How the government spends its money in Malaysia normally comes into the public eye during the yearly Budget announcement, when year-on-year comparisons can be made. But what about longer term trends?
Government expenditure forms an additive component of gross domestic product (GDP), the indicator used to assess a country’s growth and general (though disputable) economic wellbeing. Like individuals equipped with credit cards or credit facilities, how much the government spends in any one year need not be limited by the amount it will earn in that year, as long as it can repay its debt. This means that the figure for government spending can increase even in times of crisis when funds are low.
Conventional economic wisdom suggests that government expenditure should rise in times of economic crisis, as higher unemployment requires greater welfare spending to help cushion the fall. A country with well-implemented automatic stabilisers, as taxes and welfare benefits are called, will experience countercyclical fiscal policy: in good times, government spending should fall, and vice versa for bad times.
The story for Malaysia, however, appears to be the complete opposite. Government spending (the red line) closely tracks GDP growth, falling when there is a recession and rising in good times. In other words, we spend too much when times are good and are then forced to cut back when revenues fall. While causality can run both ways (that is, fiscal policy affecting GDP growth instead of the other way round), numerous papers have suggested that fiscal procyclicality is a real political economy problem, one that we should be wary about.
There is a general tendency for budgets to be structured as expansionary ‘election budgets’ with something for everyone, especially when times are good, but lessons should be drawn from the experiences of Japan (the lost decade) and the more recent credit crunch, where fiscal stimulus eventually became key to bringing countries out of recession and/or stagnation. Instead of finding the best way to fix a problem in the economy, we do not want to be caught in the trap of making the magnitude of a recession even worse.
My Pick of the Week –Quotable Quotes:
“Markets are the essence of a market economy in the same sense that lemons are the essence of lemonade. Pure lemon juice is barely drinkable. To make good lemonade, you need to mix it with water and sugar. Of course, if you put too much water in the mix, you ruin the lemonade, just as too much government meddling can make markets dysfunctional. The trick is not to discard the water and the sugar, but to get the proportions right.” – Dani Rodrik