Should Government be Minimised as much as Possible in the Emerging Markets - Essay Example

Should Government be Minimised as much as Possible in the Emerging Markets? To start with, emerging markets are defined as countries that have characteristics of developed market but such countries have not developed to standards that can be ranked in equal measures as developed countries such as the United States and the United Kingdom as argued by (Burawoy,& Verdery, 1999). Examples of emerging markets are Russia, Ukraine, Poland, Czech Republic, Slovakia, Slovenia, and Hungary, among others. Public spending is described as, the spending that is undertaken by the government in a given nation on wants and needs that are collective. It includes, spending on defense, education, infrastructure projects, and the health care sector (Berglof, and Bolton, 2002). The source of money or the finance that is used for public expenditure by the government is mostly from taxation. One of the distinctive features of public spending in emerging markets is the use of social safety nets. According to Chu and Gupta (1998), safety nets basically mean transferring payments that are non- contributory which seek to prevent the people who are vulnerable to poverty and shocks from falling down to a given level of poverty. The providers of the safety nets are the private sector (charities, NGOS), and the public sector (donors and the government). Another distinctive feature seen in the emerging markets is that the distribution of income during the pre-transition period in most Scandinavian countries had a Gini coefficient of 0.25 compared to that of the U. S which stood at 0.4. During the post transition period for example, the Gini coefficient was 0.2 in Slovakia and 0.5 in Ukraine (Keane and Prasad, 2000). This can be seen in the figure 1 below Poland experienced indeed a substantial rise in inequality of earnings in relation to labour. However social transfers were significant in the mitigation of the shift, and as a result the increase in inequality of income was moderated. Interestingly, these transfers were mainly targeting individuals who stood a chance to lose more as a result of transition. The intentions of these individuals were not to be poor but rather to be middle class (Gans, 2011). The figure 2 below shows the income distribution in Poland during the transition period. Source: World Bank The figure 3 below shows the overall distribution of income in the emerging markets. The general trend is that in most cases income distribution is normally not balanced among the countries. Analyzing the table found below, what is evident is that income disparity is greater in Russia as compared to Slovakia. Source: World Bank Generally during the old regimes of the emerging markets such as Russia, Poland, Slovakia, Slovenia, among other nations which were under the soviet, were generally characterised by a high level of government expenditure in relation to the GDP (Ofer and Vinokur, 1992). The figure 4 below shows the government expenditure in various emerging markets. In general it indicates how the economy behaves when the government increases its spending. During the old regimes prior to transition, most emerging markets were characterised by high government spending. Perhaps this explains why the Rahn curve behaves this way. Source: Peter Brimelow (1993). ‘Why the Deficit is the Wrong Number,’ Forbes March 15, 1993. Fig.4: Graph indicating economy behavior with expansion in government size Looking also at the expenditure of Russia in general during the transition era, the main observation is that generally the expenditure in Russia in relation to GDP was generally very high (Lieberman, 1995. The diagram below supports this argument. Source: Le (1996) From the figure 6 above one can clearly notice that between 1991 and 1993, there was increased spending by the government before it dropped. Levels of spending also started to increase again1998. While at the same time if one compares the GDP growth rate of Poland to that of Russia, then one will notice that Poland is doing well economically as an emerging market compared to the Russian economy (Le, 1996). The figure 7 below shows the GDP growth for Poland The need to downsize the size of the government among the emerging markets necessitated the transition process from the communist system to the capitalism system of governance. It also made it possible for the economies of the emerging markets to move away from a centrally planned economy to a decentralized planned economy. Prior to transition, the expenditure of the government in relation to the GDP was extremely high (much more less in Vietnam, and China), nearly 50% (evident in the last few years of the socialist government), and also in some nations it stood at 55% (average in vast of the Central and Eastern European (CEE) states, and in other states of the Commonwealth of Independent States (CIS) such as Czech republic, Slovakia and Hungary, the spending of the government in relation to the GDP was 60% (Ofer, and Vinokur, 1992). Transition thus begun in many world economies and prices were rapidly being liberated from low levels that were artificial, which eventually led to burst in corrective inflation. The demand which had been created during central planning periods made it possible for the inflation to be sustained. Transition earlier had inflation rates averaging 450% in one year as experienced in CEE states, and nearly 900% synonymous with the Baltics states, and slightly over 1000 % as witnessed in the CIS states. However by 1998, the annual inflation rate had been reduced just to single digits by the CEE and Baltics states, and around 30% by the CIS states (Andreff, 2006). Because of transition in the emerging economies such as Russia, Poland, and Slovakia, experienced some inflation as a result of the liberation of prices. Price liberation is one of the key aspects of transition used in the emerging markets. Most emerging markets such as Russia, Poland, Ukraine, and Bulgaria, among other emerging markets adopted price liberation where the price controls were lifted and the economic agents were indeed provided freedom of entrepreneurship. Price liberation in the emerging markets was carried on two fronts. The first one is domestic liberalization which entails lifting of price controls and the reduction of subsidies to both producers and consumer prices. The external front which basically entails stopping trade controls, the unification of exchange rate, and letting the exchange rate to adjust itself up to the