In economic matters one must always look well beyond the proclaimed purpose of any given initiative to see its ultimate effect.
— John Kenneth Galbraith, 1994

Depression fears are being raised throughout the world at the moment. The US has crafted a US$838 billion (RM3 trillion) stimulus package, with the whole world doing the same with smaller ones. The UK followed the US in earnest while Germany voiced scepticism. Even China, which is nowhere near recession yet, has launched one to address job losses and allay the fears of returning rural labourers.

In all likelihood, the US and the UK cannot afford to go on further deficit spending as both are already suffering from twin (fiscal and foreign exchange) deficits, but that is another story. The priority of the Western world now is to promote activity, get people to spend and reduce unemployment. Never mind that new houses and cars are not really needed and household savings rates has been almost zero or negative.

Malaysia has also joined the stimuli game. Gross domestic product (GDP) figures of late have been well below the target set earlier at 5.4%. Retrenchment is making the news as businesses close down or are down-sized. Bangladeshi workers totalling 55,000, recruited just before the onset of the economic storm, have had their visas cancelled. The public and, in particular, union leaders will not tolerate the large-scale entry of foreign workers in the face of job losses by locals.

We now have two stimulus budgets. The first, announced in November last year, totalled only RM7 billion while the second, unveiled in March, provided for a massive RM60 billion. One unwelcome effect of the current crisis is digit-fatigue syndrome — the inability of humans to comprehend massive, massive figures. No doubt, Malaysians would have trouble figuring the size of the RM67 billion stimuli, coming on top of the earlier 2009 budgeted federal expenditure of RM197.2 billion.

Below are some of my assessments of the fiscal stimulus package.

The Monetarist-Keynesian debate: At the outset, it should be noted that the Monetarist or Chicago school of economics does not believe that fiscal deficits-cum-massive government expenditure is a solution to an economic depression. Monetarists believe that the Great Depression (1929/39) was caused by money supply contraction. Keynesians, on the other hand, believe that money supply expansion in a depression is useless because investors no longer respond to interest rate reductions or that the interest rate mechanism becomes useless once very low rates of interest have been reached. For example, interest rates in several countries are currently approaching zero per cent. Keynesians believe that the way out of a depression is massive government spending.

The jury is still out on whether the Monetarists or Keynesians were right about the cause of the Great Depression. President Franklin D Roosevelt, who championed Keynesian ideology, embarked on massive government expenditure programmes and did manage to boost the American people’s morale. But Monetarists pointed out that between 1933 (Roosevelt’s first year as president) and 1939, there was no significant reduction in the US unemployment rate. In 1939, it was still a massive 17% and full employment was only achieved during the Second World War and post-war rebuilding of Europe.

This is not the place to assess the Monetarist-Keynesian debate. Suffice it to say that the arguments of each were inconclusive and new economic schools (supply-side, rational expectations and behavioural economics) have since emerged to cloud the debate. The point to be made is that massive government expenditure is not a silver bullet for a depression. Expenditure does not ensure success.

Malaysia’s stimulus package has one thing in common with that of the US. Both countries had sizeable deficits even before the introduction of these packages. Prior to the economic crisis, Malaysia’s federal government budget deficit was projected at 4.8% of GDP. With the second stimulus package, the deficit is now expected to be 7.6% of GDP in 2009.

We must remember that budget deficits are cumulative and compounding in their effect. If we have deficits of 5% each year over five years, we will end up with accumulated deficits of around 25% of the third-year GDP. Needless to say, interest servicing and foreign liabilities increase correspondingly with the size of government debt.

Even if we concede that stimulus packages can be beneficial, the ill effects of high budget deficits must always be borne in mind. High budget deficits bring negative effects and perceptions ranging from deterioration in credit ratings and currency flight to high inflation and currency devaluation.

