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Economic G rowth and Public Finance of G-20 Countries How to get it right?. By Pan Xiaoyan-Rully Prassetya - Satomi Kikuchi-Zahra Mir LKYSPP NUS December 2011. The Case.
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Economic Growth and Public Finance of G-20 CountriesHow to get it right? By Pan Xiaoyan-RullyPrassetya- Satomi Kikuchi-Zahra Mir LKYSPP NUS December 2011
The Case Effective policies to stimulate economic growth are at a premium in the G20 economies. How should G20 governments prioritize public spending and investment to generate and capitalize upon the growth opportunities of the 21st century? What reforms might spark a return to a dynamic growth trajectory? Teams should present a policy that they believe to be critical to the mid- to long-term economic health of developed economies.
Presentation Outline • Introduction • Strategies: • For boosting growth • For correcting fiscal condition • Case Study: Indonesia and South Korea • Closing
The World Economy • Several current events affecting growth: • Eurozone sovereign debt crisis • Slow economic growth in US (slow demand and high unemployment) • Decrease in china manufacturing (PMI fell to 49) • The inequality problem (e.g. the 99% movement) • Finally, low confidence in the market (consumer and business)
Low Growth Source: CIA World Fact
High government deficit Source: CIA World Fact
High debt to GDP ratio Source: CIA World Fact
Basic Strategy *Such as Australia, Brazil, Canada, China, Germany, Korea, and Indonesia
Key Strategy for Boosting Growth • Government's effect on economic growth is determined by its effect on productivity and labor supply. • Government spending on education, physical infrastructure, and research and development, for instance, could increase productivity rates--but only if government invests more competently than businesses • Research support: • ‘The problem with the euro zone was the one part of the framework that they thought they needed was limiting fiscal deficits and that was just a misguided analysis’- Joseph Stiglitz reference: http://www.bbc.co.uk/news/business-15110053 • OECD Economic Outlook, November 2011 • IMF World Economic Outlook, September 2011
Why Cutting Spending isn’t a good option? • High tax burden so adjustment needed on spending side • Pressures from population aging imply that entitlement spending will have to be reformed in many countries. This will also incentivize more people to work to increase output. • Medicare and social security. Deficit today ‘was created by out-of-control spending on everything other than entitlements’ – York, Washington examiner • Acts as a dose of fiscal stimulus in a sluggish economy • An automatic stabilizer , base line demand in downturns • Multiplier effect magnifies the stimulus
Steps (What should be done or to be prioritized) • Incentive through Tax • Give targeted tax break or tax cut; Ex.to the business who hire low income workers and unemployed youth, to non-wealthy individuals. • Incentives through spending: • Public investment (Ex. Roads, Bridges, Hospitals, Schools) • Workfare program (training and soft loan for the small businesses) • Soft loan to small business
Additional Thought • We need developing Asia (mainly China) to drive the global consumption + Reform its currency Will boost production and export in troublesome countries growth back to normal (global rebalancing). • Currently Asia contribution to world economy growth is 2.3% out of 3.9%; while China share is 1.4% • Many G-20 Countries have trade deficit with China • The developed countries have to increase their productivity and export.
Options in Correcting Fiscal Condition (Short and Medium Term) Fiscal consolidation should be done in a correct pace. Thus measures which shows commitment and credibility have to be taken.
1. Options in Correcting Fiscal Condition (Revenue) • Boosting revenue: • Improve the tax collection system. • Improve the tax structure where applicable, such as increase the tax rate of building and land tax as well as revise the VAT system. • Go after tax evaders/shadow economy. • Remove excessive tax cut, especially for the wealthy.
1.1 Improve Tax Collection System • Promote reform so that the registered tax payers and compliance rate increased. • Current tax ratio and compliance rate in G-20 Countries
1.2 Reduce Tax Evaders/Shadow Economy Source: International Herald Tribune, November 3rd, 2011
1.2 (Cont’d) • Shadow economy in European equivalent to 19.3% of its GDP From 7.9% in Switzerland to 32.3% in Bulgaria. • Suggestions: • Establish agreement with other countries (Ex. Sharing data on account holders) • Employ a high quality tax auditors so that there is no wealthy persons who don’t pay tax and no firm who evade tax (e.g. report losses to avoid tax, transfer pricing). • Tax holiday
1.3 Remove Excessive Tax Cuts for the Wealthy • Tax cut in G-20 • In USA: • Tax cut for USD 1 million or more earners is $103,835; while for $40-50,000 earners is only $909. • In 2009, 1,470 millionaires and billionaires paid zero tax. • Tax rate of warren buffet is 17.7% while for his secretary is 30%
2. Options in Correcting Fiscal Condition (Spending) • Reducing the spending: • Cut an non-urgent spending, such as military expenditure. • Improve government efficiency, such as give officials outcome-based targets and merit-based salary policies. As well as reduce uncontrolled public employment through public employment moratorium if needed. • Cut back grants and social welfare systems; Increase access to health and education (ageing-related public spending).
