- Questioning growth without corresponding productive expansion
The Gross Domestic Product (GDP) represents the total value of the final goods and services produced in a country. But modern economies are heavily financialised. Hence, a large part of GDP, national income, and national production is not production at all; rather, it is a transfer payment. For example, interest charged by financial institutions, late fees, and other charges are considered service income.
The theory is that interest and other related charges are a service. Rents that landlords charge, the economic overhead that monopolies charge, and the interest that financial institutions charge were all considered as an economic rent a century ago, meaning this rent was an unearned income. Milton Friedman once famously said there is no free lunch. But, in reality, the whole economy is about getting a free lunch.
What we find is the financial sector playing an increasing role in national income and GDP accounts. However, its role is not to really increase production; instead, it is to create wealth financially, mainly through debt leveraging. Particularly, it has overseen de-industrialisation since the 1980s.
The neoliberal growth paradox
In most countries, the lion’s share of bank lending goes to finance and real estate, and the effect has been to increase debt leveraging for assets, which increases prices.
If we take a closer look at credit creation by the banking system in Sri Lanka, the majority of funding allocation goes to consumption and providing asset purchase loans to the private sector. What this means is the rise in market prices for assets, not their value.
The whole point of this is to create capital gains. In order to keep the system going, creditors keep creating loans to provide credit, enabling debtors – households, firms, and countries – to keep paying their debts by lending them the money required to pay interest.
As per Hyman Minsky, this stage is called the Ponzi stage of the financial cycle. So, it seems that the economy is growing, but what it really does is keep the debt overhead solvent through the financial Ponzi scheme, and all of this is counted as increasing GDP and national income.
However, what it really does is create economic polarisation that concentrates income growth among the wealthiest class of the population. What it means is that they do not make money primarily by increasing production, but rather by extraction (transfer payments) through financial engineering and asset price inflation.
Further, there is a clear trend emerging in Sri Lankan GDP growth rates since 1980. The clusters of years with reasonably higher growth rates were directly backed by external funding or foreign funding for infrastructure development projects. In other words, these growth rates were not an outcome of neoclassical free market logic.
Basically, government spending on infrastructure injects new resources into the economy, thereby boosting the rate of growth. The flipside of that is that these infrastructure investments have created a massive foreign debt overhang.
This fact also debunks the myth that the 1978 neoliberal free market economic policies contributed to accelerated economic growth. During these 48 years of the neoliberal free market economic policy regime, the rate of growth exceeded the magical 7% only in six years.
The most critical issue is not achieving a frequent high rate of growth, but the inability of the economic model to sustain the growth momentum. Therefore, regular downward swings in the economic growth rate suggest that the growth dynamic was not inbuilt in the 1978 neoliberal free market economic policy regime.
SL’s debt, tax and speculation-driven GDP growth
In a recent Committee on Public Enterprises (COPE) session, which was held in July to discuss the GDP growth of Sri Lanka, some crucial information regarding the Sri Lankan economy was revealed. It was revealed that the three main pillars contributing to GDP growth were construction, or more broadly speaking, the real estate sector, Government taxes, and interest income of the financial sector.
As I have clearly mentioned at the beginning of this article, information is surfacing to prove my argument that GDP is getting inflated due to transfer payments and not because of an actual increase in production. Both taxes and interest payments genuinely fall under the transfer payments or unearned income category because these payments are transferred from the actual producer, reducing their capacity for future spending or investments.
The growth arising from the real estate sector is mainly due to speculative investments taking place in apartment markets. Banks are heavily creating loans or credit of up to 100% of the price of the apartment, turbocharging asset prices and attracting speculative investors. Most of the buyers of apartments are absentee owners and not owner-occupiers.
There has been a massive 240% increase in private sector domestic debt over the past 10 years, while the real economy has expanded by only around 20% during the same period. This is an alarming statistic because it suggests that a substantial portion of this debt has not been invested in productive activities but has instead been directed towards consumption and asset markets through speculative investments. As of March this year, private sector outstanding domestic debt is around Rs. 11.9 trillion.
Deputy Minister of Industry and Entrepreneurship Development Chathuranga Abeysinghe stated that the private sector had contributed to GDP through debt financing to the extent of Rs. 2.1 trillion. However, Opposition Parliamentarian Harsha de Silva disputed this, saying that the majority of private sector debt was taken up to import vehicles and that vehicle importation did not contribute to GDP.
It is true that vehicle importation does not contribute to GDP. In fact, it is harmful to the economy since it erodes our foreign reserves and increases the indebtedness of our private sector.