desired levels. The table 1 below shows the effect of liberalization of prices in various emerging markets Source: Ofer & Vinokur (1992) The effects of price liberalization are what results in the hardening of the budget constraint (HBC). This is because there is strict relationship between the expenditure and the government earnings. This means that the excess spending will not be met by the government because under the hardening of budget constraints; subsidies and bailouts are absent (Bergh, & Henrekson, 2010). The advantages of downsizing government expenditure among the emerging markets Downsizing has led to privatization of state enterprises in the emerging markets. The former state owned enterprises are now under the private ownership and this has indeed helped in improving the efficiency of the assets that were initially under the state management as noted by (Edward, 2000). Privatization has further enabled the emerging markets to attract foreign investments in their economies. This helps in the growth of economy since the government gets enough revenue from these firms which are operating in the country. The figure 8 below shows the capital inflows from the developed economies to the emerging markets. Source: Edwards, S. (2000). ‘Capital Flows and the Emerging Economies:’ Theory, Evidence, and Controversies. Privatization also aids a lot in sustaining and supporting liberalization programs in the country because they encourage competiveness among different enterprises in the country (Brown, Earle, and Telegdy (2006). The figure 9 below shows the level of privatization in some selected countries of the emerging markets. Source: EBRD (2001). Transition Report In summary most emerging markets have embraced privatization in their economies so as to help them to enhance their economic growth and also to help them reduce the government spending. Privatization in emerging markets are characterized by large scale privatization, small scale privatization, enterprise restructuring and price liberalization as indicated in figure 10 below Source: Klonowski (2012) LP=large scale privatization SP=small scale privatization EnRes=enterprise restructuring PrLib=price liberalization Another advantage of downsizing of government spending in the emerging markets is that it results to the increase of revenue to the government. The government gets the revenue in form of taxes from the various business enterprises that are operating in the country. For example the foreign companies that are operating in the various emerging markets such as Hungary, Russia, Slovakia, they bring money to the government of the host country. Source: Edwards (2000) From the figure 11 above one can easily notice the amount which the foreign investors invested in the emerging markets (transition economies) from the year 1997 to the year 2004. This indicates just how much the government is getting from the foreign investors who invest in its country. The state also gets revenue from its citizens who do business within the nation. Thus through taxation, the government gets a lot of revenue that helps it to function well. Another advantage of downsizing in the emerging markets such as Russia and Poland is that it led to the decrease of subsidies. Because of the privatization of the state owned agencies in most of the emerging markets subsidies in these economies was greatly reduced. The reduction of subsidies also gave rise to the use of hard budget constraint (HBC) which was adopted in these countries as one way of tackling transition. HBC is where there is strict relationship between spending and earning. The government subsidies and bailouts are not encouraged under this system of budgeting approach. On the other hand the use of soft budget constraint among these emerging markets was done away with since it was not helping the economy to improve. Soft budget constraint (SBC) is when there is a relaxed relationship between expenditure and earning. Under this approach the excess spending is paid by the government in form of subsidies and bailouts. Many economists and policy makers in most of the emerging markets such as Poland, Slovakia, and Russia adopted the use of the hard budget constraint. This helped them to post good economic growth in their countries. Thus it has been agreed that if a country wants to have good economic growth, then the use of hard budget constraint is more preferred than the use of soft budget constraint (Tsai, and Yen 2008). The growth of the Slovakian economy can largely be attributed to this approach of the use of the hard budget constraint, which normally calls for the lifting of price controls, the reduction of subsidies, and stopping trade controls (McKinley , Zhao, and Rust, 2000). These reforms and good institutional legal framework boosted the economic growth of Slovakia government. The figure 12 below shows how the Slovakian government as an emerging government is posting good results. Source: Organization for Economic Co-operation and Development (2004) Another advantage of downsizing in the emerging markets is that it has resulted to the reduction of the government expenditure bills in the public sector in terms of employments. This is because of the privatization that has really helped in reducing government expenditure. As a result of privatization in most of the emerging markets such as Czech Republic, Poland, Russia, where most of the former state owned corporations have been privatized, the government expenditure has also reduced significantly (EBRD, 2004). The reason for this is that the government does not employ many people because many of them are observed by the private sector. The table 2 below shoes the level of private sectors in different emerging markets across the globe, which can help in explaining the reason for the decreased government expenditure. Source: EBRD (2004), Transition Report What can be established from the table above is that Armenia as an emerging market has got the largest share of the private sector. This implies that even its government spending in terms of employment bills is reduced. But are some emerging markets in the Eastern Europe does pay for unemployment bills even if the employment bills are reduced. Interestingly one would think that corruption in among the emerging markets will be done away with, but then corruption seems to thrive more in an official economy compared to the unofficial economy. The figure 12 below shows the government spending and freedom from corruption in various emerging markets. Source: World Bank Data (2007) Source: GIA Business