Living beyond your means not economically healthy

by R.M.B Senanayake

It is obvious that an individual cannot live beyond his means for even a limited length of time even in an age where borrowing is easy. If you live beyond your means, you will be forced eventually to live beneath your means. Living and consuming on borrowed money cannot last.  When living extravagantly, it seems the good times will continue forever.  But when the bills come and the debt piled-up with interest needs to be repaid, the good times end.

It would appear that the bills for weapons purchases on credit are now coming but we do not know how much they are. Sometimes people think that owning houses, stocks and other assets which may appreciate will enable them to realize them and continue to live extravagantly. The EPF seems to be a late convert to this view. But these are not always appreciating and can come down quite as fast as they went up as we saw in the last quarter of 2008.

Once the values of stocks and houses depreciate a source of newly borrowed funds is required (IMF for a nation when Foreign Reserves are depleted). It is then that the individual comes to the realization that hard work and effort are required to produce sustained wealth. Working minimally will have to be replaced with working maximally to survive, as well as to pay for the extravagance of previous years. The consequence is more work and a diminished standard of living.

Can a government live beyond

its means?

 Can a government or a nation as a whole live beyond its means? Our politicians seem to think that it can be done. They are spending public money as if they are plucking it from trees. After Independence we went through the Korean Boom when our rubber fetched unusually high prices. We also had a large accumulated amount of Sterling balances (unlike today’s borrowed high Gross Foreign Reserves).  So the politicians of the day introduced welfare schemes like the rice subsidy and even gave rice free at one time. They also introduced free health care (during colonial times I remember my mother having to pay some 50 cents or so to the Government Dispensary in Nugegoda for treating me) and also free education for everybody.

Nobody bothered to calculate the costs of these measures or project their costs increases over time with the increase in population. Since the government had enough revenue in the first half of the fifties this lapse didn’t matter. But towards the end of the 1950s and the 1960s the cost escalations sent the government budgets into the red. T.B Ilangaratne then introduced deficit finance as policy guided by the thinking of Raoul Prebisch, the Latin American economist of the late 1950s. Latin American countries which followed his doctrine ended up with hyper inflation.

We too resorted to extensive money printing under SLFP regimes and when it led to balance of payments problems went to the IMF. Several times we have gone to the IMF but we never really altogether followed the austerity measures they prescribed to provide a corrective for our problems. Instead we curtailed their programs as soon as we raised our heads above water. We also borrowed extensively from the World Bank and from bilateral sources- China, India, Iran etc. citing the concessional terms offered as justification.  Since we continue to live beyond our means, if we cease borrowing money from the International Monetary Fund (IMF), the World Bank, and other donor agencies, the country’s future is bleak.

Future –is it bleak?

Are we a society living way beyond our means and seemingly helpless to save ourselves?  Are we headed for some kind of crisis or maybe just a gradual descent into misery — or are all such worries unnecessary fretting by pessimists of the dismal science? The domestic savings of the nation is a mere 14% of GDP. Macro-economics is an aggregation of the behavior of individual economic agents. We have not only large public debts - even our private sector has over-borrowed. Unfortunately we have no published figures of consumer credit, hire purchase credit and borrowings on credit cards. Some, if not many of these individuals, are living beyond their means. Then there is the government which has been running deficits in the current account of the budget- spending more than tax revenue which constitutes a dis-saving of 3% of the GDP which reduces the National Savings by such figure.

The "band choon" culture

The government and the people are following not the prudent work and savings ethic - the Protestant ethic which economists identified as the cause of development in the West; but instead the ethic of living for the day or in popular parlance the ‘band choon culture". The hard requirements of economic life are at variance with the live-for-the-day ethos of the culture we subscribe to. Yet the country has kept growing, the living standard of the majority rising, our life expectancy increasing, and we think everything is tickety boo as the song goes. The unwinding could be far more gradual. The result, years from now, could be of future generations paying unimagined portions of income to cover their parents’ and their own debts (personal and national) and to pay interest and dividends to the foreigners who financed our living beyond our means.

The population has trebled since the 1950s and the welfare services like free education and free health are unable to cope with the increased demand. Not having sufficient funds and no management, these services are collapsing as their quality deteriorates. The intended beneficiaries are turning to the private sector in health care. But in education they do not have this option because vested interests oppose any expansion of private sector education- both general as well as  higher education. Our youth are the victims deprived of a quality education necessary for their upward social and economic mobility.

It s almost impossible for the government to cater to the increased population. The population is also aging which requires the working population to work even harder to provide for their old parents and dependants. But many of the educated youth can’t even obtain employment. The macro-economic imbalances include not only the imbalance between aggregate supply and demand but also several other imbalances. Elementary economics teaches that in a market economy the consumer is sovereign and the suppliers provide what the consumers demand. It is not so when the government is the supplier and the service (education) is provided free. Instead the bureaucrats supply what the politicians want them to supply.

Since the service is not uniform in quality, the consumers seek to enter the quality schools ever willing to bribe the principals. Rationing by regulation instead of price (even if illegal) never really works. In the case of university education those who gain admission through the competitive examination do not wish to accept entry to the several universities which are sub-standard. Unless the government monopoly is broken and the private sector allowed entry into all sectors of education, the supply of education will not cater to the demand. The affluent can break out of the system by sending their children abroad paying large sums of money. But soon they will find that such investment does not give a return unless they obtain employment abroad. This has become harder with the recession in the West.

Interest Burden

Another problem is the cost of interest that will have to be paid. Domestic debt owed to citizens can be paid off by debasing the currency through high inflation as we have done over the years. The interest rate can also be repressed as we do now. But the problem is with the foreign debt where there will be increasing outflows on debt servicing in foreign exchange. It also poses a problem to the government budget for more and more money has to be set apart from it to pay interest.

Repayment of the debt itself may be rolled over but this is not always possible as we learnt during 2008/2009. So we have two options- inflate ourselves out of domestic debt and control the resultant current account deficit in the balance of payments ( as in the 1970s ) or borrow and borrow more from foreigners while holding the external value of the rupee below its real effective rate (around Rs 127). The rupee is artificially held at 112 to the dollar- sacrificing the long term for the short term.

It is difficult for a country with macro-economic imbalances to have a fixed exchange rate and free capital movements, and also follow an independent monetary policy. This is now coming to be true. The Central Bank has temporarily, halted open market operations. This means no sterilization of the increase in money supply caused by its buying dollars at a rate that will prevent the appreciation of the rupee. The policy of printing money or borrowing from the central bank and the banking system will mean expansion of the money supply. Too much monetary expansion leads to revival of high inflationary expectations which would mean higher inflation in the not too distant future.

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