Economic crisis and Fiscal Stimulus by Government

recession-2008Whole world is now under the effect of recession. Although Indian government has its own fuggy definitions of recession and Mr P. Chidambaram1 still stresses out that India is not facing any recession, yet he agrees that Indian industries are facing slowdown.
Despite the constant denial of government about recession, Indian government has already issued stimulus packages of relief to the market each worth of Rs200 crores, in October and than in January, yet now again; Indian government is ready to push a new stimulus package to help economy.
Mr P. Chidambaram in his interview with The Hindu Businessline2 said

“We have to take counter-(measures) and sometimes corrective measures to ensure high domestic demand. While the government is taking fiscal measures, the RBI is taking monetary measures’

Let us see, will such fiscal stimulus can help economy?
Paul Krugman3 along with all other Keynesian economist keep stressing how Important it is for government to help market.
The idea of all Keynesian economists is people do not trust in market in the period of recession, and if market is left free in such situation, it will lead market to self-destruction, hence government should save the market.
It is also knows as consumerism. It states that spending of one individual becomes the earning of other person. Thus, spending generates income, so government should influence overall spending and encourage people to spend more. By doing so, recession can be averted.
Keynesian system works upon the theory of Potential Output4 which is the highest gross domestic product an economy can generate without increasing inflation, in a given pool of resources, that is labor, tools, technology. If the real output or GDP lags behind the Potential Output, government says it is recession.
If demand of products is not enough, it causes economic meltdown, as only some part of the pool of resources is used, other goes on waste or unemployed.
Thus, it makes sense when Keynesians says that government should do its best to maintain the demand as that will end the recession.
So what is Fiscal Stimulus?
Keynesians states that if during a recession consumers fail to spend, then it is the role of the government to step in and boost overall spending in order to grow the economy.
Yet, Government do not produce wealth so how it can increase spending? Government increases currency in the market to increase the liquidity, what it forgets is, currency is not the wealth: currency is just the tool by which we exchange wealth. There should be real wealth in order to increase spending.
Let us say a farmer produces wheat. He exchanges 20 kilogram of wheat for a pair of Kurta (shirts) from a tailor. That is, he funded for two shirts by providing 20 Kg of wheat. Wheat saves the tailor from starvation, on the other hand, Tailor funds for production of wheat by producing shirts for the farmer, which saves him against weather.
Now, the tailor needs rice and pulses too. So in order to buy rice and pulses, he decides to produce more shirts. For that, he needs more cloth, needles, and machine.
To buy more cloth, needles and machine, he pays some more shirts he produced and saved earlier. Thus, to increase his production, he needs to fund it with the real wealth he produced that is the shirts. Yet, if the production of shirt is stopped for some reason and he has no shirt to exchange for further cloth and needles, he would not be able to pay for more cloths. That will abort his idea of making further cloth and he will not be able to buy rice and pulses.recession-dec2008
Government do not produce cloths, or rice or wheat or pulses. It produces currency or note, by increasing notes or currency in market, government cannot increase wheat, cloth, rice, or pulse. By increasing currency, it will increase inflation only, or the depreciation of the currency. Here is the explanation.
To increase production, the tailor needed more saved real wealth, that is, the shirts he produced. Similarly, if the farmer wants to increase his production by buying a tractor, he needs to fund his saved wheat, the real wealth in order to exchange for a tractor. Same way, other producers must have final, saved, real consumer goods; real savings, to fund the purchase of goods and services they require. Money is just the medium of exchange it is not wealth.
When government do not produce wealth, how will governmental outlays and stimulus packages will help?
The people government will engage in the all these stimulus programs and bail outs of banks and other non-productive-activities, will further expect compensation. To pay them, government will have to increase tax on those who are still generating real wealth. Thus, it will cause further loot, and will further decrease the potential of producers. Otherwise, government will take foreign help, thus increasing national debt.
India’s fiscal deficit is already high at 11% of the GDP.
It shows that any stimulus package from government in any form will cause further deficit, further problem for India.
What can help is the real wealth stimulus from governmental stores, if government provides market with real wealth, like wheat, rice, cloths etc, it will help, but then, it will decrease the export potential. Increasing currency will not help anybody; on the other hand, it will cause further inflation.
We must not forget that government can invest only that which it robbed from us in form of compulsory taxation.
It is a general belief that Governmental regulations can avert such economic meltdown.
We know along with USA, China is also facing economic slump and so is India. Now China and India both are well regulated economy so the belief is wrong. singapore_scotts_tower
American New President Obama is hell bent to revive US economy with his new deal and new stimulus plans. As explained earlier it is all futile and may lead to further closed economy with high tax rates and weaker producers
Singapore5 on the other hand is easing down with market providing more freedom reducing taxes.
Singapore government has decided to reduce corporate tax. Government has announced property and personal tax rebates for citizens too, that is more freedom.
The new Tax Cuts will lead Singapore closure to Hong Kong and the economic freedom will provide enough attraction for investment in service and manufacturing industries. Obviously, providing market freedom and reducing governmental interference is much better than the Bail Out packages, governmental Fiscal Stimulus programs, and more regulations and increased tax.

  1. Mr P. Chidambaram,The Hindu Businessline []
  2. Mr P. Chidambaram,The Hindu Businessline []
  3. Paul Krugman, Keynesian Economist []
  4. Potential Output, Wiki Link []
  5. Singapore Tax Cuts, Bloomberg news []

6 comments for “Economic crisis and Fiscal Stimulus by Government

  1. January 25, 2009 at 7:00 am

    Nice writing. You are on my RSS reader now so I can read more from you down the road.

    Allen Taylor

  2. January 28, 2009 at 6:33 am

    Will the Obama stimulus Plan Work?

    No it won’t…why?

    let’s see

    Obama: “Will you tell me what’s wrong with the economy?”
    Jake: “What I just told you over the last three hours, is that it won’t work.”
    Obama: “Why not? Just tell me why not!”
    Jake: “Okay, I’ll tell you. You want me to be Economic Dictator?”
    Obama: “YES!”
    Jake: “And you’ll obey any order I give?”
    Obama: “Implicitly!”
    Jake: “Then start by abolishing all income taxes.
    Obama: “Oh no! We couldn’t do that! That’s not the field of production. That’s the field of distribution. How would we pay our government employees?”
    Jake: “Fire your government employees.

    - From Ayn Rand’s Atlas Shrugged, when John Galt (Jake) is held prisoner by President Thompson (Obama) and told at gunpoint he should “fix” their economy.

    Read more here—

    The Dilemma of Reserve bank of India

    The Government help for economic Crisis

  3. January 28, 2009 at 8:36 am

    This was a well written post. I agree with you on this issue. The bailout to the banks was basically rewarding failure, it also punished the good banks which did not go bust due to careful lending. America is in the middle of Obama-fever right now, a combination his own personal charisma and Bush’s incompetence. This country is already running huge budget deficits, I think he should have emphasized finding ways to cut expenditure.

  4. Siddharth
    February 2, 2009 at 4:05 pm

    I think insofar as the stimulus packages are concerned some companies deserve them because of the past taxes paid(HUGE amounts) by the big companies to the Government. However the Government cannot leverage it to nationalize these companies.

  5. February 2, 2009 at 6:38 pm

    Well, governments cannot be so honest on any plane.
    Although Singapore government is trying to be honest to maximum limits, but you will see, once the singapore economy comes above the turmoil of crisis, it will again increase taxes to make it a cyclic process.

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