Perspective for emerging markets (2011) The figure 13 above shows the corruption index in emerging markets. Perhaps this can help in explaining why corruption is high in some emerging markets as compared to some. As scholars say that corruption is more rampant in official economy than in unofficial economy. China is a living proof of this fact as it can be noted in the figure above. The disadvantages of downsizing government expenditure in emerging markets Downsizing of government expenditure leads to unofficial economy in some of the emerging markets. What leads to a state of an unofficial economy is when the organizations profits are taken away from them via taxation, regulation, or corruption (Edwards, 2000). This act leaves many entrepreneurs in these emerging markets with no option but to operate unofficially. Unofficially economy means that the entrepreneurs are avoiding regulations and taxation. These firms can go further and employ protection from both public and private means which are all unofficial. They can go as far as acquiring the use of criminal organizations to protect them. This state of the economy normally affects the government dearly (Gilson, Hurd, and Wagar, 2004). For one tax collection will not be effective because many people are avoiding taxation and regulations. This means that these governments cannot do their work effectively such as the provision of important public goods and services e.g. law and order. The resource allocation can also be affected dearly since most of people are operating in unofficial economy and they are avoiding taxation. This state of economy can also have a negative impact on investment (FDI), since most of them will not wish to work under these conditions. The graph below shows an example of unofficial economy across the globe but our main interest is in the emerging markets (Edwards, 2000). Source: Schneider, and Enste, (2013). From the figure 14 above if one sample the emerging markets in the figure above, Bulgaria, Poland, and Hungary are leading in levels of unofficial economy. On the other hand the levels of unofficial economy in Slovakia are relatively low compared to other emerging markets (Mahoney, 2011). Another disadvantage that is associated with the downsizing of the government is overregulation of the government. The government tries to fix taxes as it pleases them so as to get revenue. There are stiff regulations from the government as a result of regulation. This is common to almost all the emerging markets that are undergoing transition (Kornai, 2000). The liberalization of the prices at times may not go down well with the people in these countries and the government may be tempted to come in so as to regulate the market prices. This happened in Russia at the onset of transition, but later on the government left the prices to stabilize naturally without interfering. This is another challenge that can come with downsizing of the government in the emerging markets (Schneider, and Enste, 2013). Downsizing may also leads to the government reducing its spending in their infrastructure. This if not checked then it can cripple down the government activities since infrastructure is very important aspect of economic development. Thus if the government reduces its spending on infrastructure, then it can impede development of these emerging economies. A number of scholars believe that it is better for the government to reduce its spending, but it should not reduce its spending on infrastructure (Burawoy, & Verdery, 1999). Good infrastructures will attract foreign investment that will in turn help in economic growth. But on the other hand, poor infrastructures will drive away potential investors from the country. Thus the emerging markets needs to reduced its spending yes for it to attain economic growth, but then that should be done in some sectors of the economy and not their infrastructure sector (Cascio et al, 1997).. Downsizing of the government can also lead to rationalization of decreasing the government size. This can be done in various sectors of the economy where the government may decide to decrease its size by sending people home so as to reduce on its spending. But then it may be good to these governments but it hurts the people who are being sent home, and they may resort to illegal activities for them to survive. These illegal activities may harm the government in its quest to attain economic growth (Pistor, Raizer and Geffer 2000). Conclusion Public spending can both be seen as good and bad in these emerging markets with respect to the economic growth of any nation. Generally during the old regime prior to transition, public spending was very high. The old regime also did employ the use of social safety nets to prevent individuals who are vulnerable from poverty and shocks from falling down to a given level. The income distribution of the emerging markets such as Russia, Poland, Slovakia, and other emerging markets were largely unequal. There was big disparity in the income distribution in these emerging markets. Transition in that occurred in these emerging markets was basically characterized by the liberalization of prices, market stabilization, and also privatization. Liberalization of prices resulted in reduction of subsidies, and the general reduction in government expenditure. Liberalization of prices also led to the introduction of hard budget constraint (HBC) among the emerging markets, and shifting away from soft budget constraint (SBC). There are several advantages that come along with downsizing of the government in the emerging markets. For instance it leads to privatization which is evident in most of the emerging markets of countries such as Russia, Poland, Slovakia, Ukraine, among others. In addition to this some other advantages are reduction in subsidies, reduction in government expenditure with regard to employment bills, increase in revenue to the government, among other things. On the same note downsizing also has got its own disadvantages such as resulting to unofficial government, overregulation, and reduction of government expenditure that can lead to rationalization of the government size. References Andreff, W. (2006). ‘Corporate Governance in Mickiewicz (ed.), Corporate Governance and Finance in Poland and Russia. 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A model to explore the mystery between organizational downsizing strategy Yang, D. L. (2004). Remaking the Chinese Leviathan: Market transition and the politics of governance in China. Stanford, Calif: Stanford Univ. Press. Read More