Government budget allocation and the wellbeing of citizens | Daily News

Government budget allocation and the wellbeing of citizens

Government budget allocation and the wellbeing of citizens are very much interrelated. The material wellbeing of citizens, by and large, depends on their consumption of goods and services, which in turn depends on income and how they spend it.

The citizens allocate their income on various consumption activities while part of their income goes for saving and future investment. On average, Sri Lankans spend about 70% of their income on consumption while 30% on saving. The ability to produce and generate future income of individuals and the country depends on how individuals and government allocate income on consumption and investment. The government can influence the country’s output level by way of distributing its funds in productive investments. This article aims to examine how the various governments of Sri Lanka allocate funds and their impact on the country’s production. The writers have used modern econometric tools in quantifying the effects of fiscal allocations.

How the government spends her income

The government earns income from tax and non-tax sources and spends them on various activities. It is a conventional thing of the finance minister to present detailed information about income and expenditure for the next fiscal year. The government has recently managed to get the budget passed for the next fiscal year with the parliament’s majority votes. Meanwhile, in the Annual Report 2019 (in Box 10, p. 224),the Central Bank of Sri Lanka has emphasised the importance of effective government expenditure management with declining revenue collection. According to the report, government revenue is inadequate to cover even the expenses of recurrent expenditure. As recurrent expenditure increases uninterruptedly, capital expenditure tends to decrease, undesirably affecting the country’s long-term growth prospects. Moreover, the inflexibility in the government’s primary spending (total expenditure and net of interest payments) has created a sustained deficit in the primary balance, except in a few years in the country’s post-independence fiscal operations.

Given the above situation, it is worth closely looking at the major expenditure items, trends, and concerns? The following figure reveals how the government spent. In 2019, most of the expenditure has been used to pay interest and social services, 31% each, while economic services and general public services sectors get 22%and 16 %, respectively. The interest payment has become a heavy burden because it accounts for 48% of government revenue and 31% of expenditure. Most interest payments are going out of the country because of heavy foreign borrowings. Therefore, it has less contribution to economic progress and citizens’ wellbeing than other expenditure items such as social, economic, and general public services.

The government should not be an agent for providing jobs

The general public services sector in the figure includes salaries and wages of civil administration, defence, and public order and safety. In 2019, the government spent a massive amount of money on salaries and wages, 36% of government revenue, and 16% of total expenditure. Why the government spends an enormous amount of money on this sector? This is mainly because of the excessive hiring of workers to the government sector. In 2019, the employed population was 8.181 million, of which public sector employment accounts for 1.434 million or 17.5% of total jobs. Sri Lanka seems to have one of the largest public sector workforces in South Asia. This vast public sector workforce generates an additional burden on subsidies and transfers, including pension payments, which accounted for 26.7%. Expenditures on public sector retirees amount to about 1.5% of GDP, 7.3% of total government expenditures, and 12% of total government income. Sri Lanka has accomplished a substantial increment in labour productivity compared to its Asian peers. The writer believes that total labour productivity can further be enhanced or maintained by reducing government workers’ number.

According to the Asian Development Bank study in 2017, by 1994, the fertility rate had already moved to the replacement point of 2.1, and it continued to drop in the 2000s. Comprehensive health care facilities, together with free education up to the university level in Sri Lanka, strengthened this transformation. In 2015, the share of the senior people (65 years and above) reached 10%. The aging population’s increase will further escalate the country’s dependency ratio to 76% by 2050. The population aging will cause reasonable stress on pension and health expenditures in the years to come.

The future wellbeing of citizens and the country mostly depends on savings and investment, but not on consumption

To have a better future, individuals are saving today. The same argument applies to the government as well. If the government spends its income wisely, it should spend more funds on effective investments. Currently, the government does not save simply because it spends more than its revenue. The only ways of finding funds for the county’s investment are private savings, foreign exchange earnings (through exports, tourism, and remittances sent by about 3 million expatriates), foreign investments, aid and grants, and foreign borrowings. In Sri Lanka, private savings are not very high, and the trade balance has been negative for most of the years because of more imports of goods over exports. Then we are left with mainly foreign remittances, income from tourism, foreign investment, and borrowings. It seems that the government is heavily borrowing, and it is worth looking at how most of the borrowed and taxed money is being spent.

