That one per cent of nominal GDP
My take-away from the Opposition spokesman on finance's budget presentationTuesday, March 23, 2021
I watched Opposition spokesman Julian Robinson give his budget presentation on March 8, 2021, and after he was finished his proposal for a one per cent increase in nominal GDP was on my mind.
I had expected him to speak about procyclical versus countercyclical policies. Essentially, that is what his argument was: the Government needs to be less procyclical and a little bit more countercyclical. I do not think using the terms could be misconstrued as being highfalutin.
In a time of contraction, spending less and taxing more is considered procyclical. In Jamaica's case, we have had a long history of being procyclical. For the FY 2021/22 fiscal year, there are no new taxes, so that part of the procyclical test does not hold. However, it is common sense that if your economy contracted by double digits for the fiscal year ending March 31, 2021, and is still experiencing similar constraints, there is not much more to squeeze out of the poor economy.
So, let us call a spade, a spade. Let us call the policy by its correct name.
Pro-cyclical versus counter-cyclical fiscal policy
Evidence has shown that the more appropriate fiscal policy response to crises that have resulted in a significant decline in gross domestic product (GDP) is not a procyclical response, but rather a countercyclical response. In other words, instead of reducing spending and increasing taxes when there is a recession, the appropriate response is one where spending is increased and tax rates are not increased.
Following the global financial crisis, fiscal rescue packages in 2009 for 32 countries, including the G20, represented 1.4 per cent of global GDP ( Khatiwada 2009 in ADB Institute Working Paper 288 (2011); p 4). The majority of the stimulus came from G20 nations. Fiscal rescue packages tend to have three main components — infrastructure, tax breaks and transfers. While infrastructure is a big ticket item, the experience of past global recessions has been that infrastructure projects alone are not the solution since the aim is to “increase the level of aggregate demand in a timely, temporal and targeted manner” ( ADB Institute Working Paper 288 (2011); p 5).
After the global financial crisis, fiscal stimulus packages in selected Asian countries showed that the larger the projected decline in GDP, the larger the stimulus package as a per cent of GDP. Malaysia, for example, had a forecast decline in GDP of 7.3 per cent and its stimulus package was 10 per cent of its 2008 GDP ( ADB Institute Working Paper 288 (2011); p 6). Malaysia chose to focus on ( Table 6, in ADB Institute Working Paper 288 (2011); p. 12):
1. Reducing unemployment and increasing opportunities (three per cent of its fiscal stimulus package)
2. Assisting the private sector, especially SMEs (48 per cent of its fiscal stimulus package)
3. Building future capacity in terms of fiscal resilience and stimulating key sectors that had the potential to drive growth in the future (32 per cent of its fiscal stimulus package)
4. Easing the burden on the vulnerable (17 per cent of its fiscal stimulus package).
Malaysia's results showed that a one per cent rise in government expenditure resulted in a 0.35 per cent rise in its GDP or a 35 per cent multiplier effect ( ADB Institute Working Paper 288 (2011); p 13). The global financial crisis is the only relevant comparator in terms of the magnitude of GDP fallout countries have experienced with the pandemic.
Closer to home, the United States Government has been spending and plans 'more spend'. The United States will provide the following in its proposed US$1.9 trillion relief/stimulus package: increased unemployment benefits, housing assistance, health insurance subsidies and extension of programmes.
The Brookings Institute study projects that the aforementioned is estimated to have the greatest effect on GDP, increasing it by nearly 10 cents per dollar of aid in the second quarter of this year ( https://www.newsweek.com/joe-bidens-stimulus-financially-vulnerable-will-provide-biggest-boost-economy-study-1565603). The effects of the measure are expected to peak in the first quarter of 2022 at roughly 25 cents per dollar of aid. This suggests that the multiplier effect on US nominal GDP will be approximately 10 per cent, with a ceiling of 25 per cent.
Jamaica might not have the 10 per cent multiplier effect on nominal GDP for every dollar of additional GDP spent, even if we spend an additional one per cent of GDP or $21.5 billion, because our Government is not providing a comprehensive package like in the United States. This kind of multiplier effect is more likely to occur in Barbados and the OECS countries which are providing comparatively larger fiscal stimulus packages to households and firms.
Despite the differences, there is still scope to grow the Jamaican economy if the stimulus package results in greater productivity, especially among the most vulnerable where caloric intake is positively correlated with productivity.
