Country specific effects of fiscal stimulus

Ethan Ilzetzki, Enrique Mendoza, and Carlos Vegh (2011) analyze a quarterly dataset on government expenditures for 44 countries (20 high-income and 24 developing) from 1960 to 2007 and argue that the impact of government fiscal stimulus depends on key country characteristics:

1. The output effect of an increase in government consumption is larger in industrial than in developing countries. Only after a lag of two to four quarters does output rise in response to an increase in government consumption, and the cumulative output response is not statistically different from zero. Furthermore, increases in government consumption are less persistent (dying out after approximately six quarters) in developing countries than in high-income countries. But, only in developing countries is the multiplier on government investment significantly higher than the multiplier on government consumption. Thus, the composition of expenditure may play an important role in assessing the effect of fiscal stimulus in developing countries.
2. The fiscal multiplier is relatively large in economies operating under predetermined exchange rate but zero in economies operating under flexible exchange rates.The differences in the responses to increases in government consumption in countries with fixed and flexible exchange rate regimes are largely attributable to differences in the degree of monetary accommodation to fiscal shocks in these nations. The results imply that the central banks' response to fiscal shocks is crucial in assessing the size of fiscal multipliers.
3. Fiscal multipliers in open economies are lower than in closed economies. Economies that are relatively closed, whether because of trade barriers or larger internal markets, have long-run multipliers of around 1.3 to 1.4, but relatively open economies have negative multipliers.
4. Fiscal multipliers in high-debt countries are also zero. When the outstanding debt of the central government exceeds 60 percent of GDP, the fiscal multiplier is not statistically different from zero on impact and it is negative in the long run.

This might mean that in a least developed country like Nepal, the government can do a lot to jack up growth rate. First, government investment has to be high as consumption level is already high in Nepal. This means investment in infrastructures, education, health and research & technology. Second, since Nepal has a fixed exchange rate with India, and if the central bank rolls out monetary policy that is consistent with fiscal stimulus, the resulting fiscal multiplier could be large. Also, given the idle resources and massive unemployment, fiscal stimulus (with good governance on the use of money) would produce sizable impact on the economy.

About, high-debt argument, Krugman disagrees with the 60 percent of GDP threshold (Reinhart-Rogoff argue that debt over 90 percent of GDP leads to drastically slower growth. Krugman dismisses this idea.)

How to ensure stable growth in post-crisis Asia?

By raising consumption and investment or reorienting investment from tradable to nontradable sectors. These changes in investment could be facilitated by financial reforms that enhance domestically oriented firm’s access to credit, stronger incentives for corporate restructuring, policies to bolster the business climate and reduce uncertainty, and by improvements in infrastructure that raise the returns to private investment.

More on this on a paper by Nabar and Sayed 2011.

Higher food prices are here to stay

Thomas Helbling and Shaun Roache (2011) argue that higher food prices are here to stay not because of weather factors, but due to the ongoing structural change in international food markets. The weather-related supply shocks will normalize after production increases during favorable weather conditions. But, what will be hard to change is the fact that consumers in emerging and developing countries are getting richer and changing their diet, particularly eating more high-protein foods such as meat, dairy products, edible oils, fruits and vegetables, and see food. These products are more income elastic than staple grains. So, supply adjustment to the structural increases in demand for major food commodities will take more time than adjustments related to weather-related supply shocks. Improved technology and higher yield growth could compensate for the such scarcity in the long term. But, for the short term, higher food prices could find a new normal that is higher than previous thought.

What is causing the rise in food prices?

• Food is not traded as extensively and readily as manufactured goods, because of protectionist agricultural policies. Since most food is not traded, international food prices are only one determinant of domestic food inflation.
• Structural changes in diet in emerging and developing countries, i.e. more consumption of meat, and more demand for animal feed to rear cattle.
• Increasing use of food grains to produce biofuels. High oil prices and policy support (for production of biofuels) have boosted demand for biofuels. In 2010, the production of corn-based ethanol absorbed 15 percent of global corn crop. Meanwhile, high oil prices directly increase cost of production of food because fuel is used to produce inputs such as fertilizers.
• Over the past decade, global productivity growth (the amount of crop produced per hectare) has fallen for rice and wheat compared with the 1980s and 1990s. Ceteris paribus, less productivity growth means higher prices. For farmers, average prices have to increase to provide enough incentives for increased supply. But, with lower yield growth, production increases have to come from using more land (higher acreage).  Meanwhile, low yield growth and limited land availability amid rapid demand growth could lead to shifts in international trade patterns.

