Financing Economic Growth: Macroeconomic Perspective

The centre-point in macroeconomic analysis of countries is the growth of real national income or economic growth. Its second layer contains consumption, savings and investments. While they are the means how the national income is utilized, they are also the sources or forces that promote further growth of income. The rest of analysis covers how various market factors and external shocks including state policies affect consumption, savings and investments that result in overall movements of the economy.

In some periods, economies grow faster while some other periods are economic recessions. In general, economies undergo cycles of growth or business cycles which are connected to imbalances among consumption, savings and investments. Therefore, economic stability is considered as the core of economic management as economic volatilities or significant business cycles are not considered healthy for the public.

Economic growth

Economic growth is an estimate for the growth of the total production volume of all goods and services during a particular period, e.g., quarter or year. Economists and statisticians have developed techniques to measure the production covering various sectors such as agriculture, mining, manufacturing, trade and services. The growth of production depends on mobilization and utilization of resources such as labour, land and capital and the level of productivity. The improved productivity allows more production out of same quantity of resources.

Therefore, economic analysists look at both mobilization of resources and improvement in productivity underlying the economic growth. In general, higher economic growth reflects more opportunities for employment and income. Higher production also has favourable impact on prices or inflation in the economy. Therefore, countries seek higher economic growth to improve living standards of the public. However, whether the increase in income and employment from economic growth helps to reduce income disparities of people/households is a different line of analysis.

Consumption

Consumption is the use of income for regular spending for living such as food, clothing, rent, transport, education and health. It counts the major part of demand for goods and services produced. To keep production and economic growth, the momentum of consumption is necessary. For example, if consumption tends to fall due to whatever reasons, producers will confront a rise in their inventories/stocks that will result in cut-down of hiring labour and production in the next production cycle. Consumption depends not only on current level of income but also on expected income. Therefore, credit is extensively used to finance current consumption. For example, credit cards system facilitates current consumption based on expected future income. Bank term-credit schemes also help current consumption on high value consumer durables based future income streams of borrowers.

Consumption is categorized into government and private. Government consumption is mainly purchase of goods and services for provision of public services such as civil administration and law and order which are essential for smooth functioning of the economy and its growth. The government consumption or recurrent expenditure is about 75% of government expenditure in the national budget and about 12% of total consumption in the country.

Unlike in old economic analyses of developing countries, consumption is given a positive attitude on the economic growth process in modern economies, especially in advanced market economies. During the past decade, monetary and fiscal policymakers have been facilitating considerable increases in consumption to recover from the economic and financial downturn in the US and Europe. Japan has been in struggle during the last two decades to boost consumption to recover from the recessionary economy.

Savings

Saving is the part of income that is not consumed. In case of a person, saving may be held at hand or in financial investments at banks or capital market. In turn, such financial investment may be used by the borrowers for their consumption. However, the term “savings”, i.e., domestic or national savings, in macroeconomy is the amount of savings utilized for investments. In that sense, savings of persons whether used for consumption or investment is good for the economy. The development of financial markets and institutions promotes savings habits and enable fast and effective mobilization and utilization of savings for economic activities where savings in currency at hand reduces. Savings depends on income levels, expenditure levels and interest rates. As higher interest rates reflect the increase in opportunity cost of holding money, people tend to save more during high interest rates. In general, countries that run on large national budget deficits, government savings is negative due to consumption higher than the revenue. Therefore, private savings is required to finance both budget deficit and investments.

Investments

Investments are the spending undertaken to enhance the capacity or scale of production or capital stock. Buildings, machinery, new technology, infrastructure, research and development and commencement of new businesses fall under investment. Skill development is also a part of investment as it enhances the productivity. Spending involved in on-going production cycle is not investment as such spending is the working capital funded by cash inflows on existing production. All economies require investments to maintain and promote economic growth for better living standards for the people. A significant part of investments in countries is the government investments that primarily fund infrastructure development such as reservoirs, roads and ports that enhance the overall production capacity of the country. The government investment was 13% of total investments in 2017.

Financing of Savings-Investments Gap

Investments are financed by savings. As the majority of savers are not producers who seek to invest, a market is necessary to channel savings to investors. Some business firms may use own savings as part of investments. Banks, financial institutions and financial markets have engineered a large number of products to mobilize savings to finance both consumption and investments with varying risks and businesses among the borrowers/investors. Venture capital is the risky financial product invented to promote start-ups that have revolutionized the global economy. Liberalization of exchange controls since 1980s has led to a global financial market to trade savings cross-border.

In monetary economies, the gap between savings and investment creates significant economic instabilities. Any savings not consumed or invested causes the spending of the economy to fall short of the production and inventories/unsold production to rise above the normal level. This leads to producers to cut-down production and employment in the next production cycle as existing inventories can be utilized to supply. Similarly, increase in investments and production funded by borrowing from abroad will also increase inventories unless consumption/demand rises. Therefore, macroeconomic theory presents a view of economic stability when savings and investments are maintained at balance. Accordingly, business cycles are caused by misbehaviours of savings and investments.

