Friday, December 10, 2010

The Armey’s Curve

UB Post
December 10, 2010

The 2011 Budget of Mongolia has been approved, setting three records in its modern or capital development history. First record is that it became the biggest budget in the history of Mongolia (MNT4.0 trillion). The second one is that the 2011 budget is the most cumbersome budget or more than the half GDP.

Third record is that the deficit in this budget will be equivalent to 1/10 of the economy for the first time. Let us analyze each of them in more understandable way. The biggest budget never seen in the history of Mongolia on one hand shows the beginning of rapid economic development of the country. On the other hand, it will be a huge challenge for the governance to pass MNT4.0 billion through the Government. The corruption will get even bigger, leading to expansion of black economy.

The queue of applicants wishing to get a job in government system will get longer and longer and the bureaucracy of government officials will get stronger and stronger. The consumption of government will get more luxurious. Budget of any country is compared to its economy or GDP to measure government’s portion in the economy. This proportion cannot be zero or if there is no government, then chaos will spread and economic creative actions will not create any accumulation or there will be no wealth.

This proportion cannot be 100 percent too. We had experienced it in our recent history. There has been continuing debate about what can be a proper proportion rate in order to make the economy more fruitful and U.S Congressman Richard Keith “Dick” Armey first applied graphics of such proportion and it is called the Armey’s Curve. It is believed that the highest possible proportion of government is that it should not exceed the half of economy. If it does, then it will negatively impact economic growth.

In other words, the government is just like meal. If you undereat or overeat a meal, both diets are bad for your health. Our budget of next year “overeat” by 2 percent reaching 52 percent. Economists claim that 15-17 percent is the most appropriate and proper rate. Does anyone remember that two years ago IMF had rescued our country from real bankrupt by granting a US$290 million credit and that Mongolian Government had pledged to keep budget deficit below 5 percent in order to receive this credit?

Though the European Union demands its member states to keep the budget deficit at 3 percent, Greece and Ireland was about to get bankrupt because their deficit reached to 13 percent and 16 percent respectively. They had to ask credit from abroad to rescue their countries. Mongolia plans to spend MNT4.0 trillion next year, which is more than total budget income by some MNT700 billion, which means budget deficit is about to reach 10 percent of the economy in 2011.

Since the country is going to spend more than it earns, somehow this gap must be financed from a source. There are only two options for the country in budget deficit: Print paper money or take credit from abroad or home sources. The former will directly create inflation.
The latter is to get loan and next generations will pay this loan. It will depend on expenditure purposes of the budget if the second option will create inflation or not. If the budget is spent to create value, there will be more job places and bring other resources into circulation and there will be no risk of inflation.

The inflation will get high if the final consumption grows. Mongolia is now at the risk of inflation because one third of that big budget spending is the cash of political promise to be distributed in the form of social allowance. If such a big money is spent for energy and infrastructure development, it would create more job places, improve economic productivity and exert positive impact to inflation.
This year’s government investment for energy and infrastructure hardly approximates with half of cash handout or with last year’s amount. As World Bank Country Economist for Mongolia Roger van den Brink said, there is a high probability that inflation rate reach up to 25 percent after one year. In that case, it means one fourth of social care will just disappear. It is also said that the inflation is a theft committed by the government.

In Mongolia, budget spending must be low and stable. We should not forget that the budget growth is caused by the growth of price of some minerals at international market, which means we did not create this growth ourselves.

Translated by P.Shinebayar

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