

—

Social security contributions Capital revenue

Budget deficits and economic activity in Asia Total revenue

16

10.81

13.63

13.26

13.63

13.16

13.80

—

—

16.99

22.90

23.68

20.51

21.05

21.39

21.18

—

(11.24) (17.86) (17.16) (15.77) (15.48) (14.33) (14.01)

—

Indonesia Current revenue Direct taxes Indirect taxes

(2.16)

(1.98)

(1.86)

(2.13)

(2.18)

(2.00)

(3.40)

—

Social security contributions

—

—

—

—

—

—

—

—

Capital revenue

—

—

—

—

—

—

—

—

16.99

22.90

23.68

20.51

21.05

21.39

21.18

—

Current revenue

12.99

17.77

18.15

18.66

18.72

18.17

18.19 18.17

Direct taxes

(3.64)

(3.97)

(4.16)

(4.45)

(4.26)

(4.16)

(4.60) (4.59)

Indirect taxes

(5.98)

(8.16)

(8.11)

(8.31)

(8.56)

(8.17)

(7.86) (7.75)

Social security contributions

(0.11)

(0.19)

(0.18)

(0.21)

(0.21)

(0.23)

(0.27) (0.29)

0.15

0.25

0.15

0.20

0.20

0.13

13.14

18.02

18.30

18.86

18.92

18.30

Total revenue South Korea

Capital revenue Total revenue

1974 1980

1981

1982

1983

1984

0.24

0.14

18.43 18.31

1985

1986

Malaysia Current revenue

20.74 26.28

26.79

—

Direct taxes

(5.68) (9.87) (10.21) (9.68) (10.45) (10.03) (11.36)

—

Indirect taxes

(4.56) (4.41)

(4.23) (4.31)

(5.32)

(4.77)

(4.76)

—

Social security contributions

(0.07) (0.10)

(0.14) (0.15)

(0.14)

(0.13)

(0.16)

—

0.05

0.06

0.05

0.13

—

20.80 26.35

27.49 26.55

26.70

25.79

26.92

—

Current revenue

13.58 16.25

16.32 15.64

15.95

16.99

15.97

—

Direct taxes

(1.00) (2.24)

(2.54) (2.59)

(2.42)

(2.07)

(1.91)

—

Indirect taxes

(4.64) (5.47)

(5.41) (5.22)

(5.18)

(5.95)

(5.28)

—

Capital revenue Total revenue

0.06

0.07

27.38 26.50

0.11

26.64

25.74

Pakistan

Social security contributions

—

—

—

—

—

—

—

—

Capital revenue

—

—

—

—

—

—

—

—

13.58 16.25

16.32 15.64

15.95

16.99

15.97

—

11.97 12.90

11.63 11.06

11.79

10.44

11.25

—

Total revenue The Philippines Current revenue

A review of the record

17

Direct taxes

(2.84) (2.73)

(2.52) (2.41)

(2.27)

(2.25)

(2.99)

—

Indirect taxes

(3.06) (5.41)

(4.87) (4.53)

(4.45)

(3.49)

(4.10)

—

Social security contributions Capital revenue Total revenue

—

—

—

—

—

—

—

—

0.03

ng

ng

ng

ng

ng

ng

—

11.63 11.06

11.79

10.44

11.25

—

12.00 12.90

1974

1980

1981

Current revenue

20.62

25.37

26.58

Direct taxes Indirect taxes

1982

1983

1984

1985 1986

29.77

28.59

27.96

—

(7.14) (8.24) (9.31)

(10.18) (9.70) (8.84) (7.54)

—

(3.32) (4.01) (3.67)

(3.94) (3.99) (3.99) (3.85)

—

Singapore

Social security contributions

27.71

—

—

—

—

—

—

—

—

1.13

1.02

3.06

3.16

2.13

0.61

10.37

—

21.75

26.39

29.64

30.87

31.90

20.20

38.33

—

Current revenue

15.94

20.20

17.36

16.67

16.60

19.74

19.00

—

Direct taxes

(2.19) (3.14) (2.39)

(2.95) (2.77) (3.56) (3.60)

—

Indirect taxes

(5.32) (5.41) (5.83)

