THE ISSUE – Reducing expenditure seems best option
The issue: Will Government spending cuts solve Barbados’ economic problems?
SOLVING THE BUDGET-DEFICIT PROBLEM is a concern for many countries, said local Central Bank economists Tracy Maynard and Kester Guy in a paper on The Causal Relationship Between Government Expenditure And Tax Revenue In Barbados.
They said some economists emphasized tax increases or tax cuts while others favoured spending cuts to solve the problem of not having enough revenue to cover state expenditure.
It is an issue for the Barack Obama administration as well as most European Union governments.
According to the authors, “Escalating fiscal deficits are known to have adverse effects on an economy, varying from high real interest rates, a decline in private sector investment and an increase in the rate of inflation.
“Sargent and Wallace (1981) argued that the real driving force behind inflation is not the growth of the money supply but the level of government debt.”
They contended that “given the severe impact deficits have on the development of a country, research literature has focused on solving the problem of when a country spends more than it earns”.
“There is the widely held view that a reduction in Government expenditure is the optimal solution to solving the fiscal deficit rather than an increase in taxes.
“These advocates believe that the more a government receives in taxes, the more that government will spend, which in turn could lead to a situation where the deficit is unchanged or has deteriorated.
“This line of thought is known as the tax-and-spend hypothesis. Others argue against this, and postulated that tax increases will not lead to an expansion in spending; rather, they perceived it as a useful approach for reducing the deficit together with a contraction in government expenditure.”
As Barbados battles with its own Budget difficulties and revenue decline in the face of a slow economy, the administration is being pressed to cut state expenditure and bring down its unsustainble debt levels.
Government has accepted that cutting the deficit was necessary to return the country to a sustainable growth path and, in this connection, it has committed to significant deficit-reduction targets in its Medium-Term Fiscal Strategy.
Earlier this year the International Monetary Fund joined the chorus on this matter, going so far as to suggest a two-year public sector wage freeze as part of its prescription to bolster the nation’s sagging economy.
“The Barbadian economy has achieved modest growth only in the face of the prolonged global recession. Real gross domestic product growth will be tepid at around one per cent this year despite higher tourist arrivals, as overall economic activity is subdued.
“Similar to earlier forecasts, downside risks are mounting, especially as Barbados’ main trading partners face heightened uncertainty, while commodity prices, especially in food and fuel, continue to be at high levels,” the report noted.
“While recent measures to bolster revenues, including the hike in the value added tax rate, were bearing fruit, losses in state-owned bodies continue to be a drag, especially on the overall borrowing needs of the public sector which has become heavily dependent on the National Insurance Scheme,” the report added.
“While noting that in the current weak economy, fiscal consolidation will need to consider the need to keep priority social spending intact, additional measures will be needed and implemented quickly if the debt-to-GDP ratio is to stabilize from its high level and be further reduced over the medium term.”
The team advised adopting a wage freeze for the next two years to curb current spending, and wage restraint in the general economy to help boost competitiveness and lower inflation expectations.
The situation facing Government calls for some tough choices, including revisiting some expenditure items to see where further and more significant cuts can be made to lower the deficit.
Economist Anthony Johnson earlier this year suggested that a complete analysis of Government spending be undertaken to see what cuts could be made.
He said Government had to find ways to trim its huge expenditure bill – and not by any marginal figure – if it wanted to do the job at hand. In cutting transfers, he said, Government had to be careful it did not deprive some agencies, particularly economic sectors, of financing that was vital to the growth of the economy.
In their paper, Maynard and Guy explained that Barbados had been recording fiscal deficits since 1920, and in 1950 it was gradually reduced.
However, in recent years the deficit has been growing rapidly as Government engaged in substantial capital spending combined with increasing current expenditure.
In this regard, analyzing the interrelationship between taxation and Government spending brings to the forefront useful information that can provide a possible solution to the deficit situation.
They said the size of a fiscal deficit in an economy also played an important role in determining the level of financial assistance, if any, a country was likely to receive from major financial institutions in times of distress or economic hardship.
As they pointed out, from the perspective of policymaking and the deficit-solution debate, it appeared that reducing expenditure in Barbados should prove an optimal solution to the Budget deficit problem.