On the Need to Increase Government Expenditure – Wages of inequality

Source: This post on the Need to Increase Government Expenditure has been created based on the article “Wages of inequality: The income-growth gap” published in “Indian Express” on 7^th February 2024.

UPSC Syllabus Topic: GS Paper 3 Indian Economy and issues relating to planning, mobilization of resources, growth, and employment; Government Budgeting.

News: The article discusses the trends regarding budgetary expenditure. It also highlights the issues with the current fiscal policy framework of lowering expenditure (in order to lower debt-to-GDP ratio) being followed by the government.

A detailed article on Interim Budget 2024 can be read here.

What are the trends regarding budgetary expenditure?

Lower Growth in Total Budgetary Expenditure: In nominal terms, budgeted total expenditure grew by 6.1% over last year. This increase is the lowest in two decades.

Rise in Capital expenditure: It increased by 16.9% (though less than the increase last year) to Rs 11.1 lakh crore.

Decline in Revenue expenditure: It has declined by 0.8%.

Thus, according to the author, it is overall a fiscally conservative budget. It also continues to shift the composition of expenditure towards capex as has been the trend in the last few years.

What are the objectives of the present fiscal policy framework?

1) Reducing the level of debt-to-GDP: The rationale for debt reduction follows from the FRBM review committee recommendations (debt-GDP ratio of the Centre at 40%, currently at 58%).

2) Mitigating the Impact of Expenditure reduction: Here, the government has tried to shift the composition of expenditure away from revenue towards capital expenditure. This is because it has a greater impact on output (multiplier value).

What does the debt-to-GDP ratio depend on?

The debt-to-GDP ratio of any period depends on two distinct factors.

1) Gap between GDP Growth rate (g) and Interest rate on Borrowings (r): The greater g is with respect to r, the lower would be the ratio.

2) Primary deficit-GDP ratio: The lower the primary deficit-GDP ratio, the lower would be the debt ratio.

Note: Primary deficit is the difference between a government’s fiscal deficit and the interest paid on the previous year’s borrowings.

How can the Primary deficit-GDP ratio be reduced?

1) Increasing the tax-GDP ratio.

2) Reducing the expenditure-GDP ratio.

Since the tax-GDP ratio has remained almost the same, the burden of this has fallen on the second option. In other words, the target of lowering the debt-to-GDP ratio essentially means to set a limit on the expenditure growth rate.

What are the issues with this fiscal policy framework?

1) Arbitrary level of debt-to-GDP ratio target: Debt stability can be achieved even at the present level of debt-to-GDP ratio by registering a growth rate greater than the interest rate.

2) Insufficient to address Developmental Challenges: In particular, generating employment in productive modern sectors is hindered by lowering expenditure.

What is the employment situation in the Indian economy?

1) Reversal of Trends in Structural Employment Shifts: Usually, the proportion of workers engaged in self-employment (agriculture, petty retail and traditional services) shrinks and the share of wage workers in the modern sector (manufacturing and modern services) rises. However, the share of regular wage workers in the total workforce declined and then stagnated at 21%. Additionally:
a. Self-employed workforce is growing at a much faster rate compared to salaried workforce.
b. Women, in particular, have entered the workforce in large numbers, mostly into self-employment.

2) Labour Earnings have Stagnated: In real terms, regular wages and self-employment earnings have grown at just under 1% since 2017. This indicates a worsening of the income distribution as well as lack of improvements in welfare.

According to the author, addressing this will require government expenditure to rise.

Question for practice:

Why is lowering the debt-to-GDP ratio by lowering expenditure bad for the employment situation in the Indian economy?