Economic Policy Review ISSN 1313 - 0544

The Government’s Spending

Author: Metodi V. Metodiev / 05.02.2009
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During the past few months the Government announced several times its intentions for big spending for a number of activities. On the other hand, the financial crisis opened a new opportunity for political spending. The big spending is defended under the so-called Government measures against the crisis.  Here the Bulgarian Government has common grounds with the new Obama administration - one part of the programs in both countries for stimulating the economy is directed towards infrastructure projects.

All of that combined with the fast distribution (only for 21 days during December 2008)  of over 4 billion levs from the fiscal reserve and with the coming elections makes me think that during the pre-election months of 2009 some additional bombastic spending could take place.

In a study by the Institute for Market Economic on the additional spending of the Bulgarian Governments during the period 2000 - 2007 it is evident that exactly the years before the parliamentary elections, namely 2000 and 2004, are the ones with the highest percentage of approved additional spending, respectively 7.7% (2000) and 7.1% (2004) compared to the expenses in the consolidated fiscal program. 

Political economy of the Government spending

By definition the politicians are attempting to defend the need for spending large amounts of money with various social endeavors or investments in various projects, thus the Government is helping business, and hence economic growth. We could find such examples in various social programs, strategies and plans (for example the project for technology parks etc.), in maintaining money losing companies (Bulgarian State Railroads), where the economic logic, by definition, claims that they must be put in private hand, because such activity is natural for the entrepreneurs and not for the state.

According to the economics lecturer at Harvard University Gregory Mankiw the logic behind governmental spending could be rephrased as follows: "If we assume that you hire your neighbor to dig a whole into your yard and than to fill it up for a $100 and than he hires you to do the same in his yard, than the official statistics will report that two new jobs have been created and the GDP has increased by $200. In reality this is a waste of time and resources, regardless which one among the two is better in this endeavor"[1].  

Wasting money does not lead to effective and rational distribution of resources. Many studies indicate that in reality the multiplier, measuring the effect of a unit of spent resource to the additional revenue received of governmental spending, is very small.  The concept of strongly positive effect of Government investments is related to the basic textbook in macro-economics, stating that the multiplier of the state expense is one and/or greater than one. In other words, if the Government spends one unit this would lead to increase by at least one unit of the income in the economy.

But what happens if the multiplier is zero, which may be the more accurate claim. Than the increase in Government spending/investment would lead to reduction in the same volume of the remaining components of the national income (savings, investments, net export). In other words the social price of every additionally spend lev by the Government is equal to one. This effect is present due to the interference of the Government with the redistribution of resources in the economy. Based on this fact stimulating specific industries have more likely a zero net effect.

It would be logical for the state to try to take fewer resources from the business and the people in the form of quasi-tax burden. That way it will stimulate the savings and investment, thus the entire economy, while the resources would be distributed very effectively. 

If we have to look for hidden political meaning, then the move by the Obama administration is very interesting, who spent much time thinking who should head the Council for Economic Policy. Finally, Christina Romer was put in charge, a person with more liberal ideas on the development of the economy.  Some of her main interests are related to the analysis of the effects of fiscal policy. One of her latest studies indicates that if the tax burden is reduced by $1, then the GDP would increase by approximately $3. In other words according to that study the multiplier of tax reductions is about 2. 

With reference to Bulgaria, I firmly believe that the debate about the economic policy must be directed not towards strategies on how to spend more and more, but towards policies leading to less interference by the Government in the economy and greater freedom to do business. I hope that at the beginning to the election year the government could take adequate long term decisions and not short term - pre-election ones.

[1] The quote is taken from an article written for the New York Times.