Unseemly rush for “mana aku punya?” syndrome: Malaysia has another similarity with the US in respect of lobbying for one’s own economic interests. Independent power producers are adept at stopping tax increases even though some of them are enjoying overly lucrative payment terms, which are extremely troublesome for taxpayers. Similarly, some toll road concessionaires are making obscene profits in relation to their investments (the loans for which are guaranteed by the government). Both groups deserve to pay excess profit taxes. Now, this “mana aku punya?” (where’s my share) syndrome has crept into our budgetary allocation process. These interest groups, which include ministries, business chambers and non-governmental organisations, are not slow to smell the opportunities available. One gets the impression that the stimulus packages provide a “second bite” at the taxpayer’s apple for such organisations. If one had failed to persuade the Treasury with the regular budget, now is the time to try again.

Government revenue (financial resources) is a valuable thing: Having a stimulus package can make one forget that government revenue is a valuable and difficult to collect resource. Herein lies a grave danger posed by any stimulus package. The fact of the matter is that whatever the government spends has to be funded either by taxes or borrowings. Taxes are difficult to collect even in normal times. And borrowings bring along in their train interest, reduced financial credibility (when viewed as excessive) and tax burdens on future taxpayers.

Thus, even though we know that a stimulus package is intended to promote economic recovery, it is still necessary to avoid wastage, to stay away from foolish projects, to prioritise allocations efficiently, to give emphasis to positive multiplier expenditures and to think through the “permanent” implications of projects and programmes. For example, allocating money to an economic activity that is already well funded, say, biofuel research, is not going to have any stimulus effect. And beware of projects and programmes that will automatically entail expenditure well after the need for stimulus has disappeared. One example would be building mega medical facilities, which will have to be supplied with doctors, nurses and medicines well into the future. There is a natural tendency to “lower the guard” with stimulus expenditure and such laxity can extend well beyond any stimulus period.

Procurement, procedures and processes: Following the endless exposure to overpriced projects and purchases as well as clear evidence of shoddy construction (cracked land bridges, fungumous hospitals, grounded aircraft, collapsed school roofs and absconding joint-venture partners), the public is well justified for adopting a cynical, disbelieving attitude towards increased government expenditure. Nightmarish stories of exorbitant prices stick in the public imagination. The public needs assurance that the stimulus package funds will be properly spent. It takes time, skill, dedication and honesty to go about designing good buildings, setting proper product specifications, supervising construction, checking on goods supplied, avoiding overpayment and ensuring proper documentation. For this to happen, we need sound, well-trained and properly supervised professional staff in place. Merely allocating funds is not enough. We need the machinery to be in place as well to do the designing, evaluation, selection and supervision, which any procurement entails.

Use of guarantees: The second stimulus package makes considerable use of government guarantees instead of direct cash injections to minimise fiscal deficits. Of the RM60 billion, RM25 billion consists of guarantees, with the actual funds coming from banks while the government bears default risks. The thing to note is that even though initial funding for guaranteed funds does not come from the government, the risks are borne by the government and hard cash has to be paid when a default happens. Until repayment is made, the sums involved constitute contingent liability on the government’s accounts. The government officials involved should exercise care before approving any guarantees. They need to ensure that borrowers and projects are not fraudulent, proper feasibility studies are done and disbursements made after all conditions have been complied with.

Conclusion: Bringing an economy out of a depression or deep recession is much more complex and uncertain than it appears. This can be seen from the 1929 Great Depression, which was only finally resolved by the Second World War. The complexity can also be seen in the European scepticism and unwillingness to accept the Anglo-American deep-deficit solution. There is no certainty that expenditure deficits could automatically lead to increased economic activity. On the other hand, the dangers posed by excessive government deficits are much more predictable. Excessive fiscal deficits invariably lead to inflation, undermining of currency values, reduction in credit ratings, currency flight and added debt burdens on future generations. It is also clear that while spending more, one must not lose sight of the need for prudence, proper evaluation, care and supervision in handling every ringgit.

Radzuan Halim, a former merchant banker, teaches MBA and law students



This article appeared in The Edge Malaysia, Issue 752, April 27-May 3, 2009