2.2 Improve Government Efficiency • Very crucial moreover if government propose a higher tax. • Measures: • A better functioning internal auditor and Supreme Audit Institution. • Reduce public employment if possible • Use ICT (e-government) • Reduce extravagant facilities to government top officials
2.3 Reduce Grants and Social Welfare Program • Change it to workfare program • Encourage the low earner to work (Give income support and retirement contribution) • Give funding support for employers to train their low wage workers
Case Study: Indonesia and South Korea
1. Indonesia: Crisis Background and Condition • Conditions at financial crisis: • the floating of the Thai baht in July 1997 • Rupiah began depreciating • Foreign investors withdrew their funds • Local firms with foreign borrowings sold Rupiah to purchase enough foreign currency, furthering Rupiah’s decline • The foreign debt of these local firms soared to level far exceeding their debt repayment capacity. • Indonesia’s banking sector froze • Business began shutting down • Unemployment began rising • Rapidly rising food prices • Buying power of population eroded • Social unrest erupted • 32-year Suharto presidency ended (21 May, 1998) • Major Cause: • Large capital inflows • A weakly regulating banking system • a slightly overvalued exchange rate and slowing export growth • The rapidly-growing business interests of President Suharto and his family and close associates
Crisis management • Early Stages: was widely praised • Widened the trading band on the rupiah • Sharply raised interest rates • Postponed several large investment projects • Quickly eased restrictions governing foreign direct investment • However, was badly mismanaged by both Suharto and by the IMF • Suharto’s unwillingness to enforce policies that might damage the business interests of his family and close associates, his inconsistency, and ultimately his confrontational approach undermined confidence and accelerated Indonesia’s economic contraction. • Ex: The government postponed 150 investment projects, only to announce several days later that 15 of the biggest would be allowed to go forward, which is all controlled by Suharto’s close associates.
Crisis management (Cont’d) • In mid-October 1997, the government called in the IMF: • Tighter fiscal and monetary policies. • Financial reform through bank closures. • The IMF’s lack of familiarity with the Indonesian economy and its key institutions, and its poorly conceived reform program did the economy far more harm than good.
2. South Korea: Background Seoul 1995 Seoul 1953 - 1995: GDP per capita exceeded 10,000 USD - 1996: Joined the OECD Real GDP growth rate = about 7%, Unemployment rate = around 2%
2. South Korea: Causes of the problem Korean financial crisis Crisis in Asia • Large unhedgedprivate short-termforeign currency debt Deteriorated Fiscal condition Widespread insolvency Liquidity attacks Currency depreciation • contagion Decline in market confidence financial system (banks) Other factors Weakness of financial system- Inadequate regulation and supervision - Tradition of government guarantees- Heavy governmental role in credit allocationUnhedgedprivate short-term foreign currency debt - Insufficient data - Inadequate risk assessment - Low interest rates in creditors countries - Limited exchange rate variability(substantially pegged to the US dollar) • Investment in unsuccessful projects- Some major Chaebol (conglomerate) went bankrupt • Deterioration in macroeconomic condition • US’s “strong dollar” policy -> Won was overvalued • Semiconductor (then South Korea’s main export) got much cheaper than before • Cyclical problem • Deceleration of export growth • Negative terms-of-trade
2. South Korea: Implication • Differences with current Euro crisis • Debt in private sector was the problem(fiscal condition was apparently sound before the crisis) • Borrowing in foreign currency (US dollars) • Similarities with current Euro crisis • Borrowed from IMF (-> avoided default) • Contagion: the crisis came to South Korea after other economies such as Thailand and Hong Kong got in trouble • Implication • Fundamental problem lied in structural weakness in economy … South Korea underwent reforms to tackle this problem (ex. Reform in Chaebol system) -> thought to be successful=> importance of facing at fundamental problems!
Closing • Key Principles: • Fiscal responsibility (close to zero primary balance). • Restructuring public expenditure with specific focus on demographic challenges. • Focusing spending on key areas namely education and infrastructure. • Good governance (Transparency), and • Cooperation among policy makers and Public support/understanding Political side
Closing (cont’d) • Short term priorities • Spend more (more stimulus) and improve government efficiency • Solve the euro zone debt crisis (Need greater political will and actions from the leader) • Long term priorities • Reduce the deficit • Green growth
Thank You,, Nothing could beat high productivity and responsible spending,,