• Food prices are pushed up due to a series of weather-related supply shocks since mid-2010. Droughts and wildfires decreased wheat production in Russia, Ukraine, and Kazakhstan; a hot and wet summer led to lower-than-expected corn harvest in the US; and La Nina weather episodes hit rice production in Asia. Worse, shortfall in production led to the imposition of grain export restrictions in Russia and Ukraine. Patterns of protectionist trade policy has been observed after the supply shocks.
• Stock-use ratio (stocks relative to consumption) are low, causing food price volatility. Reluctant inventory holders withhold release of grains due to fear of future shortages, thus affecting food supply and prices in the market.

Public investment and economic growth

Public investment on infrastructures, education and health are prominently featured in developing country’s fiscal budget. But, how fruitful are these investments? Does increase in public investment leads to growth? The World Bank (2007) argued that public spending on infrastructure, education, and health yields positive effects on growth. Similarly, the Commission on Growth and Development (2008) noted that fast-growing countries are characterized by high public investment, defined as 7 percent of gross domestic product (GDP) or more.

Recently, Arslanalp, Bornhorst and Gupta (2010) studied the impact of public investment on economic growth for 48 advanced and developing economies during 1960–2001. They found that public investment generally has a positive impact on growth. Specifically, on average, GDP grew by 3.4 percent in advanced economies and 4.4 percent—1 percentage point more—in developing economies from 1960 to 2000. Here they summarize the main findings of their paper. They argue that the mixed result is resulting because most of the studies look at investment rate (% of GDP devoted to capital stock). However, the authors argue that the rate of growth of capital stock should be the focus. The capital stock—together with other production factors, such as labor and technology—determines an economy’s production potential. The investment flow in any given period, by contrast, determines how much capital is accumulated and therefore available for production in the subsequent period.

Tackling the issue of depreciation:

---

The value of the capital stock is calculated using the perpetual inventory method. In this method, the net capital stock—public and private—is determined by adding gross investment flows from the current period to the depreciated capital stock of the previous period. As a result, the stock data account for the wear and tear on assets.The choice of depreciation rates presents perhaps the biggest challenge to tallying the capital stock data—mainly because country-specific estimates of depreciation rates (how much of the capital stock is used up in a period) are typically not available. Instead of applying a uniform rate to all countries, we differentiate the assumed depreciation by groups of countries reflecting different types of assets typically available in those countries. These assets have different life spans, resulting in different depreciation rates. For example, concrete structures are typically estimated to last longer than assets related to technology, whose investment life may be only a few years. As countries become richer, the share of assets with shorter life spans rises, thereby raising the overall depreciation rate.

The U.S. Bureau of Economic Analysis estimates that overall depreciation rates for public capital in the United States were about 2½ percent per year in 1960 and 4 percent in 2001 (Bureau of Economic Analysis, 2010). We extended this assumption to the public capital stock estimates for all advanced economies in our sample. For middle-income countries, we used a time-varying profile in which the depreciation rate starts at 2½ percent in 1960 and reaches 3½ percent by 2001. We assumed a constant rate of depreciation of 2½ percent for low-income countries throughout the sample period. We confirmed our findings using other plausible depreciation rates.

---

---

The correlation between average public capital growth and average GDP growth is much higher than between the average public investment rate and GDP growth.

---

---

It shows that the public investment rate has been on a downward trend since the early 1970s in advanced economies. In contrast, the public investment rate increased significantly in developing countries in the 1970s, although it returned to its earlier levels in the 1980s. Public capital stock, as a percent of GDP, peaked for advanced economies in 1983 and for developing economies in 1985. The peak levels were 60 percent of GDP for advanced economies and 61 percent of GDP for developing economies.

