Last week the finance minister revised economic growth outlook indicating that the 5.4% growth estimated for 2016 is no longer achievable.
This cut on growth expectation was attributed to the decline in gold and oil production, but I have a different position why we could not attain the 5.4% GDP target.
In one of my articles in November 2015 on the government budget analysis, I stated the reason why the 5.4% growth rate was not achievable.
I asked the following question; how did the government set this GDP growth target and with what level of money supply, what level of fiscal deficit does government have to assume in order for the private sector to grow, taken into account the persistent trade deficit.
Answers to the above questions are the drivers on which to estimate the GDP target and these require a certain level of stimulus package to the private sector to engage the employment of idle resources in order to increase aggregate demand. However, the reason why government is unable to achieve this growth rate is that, Government is running an austerity program, Period!
So what is this austerity program and what are the economic implications of austerity? Ghana’s Austerity program is when the government tries to reduce the budget deficits by cutting spending and raising more taxes from the private sector. In other words, Ghana’s economic policy to pursue austerity, involves either deficit reduction, zero deficit or running budget surplus, happens when more money (cedis) flows out of the economy (ie the private sector) in the form of taxes, than flows into the economy, in the form of deficit spending.
In a simple language, austerity is an effort where the sole source and issuer of money (ie government) restricts the supply of money by cutting spending and at the same time sucking out private sector savings to reduce consumption and investment which are critical for economic growth.
The higher taxes take away spending power, and so when private businesses do not expect to sell enough to justify the full use of labor and other resources, the idle resources will remain unemployed.
The motivation to adopt austerity is to reduce government debt by increasing private sector debt (i.e. raising taxes), and to support the public sector at the expense of the private sector.
Since money, is the fuel that runs our economic engine, reducing deficit not only lowers aggregate demand but also slows down economic growth, which leads to recession and brings contractions.
It is therefore not surprising to see this economic growth target revised downwards because anyone who understands austerity program and its effect saw it coming.
Austerity (zero deficit) reduces growth, and has done and is going to do more of what it always does; that is; destroy economy, create unemployment, bankrupt the private sector, impoverish the people and widen the gap between the rich and the poor.
Austerity is the single worst economic plan in history and has never worked to increase economic growth nor bring national prosperity in any country and Ghana cannot be an exception. Ghana cannot tax itself into prosperity, and cannot grow without money growth.
The combination of more taxes and more outside borrowing when the balance of payments is negative will definitely lead to contraction, while giving false impression of the government being financially wise.
More borrowing from outside will inevitably lead to declaring Ghana as HIPC or bankrupt.
Therefore, ignore any Ghanaian politician who wants to pursue austerity programs and at the same time also promises to create jobs, grow the economy as well as improve the standard of living of people.
Such promises are empty because they would not be able to deliver; the two (austerity and economic growth) does not work together.
Mathematically, austerity always decreases GDP.
There is no mathematical formula that will demonstrate a decrease in government spending and/or an increase in taxes to have a positive effect on GDP.
If the government of Ghana takes more cedi out of the economy than it puts in (ie government running balance or surplus budget), how is it supposed to make the economy grow?
No serious economist knows how that works, except perhaps in the finance minister’s economics where he promises to grow the economy and create more jobs under an austerity plan; what an upside-down economics?
Stated differently, austerity has one purpose and the only purpose is to widen the gap between the rich and the poor.
If government of Ghana succeeds in collecting more taxes from any group of people, (both rich and poor), the poor are the ones that are hurt the most.
In order to explain this concept very well, let’s suppose the Government spends Ghc100 and taxes Ghc100; (where Government Spending Equals = Taxes) we called this situation balanced budget or zero deficit government is pursuing. In this case the private sector does not save, accumulates nothing (ie zero savings). This is because; every money that flows into the private sector is taken away by government through taxes. On the other hand, if Government spends Ghc100 and taxes GHc80; (where Government Spending is Greater than > Taxes), the difference of Ghc20 (Ghc100-Ghc80), is private sector saving which can accumulate as financial assets.
The government deficit of 20 is exactly equal to the private sector savings of Ghc 20 which would be sitting as a bank deposit, created by the government deficit spending.
In this case, the private sector accumulates that Ghc20 as savings (ie money the Government has not collected via taxes) and this is like stimulus for the private sector to spend and invest to grow the economy.
Finally if the government spends Ghc 100 and Taxes Ghc120, (where Government Spending is Less Than <Taxes), also called Government budget surplus, meaning more money has been taken from the economy (called the private sector), the private sector would owe the government a net tax payment of Ghc20, which means the private sector disposable income would fall.
