With due respect, I think President Mahinda Rajapaksa needs a lesson on economics. By profession he is a lawyer and we do not expect him to know everything about economics, but since he being the Commander in Chief in regard to the nation’s economy holding the portfolio of the Minister of Finance, the nation expects him to know a little bit about economics when he interpret economic policy. This is a challenge for any president who is not an economist by profession. When the former U.S. president Richard Nixon who was a lawyer too by profession decided to abolish the Breton Woods Agreement unilaterally, he convened a summit of his economic advisers at Camp David. He carefully listened to opposing views, perhaps which is the easiest way that anybody could study a subject that he or she is not familiar with. That was a huge economic decision with global impact. Nixon learned much about economics and once he said that “We all are Keynesians now”, that was to interpret that his administration was to abandon the formally favored less-interventionist-policies.
When President Mahinda Rajapaksa declared opened the Mattala Airport he said that previously Sri Lanka borrowed from foreign countries to “eat bread” but his administration is borrowing to build infrastructure like the Mattala Airport. When I heard it I thought it was just a slip of tongue of a political leader. But he reiterated the same point a few days ago when he declared opened the new Water-Break of the Colombo Harbor. This made me to think that his opinion is not just a slip of a tongue instead it is an economic theory and policy of the government.
In economic terms what the president tries to insist is that borrowing for consumption (to eat bread) is not what he is doing; he borrows to build infrastructure which is considered as investment. His economic conclusion might be that borrowing for consumption is bad and borrowing for so called investment is good. If this was his conviction then it appears to be right but unfortunately non-revenue generating expenditure made on infrastructure is economically considered as consumption – And moreover, the expenditure made on lost making commercial ventures with borrowed money is the worst form of consumption.
In other words, if the Mattala Airport is not viable commercially at least to recover its operational cost and is required to finance its operation through the government budget, then eating bread is better than the expenditure incurred on Mattala Airport, because feeding of hungry citizens is a common interest of the nation but financially unviable commercial airport is not a common interest of the nation. The danger is that such ventures threaten the financial stability of the country than eating bread. The same is true for the Hambantota Harbor if it did not prove its financial viability at least in near future. Likewise the Mihin-Lanka is not a common interest of the nation and hence is not required to be supported by the government. The same cannot be said in regard to the Southern Highway and the new Water-Break of Colombo Harbor if those infrastructure projects can be proved to be essential to expand commerce. This means certain projects fall into the category of common interest and is required to be financed by the taxes or loans mobilized by the government, which loans will be repaid by the income of future taxes. These points might need further explanation.
Let us start from GDP because GDP (Gross Domestic Product) is a household term today. In general, when the government spends Rs. 100 the GDP will go up by Rs. 100. The reason is the government expenditure is included in GDP calculation. In fact GDP is calculated by adding up four parameters; GDP = C+I+G+NE, whereas, C=Household consumption, I=Investment, G= Government expenditure and NE= net exports (or exports- imports). Now you may easily understand why the GDP goes up by Rs. 100 when the government spends Rs. 100, because it is added up to the parameter called “G” in the above equation. Investment too, is a parameter in this equation. Is the government expenditure (G), considered as investment? No, it is considered as “consumption.” In fact the government is considered as the only institutional consumer in the economy. Is this getting complicated? Do not worry, believe me, it is easy to understand than you think.
The best quote that I could find to explain as to why we should consider the government expenditure as “consumption” was from Karl Marx. He said “tax is an income deprived to employees to pay for those in government to produce things of common interest.” As far as I know all capitalist economists agree with his notion on this particular point.
So, tax is a part of an income deprived to people. What do the people do with their income? They consume and such consumption is known as household consumption which is “C” in the above equation. Now assume that you have to pay for your child’s school. The money spent on to pay for the school is also household consumption. Instead of you paying to the school direct, you pay a sum of money out of your income to the government as taxes and the government pays for your child’s education. When you pay for your child’s education it is consumption and so is the situation when the government spent your money on your child’s education. In economics there is no difference between you paying for education or the government paying to produce educational service; both situations are accurately treated as “consumption.”
So, what is educational service? It is a common interest of the society because people need their children to be educated. According to Marx, the government is to produce services of common interests of the society and capitalist economists think that this should be done as long as such services cannot be produced on demand-and-supply basis. Also Karl Marx justifies the taxation because the people who are being taxed will be benefitted from the common interests produced by the government with taxes. The flip side of this notion is that the taxation is not justified if people in general are not benefitting from the expenditure incurred by the government.
The government has no money or income other than taxes; as such it can only consume and by no way the government can invest. One might think that if the government borrows domestically or from a foreign source, such financial resources are not taxes. It is true for the current period of accounting, but how the government is going to repay the loans? Government loans are repaid by your future taxes and that is why the loans are linked to taxes. Also one might think, that if a venture that is built on government expenditure, is generating profits, then that must be a prudent decision; unfortunately not, because revenue generating ventures or the ventures that have potential to generate revenue is not inclusive in what we call the “government.” This is the reason that the Bank of Ceylon, People’s Bank, Sri Lanka Insurance Corporation, CEB, CPC, etc., are not considered as part of the government even though such institutions are owned by the government. Therefore the rule of thumb is that the government must not spend money on commercial projects. The government must strictly spend only in producing common interests.
What are the most common common-interests? Those are general administration, judicial system, maintenance of law and order, education, health care, advanced scientific research and development, relief for poor, allowances for unusual emergencies, etc. Also certain infrastructure projects are treated as common interests. For example, road and rail network, free trade zones, essential industrial parks, harbors, airports etc., but the condition applied here is that those projects must be proved essential to expand the commerce and well-being of the people. By this definition, are the Mattala Airport, Hambantota Harbor, Highways constructed and proposed, New Water-Break of Colombo Harbor be considered as essential? If not, there is no difference between eating bread and undertaking the said projects.
As we noticed above these common interests are being produced from your taxes and taxes only. If the government reduces taxes, people will have extra sum of money which can be spent for their well-being. Therefore the general rule for the government is that it should be the most productive institution in the economy; being unproductive is a waste of tax money and tantamount to a crime. Let me explain this point a little further.
The need for a kind of general administration is a common interest and over administration is a sign for unproductivity. Having excessively large cabinet is an example for unproductivity. Also, having to hold any election before the expiration of the term is another example for unproductivity. Having the best possible rule of law is the way to increase productivity in maintaining the law and order of any country. If people know that the rule of law applies evenly to anybody, then we will see that no fanatical groups take the law into their hands. Will that reduce the cost of maintenance of law and order? Yes, it is. Would there be a shooting and killing of people in Weliweriya if the rule of law applied in giving orders to shoot? Would it save tax money and lives if the rule of law applied in dispersing demonstrators? Of course, it is. Also, as an example, let us think that the government held elections each year. This increases the expenditure of the government that needed to provide for the election commissioner. Since the government expenditure is added up in calculating GDP any increase of expenditure for elections must push the GDP up. But we know the increased election expenditure will not increase the well-being of citizens. This means the government’s wasteful expenditure results in increasing GDP without any bearing on the lives of people.
Therefore, the government must increase its productivity in all areas of its activity. Then only, people feel that their well-being is increased with the increased GDP.