(6.52) (7.93) (9.19) (8.70)

—

Capital revenue Total revenue Sri Lanka

Social security contributions

—

—

—

—

—

—

—

—

0.02

0.01

0.02

0.02

0.01

0.01

0.01

—

15.96

20.21

17.38

16.29

16.61

19.75

19.01

—

Current revenue

14.61

13.83

14.45

13.95

15.46

15.48

15.61

—

Direct taxes

(1.74) (2.46) (2.75)

(2.89) (2.89) (3.15) (3.24)

—

Indirect taxes

(6.19) (6.37) (6.59)

(6.64) (7.73) (7.14) (6.86)

—

Capital revenue Total revenue Thailand

Social security contributions

—

—

—

—

—

—

—

—

Capital revenue

ng

ng

ng

ng

ng

ng

ng

—

14.61

13.83

14.45

13.95

15.46

15.48

15.61

—

Total revenue Note ng: negligible

Budget deficits and economic activity in Asia

18

Table 1.6 Correlation coefficients between nd and rd Country India

rnd,rd

Country

rnd,rd

The Philippines

1961–83

0.35 1961–85

0.06

1961–73

0.02 1961–73

0.22

1974–83

0.25 1974–85

−0.07

South Korea

Singapore

1961–84

0.43 1964–86

−0.29

1961–73

0.37 1964–73

−0.25

1974–84

0.72 1974–86

−0.09

Malaysia

Sri Lanka

1971–86

0.57 1961–84

0.17

1971–73

0.93 1961–73

0.05

1974–86

0.56 1974–84

0.75

Pakistan

Thailand

1961–84

−0.16 1961–85

0.69

1961–73

−0.10 1961–73

0.66

1974–84

−0.07 1974–85

0.90

qualitative similarities, the magnitude of these net transfers differed significantly; for example it was as high as 4.3 per cent in 1984 for Singapore, and as low as 0.19 per cent for Sri Lanka in the same year. From the above discussion, it is clear that correction for inflation can make significant differences to the estimates of budget deficits. However, this is not to suggest that nominal budget deficits are an irrelevant construction. We have already seen how its various components, namely the components underlying expenditure and revenue, can shed interesting light on controversies surrounding causes of deficits.

FISCAL DEFICITS AND PUBLIC DEBT It can be seen from the government budget constraint that a necessary condition for the growth of public debt over time is the existence of fiscal deficits. However, this is not a sufficient condition if the deficits are totally financed by foreign grants or monetary expansion. In such an event the debt to GDP ratio will not grow, and in fact may fall. The issue of whether the actual ratios experienced by the countries in our sample are sustainable in the long run or not is examined in the next chapter. While there are

A review of the record

19

Table 1.7 Monetary erosion and inflation tax on public debt Public sector borrowing requirement as percentage of nominal GDP

Public sector borrowing requirement as percentage of real GDP

Year

Monetary erosion of public sector liability as percentage of nominal GDP

Interest Inflation tax payments as as percentage percentage of GDP (−ve of GDP in sign)

