Inflation and fiscal deficit, the lessons of Keynes that we must remember
John Maynard Keynes, one of the greatest economists of the 20th century, is universally famous for his thesis – which revolutionized classical theory – according to which the State must increase spending, the fiscal deficit and the public debt to offset a sharp drop in consumption and private investment in times of economic depression and widespread unemployment.
Keynes noted the limitations of his doctrine. In particular, he repeatedly warned against overspending and deficit spending, due to its inflationary effects. He drew a clear distinction between current state spending, which had to be balanced with revenue, and capital investment (public works) to stimulate employment, which would be financed by increasing public debt and the deficit. He stated that a deliberate shortfall in the current expenditure budget would be “an unusual and almost desperate measure” (Collected Writings, 27:354). And in a December 1933 letter to President Franklin D. Roosevelt he wrote: "Issuing money to increase production and income is like trying to gain weight by buying a longer belt."
The British economist also said: “Through a continuous process of inflation, in an underhanded way, the government can confiscate an important part of the patrimony of the citizens. On the other hand, this confiscation occurs arbitrarily, impoverishing the population and benefiting a minority” (The Economic Consequences of the Peace).
What is understood from this paragraph of Keynes? That the person responsible for inflation is the State. The statement is crystalline, conclusive, and does not leave much room for speculation about possible "corresponsible". Added to this is something that often goes unnoticed, and that is related to the word “secretly and unobserved” that Keynes uses to describe inflationary confiscation.
The purchasing power that is lost to inflation does not disappear in a vacuum, as it seems. The losses of the citizens have their counterpart in a profit of the State, which benefits from a "liquefaction" of its debts. Without being identical, this liquefaction has a macro effect similar to a collection. Thus, the population, unknowingly and unintentionally, makes an invisible and continuous contribution to the treasury for an amount similar to the amount it loses in purchasing power. That is why inflation is a tax.
The higher the inflation, the higher the “rate” of the tax, which today collects more than VAT and income tax, according to some estimates. And, as Keynes anticipated, the higher the inflation, the higher the poverty, since inflation worsens the distribution of income by punishing the poor harder.
What must be done to reduce inflation in our country? Following the Keynesian principles outlined above, the first objective should be to achieve fiscal balance and maintain it over time, leaving behind more than half a century of chronic deficits. This is a fundamental step, although by no means the only one, towards reducing the inflation rate, stabilizing the exchange rate and increasing real wages.
Obstacles
What are the obstacles to achieving fiscal balance? In the first place, the absence of a firm political decision, from which the necessary measures are arbitrated to achieve the objective. Secondly, the magnitude of consolidated State spending, which increased from 25% of GDP, the approximate average of the last century, to a peak of 45% in the last decade. Nearly half of the national production of goods and services (registered; the informal economy does not enter, or is only partially captured, in the calculation of GDP) is used to cover public spending.
In the aforementioned period, the number of public employees doubled to 3.8 million (Nation, provinces and municipalities). Since then, the only thing the country has known is stagnation, inflation and poverty. This is a foreseeable result, since the increase in spending implied a monumental transfer of income from the productive sector of the economy to the state sector, through higher taxes, withholdings on exports and the inflationary tax.
What are the consequences of state intervention policies aimed at combating inflation through controls and subsidies? We owe Keynes an early and visionary warning of its effects: “A host of folk remedies have vainly attempted to cure the ills of the day, which – subsidies, price and rent controls, persecution of speculators, and taxes on windfall profits – eventually they became no less a part of the problems” (Essays in Persuasion, Ch. II).
In the Argentine case, the distortion of relative prices derived from the action of the State, the high cost of energy subsidies, exchange problems and the inertial effect of inflation of 50% per year (source of inflation theory multicausal) only tend to worsen over time. As our own painful experience teaches, these measures accumulate delays and deviations that later make necessary what has been called an "openness of the variables", with disastrous consequences, such as the Rodrigazo in 1975, the end of the little table in 1981, the hyperinflation of the radical government in 1989 and the exit from convertibility in 2001/2002.
What are the options for balancing public accounts? When public credit is depleted and is replaced with a monetary issue that only serves to aggravate the problems, the only way left is to increase taxes or reduce spending. The third option, which we would call “virtuous” –exiting the deficit through growth– is what we would all like. But growth depends on investment, which under current conditions is unlikely to materialize on the necessary scale.
