Overspending is fairly straightforward when it comes to households. It’s a little more nuanced with corporates, but its a lot more convoluted when it comes to governments and nation states.
Here’s a quick rule of thumb, when it comes to governments:
- A country is living beyond its means when its running a current account deficit
- A country is living within its means when its running a current account surplus
How does this relate to governments? It doesn’t.
A country can be running a surplus or a deficit irrespective of whether the government is running a surplus or deficit. It’s really about the balance in the flow of funds between the different sectors in an economy – governments, households and corporations. Just because a government runs a deficit says nothing about whether the country as a whole is living beyond its means.
The role of the government here is really as a counterbalance to the private sector and households – ensuring that national welfare is maximised. In that context:
- A country where both the current account and the government are running a deficit is truly living beyond its means, and you can with ample justification blame the government;
- In a country where the current account is in deficit but the government is running a surplus, you can blame households or corporations, whichever one happens to be running a deficit (and by construction, one of those sectors MUST be running a deficit);
- In a country where the current account is in surplus but the government is running a deficit, the government is absorbing the excessive savings of either households or corporations (i.e. one or both of these sectors are in surplus), without which economic activity would be below potential (i.e. social welfare won’t be maximised);
- In a country running a surplus on the current account as well as the fiscal budget, the government is effectively failing to fully provide for its citizens. One or both corporations and households are saving excessively, and the government is making the situation worse by not dissaving – social welfare is not being maximised, and there is a good argument for expanding government consumption and investment (yes, I’m looking at you, Singapore).
So, what’s the best situation? When both current account and government books are in balance. A current account surplus, no matter whether the government is running a deficit or surplus, means there’s money left on the table, which is going out to be invested somewhere else.
The pseudo-mercantilist notion that surpluses are “good” and deficits are “bad”, ignores the implications on savings, investment and domestic social welfare. Current account deficits by the same token aren’t necessarily bad, as long as it also implies inflows of capital for investment, and not to fund consumption.
My view of the ETP and its role in pulling in investment and capital imports have always been within this rough framework. Hence, I’m not overly concerned about Malaysia’s declining current account surplus. It’s come from higher imports of capital goods, and not from an increase in imported consumption goods or a decline in exports. Reducing the fiscal deficit shouldn’t be a priority, until and unless private investment fills the savings-investment gap.
Similarly, my views on Singapore are also coloured this way. Running both a current account surplus AND a fiscal surplus suggests insufficient public investment and/or a much higher level of social support that could be afforded. There’s no point in being a rich country, if citizens don’t get the full benefit.
Posts
Hisham,
ReplyDeleteCould you show the data that support this statement ?
"It’s come from higher imports of capital goods, and not from an increase in imported consumption goods or a decline in exports. "
@anon 2.27
DeleteI can't show the data in a comment box, but the share of consumer goods imports in total imports have been more or less static since 2011.
Capital goods imports took a bigger share during that period, going from around 13% and rising to 16% before dropping back again in 2014 (it's begun to rise again).
The difference is reflected in intermediate imports (used for production), which fell from 68% in 2011 to about 57% in 2012-2014.
Ok... Simplistic question. But the economic assumption for expenditure is always that it is well spent right? So if we have a two way surplus the governments role has to be (1) Decide to spend (2) Decide what to spend on, right? Because I could think of a few examples where spending on the wrong things is worse than not spending, or am I being too micro (Very selfishly, I wouldn't mind more govt. spending on healthcare. Cancer treatment is financially debilitating...)
ReplyDelete@The Slug
DeleteI think I specifically mentioned investment in the post somewhere. But in any case, the government spending on the wrong things, is still spending into the economy, raising household and corporate incomes irrespective of the advisability of what the government spent on, after which they can decide on their own what is best to spend on. There will be some equity arguments here (who's benefiting from government spending?), but it doesn't detract from the main point I'm trying to make.