---

How will India’s fiscal budget affect Nepali economy?

The Indian Finance Minister Pranab Mukherjee presented to the Indian parliament a fiscal budget of around US$278.38 billion for the next fiscal yar (April 1, 2011- March 31, 2012). Since Nepal shares an open border with India and has also pegged its currency with Indian rupee, the fiscal policies (both expenditure and tax) of India affect the Nepali economy as well. Here is a list of issues officials at the finance ministry in Nepal will have to grapple with while rolling out next fiscal year’s budget (July 16, 2011-July 15, 2012).

• Inflation in India (expected at 5%) will affect price levels in Nepal. The increase in purchasing power (indirectly) due to subsidies and indexing MGNREGA wages (IRs 100 in real terms) to consumer price index will not help to decrease prices of essential items; it will either maintain status quo or an increase in prices. In real terms, the Indian consumers would not lose that much. But, Nepali consumers will lose (both in real and nominal terms). Also, purchasing power of average families will increase by over IRs 2000 due to upping of personal income tax exemption (at IRS 180,000). The nominal increase in demand will further increase demand in the Indian market. If it affect general prices, then Nepal will also bear the brunt. But, if it increases real expenditure on sectors with idle resources (including travel and recreation), then Nepal might benefit.
• The increase in services tax (hotel, airfares, branded products, etc. of 10 percent) might make Nepali destinations relatively cheaper. However, nothing concrete can be said on this regards as it all depends on relative (cost of production) prices on the sectors concerned between the two countries.
• Indian farm and fertilizer subsides will affect Nepali agricultural prices as Nepal imports a lot of food products from India. Meanwhile, Nepal has agreed to eliminate Agricultural Reform Fee (ARF) for Indian agro-good, making Indian agro products further cheaper in the Nepali market. It might make some agro-products cheaper in the product market. But, it might also erode our agriculture production and employment (especially that of commercial ones).
• The decision to impose higher tariff on gold will further widen gold price differential between Nepal and India. Nepal will have to increase tariff on gold to discourage gold smuggling to India and to not let balance of payments deficit further widen.
• Similarly, prices of fuel have not been revised. So, some price differential on the two sides of the border is very likely, leading siphoning off of fuel from Nepal to India. It will not only affect domestic availability of fuel but also widen trade deficit as Nepal buys fuel at international prices from IOC and sells it in the domestic market at a little deflated price.

I will add more on later posts.

Trade and Labor Market Outcomes

---

This paper reviews a new framework for analyzing the interrelationship between inequality, unemployment, labor market frictions, and foreign trade. This framework emphasizes firm heterogeneity and search and matching frictions in labor markets. It implies that the opening of trade may raise inequality and unemployment, but always raises welfare. Unilateral reductions in labor market frictions increase a country's welfare, can raise or reduce its unemployment rate, yet always hurt the country's trade partner. Unemployment benefits can alleviate the distortions in a country's labor market in some cases but not in others, but they can never implement the constrained Pareto optimal allocation. We characterize the set of optimal policies, which require interventions in product and labor markets.

---

Full paper by Helpman, Itskhoki, and Redding (2011) here.

Highlights of India’s FY 2011-12 budget

Highlights of budget for next fiscal year (April 1, 2011- March 31,2012) presented by Indian Finance Minister Pranab Mukherjee on Monday to the parliament. Budget summary sourced from Reuters.

At US$ 1= IRs 45.18 exchange rate [100 crore = 1 billion], total estimated expenditure equals to US$ 278.38 billion, total estimated revenue (tax and non-tax) equals to US$ 174.83 billion; and total deficit borrowing (recovery of loans, other receipts and borrowing and other liabilities) equals to US$ 103.54 billion. Total estimated GDP for FY 2011-12 is US$ 1.99 trillion.