India 1974

2.8937

−1.8226

4.5101

1.1264

−3.3837

1975

3.0319

−1.1336

4.0273

1.3071

−2.7202

1976

2.9127

3.9144

−0.8825

1.5050

2.3875

1977

6.9238

1.1034

1.8093

1.5422

−0.2671

1978

2.9575

6.0074

0.9164

1.7147

0.7983

1979

5.7114

2.2982

0.6594

1.7652

1.1058

1980

6.4347

1.3670

4.3443

1.7692

−2.5751

1981

5.0149

3.2133

3.2213

1.8707

−1.3506

1982

9.2842

2.2508

2.7641

2.1296

−0.6345

1983

4.4363

6.8149

2.4694

2.2938

−0.1756

1974

4.3823

1.7899

2.5924

0.3541

−2.2383

1975

3.8963

1.6651

2.2312

0.3492

−1.8820

1976

2.5893

0.7896

1.7998

0.4588

−1.3410

1977

2.6711

1.2153

1.4559

0.7402

−0.7157

1978

2.6036

0.8602

1.7434

0.7919

−0.9515

1979

1.7599

0.9023

1.6675

0.9137

−0.7538

1980

4.7475

2.8956

1.8519

1.1462

−0.7057

1981

4.2908

2.7701

1.5206

1.2118

−0.3088

1982

3.7726

2.9261

0.8465

1.2332

0.3867

1983

2.2494

1.6742

0.5752

1.1258

0.5506

1984

1.3056

0.7198

0.5858

1.2441

0.6583

South Korea

Budget deficits and economic activity in Asia

Public sector borrowing requirement as percentage of nominal GDP

Public sector borrowing requirement as percentage of real GDP

Year

Monetary erosion of public sector liability as percentage of nominal GDP

20

Interest Inflation tax payments as as percentage percentage of GDP (−ve of GDP in sign)

Malaysia 1974

3.6399

0.3421

3.2978

2.1743

−1.1235

1975

5.4227

6.4951

−1.0724

2.6688

3.7412

1976

5.8252

2.3127

3.5125

2.8904

−0.6221

1977

5.8319

3.7575

2.0743

2.9499

0.8756

1978

3.0750

0.1256

2.9494

2.9114

−0.0380

1979

5.4002

2.2758

3.1244

2.7904

−0.3340

1980

4.3839

2.4692

1.9148

2.9843

1.0695

1981

7.0991

6.7538

0.3453

3.5513

3.2060

1982

10.1232

9.2604

0.8628

4.3321

3.4693

1983

7.5383

5.7107

1.8275

4.9522

3.1247

1984

3.9221

1.4724

2.4497

5.5563

3.1066

1974

6.1370

−4.6759

10.8129

1.7375

−9.0754

1975

3.2559

−6.1298

9.3859

1.4952

−7.8907

1976

11.5450

6.8902

4.6548

1.6438

−3.0110

1977

8.1002

3.3185

4.7817

1.8015

−2.9802

1978

6.6262

2.5792

4.0470

1.8362

−2.2108

1979

9.9239

7.3251

2.6077

1.9543

−0.6534

1980

4.3235

−0.4299

4.7534

2.0765

−2.6769

1981

2.3457

−2.1250

4.4707

2.0258

−2.4449

1982

13.6155

10.1686

3.4469

2.5580

−0.8889

1983

5.7294

3.0763

2.6531

2.9334

0.2803

1984

6.9847

2.8128

4.1718

3.2489

−0.9229

Pakistan

A review of the record

Public sector borrowing requirement as percentage of nominal GDP

Public sector borrowing requirement as percentage of real GDP

Year

21

Monetary erosion of public sector liability as percentage of nominal GDP

Interest Inflation tax payments as as percentage percentage of GDP (−ve of GDP in sign)

