Just recently I received something
interesting on Tweeter; the Second Bill of Rights proposed by U.S. President, Franklin
D. Roosevelt in 1944. Frankly, I have
never seen a better articulated set of macroeconomic objectives that is more relevant
than ever, globally.
·
The right to a useful and
remunerative job in the industries or shops or farms or mines of the Nation;
·
The right to earn enough to
provide adequate food and clothing and recreation;
·
The right of every farmer to
raise and sell his products at a return which will give him and his family a
decent living;
·
The right of every businessman,
large and small, to trade in an atmosphere of freedom from unfair competition and
domination by monopolies at home or abroad;
·
The right of every family to a
decent home;
·
The right to adequate medical
care and the opportunity to achieve and enjoy good health;
·
The right to adequate protection
from the economic fears of old age, sickness, accident, and unemployment;
·
The right to a good education.
And what’s particularly important here
is that it is a Bill of Rights, unequivocally epitomizing
a rights-based approach to development.
However, questions will immediately be raised on its financial
feasibility; in particular, where does the government get the money to satisfy
claims of millions of people? From
taxpayers? By borrowing in financial
markets? But wouldn’t this “crowd out”
private sector investment and consumption spending? Or even worse wouldn’t borrowing breach the
public debt target of 60% of GDP? And wouldn’t
government spending raise the fiscal deficit?
Hasn’t this been capped at 3% of GDP?
A move towards a rights-based approach
to development will remain a non-starter as long as answers to these questions are
sought within the framework of neoliberal macroeconomics. And this is indeed
the problem today in India; everyone agrees that we need to create a million
jobs a month – but how? Nobody seems to
have a definitive answer. It is therefore imperative to replace the narrative
of austerity by rejecting the emphasis of mainstream macroeconomics on (low and
stable) inflation targeting and in turn, on the fiscal deficit target. The only theoretically and institutionally sound
economic paradigm available today to accommodate a rights-based approach to
development is Modern Money Theory (MMT).
Not only does it bring back full employment with a job guarantee program
(MNREGA was a partial step in this direction) as the core objective of
macroeconomic policy but also allows the state to expand its role in other
social sectors.
Drawing upon the ideas of John Maynard
Keynes, MMT demystifies the institution of modern fiat money; money that is not backed by any physical asset like
gold or silver. Presently, economically
sovereign states issue their own fiat money (members of the European Monetary
Union are not in a position to do so). In
such a situation there is no limit to the currency a state can issue – all
constraints like, for instance, the Fiscal Responsibility and Budget Management
(FRBM) Act 2003 in India, are only self-imposed and not, economically speaking,
binding.
A fundamental question must be posed
here; why does the state issue money? The
state, to fulfill its objectives, must transfer real resources from the private
to the public sector. In doing so, it
issues its IOU (I owe you) or money in exchange for the resources transferred
to it. But why would the private sector
accept these IOUs (which are merely recorded in computers or pieces of
paper)? Because the private sector must settle
its obligations to the state – taxes, penalties, fines, etc. – in this money
only. This is what is meant by the term
“legal tender”; the state will accept only
its own IOUs to settle all claims made by it on the private sector. MMTers therefore assert that taxes drive money. The state does not need its own IOUs to
spend. Instead, the private sector needs
the state to spend and issue its IOUs so that it can settle tax obligations to
and other claims of the state.
Based on this fundamental insight on
fiat money, let me attempt to reveal the meaninglessness of arbitrary fiscal
deficit target numbers like 3% of GDP, which unfortunately drives macroeconomic
discourse. One has only to read through
the basis of country ratings to realize the importance accorded to this number
which has been elevated to the status of a core macroeconomic objective when it
should be considered as nothing more than a policy tool of the government. Simply put, the fiscal deficit is government
spending less its “revenues” of which taxes are a major component. In other words, the deficit comprises of injections
made by the government less what is drained out as taxes from the private
sector’s increased purchasing power accruing from these injections. When the government spends more than it sucks
out of the system, the balance adds to the money available with the private
sector to spend on goods and services. What
happens when the government runs a fiscal surplus? It sucks out more than it injects leaving the
private sector with either a liability to the government or forcing it to dip
into its stock of savings to settle tax obligations. Which option would the private sector prefer;
a fiscal deficit or surplus? A deficit, of
course.
It is also important to understand
that theoretically speaking spending by the government must come before
collection of taxes; the government collects taxes only in the unit of account
defined by it (the rupee) and the money thing specified by it (cash or reserve
money held by commercial banks with the central bank). The latter, however, can be created only when
the government spends or when the central bank (an institution of the state) does
so. Unless adequate reserve money or
cash exists in the system, it is impossible for the private sector to settle its
tax obligations to the government.
A final question; apart from making
its IOUs acceptable to the private sector, what is the function of taxes? Taxes, as we have seen, drain money or
purchasing power injected by the government spending thereby checking
inflation. A narrow income or direct tax base compels the
state to drain surplus purchasing power from a few people or companies in the
private sector thereby imposing a skewed burden on them and distorting
incentives on productive activity. To
avoid this, the state may resort to the imposition of indirect taxes to drain
purchasing power, which are, however, regressive in nature and also less
preferred than direct taxation for their distortionary effect on relative
prices particularly when differential tax rates are imposed on goods and
services.
From this simple understanding of
modern fiat money, MMT rejects the notion of arbitrary fiscal deficit target
numbers. What is important is that the
state can spend any amount of money it desires.
However, when such spending is unable to raise productivity and/or
alleviate supply-side constraints, it could result in inflation. MMT, however, implies a fundamental shift in
the narrative; at a macro level, economies face only real resource and governance
constraints, not financial constraints in their own currency. The problem therefore is not availability of money
but how effectively it is spent.