BORROWING

• Gross market borrowing for 2011-12 seen at 4.17 trillion rupees
• Net market borrowing for 2011-12 seen at 3.43 trillion rupees
• Revised gross market borrowing for 2010-11 at 4.47 trillion rupees

FISCAL DEFICIT

• Fiscal deficit seen at 5.1 percent of GDP in 2010-11
• Fiscal deficit seen at 4.6 percent of GDP in 2011-12
• Fiscal deficit seen at 4.1 percent of GDP in 2012-13
• Fiscal deficit seen at 3.5 percent of GDP in 2013-14

SPENDING

• Total expenditure in 2011-12 seen at 12.58 trillion rupees
• Plan expenditure seen at 4.41 trillion rupees in 2011-12, up 18.3 percent

REVENUE

• Gross tax receipts seen at 9.32 trillion rupees in 2011-12
• Corporate tax receipts seen at 3.6 trillion rupees in 2011-12
• Tax-to-GDP ratio seen at 10.4 percent in 2011-12; seen at 10.8 percent in 2012-13
• Customs revenue seen at 1.52 trillion rupees in 2011-12
• Factory gate duties seen at 1.64 trillion rupees in 2011-12
• Non-tax revenue seen at 1.25 trillion rupees in 2011-12
• Service tax receipts seen at 820 billion rupees in 2011-12
• Telecoms fees, auction of broadband spectrum to raise 296.5 billion rupees in 2011-12

SUBSIDIES

• Subsidy bill in 2011-12 seen at 1.44 trillion rupees
• Food subsidy bill in 2011-12 seen at 605.7 billion rupees
• Revised food subsidy bill for 2010-11 at 606 billion rupees
• Fertiliser subsidy bill in 2011-12 seen at 500 billion rupees
• Revised fertiliser subsidy bill for 2010-11 at 550 billion rupees
• Petroleum subsidy bill in 2011-12 seen at 236.4 billion rupees
• Revised petroleum subsidy bill in 2010-11 at 384 billion rupees
• State-run oil retailers to be provided with 200 billion rupee cash subsidy in 2011-12

GROWTH, INFLATION EXPECTATIONS

• Inflation seen at 5 percent in 2011-12
• Economy expected to grow at 9 percent in 2012, plus or minus 0.25 percent

TAXES

• Standard rate of excise duty held at 10 percent
• Service tax rate held at 10 percent
• Scope of service tax to be widened
• Minimum alternate tax raised to 18.5 percent from 18 percent
• Iron ore export duty raised to 20 percent
• Personal income tax exemption limit raised to 180,000 rupees

DISINVESTMENT

• Disinvestment in 2011-12 seen at 400 billion rupees

POLICY REFORMS

• Food security bill to be introduced this year
• Foreign direct investment policy to be liberalised further * Infrastructure debt funds to be created
• Infrastructure growth to be boosted with tax-free bonds of 300 billion rupees
• Foreign institutional investor limit in 5-year corporate bonds for investment in infrastructure to be raised by $20 billion
• To permit Securities and Exchange Board of India (SEBI) registered mutual funds to access subscriptions from foreign investments
• Public debt bill to be introduced in parliament soon

SECTOR SPENDING

• Infrastructure allocation increased by 23.3 percent to 2.14 trillion rupees in 2011-12
• To allocate more than 1.64 trillion rupees to defence sector in 2011-12
• Corpus of rural infrastructure development fund raised to 180 billion rupees in 2011-12
• To provide 201.5 billion rupees capital infusion in state-run banks in 2011-12
• To allocate 520.5 billion rupees for the education sector
• To raise health sector allocation to 267.6 billion rupees
• Mahatma Gandhi National Rural Employment Guarantee Scheme wage rates linked to consumer price index; will rise from existing Rs.100 per day.

AGRICULTURE

• To focus on removing supply bottlenecks in the food sector
• To raise credit flow target to agriculture sector to 4.75 trillion rupees
• Give 3 percent interest subsidy to farmers in 2011-12
• Cold storage chains to be given infrastructure status
• To provide 3 billion rupees for 60,000 hectares under palm oil plantation
• Actively considering new fertiliser policy for urea

MAJOR CONCERNS

• Food inflation remains a concern
• Current account deficit situation poses some concern
• Must ensure private investment is sustained
• "Certain events in the past few months may have created an impression of drift in governance and a gap in public accountability ... such an impression is misplaced."
• Corruption is a problem, must fight it collectively