The Philippines 1974

3.0339

2.5441

0.4899

0.3473

−0.1426

1975

1.7757

1.0852

0.6905

0.8333

0.1428

1976

1.3119

0.7288

0.5830

0.5563

−0.0267

1977

1.3834

0.6544

0.7290

0.5891

−0.1399

1978

0.1515

−0.9801

1.1316

0.6397

−0.4919

1979

0.2812

−0.6722

0.8534

0.8794

−0.0740

1980

0.8808

0.2776

0.6032

0.8631

0.2599

1981

1.5373

1.0680

0.4694

0.7983

0.3289

1982

2.5089

1.7979

0.7109

1.0479

0.3370

1983

1.0409

−1.6847

2.7256

1.3103

−1.4153

1984

3.0140

1.9915

1.0225

1.9498

0.9273

1974

6.0910

2.0761

4.0150

1.4191

−2.5959

1975

8.7938

7.9599

0.8339

1.6302

0.7963

1976

11.0573

10.3510

0.7063

2.1364

1.4301

1977

11.3162

10.6628

0.6534

2.6934

2.0400

1978

8.7605

7.5665

1.1940

2.9950

1.8010

1979

8.3175

5.7205

2.5970

3.0914

0.4944

1980

9.0590

4.2645

4.7945

2.9493

−1.8452

1981

8.3950

5.3863

3.0086

2.6245

−0.3841

1982

10.9948

8.6403

2.3545

2.8834

0.5289

1983

11.7115

9.474

2.2379

4.3775

2.1396

1984

7.6059

7.1778

0.4281

4.7293

4.3012

Singapore

Budget deficits and economic activity in Asia

Public sector borrowing requirement as percentage of nominal GDP

Public sector borrowing requirement as percentage of real GDP

Year

Monetary erosion of public sector liability as percentage of nominal GDP

22

Interest Inflation tax payments as as percentage of percentage GDP of GDP

Sri Lanka 1974

2.5746

−3.5929

6.1675

2.4399

−3.7276

1975

4.1803

2.1846

1.9957

2.6301

0.6344

1976

4.6287

2.1473

2.4814

2.7812

0.2998

1977

3.2631

−0.7771

4.0402

2.7962

−1.2440

1978

2.565

0.1450

2.4215

3.2064

0.7849

1979

5.2227

1.9325

3.9201

3.2355

−0.6846

1980

13.2743

9.3405

3.9338

3.4227

−0.5111

1981

5.8643

0.9013

4.9631

4.5362

−0.4269

1982

7.2210

4.2541

2.9669

5.1523

2.1854

1983

3.0805

−1.2309

4.3115

5.4473

1.1358

1984

1.0803

−3.5729

4.6533

4.8430

0.1897

1974

−0.5872

−3.0662

2.4839

1.1685

−1.3154

1975

0.7797

0.4094

0.3703

1.2446

0.8743

1976

3.0714

2.5814

0.4899

1.0550

0.565

1977

2.7453

1.6686

1.0768

1.0676

−0.0092

1978

2.7258

1.6407

1.0851

1.1322

0.0471

1979

2.3353

0.8977

1.4376

1.1330

−0.3046

1980

2.8631

1.0068

1.8562

1.4134

−0.4428

1981

2.2489

1.2145

1.0344

1.7620

0.7276

1982

3.8894

3.4035

0.4859

1.9630

1.4771

1983

2.7537

2.2261

0.5276

2.4142

1.8866

1984

3.3695

3.1119

0.2576

2.4993

2.2417

Thailand

A review of the record

23

Table 1.8 Government debt as percentage of GDP Year

India

Indonesia

South Korea

Malaysia

Pakistan

1974

34.2

23.19

13.83

40.17

67.80

1980

44.03

18.57

14.05

43.42

54.49

1981

43.66

16.92

15.62

54.05

48.20

1982

48.76

27.96

17.65

60.92

55.23

1983

45.98

30.11

17.56

74.29

54.86

1984

48.93

26.37

16.86

72.81

54.55

1985

—

55.79

16.80

—

59.41

1986

—

—

15.17

—

—

Year

The Philippines

Singapore

Sri Lanka

Thailand

1974

—

39.23

53.62

20.04

1980

15.47

64.70

78.39

22.96

1981

17.45

61.53

77.50

24.05

1982

20.78

66.18

81.57

28.45

1983

21.98

71.20

81.48

30.58

1984

29.44

75.79

69.22

32.05

1985

30.67

87.63

80.92

36.95

many reasons which motivate countries to engage in issuing public debt, the aim of this brief section is not to investigate the underlying reasons, merely to report the recent trends. This is done in Table 1.8, in which the data relate to total outstanding public debt as reported in Government Finances, a publication of the International Monetary Fund. The data are expressed here as a percentage of GDP. We can note a number of points from this table. Compared to 1974, the ratio in the 1980s was higher for all of the countries except for Pakistan. The ratio, however, remained relatively stable in India, South Korea, Pakistan, and Sri Lanka. It shows a consistently rising trend in Indonesia, Malaysia (except for 1984), the Philippines, Singapore, and Thailand. In terms of the values of the ratio, there are substantial intercountry differences. Thus the approximate mean values for the 1980s for these nine countries are 46.00 (India), 30.00 (Indonesia), 16.00 (South Korea), 61.00 (Malaysia), 54.00 (Pakistan), 26.00 (the Philippines), 71.00 (Singapore), 78.00 (Sri Lanka), and 29.00 (Thailand). The range is thus quite wide, from a low of 16.0 per cent for South Korea to a high of 78.0 per cent for Sri Lanka. It would be an interesting exercise to attempt to explain the reasons for these wide differences.

