New Delhi: Fiscal discipline has broken down across the world and government spending is “highly untargeted”, including the spending seen in Europe on energy, said former RBI governor Raghuram Rajan Wednesday.
Speaking at the World Economic Forum (WEF) Summit in Davos, Switzerland, Rajan explained that part of the problem is due to “fractured” political consensus with regard to monetary and fiscal policy in countries such as the US.
“Why has fiscal discipline broken down? One argument is that we’ve had all these extraordinary crises,” he said, referring to the 2008 financial crisis, Covid-19 pandemic and the Ukraine conflict.
However, he added, “But a part of the problem is that there is a fractured political consensus in many industrial countries. That is part of the reason that the US overspent.”
The US government recorded a deficit of nearly $1.42 trillion for the calendar year of 2022 amid high inflation and repeated hikes in interest rates. This is making borrowing even more costly and has ripple effects on the global economy.
Rajan further said that spending today is “highly untargeted”, including the expenditure on energy taking place in Europe in the wake of the Ukraine conflict.
He also predicted that fiscal and monetary policies will be more in conflict than in “coordination” in the long-term.
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Need to assimilate refugees in labour force
Asked how to improve the quality of government spending, IMF deputy managing director Gita Gopinath suggested the use of digital infrastructure for better targeted spending and for developing countries in particular, to focus on raising their tax base.
“The use of digital public infrastructure has been very helpful in this matter. Countries are able to target their spending better,” she said.
“For several countries and particularly for emerging and developing economies, there is a lot that they can gain in terms of fiscal space if they are able to do more in terms of the quality of spending but also in terms of raising sufficient tax revenue,” she added.
Rajan also talked about the need to find ways to better assimilate refugees in the labour force.
“One of the things we need to do far better is to assimilate refugees in the labour force while they’re in a particular country. That would reduce the fiscal burden a lot,” he said.
“But how to do it in an effective way without creating more social conflict domestically is a really important question… is there a way to use their talents in an effective way?” he asked.
Criticism of Biden’s Inflation Reduction Act
While speaking about high government spending across the world, Rajan urged countries to pay attention to investments in clean energy, adding that this is an area that could add further stress to the public sector balance sheet.
The more you focus on incentive structures like subsidies — what that does is put the burden on the public sector balance sheet,” he said.
“Who’s going to bear the burden of green investment? The more you focus on incentive structures like subsidies — what that does is put the burden on the public sector balance sheet,” he said.
Citing the US as an example, he said the consensus in such countries is that it is too challenging to place this burden on the private sector.
He further criticised the Biden administration’s Inflation Reduction Act, signed into law last August, which includes a range of subsidies such as $3.6 billion in credit subsidy to the US’ Department of Energy for innovative clean energy technologies.
“We just saw the Inflation Reduction Act that is full of incentives. This is yet another place where fiscal [policy] needs to think very hard,” he said.
“Are we going to take the easy route and not impose some of the costs of the (green energy) transition on the private sector? Are we going to take it all on the public sector balance sheet, meaning the public sector balance sheet will have yet more burdens going forward…?” he asked.
(Edited by Smriti Sinha)
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