However, it was revealed that the taxes collected through vehicle importation were boosting GDP. Even Treasury officials admitted that GDP growth at present was a result of private sector debt-ridden consumption, and that this could not be sustained in the long term. Instead, GDP growth should be achieved through the growth of production.
Further, it was revealed that Government taxes had exceeded expectations by 1.5% of GDP in total. Taxes increased up to 15.4% of GDP. Government budgetary spending has decreased by 2.8% of the allocated budget; total expenditure remains at 19% of GDP. Accordingly, the Government primary surplus has exceeded expectations by 3.1%, reaching 5.4% of GDP in total.
What this really means is that the Government is implementing a neoliberal blueprint. While it goes on a rampage of increasing taxes on the working-class population, it makes sure it cuts the allocated budget that facilitates and improves the livelihood of the same class. The Government has declared war on the working class by ultimately pushing it into a deficit or debt position to support the Government surplus by extracting whatever surplus it had in terms of taxes.
Besides, as per a research paper by Christina Romer and David Romer of the National Bureau of Economic Research in Cambridge in July 2007 under the title ‘The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks,’ it has been revealed that tax increases of 1% of GDP will lower real GDP by roughly 3% in the long term.
‘Taxes for revenue are obsolete’
In 1946, the Chairman of the Federal Reserve Bank of New York famously said: “Taxes for revenue are obsolete.” What this means is that, for a country with a sovereign fiat currency, taxes do not function as a source of revenue for the government.
The reason is simple: as the issuer and the absolute owner of the rupee, the Government has no need to collect it from a third party in order to spend. However, taxation is essential to the value and stability of the rupee, as it is the most powerful mechanism driving demand for the currency.
Furthermore, taxation must be used as a tool to extract economic surplus from areas where it has accumulated and to prevent its excessive concentration in the hands of a few.
If the Government wants to boast about real revenue, it should be accumulating foreign currency or gold instead. That will truly strengthen the balance sheet of the Sri Lankan economy since no foreign supplier or foreign creditor will accept payments in rupees; instead, it demands payment in foreign currency.
In reality, taxes are not an income source for the Government. If the Government wishes to create an income source that will truly contribute to GDP, it should consider engaging in social production and service processes that will give it real income. This misinterpretation comes due to our inability to determine how economic value is being generated in an economy.
Until the mid-19th century, almost all schools of economic thought agreed that not all activities that demand a price create economic value. This is because value is generated at the heart of the production of new goods and services: how these outputs are produced, how they are shared across the economy, and what is done with the earnings created from production.
Once value is created, it is then shared among other activities by extracting value from the original source. This extraction of value can also be identified as transfer payments or unearned income, and gaining disproportionately from the ensuing trade.
However, neoliberalism has changed this type of thinking by claiming that anything that demands a higher price has a higher value; in other words, economic value creation has become a subjective matter. Hence, in the neoliberal economic order, taxes are considered government income that contributes to GDP instead of an extraction.
While GDP growth has often been equated with economic progress in neoliberal economics, heterodox economics challenges this view by highlighting several critical limitations.
According to heterodox economics, economic policy instruments do affect scale, such as GDP-enhancing macroeconomic policies. Consequently, the notion of continually expanding the scale has become problematic, as the economic subsystem has grown to the point where its physical demands on the ecosystem are significant.
Thus, it is evident that the scale of economic activity cannot be determined solely by market prices but must reflect social decisions that account for ecological limits. Similarly, distribution cannot be determined by market prices but by a social decision reflecting a just distribution by providing ordinary people with purchasing power.
It is evident that the GDP growth mantra has contributed to increasing inequality, making the rich richer and the poor poorer. The market has failed to deliver a just distribution of wealth, particularly for the poor.
Moreover, GDP growth is not necessarily related to a more equitable distribution of income or wealth, thereby exacerbating social inequality. In fact, the pursuit of GDP growth often obscures critical issues such as income inequality, the erosion of social wellbeing, and the deterioration of environmental health.
Given these limitations, heterodox economics argues that focusing on GDP growth as the primary objective is short-sighted. Instead, policymakers should prioritise alternative measures of wellbeing that emphasise environmental sustainability, social justice, and quality of life.
For instance, the Genuine Progress Indicator (GPI) provides a more comprehensive measure by adjusting GDP to account for environmental costs and social outcomes, offering a more accurate reflection of national wellbeing.
(The writer is a graduate of Monash University, Melbourne, Australia; an entrepreneur; and the author of the book ‘Wikalpa Maga – De-Dollarization’)
(The views and opinions expressed in this article are those of the writer and do not necessarily reflect the official position of this publication)