Economic Growth 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

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

Introduction

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)

The world economy growth:

• 2010 : 5.1%• 2011 (est.) : 4%• 2012 (pred.) : 4%

Real GDP growth in advanced economies:• 2011 : 1.6%• 2012 : 1.9%

Real GDP growth in emerging & developing economies:• 2011 : 6.4%• 2012 : 6.1%

G-20 Conditions

Low Growth

India

China

Turke

y

Argen

tina

Brazil

South

Kor

ea

Indo

nesia

Mex

ico

Russia

Japa

n

Saudi

Arabia

Germ

any

Canad

a

South

Afri

ca

United

Sta

tes

Austra

lia EU

Franc

eIta

ly

United

King

dom

0

2

4

6

8

10

12

Real GDP Growth Rate 2010 (in %)

Source: CIA World Fact

High government deficit

Saudi

Arabia

South

Kor

ea

Argen

tina

Indo

nesia

China

Mex

ico

Germ

any

Austra

lia

Turke

yBra

zilIta

ly

Russia

South

Afri

caIn

dia

Canad

a

Franc

e

Japa

n

United

Sta

tes

United

King

dom

-12

-10

-8

-6

-4

-2

0

2

4

6

8

Budget Surplus to GDP Ratio (in %)

Source: CIA World Fact

High debt to GDP ratio

Japa

nIta

ly

Canad

a

Germ

any

Franc

e

United

King

dom

United

Sta

tes

Brazil

India

Argen

tina

Turke

y

Mex

ico

South

Afri

ca

Austra

lia

Indo

nesia

South

Kor

eaChin

a

Saudi

Arabia

Russia

0

50

100

150

200

250

Public Debt to GDP Ratio (in %)

Source: CIA World Fact

Strategies

Basic Strategy

 Period Countries ↓

Short Term Long Term

Countries with Problem in Fiscal condition and economic growth

Spend more in government spending, mainly in public investment expenditure, to promote growth

Run the fiscal condition responsibly/reduce government deficit

Countries with No or little problem*

Promote more good governance and keep the fiscal condition healthy

Promote better governance and keep the fiscal condition healthy

*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

Why Cutting Spending isn’t a wise option? (Cont’d)

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

Countries GDP($ bio)

Tax Ratio

Registered Tax Payers

Compliance Rate

Ease of Paying Tax Rank

USA 14660 14.7 84% 69

China 5878 20.9 121

Japan 5459 32.9 119

Germany 3316 43.3 67.72% 86

France 2583 48.8 75.38% 55

UK 2247 40.6 77.97% 18

Brazil 2090 23.2 150

• Promote reform so that the registered tax payers and compliance rate increased.

• Current tax ratio and compliance rate in G-20 Countries

1.1 Improve Tax Collection System (Cont’d)Countries GDP

($ bio)Tax

Ratio Registered Tax

PayersCompliance

RateEase of Paying

Tax Rank

Italy 2055 46.6 62.49% 133

Canada 1574 38.2 11

India 1538 12.1 147

Russia 1465 17.9 102

Australia 1236 32.3 52

Mexico 1039 22.5 106

South Korea 1007 23.3 44

Turkey 741.9 22.8 75

Indonesia 706.7 16.9 16.7% 45-50% 130

S. Arabia 443.7 44.5 7

Argentina 370.3 23.7 144

South Africa 357.3 30.1 36

1.2 Reduce Tax Evaders/Shadow Economy

France

Germany

Italy

Japan

Turkey

United Kingdom

United States

220.2

351.6

336.8

360.1

146.2

190.1

762

Shadow Economy (In Billion Euro)

Shadow Economy (In Billion Euro)

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).

2.1 Cut Spending in non-Urgent Area

(Cont’d)

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

Improper Payment in US Federal Government

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 1953 Seoul 1995

- 1995: GDP per capita exceeded 10,000 USD- 1996: Joined the OECD Real GDP growth rate = about 7%, Unemployment rate = around 2%

Weakness of financial system- Inadequate regulation and supervision- Tradition of government guarantees- Heavy governmental role in credit allocation

Unhedged private 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)

2. South Korea: Causes of the problem

Korean financial crisis

Liquidity attacks

Currency depreciation

Widespread insolvency

Deteriorated Fiscal condition

Decline in market confidence

financial system (banks)

Crisis in Asia

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

Other factors

Large unhedged private short-termforeign currency debt

contagion

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,,

Appendixes

Top Rates of Income Tax per 2009

Top Tax Rate Trend in USA

Change in Structure of Spending between 2000-2008

Share to World Growth

Fiscal consolidation Needed