EKIP– Expert Club for Economics and Politics A Different Opinion
In last week's article, I presented an analysis of the state of the Bulgarian economy and public finances according to the most recent data from the National Statistical Institute and the Ministry of Finance. The situation, as we have seen, is not at all rosy. Long-term investments have collapsed, private consumption is also starting to weaken, and the negative contribution of net exports to GDP is reaching its worst level since 2008. Meanwhile, the state budget is unable to withstand the economic pressure, and there is even a risk of a fiscal crisis if government spending is not brought under control.
What you may be asking yourself after the previous article is – how did this situation come to be? It is good not only for us to ask ourselves this question, but also for the deputies who were sworn in to the new parliament today. Regardless of whether a stable governing majority is formed, the current parliament will most likely be pressured to adopt a budget for next year. The caretaker government will certainly try to push through one, especially if it becomes clear that we are heading towards another early election. Therefore, it is very important that the new parliament learns from the mistakes in fiscal policies voted by the previous several parliaments. Mistakes that fueled inflation and inflated the state deficit to critical levels.
How did it get here?
Over the past few years, successive regular and caretaker governments have had the luxury of constantly growing record tax revenues. Inflation is initially a big positive for the state budget, because rising prices make indirect tax revenues such as VAT higher. However, this is only a temporary effect, because if inflation remains too high for too long, it leads to a contraction in consumption and a corresponding decline in indirect tax revenues. This is exactly what is about to happen in our country – as became clear in the previous article, the economic situation in Bulgaria has already seriously deteriorated. The decline in tax revenues will be even more serious if the economy enters a recession.
Instead of accumulating savings in a good period for the budget's revenue, our rulers decided to continue spending aggressively, and as it became clear, not for investments, but for ballooning all kinds of current expenses such as pensions and generating new and new forms of "support" for the poor, because, you see, we were in a crisis. However, aid only made sense in the context of a lockdown, the closure of certain economic activities, and similar highly repressive economic measures that were imposed during the pandemic.
But even then, there was no point in handing out money like the sharp increase in pensions and the notorious “pandemic” financial supplements for every pensioner. Such spending policies, which very aggressively fuel aggregate demand in the economy, were not needed then, because wages continued to grow, unemployment remained quite low, and deposits in banks were accumulating at a high rate. The pandemic did not destroy the capacity for consumption, it only postponed its realization. But let's say that this was not so clear then, and the government wanted to play it safe, stimulating aggregate demand with all possible means of spending policy.
Procyclical fiscal policy leads to nothing good
However, what is the point of continuing such a policy since the middle of last year (2021)? Even then, the data began to clearly show that the pandemic would not lead to a long and deep recession, consumption is not just strong, but even accelerating, inflation is rising, unemployment is falling, and the difference between real and potential GDP is already positive? All these facts were already present in the data for the third quarter of 2021, and this gives an eloquent signal that instead of slowing down, the economy is heading for the exact opposite – overheating. This was categorically confirmed by the subsequent data for the fourth quarter of 2021 and the first quarter of 2022.
Within this period, the 2022 Budget was prepared, and an update was also prepared. Neither in the original budget nor in the update did we see a change in the direction of fiscal policy. The inflation of expenses continued at full force, especially in the area of current social spending. Pensions were increased by 10% and to this increase were added the so-called "Covid supplements" of 60 leva each, now as a permanent part of the pension. The minimum pension increased by 22.6%, the maximum by 33%, and the social old-age pension by 45.3%.
The rulers either did not understand what the data showed, or, pursuing short-sighted political (election) goals, they turned a blind eye to the obvious overheating of the Bulgarian economy. In the first case, they are incompetent, in the second, they are irresponsible. This myopia of theirs is certainly significantly worsening the galloping inflation.
The fiscal equivalent of chasing the wind
Galloping inflation is not something that can be “overtaken” by higher government spending. This is something that is realized by every competent economist, from any school of economics (even the supporters of a more “loose” fiscal policy such as the followers of Keynes). Inflating incomes and, accordingly, aggregate demand can only lead to even higher inflation, which subsequently eats up the acquired purchasing power anyway. Inflation always wins in the end, because sooner or later the government simply cannot afford to continue pouring more spending and aggregate demand collapses due to the inflationary pressure. And so this vicious circle inevitably ends in a crisis.
Don't get me wrong. All this does not mean that there should be no support for those businesses and households that are in a vulnerable financial situation in the context of the energy crisis. Certainly, certain businesses and households need help in the current extreme circumstances with energy prices. However, this help should be temporary and very carefully and precisely targeted to those most in need. This is not what happened with the update and the 2022 Budget itself in its original form. The "support" was done on the principle of "something for everyone" and very often in the form of higher permanent costs (such as raising pensions).
Apart from being a completely wrong approach from a macroeconomic point of view, because it fuels inflationary trends, such a policy is also ineffective. Not everyone needs assistance at all, and not everyone who needs assistance needs to be assisted to the same extent. Crisis assistance from the state should be 1) temporary, 2) specific and 3) differentiated.
What needs to be done?
What the next government should do should be crystal clear by now. It is high time that capital expenditures start being planned adequately, so that they are not executed at less than 20% four months before the end of the year. Measures to support households and businesses must stop being planned wholesale and handing out money haphazardly, because the budget cannot afford it. And that means that we, the taxpayers, cannot afford it either.
The current expenses of the state need serious optimization. The minimum wage should be frozen, because the levels of many social payments are also tied to it. Any planned and promised increases in payments and salaries for next year are highly recommended to be reconsidered. What we see from the last few issues of the Ministry of Finance, the demand for Bulgarian government debt is so weak that we risk a huge swelling of the state debt if we do not bring the budget deficit under control. I remind you that a scenario in which we are completely unable to finance our deficit, as happened with Romania in 2008/2009, is also not ruled out. Therefore, it is highly recommended that government expenses, especially current ones, be reduced or at least frozen at their current levels.
In short, the overall approach to fiscal policy needs to be reversed – instead of increasing current spending, we need to cut back. If this does not happen and we continue to spiral into deeper budget deficits, the country could fall into a fiscal crisis and the growth in public debt could become uncontrollable in the coming years.
