Government spending is a critical component in the aggregate demand that drives economic growth, says Keynes ... Every RM1 of government spending is cycled through multiple hands — from contractors to material suppliers and manufacturers, service providers and all of their employees, who will then spend their salaries on food, transportation, entertainment, retail, and so on. In short, the original RM1 of spending will generate an outsized impact on GDP.
Keynesian economics theory, named after the British economist John Maynard Keynes in the 1930s, says government spending is a critical component in the aggregate demand that drives economic growth. It advocates countercyclical fiscal policy in which governments must proactively increase spending to pick up the slack in the economy during a business downcycle to maintain full employment and optimal economic output.
US President Theodore Roosevelt’s shift from orthodox balanced budget to deficit spending, which went on to end the Great Depression, was widely held as a victory for Keynesian economics. More recently, President Barack Obama passed a US$737 billion economic stimulus package in the aftermath of the financial crisis in 2009, which most believed prevented an even worse fall in economic activities.
Fiscal stimulus policy is widely accepted as the response to recession. In fact, President Donald Trump used deficit spending — by increasing federal spending and cutting taxes — to turbo-charge the US economy last year, even though it was already growing at a steady clip. Fiscal stimulus works.
But its continuous application comes at the cost of widening government budget deficit and debts, which if not properly managed, will result in unsustainable debt servicing and quite possibly, financial ruin. The long-running crisis in Greece should be a warning to all.
This is the conundrum faced by the Pakatan Harapan government after it inherited a debt of over RM1 trillion. Not addressing the issue would be financially irresponsible. Fiscal discipline and prudence would dictate some belt-tightening and putting mega infrastructure projects on hold.
However, the global economic slowdown, especially in China, and trade conflicts are already hurting export-dependent manufacturing sectors and particularly open economies like Malaysia. Fiscal management must be long-term focused and the government must be careful not to add to external pressures and end up choking the economy.
Every RM1 of government spending is cycled through multiple hands — for instance, from contractors to material suppliers and manufacturers, service providers and all of their employees, who will then spend their salaries on food, transportation, entertainment, retail, and so on. The spending becomes an income to the next person, who then spends part of it and so on. In short, the original RM1 of spending will generate an outsized impact on GDP. This is called the Keynesian multiplier.
The multiplier effect also works in reverse. This means that a cutback in government spending could end up hurting the GDP by more than each RM1 of reduction in expenditure and debt. Since budget deficits and government debts are both expressed as a percentage of GDP, austerity may in fact result in worsening deficits and debt levels, as the negative impact on GDP is even greater.
Clearly, not all spending has the same multiplier. Hence, the aim should be on reducing expenditure where the multiplier is low and diverting funds to where the multiplier is high — while keeping overall expenditure at reasonable levels. In short, focus on getting the biggest bang for the buck.
The most obvious expenditure with low to zero multiplier effect is leakage through corruption — the dollars spent that end up hidden under mattresses or worse, siphoned off to overseas bank accounts.
Incentives for the private sector to create sustainable new jobs
It was recently reported that the government is considering salary subsidies for local youth, including fresh graduates. I believe this to be an excellent type of government spending, one with a high multiplier effect.
One, money put into the hands of young Malaysians (including many who are currently unemployed) and spent on domestic goods and services will generate greater GDP impact than when the rich spend overseas or buy imported products. Also, lower-wage individuals tend to spend substantially higher portions of their incomes as compared with their higher income peers, who save more. More spending equals more economic activities.
Two, salary subsidies will also lower the initial costs and risks for businesses considering expansion and/or new ventures and aspiring entrepreneurs in start-ups. It will stimulate investments, including in new businesses, and create new job opportunities.
Three, since the salary subsidies are paid to businesses (for every new job created), it in effect, lowers operating costs and should result in higher profits. That will, in turn, translate into higher corporate taxes. In short, the government can recoup part of its subsidy spending through higher tax collections.
It is, however, critical to ensure that the new jobs created through such subsidy programmes are sustainable. In other words, we want to avoid a situation where the jobs disappear the moment the subsidies end, say, in two years’ time. And the best way to achieve this is for the project to be private sector driven.
Businesses are best positioned to decide what types of jobs are required for their new expansion and investment plans. And only they can decide the right salaries that would make economic sense for the business to be viable in the longer term.
The subsidy is not a free lunch, it is an incentive. Businesses have skin in the game — they still need to foot the balance of the payroll, even if the government subsidises say, 50% of salaries for two years. Hence, they will be motivated to make the expansion-investments work. Only then can we be assured that these newly created jobs will be retained after the subsidies end.
In short, the objective of the subsidy must be to help businesses grow and take on new risks and, in the process, create additional employment for the country as a whole.
The subsidy should not be a supplement for employees to be given on top of market-driven salaries. To do so would lift salaries beyond what the businesses can pay. This would be unrealistic and unsustainable.
In recent years, Singapore has initiated several similar schemes — such as the Wage Credit Scheme, Special Employment Credit and Career Support Programme) — where the government co-funds a portion of salaries and wage increases for citizens. A key factor is that the jobs and salaries are left to businesses to decide. There is limited micro managing on the part of the government, save for the broad eligibility parameters.
It works best when the government intervenes least.
Datuk Tong Kooi Ong is chairman of The Edge Media Group