Budget deficits and economic activity in Asia

24

DEFICITS AND ECONOMIC ACTIVITY: A DESCRIPTIVE REVIEW While a formal quantitative analysis of the effects of deficits on various variables will be undertaken in the subsequent chapters, a review of movements in such variables in conjunction with the trends in deficits and debt observed above may reveal some patterns or lack thereof which would be instructive for the later analysis. This review is not meant to establish causality, but simply to see whether any patterns emerge which may shed some light on the hypotheses to be examined later on. In Tables 1.9 and 1.10 we examine the movements in the rates of growth of real income, reserve money, money supply, and the rate of inflation, in relation to the nominal and the real deficits and the rate of growth of nominal public debt. Money supply is represented by M1. Table 1.9 provides the mean values and variances of the variables for the period under consideration. Table 1.10 provides mean values for different time periods. Consider, first, column (1) of Table 1.9. Looking at the mean values of the real deficits as percentage of GDP and the rate of growth of real GDP, we find that countries with high rates of growth are associated both with low real deficits as well as with high. The only unambiguous case is that of India where low real deficits are also accompanied by low growth rate. But since low real deficits are also associated with high real growth for other countries, we cannot conclude that real deficits are either a necessary or a sufficient condition for rapid growth, assuming that causality runs from real deficits to growth. A similar lack of any consistent relationship between real growth and the rate of growth of nominal public debt can also be detected. The next important relationship is that between nominal deficits and reserve money, and between reserve money and money growth. These data are also given in Figure 1.3. It is interesting to note that the countries which experienced the highest mean nominal deficits, Malaysia and Sri Lanka, did not experience the highest rates of growth of reserve money. That distinction belonged to Indonesia and South Korea where the mean deficit ratio was one of the lowest in the sample. This would seem to suggest a lack of definite relationship between nominal deficits and the growth of reserve money supply. As is to be expected, there seems to be a close correspondence between the rates of growth of reserve money supply and M1. But given the lack of systematic relationships