A tax increase would be an additional stimulus for evasion and the incremental marginalization of employment, which today adds up to 7 million workers outside the system, increasing illegal competition against companies that pay their taxes on time and in due form.
In the private sector there are more black workers than white workers (adding wage earners and unregistered independent workers). Informality is no longer a peripheral issue. Today it should be seen for what it really is, a spontaneous movement of civil resistance against taxes and excessive social charges, high contingencies for litigation in the labor jurisdiction, cost of compensation for payroll reduction or temporary prohibition of it even in extreme situations; with profound consequences for the general economic order.
On the other hand, a tax increase would affect production, would make marketing more expensive, would work against the export impulse by affecting external competitiveness and would create a greater climate of discouragement for private investment, which is at very low levels, with exceptions. Far from desirable, which is the creation of additional incentives for investment and employment to increase and the country to grow again in a sustained manner.
The alternative and possible solution to tax increases, which is to reduce public spending, is a thankless task and resisted by the political system because in the short term it affects its base of electoral support, among other compelling reasons, some of ideological order.
Selective cuts
There are, however, ways to explore other than an indiscriminate reduction in spending. Without being a panacea, the OECD recommends a selective cut to avoid an extended adjustment whose political and social consequences are known. The selective criteria consists of eliminating –methodically and firmly– privileges, unsustainable cost subsidies, unjustified perks, entities whose reason for existing is questionable, oversized state bureaucracy and losses of state companies, among others. Nothing easy for a country that through decades has fostered the accumulation of these distortions to the point of making them an integral part of the system. In return, a general sacrifice of the population and a further drop in real wages would probably be avoided.
The role of the private sector
How relevant will private participation be in the framework of an eventual anti-inflation plan whose objective is to stabilize the economy and make the country grow again? Unequivocally, Keynes assigned it a central role. "It is the businessman who builds... If the entrepreneurial spirit is on, the social patrimony increases..." ("Treatise on Money", 1930).
Keynes was not ambivalent about the essential contribution of entrepreneurs, a doubly valuable acknowledgment given that he had little sympathy for them: “Capitalism is based on the extraordinary conviction that the least likable subjects, for the least virtuous reasons… work for the the common good of society”. With less humor, Keynes summarized in The Economic Consequences of the Peace: “Combining popular antipathy against entrepreneurs with the blows dealt to social security through constant alterations of the contracts between State and society, to which are added the disruptions of the patrimonial balance derived from inflation, governments make it impossible to maintain order and social stability, without having any plan” [to deal with the situation].
Have other countries' anti-inflation plans been successful under similar circumstances? The answer is clearly yes. Persistent inflation was brought down in almost every country in the world. The programs have not been the exclusive patrimony of economic orthodoxy. They were implemented by a large number of governments of different sign, including those of the left; such as that of Portugal (which reduced public spending through a judicious reallocation of budget items) and the Frente Amplio in Uruguay (which in 2012 recovered “investment grade”). The plan of the Israeli coalition government in 1985-87 was also successful. It had a lot in common with the Austral Plan. Both faced triple-digit inflation, but Israel's achieved its goals by being more consistent over time, and because the recessive shock caused by the rapid reduction of the fiscal deficit (8.7% of GDP) was cushioned by an increase in the private consumption, which had a considerable reserve of savings that, thanks to the confidence in the plan, turned to investment and consumption.
What balance does our own experience leave us? Important and sobering. There was no single or main reason for the failure of the different anti-inflationary plans that have been implemented in recent decades, but rather a series of deviations caused by ignorance, rejection or non-observance of the plan's guidelines by government officials themselves.
What is the main concern of citizens today? According to all the surveys, inflation, without individual political affiliations altering the general discouragement, which transcends those differences.
Bending inflation is an imperative that Argentina owes itself, regardless of whether or not the IMF demands it. A stabilization plan would undoubtedly have a political cost. But the cost of not putting it in place could be even higher, especially if poverty continues to grow, which can easily happen if inflation continues to rise. It is also an essential step for the gradual return of confidence in the country, an intangible whose importance cannot be exaggerated. As important or even more important than that of the investors, it is necessary, first of all, to recover the confidence of the Argentines themselves, whose greatest desire is to be able to work, progress and live in peace.