Market Economics | Interest Rate Strategy - BNP PARIBAS ...

…average fiscal multiplier is 1, at best
Prime Minister Kan did not say that taxes would be
raised so that fiscal consolidation would bolster
economic growth (non-Keynesian effect!). His
assertion is that the government will hike taxes in
order to increase public spending to boost economic
growth. But does such rhetoric really hold up against
logic and experience? First, logic tells us that
economic entities whose income has been
appropriated by the government via higher taxes will
naturally cut back on spending. Assuming the
government does not squander the money
appropriated, the increased spending by the
government will have zero effect (the plus of
government spending will just offset the minus of
reduced spending by the taxed economic entities).
The balanced budget multiplier is 1. In truth, however,
the multiplier is probably lower as the government’s
ability to use tax money more efficiently than the
private sector is questionable.
Advocating more macro-stabilisation?
Now, if the government increases spending at a time
when there are substantial idle resources due to
recession, with the assumption being that taxes will
be hiked when the economy is expanding, the fiscal
multiplier would be higher. This could be what Kan
has in mind. But this is just a case of macrostabilisation,
which can temporarily support a falling
growth rate. Bolstering the potential growth rate is a
different matter completely. The prime minister’s
argument seems to mix up macro-stabilisation and
policies to correct structural defects.
Even if it is macro-stabilisation, there is little evidence
that the tax money spent by the government with the
aim of promoting economic growth is spent
effectively. In any event, because Japan’s huge
public debt must be repaid sometime in the future,
the fiscal multiplier should, from a long-term
perspective, be deemed less than 1. That is why we
are so adamant that, except for emergencies, fiscal
policy should never be used as economic stimulation.
Since Japan’s growth rate is low not just for cyclical
reasons but also because of structural problems,
macro-stabilisation is not the right response. The
lesson from Japan’s experience over the past twenty
years, in our view, is that repeated use of macrostabilisation
depresses the long-term performance of
the economy.
Will spending on social infrastructure bolster
potential growth?
Of course, the potential growth rate can be boosted if
the government supplies the infrastructure that
private economic entities cannot. In cases of market
failure, if the government uses income appropriated
from the private sector via tax hikes to complete
needed social infrastructure, the potential growth rate
can be raised thanks to the resulting improved
convenience and return on capital for the private
sector. But can such public investment projects really
be implemented? Unfortunately, more often than not,
the government errs in selecting projects, with the
result that the authorities’ heavy meddling in the
private sector leads to reduced return on capital for
private economic entities – in turn weighing on the
potential growth rate. There certainly are necessary
public investment projects that are never
implemented, but the reason seems not to be the
lack of money. Consequently, there is no guarantee
that tax hikes would actually translate into the
creation of social infrastructure that bolsters potential
growth.
Will spending on nursing/healthcare yield greater
economic growth?
Rather than government spending in general, let’s
consider the specific case of expenditure on
nursing/healthcare. Most people would probably
support the assertion that “tax hikes to increase
government spending on healthcare and nursing
would boost economic growth”. Since we have long
argued that a big reason why Japanese save rather
than spend is due to anxieties about the future,
linked to Japan’s deficient social welfare systems, we
do not want to reject this proposition outright. But we
have one misgiving. The overriding problem in the
nursing and healthcare sector is not the lack of
money but unnecessary government regulation that
prevents the provision of nursing and healthcare
services that people want. Thus, since the problem is
in the design of these systems, increasing
government spending alone won’t result in the
provision of better services. What is needed is
deregulation. Without it, more government spending
will just waste more money, while also weakening the
nation’s economic welfare.
Problem is unnecessary regulations, not the lack
of resources
Nursing and healthcare will not be growth industries
if they become public services funded by tax money.
Growth industries are born when service providers
appear that supply the services people are willing to
pay for. In the case of nursing/healthcare, only those
actually consuming the service are in a position to
know if they are getting value for money; the
government should not make such decisions. If the
problem is deemed to be insufficient resources and
government spending is increased, as pointed out
earlier, the economic effect will be zero, as the plus
from increased spending in nursing/healthcare will
just offset the minus of reduced spending by the
economic entities that have had income taken away
Ryutaro Kono 16 July 2010
Market Mover
19
www.GlobalMarkets.bnpparibas.com