Table 1.9 Variability of the major variables Variable

Mean

Variance

Minimum

Maximum

India nd

4.89

1.71

2.78

7.16

rd

1.34

4.83

−2.87

6.62

y

3.89

15.12

−5.05

9.85

rm

11.58

34.75

3.51

22.46

m

11.31

44.11

−11.69

24.87

π

7.79

30.23

−3.10

18.78

A review of the record

25

Indonesia nd

1.50

1.32

−1.00

3.20

rd

—

—

—

—

6.80

9.00

1.93

12.58

rm

27.00

188.91

4.77

56.83

m

29.14

171.21

6.40

51.12

π

17.57

140.46

3.16

47.15

nd

1.35

1.38

−0.37

3.86

rd

0.90

4.83

−2.77

7.88

y

8.23

40.40

−10.19

22.21

rm

27.69

448.49

−13.63

66.67

m

27.11

204.16

0.56

45.63

π

17.43

79.11

3.90

33.91

nd

9.92

15.70

5.55

19.12

rd

4.16

12.45

−0.92

11.58

y

23.89

10.02

18.20

28.19

rm

13.79

88.12

2.49

35.68

m

13.31

90.41

−0.56

37.57

π

5.02

48.71

−8.38

18.00

nd

6.22

5.60

−0.06

10.32

rd

3.29

83.75

−10.22

29.60

y

4.45

11.10

−4.66

8.78

rm

12.06

51.23

−3.13

26.74

m

12.89

71.15

−5.15

32.88

π

8.35

34.80

0.00

23.17

nd

1.03

2.52

−2.91

4.23

rd

0.39

1.51

−3.02

2.70

y

4.75

86.72

−24.39

28.14

y

South Korea

Malaysia

Pakistan

The Philippines

Budget deficits and economic activity in Asia

26

rm

15.70

105.47

−7.69

47.47

m

13.40

92.45

−1.65

38.14

π

11.86

102.60

1.82

49.14

Variable

Mean

Variance

Minimum

Maximum

Singapore nd

−1.03

4.28

−5.21

4.49

rd

6.43

15.03

−1.50

13.94

y

8.43

35.81

−3.45

24.24

rm

13.22

88.42

−10.26

37.27

m

11.58

71.53

−2.09

35.51

π

3.58

30.02

−9.30

15.47

nd

9.01

22.42

3.17

22.21

rd

1.86

12.19

−5.08

8.55

y

5.25

8.71

0.06

15.76

rm

13.58

174.73

−6.58

45.47

m

12.51

93.25

−3.52

34.89

π

8.63

73.67

−1.78

24.17

nd

2.63

3.34

−0.80

6.35

rd

1.46

2.72

−3.54

3.98

y

6.92

4.28

2.67

12.20

rm

10.65

16.44

3.79

17.88

m

9.39

53.22

−8.30

20.62

π

5.50

35.98

−1.75

20.09

Sri Lanka

Thailand

Notes nd and rd: nominal and real deficits as percentage of GDP, respectively. y, rm and m: rates of growth of real GDP, reserve money and M1, respectively. π: rate of inflation measured by the rate of change of GDP implicit price deflator.

between nominal deficits and growth of reserve money supply, we cannot be too certain about the strength of the relationship between nominal deficits and growth of money supply as measured by M1. Finally, we consider the mean rates of inflation. As we shall see later, the relationship between nominal deficits and inflation is not so simple, but still a comparison of these

A review of the record

27

two variables is instructive. The countries with the highest mean inflation rate, Indonesia and South Korea, are not the ones with the highest proportions of nominal debts. In fact they have two of the lowest. On the other hand, we also observe countries such as Pakistan and Sri Lanka where both the nominal deficits as well as the rate of inflation was high. Finally, we have the case of Singapore which experienced the lowest mean rate of inflation, but then it was also the only country in the sample to have experienced a nominal budget surplus. In short, no definite pattern is discernible in this case either.