I am not proposing that the Government acts in a fiscally reckless manner. I should disclose that I have been described as “fiscally conservative” by a number of people. As I am not a politician, I wear that hat comfortably and unapologetically.
However, the point is that there are lessons from country experiences with economic crises: in order to grow more, governments have to spend more. Economic growth expands our revenue base which allows us to contribute more from “growth” towards our financing needs as opposed to relying on debt financing.
In the Latin America and the Caribbean (LAC) region, since 2000, only Haiti and the Bahamas' growth contribution to financing needs is lower than Jamaica's ( Figure 1.5, Leaning Against the Wind, World Bank 2017; p 18). Procyclicality does not stimulate growth.
The 2017 World Bank report found that “procyclical fiscal policy in some Eurozone crises contributed to making the current crisis more socially costly (both in terms of employment and social conflict)” ( Leaning Against the Wind, World Bank 2017; p 12). Jamaica was procyclical between 1960 and 1999. Between 2000 and 2016, Jamaica transitioned into the realm of countercyclical policies — almost breaking the procyclicality trap — but Jamaica is the least countercyclical LAC country, followed by the Dominica Republic ( See Figures 2.4 & 2.5, Leaning Against the Wind, World Bank 2017; pp 31-32).
Debt sustainability is the main challenge forcing us into procylicality, but if the economy grows, debt sustainability improves. This is actually what the formula in the Fifth Schedule of the Financial Administration and Audit (FAA), the 2014 amendment, means. The level of public debt influences the fiscal balance requirement and the nominal GDP growth rate influences the level of public debt.
Nominal GDP Does not Exist in a Vacuum
To make the previous point clearer, we should all be viewing nominal GDP as a dependent variable. Nominal GDP is not a constant that is set and will not change. It is a dependent variable because in order for it to be realised, other conditions have to be met, for example nominal GDP growth. In this case, nominal GDP has to grow by 10.6 per cent, from $1,948 billions to $2,154 billions. If nominal GDP growth is less, then nominal GDP will be lower.
If we have ever needed GDP growth — both nominal and real — it is now. Fiscal consolidation or procyclicality can help with debt dynamics but if we do not grow, the 100.7 per cent public debt to GDP projection for FY 2021/22 will not occur. The ratio will be higher — a worse outcome than projected.
Important Terms to Understand
Before going into the one per cent increase in the budget proposed by Mr Robinson, it is important to understand the key fiscal policy concepts (see Fiscal Policy Paper) that could influence if the one per cent additional spend is even considered.
• The fiscal balance = revenues and grants minus expenditure. Expenditure includes interest payments on debt. The fiscal balance does not include loan receipts.
• The overall balance/deficit = (fiscal balance + loan receipts + other inflows) - (amortization + other outflows)
• The primary balance = fiscal balance + interest payments
What Does the 1 per cent Mean – The Politically Sexy Version?
The Opposition proposes that the Government: add at least another one per cent of nominal FY 2020/21GDP in expenditure to the FY 2021/22 budget. It was suggested that the primary balance target be eased to accommodate this additional spend. This means reduce it from the programmed 6.1 per cent to 5.1 per cent.
To do this, expenditure in the Fiscal Policy Paper (FPP) 2021/22 would have to increase from $667.2 billion to $688.8 billion. The fiscal balance would go from 0.3 per cent to -0.7 per cent.
What Does the 1 per cent Mean – The Politically Un-Sexy Version?
However, given the Government's proclivity to procyclicality (successive governments and not just the current one), there has to be a counterproposal. No Opposition wants to propose more debt: it is just not politically sexy. As I am not a politician, I can play devil's advocate. A one per cent of GDP increase in domestic debt or $21.5 billion, using the same FPP projections, will result in an increase in domestic loan receipts from $90 billion (4.2 per cent of 2021/22 GDP) to $111.5 billion (5.2 per cent of 2021/22 GDP). Total loan receipts would, as a result, increase from $130.3 billion (6.0 per cent of GDP) to $151.8 billion (7.0 per cent of 2021/22GDP).
The assumption, and the proposal, is: a new domestic debt issuance with no interest and amortization in FY 2021/22. The fact that it is domestic debt would insulate it from any risks associated with a devaluation of the Jamaican dollar (which currently makes US$ denominated loans more expensive for the Government).
