Private investment versus deficit financing

Bangladesh is one of the few developing countries which could successfully manage its deficit financing over a long period of time. Last two decades saw one kind of financial discipline in the economy which was also an outcome resulting from the government's guarded deficit financing policy. The good thing was that the successive governments understood the adverse effects of deficit financing and wanted to limit it. The other factors leading to financial discipline were contributed by the Bangladesh Bank's prudent monetary and other policies.
Financial discipline and macroeconomic stability are, to an extent, synonym in a market economy. Almost all the economies that experienced financial indiscipline suffered from the governments' callous attitude towards the need for financial discipline. These governments were over-enthusiastic in case of public expenditure no matter what that would have meant for private sector's interest. When the government takes over the task of private sector on itself, be that in the name of public security or social security or serving more the people, then increasing deficit financing is to be resorted to in the economy raising public sector expenditure from one base to a higher one. In fact, expanding public sector expenditure puts such governments in an 'expenditure trap'.
Deficit financing is defined as an excess of expenditure over income by the government. Very few governments in the world spend within their incomes. Even some developed economies also at times turn out to be over-spenders. The resource for expanding expenditure comes normally from public borrowing. Some countries, after experiencing adverse effect of deficit financing or learning bad lessons from such financing, passed balanced budget acts compelling the governments to remain within their incomes while spending public money.
Bangladesh at one time before 1990s did not care much about financial discipline in the economy, or so to say, whether going for a big deficit or not. At that time, much smaller amount of money was used to be collected by the government - that too mostly from the customs revenues or taxes levied on imported goods. The Bangladesh economy's size was also small then and most of the areas in the economy were outside the recorded transaction domain. The main source of financing for the government was funds from the multilateral lending agencies like the World Bank, the Asian Development Bank and the IMF. Nothing was left for the government from internal source or revenue surplus. That is, all taxes and fees that were collected by the government internally were used to finance the revenue budget or giving salaries and wages to the employees of the government. It was an irony that Bangladesh could not generate any resource worth mentioning from within for its development budget before 1990s.
After two decades, things changed. The economy started generating more incomes for the government from the internal sources and that happened with a continuous growth of the economy at an average rate of 6.0 per cent of the GDP  (gross domestic product) over this period. Bangladesh is now very strongly positioned as a member of the developing countries' club with 6.0 per cent or better annual economic growth rate and with US$ 33 billion export earnings and over $ 14 billion remittances being sent by NRBs (non-resident Bangladeshis). Last two decades saw a dramatic decline in the poverty level among Bangladeshis though income inequality between the rich and the poor got widened.
Deficit financing by the Bangladesh government in the last two decades ranged between 4.0 per cent and 5.0 per cent of the GDP. This, according to economic science, is a tolerable limit. That too could have been brought down provided the government did not allow its size to grow further over this period. It is always a better option to leave the main economic activities to the private sector and the government should confine itself only to the traditional areas such as education, health care, defence, building infrastructure, etc. It seems the government has understood its functions properly and concentrated more in building infrastructure and taking care of education and health care.
But all days are not good always. For some reasons, which are mostly related to our acrimonious politics, the private sector was found to be shy in undertaking investment or playing its role in taking the economy to a higher growth path from the present level to 7.5 per cent of the GDP or beyond. Now, no policy support or prescription will be able to bring back the private sector to play its due role unless we resolve our political problems first. Should the government spend more or go for a higher deficit financing in this situation? Can the government fill up the void created by the absence of private sector investment, at least to an extent, by spending more on these areas through more public borrowing? The government's accumulated debt grew significantly overtime, but in percentage term it would seem not to be that much, simply because the Bangladesh economy also grew.
Yes, Bangladesh can go for one or two percentage points higher deficit financing if the government thinks that such an expenditure will create a multiplier effect in such a way that ultimately will prod the private sector to respond. But, no public expenditure will be enough to act as a substitute of the private sector's expenditure. Our main task should be to see how to make private sector active again in undertaking investment. The dismal situation in the private sector's investment scenario is not a natural one. It is not that the private sector is experiencing a downward business cycle condition and keeping itself off from undertaking more investment. The present situation of not undertaking investment by the private sector was created by our divisive politics. So, this problem has to be addressed first. Other economic factors also support the view that the Bangladesh government can go for a higher deficit financing.
But 'can go' and 'should go' are two different things. If the government wants to undertake more mega projects or needs to supply more resources to support the already undertaken projects, then one or two percentage point rise in deficit financing should not be seen as a matter of concern. The main concern in deficit financing is whether one deficit chases another deficit, that is, whether deficit gap is widened overtime. The main reason why the neoclassical economists view the deficit financing with scorn is that such financing is inflationary and that it undercuts the interest of private sector through crowding-out effect. Many want to say that, since our banking system is awash with idle money, if the government borrows from the system it will be neither inflationary nor will it crowd out anything. But this argument can't be supported.
The writer is Professor of Economics, University of Dhaka.
email: abuahmedecon@yahoo.com