Table 1.10 Mean values of the major variables for different periods Period

nd

rd

dg

y

rm

m

π

India 1961–65

4.93

0.60

8.3

3.0

7.5

9.5

6.9

1966–70

4.03

0.71

8.0

4.9

8.2

8.2

5.8

1971–75

3.87

0.35

11.1

3.0

10.3

12.6

10.0

1976–80

5.67

2.55

16.6

3.5

18.9

11.6

7.9

1981–85

6.65

3.20

20.0

5.5

16.4

15.1

7.9

1971–75

2.22

—

—

8.1

39.1

38.7

21.8

1976–80

0.80

—

—

7.9

25.6

31.9

20.0

1981–85

1.18

—

—

4.5

15.7

15.4

11.27

1961–65

0.56

−1.31

8.3

3.5

24.7

22.3

23.3

1966–70

0.72

1.26

80.9

12.8

44.6

36.4

13.5

1971–75

1.76

1.99

40.6

9.0

30.7

31.3

20.0

1976–80

1.67

0.81

29.2

7.7

26.0

26.6

20.8

1981–85

2.20

1.94

19.58

7.7

7.1

15.7

6.7

1971–75

7.40

3.41

15.4

7.5

18.1

16.7

5.5

1976–80

8.88

1.91

15.9

8.5

16.7

17.6

9.7

1981–85

13.36

5.69

17.6

5.2

8.5

7.8

2.6

1961–65

3.00

2.37

13.2

4.5

7.5

8.2

3.6

1966–70

7.32

3.81

16.4

2.2

8.4

9.5

5.4

1971–75

6.78

3.62

24.4

3.5

10.1

13.0

14.7

Indonesia

South Korea

Malaysia

Pakistan

Budget deficits and economic activity in Asia

28

1976–80

8.04

3.53

16.8

6.1

20.7

21.2

9.4

1981–85

5.91

3.15

18.1

6.6

12.9

13.2

8.2

1961–65

0.36

0.15

7.0

5.3

9.1

9.4

5.3

1966–70

0.98

0.44

15.5

2.8

13.7

10.9

9.8

1971–75

−0.47

0.63

24.2

7.3

17.2

19.2

14.6

1976–80

1.31

−0.10

10.4

6.0

19.1

17.1

11.7

1981–85

2.76

0.85

30.7

2.2

19.5

10.5

17.8

1963–65

3.09

1.34

9.4

2.1

10.8

2.4

0.98

1966–70

−0.97

6.57

32.9

13.1

10.5

13.4

1.7

1971–75

−1.52

4.89

23.4

9.6

20.4

16.8

8.0

1976–80

−0.40

7.55

20.9

8.8

14.6

12.1

4.3

1981–85

−2.99

8.47

17.1

6.1

10.0

7.7

2.8

1961–65

5.49

4.12

12.7

3.8

10.1

6.7

0.10

1966–70

6.64

3.20

11.4

7.9

3.0

5.4

3.1

1971–75

6.69

0.07

9.8

4.0

10.2

14.7

10.2

1976–79

13.26

2.08

22.6

5.5

25.1

19.6

14.0

1980–84

13.87

−0.68

14.7

5.0

21.1

17.1

17.5

Period

nd

rd

The Philippines

Singapore

Sri Lanka

dg

y

rm

m

π

Thailand 1961–65

0.52

0.79

9.6

7.3

7.3

5.5

2.0

1966–70

2.14

2.10

19.1

8.5

9.1

8.4

1.4

1971–75

2.69

0.56

13.5

6.3

14.2

12.5

10.4

1976–80

3.35

1.42

20.5

7.6

14.0

15.6

9.8

1980–85

4.49

2.42

17.9

4.9

8.6

4.9

3.7

Note dg: rate of growth of nominal public debt.

It is also instructive to consider the different measures of variability in Table 1.9. Consider once again the variances of real deficits and growth of real GDP. We can see that no systematic pattern is found. Thus, high variances in real deficits are accompanied by a high variance of real growth rates for South Korea, Singapore, and India, but by low

A review of the record

29

variances of y for Malaysia, Pakistan, Sri Lanka, and Thailand. On the other hand, low variance of real deficits are accompanied by low variance of y for Indonesia, but high variance for the Philippines. On the whole, therefore, an inter-country comparison of the mean values of the different variables does not reveal any consistent pattern about the relationship between nominal deficits and real deficits, and the other variables. This, of course, does not mean that intra-country relationships may not exist when viewed across time. To such an examination we now turn to in terms of Table 1.10. We proceed in the same order as above. Therefore, consider the relationship between real deficits and the rate of growth of real GDP. With the exception of Singapore and Thailand, there is no systematic direction in the movement of the two variables. Thus declines in real deficits are accompanied by increases in the real GDP growth as well as decreases. In Singapore, there is a positive relationship, as is the case for Thailand, except for the period 1981–85 when the relationship is negative. The intra-country comparison would thus seem to support the inter-country comparisons from Table 1.9. Turning to the behaviour of nominal deficits and the growth of reserve money supply, there are mixed results. Thus, for Pakistan, the Philippines, and Singapore the relationship is broadly positive. It is relatively negative for Malaysia and not at all clearcut for the other countries. However, the relationship between the growth of reserve money supply and the growth of M1 is closer and positive

Table 1.11 Correlation coefficients between nd, rd, and variables of main interest India

