In Praise of Endogenous Growth

Published on 7th July 2009

We are a bit lost in these projects worth billions of rupees announced in the budget speech of the Mauritian government. Astronomical amounts naturally titillate the minds of those who see keynesianism at work in the 2009 national budget. However, every expenditure made by the state to boost the economy is not necessarily labelled keynesian. Had it been enough to pump money in the economic system to create growth, the African continent would have already become well developed today...

This not-so-keynesian budget has rightly provided no tax incentive that stimulates consumption. When final consumption represents 90% of gross domestic product – a record level since 1976 –, it would have been unwise to reduce the rate of Value Added Tax. It is preferable to motivate enterprises to sustain their production in a way that allows employees to keep their job and maintain their consumption.

Neither has this budget brought down customs duties, ending a tradition established in previous budgets. In last year’s budget, the government forewent Rs 1.8 billion in terms of reduction in customs duties for the benefit of the population. This year, the decision to keep tariff barriers intact gives a respite to the local industry confronted with severe foreign competition.

On account of the yawning trade deficit, it would have been irresponsible to encourage imports and, consequently, the depreciation of the rupee. Although being still at a comfortable level of six months of imports, our official reserves must be well managed for the country to avoid having recourse to a credit facility from the International Monetary Fund.

Thanks in part to customs duties remaining unchanged, the budget deficit will stay within reasonable limits. With a deficit of 5% of GDP, Mauritius is among the most conservative countries in fiscal policy, in sharp contrast with the United States where the budget deficit has risen above 13%. The most important thing is that our deficit finances investment rather than consumption as it is essentially due to capital projects.

In an open economy that has macroeconomic links with other countries, the trade balance, the budget deficit, private saving and private investment are variables that are determined together. Imports constitute present consumption while exports represent future consumption. National saving remains low in Mauritius (14.3% of GDP in 2009) as much because the government budget is always in deficit as because the country exports less than it imports. The idea that the budget and trade deficits are ‘twin deficits’ has never been so true today.

Fortunately, the 2009 budget has ignored Keynes in favour of Ricardo. It underscores the ‘Ricardian Equivalence’ of taxes and budget deficits that when government increases the deficit after having reduced taxes, consumers anticipate that they will pay higher taxes later to limit public debt. Let us hope that they will augment their private saving in order to compensate for the lack of public saving.

The 2009 budget has catered for some supply side measures. The small and medium enterprises, mostly affected by cash flow problems, will have more than one billion rupees at their disposal to modernise their production equipment and to get further capital from commercial banks. In the big corporate sector, hotels and construction companies will avail of a fiscal remittance of Rs 550 million whereas profit-making banks and telecommunication firms will incur a solidarity levy to the tune of Rs 820 million.

The 2009 budget is coherent in that it revamps the Mauritian economy from the supply-side while at the same time trying to restrain the trade deficit. Such an approach can save jobs and bring in tax revenue to the state coffers. Since this budget is not really a Keynesian one, what is it then?  It appears to espouse the principles of the new classical school, illustrating the idea of endogenous growth.

We should restate the concept of growth without giving credit to neo-Malthusians who question the notion of growth, nor to economists who view growth from an accounting perspective. First, we should ignore the tyranny of statistics which defines growth simply as a real increase in GDP. When we say that overall growth is 2.5% in 2009, we do not learn anything about the diversity of growth rates within our economy. We mistakenly look at growth in a holistic manner when it has microeconomic foundations.

The sources of growth come not only from labour (quantity and quality of workers) and from capital (volume and rejuvenation of capital), but also from a third factor, the institutional factor. The accumulation of physical capital is in itself insufficient to produce unlimited growth because of the decreasing marginal productivity of capital. Instead, growth should be seen as the result of an endogenous process, the result of the deliberate actions of economic agents.  Nevertheless, the government has a role in initiating policies that influence the growth rate of the economy.

There exist a growth engine and a growth catalyst. The engine is the human capital. Knowledge helps in the production of goods and services, and accumulation of knowledge raises productivity. Per capita income can rise on the back of human capital, independently of exogenous technical progress or of population growth.

What acts as catalyst is public spending in infrastructure leading to an increase in the productivity of private assets. For this to happen, the government must tax corporate income if private firms are unable to provide the infrastructure that are essential to them to operate.

The 2009 budget contains incentives which foster endogenous growth through an efficient resource allocation. Firstly, the setting up of a new university campus and the numerous training initiatives should encourage parents to endow their children with a higher human capital by investing in their education. Secondly, businesses need only the presence of an active government that does not take away their traditional motive of profit maximisation.

When government takes the lead in cutting costs through budget restrictions, the private sector cannot get behind. The current global crisis compels every one to join into a national effort of cost consciousness and to have a social conscience.

By Eric Ng Ping Cheun

Director of PluriConseil Ltd

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