"In a country running a surplus on the current account as well as the fiscal budget, the government is effectively failing to fully provide for its citizens. One or both corporations and households are saving excessively, and the government is making the situation worse by not dissaving"
ReplyDeleteTwin surpluses is not an indication of poor policy or dissaving. Assuming that you are using the standard mundell-fleming framework with "(S - I) = (X - M) - (T - G) ", the presence of excess saving will rely on the relative size of the twin surpluses and, the one component you forgot, if savings can be effectively channelled to investments.
"Similarly, my views on Singapore are also coloured this way. Running both a current account surplus AND a fiscal surplus suggests insufficient public investment and/or a much higher level of social support that could be afforded. There’s no point in being a rich country, if citizens don’t get the full benefit."
This statement seems speculative. Singapore's economic welfare is substantially higher than that of Malaysia on most (if not all) known metrics. You could argue that Singapore could be "better" if it followed your recommendations but yet, you fail to back it up with adequate examples and / arguments (hence my point that your statement is largely speculative).
"It’s come from higher imports of capital goods, and not from an increase in imported consumption goods or a decline in exports."
What the time horizon for your analysis? DOSM statistics suggests that exports did decline in Jan & Feb 2015 with weak export growth since Q2;2014. Based on 12 month rolling average, increase in consumption goods imports was actually increasing while imports of capital goods was actually declining since Q2;2014 (largely due to two sharp drops in capital goods import in Jul 2014 and Sept 2014).
@anon 12.56
DeleteSorry for the late reply, I've been on holiday.
1. I think you meant saving, not dissaving. But reorder that identity:
(X - M) = (S - I) + (T - G)
Thus, the external balance is composed of net private and public saving (the internal balance). The private sector (S - I) can be further decomposed into corporations and households:
(X - M) = (Sc - Ic) + (Sh - Ih) + (T - G)
I didn't forget investment, but the above is the net of savings and investment. If any of the right hand terms above are positive, than there is either excess savings, or insufficient investment for that institutional category. If national savings were channeled fully into national investment, than the value of those terms would also sum to zero (and hence, so would the external balance). The presence of a positive external balance would thus point to excess saving, or insufficient investment at a national level.
2. With respect to Singapore, you might want to read these first (link and link).
In comparison to Malaysia and based on the latest numbers, public expenditure on education is about the same (in GDP terms), but spending on healthcare is nearly half.
To add to that, Singapore's pension system perfectly encapsulates what I'm talking about.
CPF is a mandatory contribution scheme, with an accumulated SGD252b at the end of 2013. Contributions are partly used to finance HDB activities (like land purchases), while the rest are invested, all through the issuance of fixed coupon SG government securities. The return on these are 3.5%/5% depending on which account under a set cap, and 2.5%/4% over the caps. Investment returns in excess of these fixed payments are kept by the government.
Given the equity risk premium, the SG government is in effect conducting a form of financial repression. Temsasek for instance claims they've achieved a long term double digit ROI, yet CPF members are stuck with their fixed low yielding bonds. The CPF scheme allows the government to issue higher yielding securities to CPF, yet it hasn't chosen to do so.
Sorry, I'm not speculating.
Comparing Singapore to Malaysia is irrelevant. The point is that Singapore's government could do so much more for its citizens than it chooses to do.
3. I'm looking at ratios. The ratio of imported consumption goods to total imports has been constant. Intermediate goods imports are cointegrated with exports. The only variable that has changed much is capital goods over the last five years.
In any case, imported consumption goods are so small (peaked at 8% of total imports in 2009; 20 year average about 6.3%), the changes here have little impact on the trade balance.
I hope you had a relaxing holiday; good holidays are so hard to come by :(
ReplyDelete1. I meant "dissaving" -- I was quoting your text verbatim. But back to the equation I : -
(X - M) = (S - I) + (T - G)
Increasing budget surplus means that (S - I) must decline, implying that either investment rises or savings decline. You may not have forgotten investment but you held investments as if it is an exogenous variable (i.e. it won't rise in response to higher current account surplus or budget surplus.