The following figures show how governments have allocated funds for public investment. The increasing share of recurrent expenditure items such as interest payments, salaries and wages, and pension payments continue to hinder public investment. These three sub components collectively consumed 96% of government revenue in 2019. Public investment had declined over the last decade from 27% in 2010 to 21% in 2019. The public investment consists of (a) Economic Services (Agriculture and Irrigation, Energy and Water Supply, Transport and, and Other); (b) Social Services (Education, Health, Housing, and Community Services); and (c) General Public Services (Civil Administration and Public Order and Safety).

The economic services, the most important contributor to economic growth than the other three, show a declining trend from 4.3% in 2010 to 3.2% in 2019.

Quantifying the output response of government expenditure items

To get a comprehensive understanding of the government expenditure items’ full impact on the economy, we used Structural Vector Auto-Regression (SVAR) models to measure the fiscal multipliers to quantify the effects of government expenditure on GDP. The long-term elasticity’s of various government expenditure items on GDP were estimated using Auto-Regressive Distributed Lag (ARDL). Nowadays, these econometrics techniques are widely used for this purpose. The table below provides our estimated elasticity’s, impact multiplier, and cumulative multiplier. The impact multiplier or interim multiplier is the instantaneous response of output to government expenditure increase. The cumulative multiplier is obtained by summing up the interim multiplier for ten years.

The impact of expenditure shocks depends ont he county’s characteristics, such as developmental level, nature of political and economic institutions, trade and exchange rate regime, and government indebtedness level. The estimated impact multiplier of total government expenditure is 0.03. This implies an additional one rupee spent today will increase 3 cents of GDP after one year. The cumulative multipliers hows that if one rupee spent today will increase 7 cents of GDP over ten years. The capital expenditure impact multiplier and cumulative multiplier are 0.19 and 2.11, respectively. The results suggest that capital expenditure has a positive impact, while recurrent expenditure harms GDP.

The impact multiplier for disaggregated current expenditure for general public service, social service, and economic service are 0.09, -0.03, and 0.37; while cumulative multipliers for the same items are –2.10, -1.25, and 17.49, respectively. The impact multiplier for disaggregated capital expenditure for general public service, social service, and economic service are -0.45, 0.91, and 0.31, respectively, while cumulative multipliers are -15.77, 10.60, and 4.19. Interestingly, short run and long run impact of current expenditure on economic service and capital expenditure on economic and social services have a high positive impact on the GDP. In contrast, current spending on social service and capital expenditure on general public service do not contribute to growth. One may surprise to see negative values for multipliers. We believe that the negative results are not spurious because of the country’s heavy debt burden and the outflow of funds as interest payments beyond the country’s boundaries.

Way forward

For most of post-independence years, Sri Lanka has experienced a deficit budget. Sustained budget deficits damage the growth prospects of the county in the long run. The deficit itself may not be that grave in the short run if the borrowed money has been allocated to effective and high return areas. The deficit reduction policies (increase revenue and decrease expenditure) are inevitable. This is possible by expanding the tax revenue base and identifying growth oriented essential expenditure items for funds allocation. Our research suggests that current and capital expenditure on economic services are the most beneficial government budget allocation sectors.

The allocation of the government budget is more political than economics. Therefore, it is up to the political authorities to decide whether citizens’ wellbeing should be brought to the next level of development or let go backward. The Central Bank has articulated the importance of effective management of government expenditure and suggested a way forward. It is vitally important now than ever before for the country’s economists and professionals to engage in an apolitical deliberation and educate the policymakers on the issue.

The writer is a Professor in Economics at the International University of Japan, Niigata, Japan, and the President of the Association of Sri Lankan Academics in Japan.