The private sector would also need to sell something back to the government to pay off its debt, thus depleting the private sector stock of wealth.
This situation sends the private sector into debt, bankrupts and eventually collapses the private sector.
Therefore, in a closed economy (where the unit of account and the medium of exchange is cedi i.e. no foreign money).
Government Deficits = Net Private Savings (Surplus).
When one side of the equation runs a deficit, the other side runs a surplus. So ask yourself and the politicians, when the government runs a deficit, who then runs the surplus? – it is the economy, or what we call the private sector.
The government economic plan of having zero deficits has reduced the money supply, caused shortage of money and is starving Ghana’s growing economy (private sector) of money.
Put it differently,
Government surplus = a deficit for the private sector. In other words, running Government budget surplus is an economic deficit.
This equation is an accounting fact that for every debit, there is a credit; for every deficit, there is a surplus; for every lender, there is a borrower; for every outflow, there is an inflow; for every sale, there is a purchaser. The equation shows that deficits are the ultimate source of all cedis for savings, therefore efforts to reduce deficits at this time when Ghana imports more than exports is an economic suicide.
No economist will dispute this equation because it is an accounting description of how Ghana’s cedi flow.
If there were no deficits there would be no cedis and your net savings would be zero.
In an open economy, Government Deficits + Net Exports = Private Sector Saving (Surplus). When we reduce Government deficits, we reduce private sector saving, a circumstance that negatively impacts the economy especially when we have current account deficit (money leaving the country) of 8.1% of GDP in 2015.
Given that the government is determined to reduce the fiscal deficit to zero, which will involve reducing government spending and increasing taxes.
What do you think will happen to Gross Private Investment, the total of Investment and saving, and the effects on the GDP? The private sector will not have spendable or disposable money to purchase goods and services and for the businesses to invest and expand.
Obviously, they will be in deficit, indebted and become bankrupt.
This economic plan is weakening the financial system and the evidence is clear when BOG released capital adequacy ratios for the month of May (capital adequacy ratios are falling from 17.9% in Jan to 16.6% in May 2016) due to a lot of non-performing loans which has now reached 19.3% in May 2016 as one of the highest since 2010.
Every day, companies are folding up and many businesses are complaining about weak sales volumes, the private sector is collapsing due to lack of money as a result of this austerity program.
Ghana’s deficit reduction program stems from the belief that government income pays for government spending.
This thinking, however, is outmoded in our sovereign country which issues its own currency.
Government does not need to have tax money before it can spend, because taxes are not meant to finance government projects.
On the other hand, the private sector (You and I and the businesses) need to have income in order to spend.
That is the big difference government has to understand.
Government and private sector finances are not the same and any attempt for government to run its finances just like the private sector will be economically suicidal.
If businesses and private individuals do not add money to the economy, the total amount of money in the economy remains static.
When the total amount of money in the economy remains static, the smallest inflation reduces the real value of money in the economy.
In an ideal situation, for an economy to grow, the money supply must exceed or keep up with the population growth, inflation and the current account deficit (ie net money flowing out of the country) to accommodate the loss of value of money. Remember that, the inflation we have in Ghana is not “too much money chasing few goods’, rather, it is factor cost inflation or cost push inflation.
Let’s use the 2015 macro-economic figures to estimate how much cedi supply we need in the country.
We all know that, in a perfect situation
- when the real value of money in our economy falls, the economy experiences a contraction. When inflation goes to 17.5%, the total amount of real money in the economy will decline by 17.5%, unless more cedi (money) is created to make up for the loss of value. An inflation of 17.5% in 2015, against a total money supply of Ghc 46,455 billion, reduced the purchasing power or costs to Ghc 8,130 billion in real money, in 2015.
- Further, when the population increases 3%, the amount of money (cedis) per person decreases by 3%, unless more money (cedis) is created to make up for the shortage. Today’s 3% population growth costs another Ghc 1,394 billion in per capita money.
- Therefore in 2015, with inflation at 17.5% and population growth at 3%, just to accomplish zero or no growth economy, we needed (1.175 x 1.03 = 1.21) or about 21% of money growth.
This does not take into consideration the outflow of money due to a negative current account (mostly the difference between exports and imports).
A negative current account increases the need for deficit spending.
- The current account deficit (more money ie dollars leaving the country than entering the country) in 2015 was $2,927 billion, or 8.1% of the GDP cost about Ghc3.8billion, which brings the per-person total money (ie government plus all private sector) creation requirement to nearly 31% (1.175 x 1.03 x 1.081).
