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Is Increasing Capital Expenditure the Right Way to Revive the Economy?

Updated: Apr 6, 2021

Remember Pete Buttegieg? He's the former mayor of South Bend, Indiana who won the Iowa Caucuses in the 2020 US Presidential Elections. For a time, it looked like he was going to be the Democratic Party nominee, but Biden's eventual performance in states like South Carolina forced him out of the race. His subsequent support to the then candidate Joe Biden proved to be crucial in helping Biden beat Sanders in the Democratic Primaries and consequently became the 46th US President. It was expected that Biden would reward him by giving him a key cabinet portfolio. However, Biden nominated him to be the Secretary of Transportation, and Mayor Pete, accepted the position. What's surprising is that transportation was never a key cabinet concern in America. A majority of Americans couldn't even name the Secretary of Transportation under Presidents Trump and Obama. So why did Mayor Pete take up this seemingly unknown position? The answer can lead us to the next chapter of economic growth in the world, and especially Indian, history.

The pandemic hit the global economy hard. The global economy in terms of economic output measured as by GDP showed a decline of almost 5 percentage points in FY20. Regardless of how the stock market is doing, it's an undeniable fact that people lost jobs and businesses got shuttered. This means that revenue expenditure (expenditure which would not lead to the creation of assets) a country normally undertakes in a financial year would not help the economy revive in the midst of a black swan event like COVID-19.

Now, governments across the world had two options for dealing with the crisis. One was giving money directly in people's hands, hoping that people would spend this money to eventually increase consumption that would help sustain businesses. This is what was tried in the US through stimulus cheques, and it is debatable if these helped revive the economy. The fundamental flaw with this plan is that people tend to save or invest money in times of crisis, instead of spending it. A reason why the stock market has been doing well during the pandemic is because retail investors are investing directly into the market or individuals investing in markets through funds and securities. Developed economies, like the US, can afford the cost of such measures even if they do not give the desired results. However, countries like India do not.

India does not have the luxury of taking measures like the stimulus checks, as these measures have heavy costs and debatable outcomes. In the US, and the West, banks are much better capitalised and corporations have better leverage. In addition to this, the US Federal Reserve, a body in control of the world's reserve currency, the US Dollar, can resort to buying junk bonds and invest in companies that have been downgraded to junk. There are more resources in Western countries as the bonds issued by their central banks have institutional trust, which means that investors regard bonds like the US Treasury Bonds as reliable regardless of the circumstances. Bonds issued by the RBI do not carry the same amount of confidence among investors. Additionally, in India, there is a fiscal deficit as it is. The banking sector is fragile due to a high number of NPAs. Furthermore, as Raghuram Rajan mentioned in an interview, markets are not generally as open to us as they are in the West. Issuing stimulus checks on a scale the US government did to US citizens would lead to an impression of low fiscal discipline, leading to investor confidence falling, restricting our access to the markets further, as indications low fiscal discipline would cause our bond ratings to be downgraded. When a country experiences a downgrade in bond ratings, investors want to sell bonds, often at higher rates than the rates at which they bought the bonds. This rush of investors selling bonds causes interest rates to go up, leading to the cost of loans for businesses and individuals to rise simultaneously, which is the opposite direction to go if one wants to stimulate the economy. This further causes foreign investors to disinvest their positions in the country, causing money to literally leave the country. This is why India has to exercise restraint when it comes to spending, and can't resort to measures like stimulus checks like Western countries.

The second option that governments have in reviving the economy is capital expenditure. Capital Expenditure is the government investing heavily in infrastructure projects, like roads and bridges. Investing in infrastructure projects creates both white and blue collar jobs. Every major infrastructure company relies on thousands of ancillary units, which in turn get services from tens of thousands of smaller companies, and this supply chain extends right to MSMEs lying at the bottom of the economic pyramid. The demand created by government infrastructure would create demand for goods produced by all elements of the supply lines. Furthermore, infrastructure projects create assets and incentivise companies to invest in the country as they lower logistical constraints. This enables future governments to pay off the loans taken to construct this infrastructure with ease. In fact, increasing capital expenditure as a model for economic revival is now also being followed by the US, the first country to issue stimulus checks during the pandemic.

This increased emphasis on Capital Expenditure through infrastructure projects by the US government is evidenced by the appointment of a prominent leader like Mayor Pete as Secretary of Transportation under the Biden Administration. Increasing Capital Expenditure through infrastructure spending is a cornerstone of the Biden Administration's economic agenda, and this is the reason why Mayor Pete, knowing the significant role infrastructure projects would play, accepted the usually nondescript role. Around the world, from Vietnam to Canada, more and more countries are investing in more infrastructure projects, and the increased global Capital Expenditure will cause the next period of global economic growth.

The question is, if increasing Capital Expenditure through infrastructure projects is such a great idea, why aren't governments willing to adopt it? This is because of the political costs involved. Infrastructure projects can easily get embroiled in corruption scandals. Moreover, the physical results from investing in infrastructure may not be seen before the next election cycle, as projects take years to complete. Stimulus checks, on the other hand, provide money directly to the people almost immediately, leading to an illusion of a government intent on delivering services to its citizens, giving the government immediate political returns, even if they may not be economically sound. Even in an economy like the US, which is uniquely positioned at the help of the global financial system, stimulus checks are seen as the last resort to be taken in extraordinary circumstances, and the US government is investing in infrastructure to stimulate growth in the long term.

In India, the Union Budget this year allocated a record ₹5.54 trillion for Capital Expenditure in the form of infrastructure spending to revive the economy. It remains to be seen if the policy manages to indeed revive the economy as it transverses through the endless maze of Indian bureaucratic corruption. However, at least in theory, this seems like one of the better initiatives taken by the Modi government, and appears to have put the economy on the right track moving forward.

(Written by Agnidh Ghosh and Edited by Aarushi Kataria.)


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