Indonesia

South Korea

Correlation coefficient

1961– 1961– 1974– 1970– 1970– 1974– 1961– 1961– 1974– 83 73 83 85 78 85 84 73 84

rrd,y

0.29

−0.16

0.52

—

—

—

0.09

0.20

−0.46

rnd,rm

0.24

−0.41

0.38

0.25

−0.64

0.11

−0.11

0.16

−0.24

rnd,m

0.08

−0.14

0.09

0.37

−0.38

0.23

−0.04

0.08

0.13

rnd,π

0.20

0.29

0.12

−0.09

−0.57

−0.02

−0.10

−0.26

0.09

Malaysia

Pakistan

The Philippines

Correlation coefficient

1971– 86

1971– 73

1974– 86

1961– 84

1961– 73

1974– 84

1961– 85

1961– 73

1974– 85

rrd,y

−0.62

−0.83

−0.62

−0.25

−0.23

0.03

0.67

−0.05

0.80

rnd,rm

−0.20

−0.30

0.02

0.25

−0.12

0.35

0.01

0.23

−0.35

rnd,m

−0.19

−0.50

0.02

0.25

−0.04

0.44

−0.06

0.38

−0.44

rnd,π

−0.37

−0.91

−0.34

0.42

0.33

0.18

−0.03

−0.37

0.06

Singapore Correlation coefficient

1964– 86

1964– 73

Sri Lanka 1974– 86

1961– 84

1961– 73

Thailand 1974– 84

1961– 85

1961– 73

1974– 85

Budget deficits and economic activity in Asia

30

rrd,y

−0.05

0.26

−0.48

0.25

0.28

0.43

−0.20

−0.42

−0.05

rnd,rm

−0.20

−0.47

0.21

0.24

−0.46

0.08

0.21

0.46

−0.24

rnd,m

−0.33

−0.67

0.22

0.42

0.24

0.03

0.05

0.25

−0.23

rnd,π

−0.10

−0.29

0.25

0.47

0.00

−0.03

−0.11

0.11

−0.67

Figure 1.3 Rates of growth of reserve money, M1, and nominal deficits for six of the countries, but not quite clear for India, Malaysia, and the Philippines. These results thus correspond broadly with those from inter-country comparisons. As for the relationship between the nominal deficits and the growth of M1, it appears to be negative for the Philippines, somewhat positive for Pakistan, Sri Lanka and Thailand, and not at all clear for the rest. Finally, we consider the rate of inflation and the nominal deficits. The relationship is not any clearer in this case either. For example, in the cases of India, Indonesia, South Korea, Malaysia, and the Philippines, there are no systematic patterns, while for Pakistan and Thailand it is mostly negative, and for Singapore and Sri Lanka it is mostly positive. We thus have a whole array of movements between these two variables. The above casual empiricism about the relationships between deficits, both nominal and real, and a number of variables can be further examined by looking at their correlation coefficients in Table 1.11. The coefficients are given for the entire sample period for each country and for two sub-periods, before 1974 and since 1974, the dividing

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31

line being in terms of the first oil shock. This table would seem to confirm the conclusions suggested above. For example, the correlation coefficient between real deficit and the growth rate of real GDP ranges from positive and negative and sizeable to virtually non-existent. A similar lack of consistent patterns is evident from the correlation coefficient between nominal deficit and inflation, and nominal deficits and reserve money growth. It is clear from the discussion in this section that, contrary to popular perceptions, we cannot draw any general conclusions about the effects of budget deficits on real growth, money growth, and inflation. While the data are suggestive in some cases, the relationships are not clear-cut enough to warrant strong inferences. For this, we must turn to a more rigorous treatment of the issues. This is the subject matter of the chapters to follow.

2 Sustainability of perpetual deficits The issue to be explored in this chapter is: can the government follow a policy of perpetual primary deficits (that is, deficits excluding interest payments on federal debt) even if it wanted to? In other words, is such a policy feasible or sustainable? There is no consensus in the literature. It is generally agreed, however, that if the rate of interest at which government borrows is in excess of an economy’s growth rate, then the ratio of the debt to GNP will rise without bounds, so that a policy of perpetual primary deficits will be impossible. The same issue could also be looked at this way: if governments, like private individuals, are subject to a present-value borrowing constraint, then a policy of following a permanent primary deficit is impossible because the constraint will be violated. Thus, we have two ways of testing for the feasibility of fiscal policies practised by countries in our sample. This chapter presents evidence using both approaches.

INTEREST RATE, GROWTH RATE, AND SUSTAINABILITY In order to examine the feasibility of perpetual primary deficits according to the traditional approach, we start with the government budget constraint, given by ∆B=G−T+rB−1 (1) where B, G, T and r represent, in real terms, market value of government bonds, expenditure, tax revenue, and interest rate. It is assumed in (1) that all deficits are bond financed. Assuming that income grows at the rate g, the ratio of government debt to GNP, given by b, can be written as (2) where x is the ratio of the primary deficit G−T to GNP. Using the approximation (1+r)/(1+g)≈1+r−g, we can write (2) as b=x+(1+r−g)b−1 (3) In steady state, with constant x, g and r, we have (4)

Sustainability of perpetual deficits

33

In order to examine the stability of b*, we can solve the first-order non-homogeneous difference equation (3). The solution is given by b(t)=b*+(b0−b*)(1+r−g)t (5) It is clear that the stationary value b* is stable if g>r, and unstable if g