Fiscal Responsibility - To Whom?

 
Feb 18th 2001

In the 1990s, legal restraints on government fiscal behaviour became something of an international fashion. As in much else in the world at the moment, this fashion was set by the United States, where in the mid-1980s the Balanced Budget and Emerging Deficit Control Act (Gramm-Rudman-Hollings Act) required a steady decline in the federal government's deficit to zero within a stipulated and fairly short time frame.

Such a provision is of course extreme by any standards (although some countries have pursued balanced budget policies without legal stipulation) and few other countries have opted for such an extreme measure. In any case, the special circumstances of the United States, which have allowed its economy to expand despite the more conservative fiscal stance, on the basis of large private investment-savings deficits financed by the rest of the world's savings, could not be replicated elsewhere. This meant that governments putting such firm constraints on fiscal policy would have to reckon with the possibility of deep and severe recession/deflation as a corollary to such fiscal conservatism.
 
Thus other such legislation as has taken place elsewhere has generally been more circumspect, allowing a little more flexibility to governments and emphasising that deficits can change over the course of the cycle in any case. Even the IMF, long one of the most vociferous opponents of large government deficits, increasingly recognises that fixed and rigid limits are neither feasible nor desirable and has recently allowed quite large deficits in some countries under its supervision.
 
Nevertheless, in some countries, most strikingly in the European Union, there have been similar, and self-imposed, restrictive constraints on fiscal policy in the 1990s. The Stability and Growth Pact, which was part of the Maastricht Treaty, declared that there should be a limit of 3 per cent for the total fiscal deficit to GDP ratio and a limit of 60 per cent for the public debt to GDP ratio. This was also made a condition for joining the European Monetary Union in January 1999. Just before that, it was interesting to see how suddenly a number of countries that had been showing much higher levels of the government deficit to GDP ratio (such as Italy, France and Germany) managed to get to the required level. There is more than a suspicion of widespread "creative accounting" that allowed this sudden decline in these countries.
 
The urge to have legal limits on government deficits and public debt is one that has stemmed from the greater political clout of finance in all these countries, as the financial groups that benefited from government borrowing also sought safeguards to make sure that these debts were sustainable and would be repaid. It is still very much the fear of adverse investor reaction, which would be most severely expressed by open capital flight, which dominantly drives the obsession to contain fiscal deficits across the world.
 
However, the fashion for regulating the extent of government deficit and public debt by law is one that is already rather passť. Suddenly, even in the centres of the developed world, and certainly among the countries of Europe, the virtues of government deficits in spurring growth and employment, creating important infrastructure and smoothing business cycles, are being rediscovered. And more and more developing countries are recognising that, while finance capital may desire and welcome such legally determined restraint, it is something that goes very much against the material interests of the majority of citizens.
 
The trouble is that our own economists and policy makers in India have tended to retain some of the more simplistic and actually wrong ideas even when much of the rest of the world has already discovered how problematic they are. What else can explain this government's urge to table a Parliamentary bill on "fiscal responsibility" that would incorporate some of the more restrictive features of such laws in other countries, and even go beyond them in setting conditions with highly deflationary implications?
 
It is true that financial interests in India and abroad have been proposing such legislation for some time, although even they may have been surprised at the alacrity and zealousness with which their cause has been taken up by the government. The background to the present proposed bill, and its theoretical justification, come from the Report of the Committee on Fiscal Responsibility Legislation, set up with the then Expenditure Secretary as its Chairman, which was submitted in July 2000.

 
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