Business Economy

Can a Government Really Stimulate Economic Activity?

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Delhi-based businessman, Tarun, examines the role of the government in stimulating economic activity. The options are limited and few. We are introducing a weekly column, every Thursday, from this week, exclusively in Different Truths.

This examines the contra thesis that a government has no role really in stimulating economic activity. In India, budgets, and statements of finance ministers are keenly watched and parsed to analyse their impact on the economy going forward. But mostly, the budget does what? Tinker with taxation here and there, and the corporate honchos then routinely praise the budgets as pragmatic, forward looking, and some such. As a common man, I want to know whether it is really affecting my life or yours.

A government engages in economic activity, by chiefly collecting taxes, and spending these on administration, social welfare, and infrastructure. As a government’s chief revenue is taxation (the other is bonds placed with the RBI and open markets), naturally, it would want to collect more taxes with each passing year, as every economic entity wishes to grow its footprint. Now, more taxes is good for the government, but it also reduces the purchasing power of the people. So, higher taxes lead to less economic activity. What about less taxes? Did any finance minister ever reduce any taxes? So, theoretically, a finance minister can stimulate economic activity, by taxing less, but never does it happen practically. What the finance ministers do, is put pressure on the central banks to reduce interest rates by .25% or .50%, and that’s it for them to stimulate economic activity. Mind you, bank rate only indirectly affects the economy, whereas, the taxation directly and immediately affects the economy.

Now, come to the expenditure part. As mentioned, expenditure has three parts – administration, social welfare, and infrastructure. While the administration is more or less systemised, with set rules for salary, pensions, government offices, etc., these would generally be the stable part year after year. That is, generally, these neither go up, nor down, unless there are disruptions like finance commissions or other such. What about social welfare? I shall come later to that. Infrastructure, now that can really affect the economic activity. Roads, ports, airports, digital structures, can really save time and money. But that is again indirect, and with long gestation periods. Still, the creation of infrastructure itself stimulates the economic activity. But where does the money come for them from? Either taxation or bonds. As we have seen, higher taxation reduces private consumption, so if infrastructure spending is financed through taxation, it has a null effect on the economy in terms of growth. Only, if it is financed by bonds, is it a stimulating economic activity.

Let’s examine the social welfare part. As the Constitution has been protective towards the weaker sections of the society, it is the bounden duty of every government to provide social welfare. This is done through subsidies, pensions, and other special schemes. Over the years, subsidies have been going up, but that does not stimulate economic activity, as the subsidies are provided to BPL families, and pensions to old people. In India, MNREGA attempts a rural regeneration, through guaranteeing employment and creating rural structures. These are mere subsistence level activities, not really creating value addition. So government’s hand is forced here.

India is a democracy. Which means that the politics here is competitive. As with every oligopoly, the political parties are forced to do marketing, to capture the attention and vote, and thus get the five-year prize of power. Social welfare was devised as a tool for the upliftment of the needy. It often takes the shape of advertisements and marketing effort of the party in power. Take for example the farm loan waiver. A social welfare alright, but extremely bad for the society, as fiscal indiscipline and social ills, get built in. Farmers are beginning to demand loan waivers as their right. One government introduced that, and others are following suit. So, social welfare, from an economic point of view, is a big drain, and thus, not an enabler to stimulate the economy by the government.

The government gets the largest attention by the populace of the country, as it is the most powerful change agent for the nation as a whole. But as we have seen, as far as economics is concerned, all it can do is reduce taxes, which it does not, so, effectively, it can never stimulate economic activity. If at all, the larger government role will only be negative for the economy as a whole.

Which brings us to the question what can the government really do? The government takes policy actions, sets up promotion boards, provides a secure environment, and very importantly, simple and enabling taxation. I cite the example of Rajiv Gandhi, here. He hurried the introduction of computers, set up regulatory authority, provided tax breaks, computer education, etc., with the result that India did get a big advantage as a computer power at the right time.

The government is merely an enabler, it can’t take over as an enterprise. We can say it helps economic activity, if works in the right spirit, but can never itself take that up.

©Tarun Gupta

Photos from the Internet

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