3. Yes, I am skipping point 2 for the time being because the points are ridiculously long and blogspot cannot process this in a single post. Since your post did state "It’s come from higher imports of capital goods, and not from an increase in imported consumption goods or a decline in exports" instead of ratios, you can hardly blame me for interpreting it that way.
I wouldn't disagree to your clarification though.
@anon 5.16
DeleteThanks, it was so-so. The room we got was terrible, and we ended up moving to a bigger (and much more expensive) one. Other than that, a break is always welcome, because they're hard to come by.
On to the points:
1. I think you're misreading the gist of my post. I am in fact advocating that governments should explicitly counteract external imbalances, such that those imbalances close (i.e. X - M approaching zero, or at least within 2% of GDP).
So if a country is running a surplus, the government should raise either consumption or investment to close the gap, or induce the private sector to do so.
The reason for that is that a surplus indicates an excess of either or both public and private savings over consumption and investment, and this is not welfare-optimising over time. There's no point in saving for a rainy day, when you don't spend anything when that rainy day comes. Investment would obviously be the superior choice, but that would be country specific - when the level of both savings and investment are low, investment should be the priority. When both are high however, there should be a higher portion of consumption.
Either way would be welfare enhancing, because in most countries, the majority of national "savings" are corporate, not household or public.
In an external deficit position, the government had better be running a surplus however.
3. A friendly word of advice from hard-won experience - when there is a structural break in the data, always look at levels or ratios, never at growth. Assessments based on growth will be subject to base effects (the stronger the break, the stronger the base effect), which could give a very misleading picture of what's going on.
1. What the government "should" do is debatable but I would like to highlight that surpluses does not necessarily reflect excess savings. Arguably, it is rising deficits that reflects excess savings (re: the whole crowding out argument and how excess savings are required to fund the deficit). The bottom line is there is no consensus in economic theory (not even a general one) that twin surpluses are "bad" (for whatever definition of the word "bad").
DeleteThe Singaporean government do spend during the rainy day (their response during the financial crisis suggests so). Yes, there is no point in saving for a rainy day when you don't spend when that rainy day comes but it is presently not "rainy", is it? Again, no, the twin surpluses does not suggest that it is rainy -- the key economic indicators suggest that the economy is doing just fine.
3. I disagree. We should always look at both growth and the ratios -- the ratios tend to be typically the same anyway. Theoretically, looking at ratios alone is worse -- if there was a deficit, the fact that the deficit is 100% attributable to imports of capital goods does not change the fact that it is still in deficit unless it is reversed by a corresponding increase in exports during the subsequent period.
@anon 10.12
Delete1. If you are referring to fiscal surpluses, I agree. On an overall basis however (which is why I wrote this blog post in the first place), a current account surplus does indeed reflect an excess of savings (or a deficiency of investment). It follows therefore that given a CA surplus, a fiscal surplus must be a contributory factor. If the fiscal surplus exceeds the CA surplus, that implies a private sector deficit. If it doesn't, then the private sector is also in surplus. Either way, there's a shortfall of domestic absorption.
My viewpoint here is the welfare of households. If a CA surplus is primarily due to corporate and government surpluses (and the corporate sector is almost always in surplus), than household welfare can be raised by the government shifting towards a more balanced or even deficit approach.
Historically, twin surplus countries have always been given a free pass, because all the pressure of adjustment (especially from financial markets) has been put on deficit countries. That's unfair, as from a global balance of payments perspective, trade and capital flows are zero sum. The surplus of one country must be counterbalanced by the deficit of another. Over consumption and investment in one, must be reflected in under consumption and under investment in another. This kind of asymmetric adjustment pressure is what led to the downfall of the Gold standard and the Bretton Woods system.
2. For the rainy day comment, I should point out that Singapore has a balanced budget rule, that requires the budget to be balanced over every parliamentary cycle. Deficits in one year must be covered by surpluses in other years. That makes the build up of fiscal reserves by other means a trifle excessive.
