Thread by @GiladIsaacs

Here’s my latest article on South African fiscal policy. It argues that the underling logic of the @TreasuryRSA and @tito_mboweni Budget isn't supported by evidence. The risk of growth trap should be first concern.

A THREAD 1/x

businesslive.co.za/bd/opinion/202…

The overriding concern of the Budget appears to be the rising level of debt, a growing budget deficit and the cost of repaying the debt. These are all NB. Together with employment, GDP, inflation, exchange rate etc. these are key macro variables. 2/x

I am not in favour of ever rising debt and deficits, or wanton spending. At the heart of Keynesian “countercyclical” fiscal policy is the notion that a country should borrow and spend during a downturn *and* that this should taper off during periods of economic growth.

3/x

Two questions arise. 1. In the current context, should debt be the overriding concern? 2. Does the Treasury’s plan represent a viable path for reducing SA’s debt and containing deficits and debt service costs?

4/x

For limiting spending to be a viable debt reduction path then this must not cause a contraction in GDP and tax revenue, or lead to a small enough contraction that the net effect on debt is positive.

5/x

Treasury’s position:“SA's fiscal multiplier are very small (and possibly negative before the crisis)”. This implies that a change in spending has little impact on economic growth. Treasury provides no evidence to support its claim. Treasury is wishing away obvious trade-offs.
6/x

Multiplier, between 1980 and 2010, was 1.6-1.8 and ex-Treasury economist shows fiscal multiplier of 2-3 post the 2008 financial crisis. Schröder and Storm calculate a multiplier of 1.68 for 2018. This means for every rand spent (or cut) GDP increases (or decreases) by R1.68.

7/x

Therefore, cut in spending = fall in GDP = fall in tax revenue. Using current level of debt, size of the economy, tax-to-GDP ratio and interest rate on debt - a reduction in spending proposed over 2 years = *rise* in debt-to-GDP and a rise in debt service costs as a share.

8/x

The Treasury’s plan will, therefore, fail to achieve its primary objective.

9/x

Conditions impact multiplier. Large “output gap” + falling inflation = raise the multiplier. Rising debt + high level of imports = lowers the multiplier. *Expanding* fiscal spending over the next 2 yrs might mean multiplier < 1.68 (e.g. households pay down debt not spend).

10/x

But contractionary impact of *cutting* spending in the near term is likely far higher than in normal times. This is because, in the midst of a crisis, government spending is a vital lifeline to the economy. If businesses go bust now, the impact on economic growth is enormous.11/x

Coz gov spend is a component of GDP, the only circumstance in which a reduction in spending would not lead to a contraction in GDP is if the private sector increased spending by equal amount. Given the widespread economic collapse we are witnessing, this is highly improbable.12/x

For all these reasons, in the midst of potentially the country’s largest economic contraction ever, and against the stated position of the IMF, making debt the *overriding* concern of the Budget is counterproductive.

13/x

This leaves two last lines of defense for the Treasury view – that given corruption and inefficiency the state is unable to spend effectively, and that even if everything argued here is true, there is, in fact, no money available anyway.

14/x

Must take state capacity seriously. But this doesn’t change statistical reality that the multiplier is in fact larger than one – even stolen money is partially spent in the local economy. Second, it doesn’t mean we need a smaller state with less money but a better state.

15/x

That there is not endless money is true, but we don't currently face a borrowing constraint. In June, despite downgrade and global crisis, money returned to SA bond markets. If we can demonstrate sustainable path for borrowing now and reducing debt later, this can be sold.

16/x

Must begin by appreciating that, given evidence we have, Treasury’s logic doesn’t pass muster. Insufficient rescue measures now, and budget cuts in near future, will almost certainly cause a fall in GDP and tax, and a rise in debt levels, the deficit and debt service costs.

17/x

Only if Treasury – and its defenders – accept this, can we begin a sensible conversation premised on need to rescue and stimulate in the economy in the short term, requiring additional borrowing and spending, complemented by a 10-year growth-led plan to draw down the debt.

18/x

Perhaps we won’t “find the money,” although there appears little evidence of that. But the point is that Treasury has already admitted it isn’t looking very hard.

19/19 END