This would also mean an increase of one per cent to the public debt stock, as a ratio of FY 2021/22 nominal GDP, holding all things equal. Domestic debt would increase from $835.8 billion (38.8 per cent of 2021/22 GDP) to $857.3 billion (39.8 per cent of 2021/22 GDP) and total debt would increase from $1268.5 billion (100.7 per cent of 2021/22 GDP) to $2190.0 billion (101.7 per cent of 2021/22 GDP).
If the Government is able to negotiate such conditions with our private sector — which is currently benefiting from its issuance of domestic debt — then the net effect (the amount/ per cent by how much public debt to GDP would decline) would go from 6.6 per cent to 5.6 per cent in that the addition to the public debt stock would be seven per cent instead of the projected six per cent, but total debt service costs would remain at 12.6 per cent of 2021/22 nominal GDP; 5.8 per cent interest and 6.8 per cent amortization on both domestic and external debt. In other words, the projected payments on interest and amortization (total debt service costs) amount to $272.2 billion or 12.6 per cent of GDP in FY 2021/22, with a net effect of 6.6 per cent — that is, the addition to the public debt stock is projected to be 6.0 per cent and total debt service costs will be 12.6 per cent. That is a net effect of 6.6 per cent (12.6 per cent -6.0 per cent).
However, if the one per cent additional expenditure is taken on, holding all other things equal, the addition to the public debt stock will be 7.0 per cent and total debt service costs will be 12.6 per cent. That is a net effect of 5.6 per cent (12.6 per cent -7.0 per cent). This means that our public debt to GDP ratio would be 101.7 per cent at the end of FY 2021/22 (provided that we achieve the nominal GDP we have projected) instead of the projected 100.7 per cent in the FPP.
It is also important to look at how the politically unsexy one per cent impacts the fiscal and primary balances.
• The fiscal balance = $672.7 billion -$667.3 billion = $5.4 billion or 0.3 per cent of FY 2021/21 nominal GDP. The fiscal balance would not change because the assumption is no additional interest on the new debt instrument for $21.5 billion.
• The overall balance/deficit = ((5.4 billion + 130.3 billion + 4.4 billion) -(146.3 billion + 17.3 Bn)) = 140.1 billion -163.6 billion = -$23.5 billion or -1.1 per cent of FY 2021/22 nominal GDP.
• When the $21.5 billion is added, the overall deficit would reduce to -$2 billion (0.1 per cent of FY 2021/22 nominal GDP): (5.4 billion + 151.8 billion + 4.4 billion) -(146.3 billion + 17.3 billion) = 161.6 billion -163.6 billion = -$2 billion
• The Primary balance = $5.4 billion + $126.0 billion = $131. 4 billion (6.1 per cent of FY 2021/22 nominal GDP).
Because our assumption is no interest payments and no amortization in FY 2021/22 on the new debt instrument, the primary balance would not change either. It would remain at 6.1 per cent.
In summary, the fiscal balance would remain at $5.4 billion (0.3 per cent) and the primary balance would remain at $131.4 billions (6.1 per cent). The overall balance/deficit would decline to -$2 billion (-.09 per cent, almost -0.1 per cent). This situation of no impact on the fiscal or primary balances can be achieved if and only if there is no interest or amortization to pay in FY 2021/22 on a new instrument for $21.5 billion. This would really be a testament to the state of the country's social partnership.
In summary, if “that one per cent” or $21.5 billion is to be spent, it is either (i) a loan, negotiated to have no interest and amortization in FY 2021/22 (social partnership with a private sector that is currently benefiting from the Govt's medium term debt strategy where more domestic debt is the strategy) so as to keep the primary and fiscal balances intact or (ii) a reduction in the primary balance by one per cent, which means substituting or deferring some planned expenditure to future years, as was done in FY 2020/21. That is the trade-off, essentially.
If the economy is not stimulated to grow, the nominal GDP target will not be met and public debt to GDP for FY 2021/22 will end up higher because of a lower denominator ie lower nominal GDP. This is even if the additional one per cent is not spent.
Based on the prime minister's presentation on March 18, 2021, the additional one per cent will not be spent. I understand the PM's hesitation but international credit ratings will not improve if fiscal sustainability is still in a precarious state. GDP growth is a factor in achieving fiscal sustainability.
The Opposition spokesman said the minister of finance, and by extension the current Jamaica Labour Party political administration, needs to be brave — is it more debt, a lower primary balance target or neither?
— Sophia Whyte-Givans is principal of SWG Research & Analytics as well as public financial management consultant with the World Bank, working primarily with disaster risk financing in the Caribbean.