3. We will have to agree to disagree here. I find growth numbers after structural breaks tend to grossly mislead as to underlying trends. And I note that I also said to look at levels.
2. This is a huge point so I hope you don't mind me splitting this into subsections: -
ReplyDelete2a. I read the two links you provided and I disagree with that assessment -- the government expenditure (as % of GDP) is not much of a governance indicator -- it simply reflects differing government philosophies. But getting down to the numbers (and you'll get a kick out of this -- Singapore's public expenditure as % of GDP is much LOWER than the what the author quoted based on both the WB and the DOS), the author's benchmark selection is pretty interesting. These rates are fairly similar as that of Hong Kong and during the boom period of the 1990s and 2000s, these figures were not far different than that of South Korea (there was a divergence mid-2000s towards the onset of the recent financial crisis). Mind you, I am picking these countries as my benchmarks as they are more comparable then the benchmark the author picked (just because a country has the similar government expenditure in absolute terms, it does not follow that they are comparable). Worse still, I checked both the national websites and several international sources for the figures in the table and they do not add up at all (Cambodia's general government expenditure is far less than the double digit amount which the author used, nearing 6%). Due to the vast inconsistencies in the figures (trust me, I checked various international sources), I am also calling to question the credibility of that author -- feel free to check those figures by yourself. No, I do not find the arguments put forth in your link to be persuasive -- in fact, I find them highly flawed.
But putting those links aside, comparing the public expenditure as % of GDP is simplistic for so many reasons. As the name implies, the figures are weighed only against the GDP. Malaysia has a far larger population than that of Singapore -- it is only natural that Malaysia requires higher public health/education expenditures relative to Singapore. If one argues that the role of the government is to provide its citizens with basic healthcare and education, Singapore's figures far outpaces that of Malaysia's. In fact, I would argue that the figures should be evaluated in tandem with public health/education expenditure per capita.
@anon
DeleteI'll take your word for it, though I absolutely agree that this is really a philosophical and not a governance question. Philosophically, I find myself disagreeing with many of the institutional choices SG has made (and don't get me started on HK). I'd note however, that Korea and Taiwan's numbers (within the framework I've described) are much more reasonable than Singapore's or Hing Kong's, in terms of the internal and external imbalances. They also do as a good a job as many developed Western economies in terms of redistribution of income. Singapore gives this lip service (though this is changing, looking at Budget 2015), and Hong Kong very little.
On the last point, I disagree. Comparing based on per capita spending alone does not convey much, because costs will be inextricably tied in with the individual country price level. Wages and property costs in SG are much higher, and this feeds into the required expenditure. You have to scale it to the price level or income level, which takes you back to the expenditure/GDP ratio.
The problem I have with Singapore's healthcare expenditure (as I noted, the education expenditure ratios are similar), is not so much the success of the system - it's very good - but that citizens have to pay for it directly. In the context of my rough framework above, I don't see why this is either necessary or desirable.
@anon
DeleteI'll take your word for it, though I absolutely agree that this is really a philosophical and not a governance question. Philosophically, I find myself disagreeing with many of the institutional choices SG has made (and don't get me started on HK). I'd note however, that Korea and Taiwan's numbers (within the framework I've described) are much more reasonable than Singapore's or Hing Kong's, in terms of the internal and external imbalances. They also do as a good a job as many developed Western economies in terms of redistribution of income. Singapore gives this lip service (though this is changing, looking at Budget 2015), and Hong Kong very little.
On the last point, I disagree. Comparing based on per capita spending alone does not convey much, because costs will be inextricably tied in with the individual country price level. Wages and property costs in SG are much higher, and this feeds into the required expenditure. You have to scale it to the price level or income level, which takes you back to the expenditure/GDP ratio.