In the past, economies were closed for foreign trade (goods, services and capital). Therefore, country investments were limited by its domestic savings. In low developed countries, savings was low due to low income and, in turn, income was low due to low investments. Therefore, a vicious circle of poverty based on low income, low savings, low investments and low income was a core idea in development economics. Therefore, it was suggested to increase investments to break the circle. As domestic savings was already low, governments resorted to project loans and aid from foreign governments to increase investments. Tight exchange controls prevented the private sector from mobilizing foreign capital/savings. The unitization of foreign savings is highly valid for all countries even today. See Table

Investments in Globalized Economies

Countries operating in the present globalized economy can have access to increase foreign savings for domestic investments. The development of financial markets has opened up trade of global savings for investments in forms of credit and direct investments by foreign investors across the world. New global supply chain where countries produce for foreign trade/markets has made investments effective and productive. In this environment, governments are only expected to maintain policy stance friendly for business and investments to facilitate local and foreign investors to carry out investments, production and trade on the basis of comparative advantages/productivity that vary across countries.

As a result, governments have privatized their business monopolies and now provide various fiscal/tax incentives to foreign investors to do businesses. Opening of foreign investment/business zones with necessary infrastructure largely free from local regulations has been a common policy strategy followed in many countries. Outsourcing of production processes across the countries facilitates countries to produce parts without large factories whereas only assembling factories are required in few locations. Outsourcing of global IT industry has spread to corner households and individuals who have the skills and has created wide opportunities for employment and income across the world.

Various information services such as publication of Ease of Doing Business Ranking, Corruption Perception Index, Business Sentiments Index and various other indices and academic research on trade and investments have facilitated governments to improve the policy framework and investors to select better locations of businesses.

 In this environment, a large number of countries and population have come out of poverty during the last three decades. The emergence of East Asia and China in the global economy is the classic eye-witness.

In new macroeconomics, countries can invest and grow beyond the domestic base of savings and resources if they are competitive to attract foreign savings and investments. In globalized economies, the current account deficit or surplus (balance in goods, service, factor income and remittances) in the international balance of payments (BOP) is the estimate for the gap between domestic savings and investment. The deficit is the net inflow of foreign savings/investments to finance the domestic production. The surplus is the outflow of domestic savings/investments to finance the production of other countries. The countries that have competitive advantages in financial trade can emerge as global financial centres to attract large scale of foreign savings and re-channel it to other countries while generating income and employment in the country.

Macroeconomic Policy Challenge

The BOP current account deficit is not necessarily an unfavourable sign of the economy in the growing cycle. What is necessary is to keep the deficit favourable and sustainable for the country’s growth and attraction of productive foreign investments such as direct investments that take business risks without creating debt to the economy.

Sri Lanka’s deficit was around 6% to 16% of GDP in early 1980s immediately after liberalization of the economy in 1977. Investment projects so financed are the backbone of the present domestic production and exports.

In contrast, if the deficit is due to heavy imports of consumption goods and services funded by foreign borrowing which is also a source of foreign savings, the country will end up in catastrophe in default of foreign debt whether the debtor is the government or the private sector. Although the recent deficit has been low around 2% to 3% of the GDP, it is the non-project imports that have caused a rising debt stock without favourable economic growth.

The BOP current account surplus which invests resources generated through trade of domestic resources abroad is also not a favourable macroeconomic achievement as such savings/resources are trapped in foreign countries with various risks including default. They also find difficult to repatriate such savings due to excessive domestic monetary expansion and liquidity that would be created by those proceeds. For example, China’s foreign reserve of around US$3.4 trillion invested world over including the US has become a geopolitical problem to China itself. It can no way use these resources within China.

Therefore, management of savings, investments and BOP is the fundamental in macroeconomic management of any country. It is in this context that the importance of economic and financial stability is presented. Therefore, macroeconomic managers of the countries, both public and private, have to innovate and manage their credit delivery systems to cover both domestic and foreign savings and investments to have a favourable mix of consumption and investment activities to ensure the wider stability of respective economies.

The geopolitical stability, investor/business friendliness of public policies/regulations and policy consistency are essential preconditions for macroeconomic management and stability in a global trade and investment environment. In review of developments in the past four decades and prevailing outlook in Sri Lanka, nobody can think of such preconditions to be prevailed in the next decade. Concepts of democracy presented by all those who seek or struggle to take-over the governance of the country in next decade do not offer a publicly accountable framework for financing the economic growth to guarantee the economic well-being that the majority public desperately needs. Therefore, this is the opportune time for them to present a macroeconomic policy management framework with deliverables and targets within their meaning of democracy for the votes of the public.

This gives the opportunity for them to be publicly assessed during their tenure of public governance.

(The writer is a recently retired public servant as a Deputy Governor of the CB and a chairman and a member of 6 Public Boards. In his nearly 35 years’ service in the CB, he also served as Director of Bank Supervision, Secretary to the Monetary Board and Senior Deputy Governor and authored 5 economics and financial/banking books published by the CB and more than 50 published articles)

 



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