- The 17.5% inflation, against a total money supply of ghc46.5 billion, costs ghc8.13 billion in real money, in 2015. Today’s 3% population growth costs another Ghc1.39 billion in per capita money. When the Ghc3.76billion current account deficit is included, the money supply should have gone up by Ghc14.3 billion or nearly 31% just to break even, for a no-growth economy. Therefore, to achieve 5.4% economic growth in 2016 (ie
is to grow 5.4%), requires money growth rate above 38% in 2016. That is to say, the supply of money must have grown at least 38%. (1.175 x 1.03 x 1.081 x 1.054 = 37.9%).
However, by the end of 2015, total money growth had grown only by 26%, which was less than necessary for ongoing zero growth.
In short, the economy had become starved for money (also called “liquidity or credit crunch”), which is the root of today’s problems. Obviously, the economy is far more complex than one simple equation, and other factors may stimulate or repress economic growth.
But fundamentally, significant money growth is required for economic growth. If you remember, the private sector and most banks were going through tough liquidity challenges in 2015.
A similar analysis was done for 2013 and 2014 and the results confirmed a high demand for money by the financial institutions, therefore putting pressure on the interest rate and exchange rate.
Since February 2016, Central Bank is working hard to lower interest rate but the financial institutions are competing desperately to take fixed deposits at any rate with some even promising 40% for 90days.
Since interest rate is a price, higher demand for scare money will push interest rate up. Anyone without economics background now understands that Ghana’s economy got off to a bad start this year with a lot of taxes.
The biggest part is that people don’t have enough money to spend. When people don’t have enough money to spend, the economy slows down.
The misguided drive for lower deficits, and imposing high taxes, translates into a drive for reduced economic growth.
Reduced deficit growth always begets reduced economic growth. The point is that money supply through deficit spending and GDP go hand in hand. Balancing the budget is a prescription to economic disaster and it is a terrible myth that balancing the budget benefits the economy. Ghana’s money supply can be expressed by this equation:
Money Supply = Trade Surplus + Government Deficits + Loans (bank & non-bank)
Government deficit spending and bank lending are the two main domestic sources cedi are created domestically, the third sources comes from our trade surplus which is external. If our Trade Surplus (i.e. imports minus exports) goes down, our money supply goes down. Money coming in from outside Ghanaian borders as payment for exports will grow the economy. However, currently, we are running a trade deficit, not a surplus, which removes money from our economy. Since trade surplus is not easy to achieve, the next alternative to grow money supply is by government deficit spending. Government has control on deficit spending and inflation and the two are just a political decision. As for the lending, the sum of all assets and liability in the private sector sum up to zero and does not add new money into the economy aside interest accumulated.
“Deficit” fools most people because these words sound negative. But think about it this way: “Deficit” occurs when the government creates and spends more cedis than it receives in taxes. One of the most important and timely equations in macro finance states:
Government Budget Deficits = Net Private Sector Savings + Net Imports
The added cedis from deficit spending as stated in the equation go to one of two places: the Ghanaian economy (Private Sector), where they become Net Savings, or to foreign economies to pay for Net Imports as the equations showed. The word “deficit” merely means more money goes out than comes in. “Deficit” is a statement of the net amount of money the government has created or added in one year. When government spending exceeds taxes, it’s called a “deficit.” When the government spends, its payments for goods and services enter the economy. When you pay taxes, the money leaves or drains out of the economy. So if deficits add money to the economy, then where does that money go? Collectively, it goes into the private sector-(you and I and the businesses) pocket as savings.
The economy runs on money and because money is the lifeblood of an economy, removing money takes the life out of the economy. Deficits put spending cedis into the pockets of consumers, who use those cedis to grow businesses and to increase wages and employment. Increasing deficit growth (which can be called “stimulus”) is necessary for long-term economic growth. Put it differently, deficit spending is the method by which government creates national prosperity. All deficit spending grows the supply of cedis. Since a large economy has more money than a small economy, it therefore means that, a growing economy must have a growing supply of money. Simply put, increasing the money supply increases purchases from businesses, which grow businesses, which increases the job supply, all of which grow our economy. Government deficit spending is the way the government adds growth money to the economy. It is therefore valid to state that the mass unemployment we see around is actually caused by deficit reduction programs adopted by the government.
Deficit adds money to the economy whereas austerity takes money away from the economy resulting in contraction; Deficit is an important source of private sector profits, it’s the source of net financial assets to the non-government sector, and without government deficit, a country such as Ghana that runs large, persistent trade deficits, would leave its private sector with large, unsustainable deficits.
The author of the article is the MD of GGFC Kwame Ofori Asomaning.