The problem I have with Singapore's healthcare expenditure (as I noted, the education expenditure ratios are similar), is not so much the success of the system - it's very good - but that citizens have to pay for it directly. In the context of my rough framework above, I don't see why this is either necessary or desirable.
You may have misquoted me. Note that I did not actually argue that we should ignore healthcare expenditure as a % of GDP. If you reread my point, I noted that it should be evaluated IN TANDEM. Of course we should not ignore expenditure per capita -- if I only looked at public health/education expenditure per capita, I would likewise be guilty of oversimplification.
DeleteAssessing health/education expenditure as a single indicator is misleading and overly simplified but assessing it together with per capita expense provides some much needed context. Regardless of your income/price-scaling (using GDP as the proxy), you must put into context the fact that Malaysia has a population about 6 times the size of Singapore and the GDP about only 10% larger than Singapore.
I can see your point that the public sector can contribute more towards health / education given its surplus but again, I would put it down to philosophic differences -- I won't necessarily say that one system is superior over the other.
2b. The CPF thing is not an easy discussion. Firslty, do you have a source that the CPF are being used to fund HDB activities? Are you arguing that there is a CPF-HDB conspiracy? Secondly, the CPF interests are effectively higher than comparable risk free assets (given that they are invested in SGS) so I am not sure where are you getting this equity risk premium (I wasn't aware that the CPF has a mandate to invest in the equity markets). Are you arguing that because Temasek boasts a high ROI, the SGS should yield a higher return? I am sorry but all I am seeing is unsubstantiated claims so yes, I believe that your statements are highly speculative.
ReplyDelete2c. Arguing that "Singapore's government could do so much more for its citizens than it chooses to do" is not a very effective argument and indeed, highly subjective. By that logic, I would challenge you to name me one government that can do so much more for its citizens. Personally, given that low to negative budget deficit (i.e. a surplus) was the prevailing philosophy for the Asian NICs, you can hardly blame them for maintaining healthy surpluses.
@anon
ReplyDelete2b. I thought the CPF-HDB link was common knowledge - apparently not. Try this (Slide 8):
http://siteresources.worldbank.org/FINANCIALSECTOR/Resources/Session5-Sock-YongPhang.pdf
The above should also be read alongside HDB's annual accounts:
http://www10.hdb.gov.sg/eBook/ar2014/financial/index.html
No conspiracy here, just a particular institutional setup. CPF buys SGS at particular yields, which the government then funnels to HDB for development of housing and mortgage financing (HDB operations are funded by govt grants).
This turns the whole setup into what is effectively a building society, where members savings are lent out to members for the development and purchase housing at low cost. It's a neat solution to the public housing problem.
But I have two big issues with this:
a. It overweights property assets in members effective retirement portfolios. This is great when property value go up, not so much when property stagnates. A second issue is that this also makes retirement portfolios illiquid - hence the saying "asset rich, cash poor", which is a growing problem in SG.
b. Given the discrepancy in flows - the government is borrowing far more than it is required to lend to HDB - the government is benefiting from a yield pickup on its investments, funded by citizens. The equity risk premium puzzle is basically the empirical finding that stocks return more than bonds at equivalent risk levels and across most time horizons.
I am in fact arguing that CPF should be given its own investment mandate, where returns directly benefit members. Right now, they don't even have any investment function - all funds are channeled directly into specially issued SGS. Having an investment function would help improve liquid balances, ease cash flow problems, while (since there would still be an excess) still allowing for affordable funding for housing development.
Note also that the SG government does not include investment income or land sales in their calculation of the budget balance. Hence even budget "deficits" turn into surpluses. This is incomprehensible to me. Given SG fiscal reserves (the size of which is still an official secret), there's no reason why some of this shouldn't be returned to the people of Singapore, either through higher returns to CPF or some other means, even without impacting the overall budget balance.
For example, a cut in GST, or lower taxes, or higher health subsidies, or higher social transfers for the poor and elderly. And why not more public investment? Over the last ten years, SG's average budget balance was over 6% of GDP. That's ridiculous and beyond "healthy". Does the SG government do a lot for its citizens? Yes, but they can do much better.
Unlike you, I don't see fiscal surpluses as healthy. It depends on the context of the other net institutional flows i.e. corporations and households, and the external balance. Focusing on fiscal surpluses as a policy objective puts all the burden of macroeconomic adjustment on monetary policy and contributes to higher volatility of growth. It also ignores potential imbalances in the other institutional sectors, which an activist fiscal policy can counteract (for an example of this analysis, try here).
This is just how the investment portfolio goes -- there is nothing particularly wrong with the arrangement.
Deletea. I would argue that you were particularly misleading here; I have no idea why you brought equity risk premium up (and even provided a helpful link to Wikipedia) when the fund is fully invested in SGS (which, as I mentioned, is effectively "risk free".
b. There is no overweight-age here; there is only an overweight-age if you define the term "effective portfolio" in some bizarre manner. No, it is not good or bad (for CPF participants) when property values go up or down -- the SGS will pay the mandated rate regardless (that is why it is effectively risk free). It will only really be "bad" if the Singapore government defaults but (as you have argued before), this is highly improbable on the balance of probabilities. Pension portfolios have 0% weightage in the property sector
c. Your "equity risk premium puzzle" is not much of a puzzle. In the first first place, by definition, no equities are effectively "risk free" so no, you cannot find an equity comparable risk level with that of SGS (that's the point; SGS, MGS, etc. are effectively risk free; equities aren't). Therefore, your "equity risk premium" argument does not apply here.
At higher risk levels, some equities may yield slightly higher return largely from "equity-like" bonds largely because the way these securities are structured (bond income are contractual and generally enjoys a higher degree of seniority and legal recourse). Whether the premium is "worth it" is another story altogether.
d. How CPF funds should be invested is another story altogether; there is no perfect asset allocation or indeed, the "right" amount of risk that the pension portfolio should take. It is also worth pointing out that CPF cannot be invested in other securities besides the SSGS by Constitution and by law.
e. You argue that "having an investment function would help improve liquid balances, ease cash flow problems" -- was the CPF having cash flow problems in the first place?
f. Again, you are putting words in my mouth. I did not say that surpluses are "healthy" (I may have used the word "healthy surpluses" but that means something else altogether).
@anon 10.52
Deletea. I brought up the equity risk premium puzzle, because I don't actually know of any other pension fund that invests solely in risk free assets. Just a few East Asian samples:
i. Japan's hyper conservative GPIF had a 24% (±11%) allocation for equities, and this was before Abenomics. The current target allocation is 50% (± 17%);
ii. Korea's NPS has a 30.2% weighting in equities and another 9.6% in alternative investments;
iii. Taiwan's PSPF (pg 32) has a 46% allocation for equity and equity like instruments.
iv. Malaysia's EPF (pg 46) has a 36% allocation for equities and 9% for alternatives.
Even in the fixed income space, not all bond investments of these funds are in risk-free government securities. Investment grade corporate bonds are a not insignificant proportion. Given the decades long structural decline in global interest rates, a portfolio invested entirely in risk free government bonds will short change those invested in them.
For a Western example, Calpers has 62.8% invested in equities, and 10.1% in property. Only 18.9% is allocated to fixed income.
The above discussion partly addresses point b and c as well.
b. As mentioned, property is in fact an asset class that pension funds invest in.
In this case however, I'm not talking about CPF but CPF members. Housing is an investment, like any other. On retirement, the available assets to the retiree would include pension savings, other investments and the property they own. In my opinion, the institutional setup in Singapore is such that there is a very strong incentive to over weight property in this retirement portfolio irrespective of how appropriate that might be (home ownership in Singapore is among the highest in the world). Hence, asset rich, cash poor.
d. Given PAP's dominance of Singapore's politics, how hard would it be to make a change?
e. I was not speaking of CPF, but again, of CPF members on retirement
f. Point taken