Have you seen the promo clip for the song “Trenulețul” by the band Zdob si Zdub & Frații Advahov from the Republic of Moldova? In this clip, the main character’s first thought when the clock rings in the morning is “Train!”. It is already late, and he needs to take a train to get from Chisinau to Bucharest.

This is how things go with the budget deficit, writes Lucian Kreitoru in his blog. When it’s too big and needs to be cut, the deficit is the first worrying thought that comes to everyone from ruling party leaders and finance ministers to all of us. The resulting uncertainty disrupts the decision-making process in both the public and private sectors.

Everyone is worried about what the government will do

Everyone is worried about what the government will do: will it cut/freeze salaries, raise taxes, increase inflation, come up with some new solidarity tax, and if so, with whom and how will it be in solidarity, forbid accumulating a pension with salary, etc. An army of politicians, analysts, and economists begins to discuss how much this or that measure helps to reduce the deficit. When either indicator reaches 1 percentage point (pp) of GDP, it’s a big deal. Most of them barely manage to reduce the budget deficit by 0.1-0.5 percentage points.

Since almost all of us are caught up in this process, a kind of vortex of our minds from which it is difficult to get out, it seems that too few of those who decide what measures to take think about the unintended consequences of different measures. the future, what values ​​we unknowingly sacrifice. In particular, by narrowing our horizons in this way, we tend to overlook that some of these remedial measures may limit or hinder private initiative or prevent it from realizing its potential and succeeding.

We misused fiscal policy, and because of this, the problem of reducing the budget deficit was almost constant

This is even more worrying because in our country, unlike developed countries, the budget deficit becomes unbearably large not only in difficult times (recessions, pandemics, etc.), but especially in good times. In other words, we misused fiscal policy, and because of this, the problem of reducing the budget deficit was almost constant.

If we continued like this, and if we didn’t worry about the size of government being too big, we could end up with a tax share of 40-45 percent of GDP and debt that exceeds GDP, like some developed countries. Some economists even believe that it is desirable.

we will look like developed countries in terms of taxes and debt, but we will still be second to last in the EU in terms of living standards

Only the private sector will be one in which competition will be atrophied, initiative will be driven by government programs (new and new PNNRs will be needed), innovation will slow down, etc. Thus, our convergence will take place only in terms of GDP shares of taxes and public debt, but not in terms of real income per capita. That is, in terms of taxes and debts, we will look like developed countries, but in terms of living standards, we will be second to last in the EU.

So far in Romania we have had, in principle, two approaches to situations where economic development has forced us to reduce the budget deficit: (i) or, mainly, we have increased taxes, which means that to a large extent we have saved the budget sector (which thus was able to avoid painful adjustments) at the expense of the private sector, (ii) or, mainly, we cut public spending, usually by cutting investment spending, depriving ourselves of the infrastructure necessary for development, but also through drastic and undesirable measures, such as through reduction of salaries in the public sector.

In the first approach, political power was less concerned with reducing economic freedom, or in other words, the economic power of the private sector, in order to increase its own power. Political power reduced the imbalance of public finances, creating an imbalance between political power and economic power, increasing the former to the detriment of the latter.

Fortunately, this power imbalance never reached a tipping point. This has not been the case since 1989, but if the freedom and economic power of the private sector declines significantly relative to political power, neither will our political freedom. This worries us because it is fresh in our minds that what happened in 1989 was essentially the opening of the way to reduce political power and increase economic power so that the two are balanced. We would like this warranty balance to continue to exist.

After four years of reckless fiscal policy guided by a dubious economic theory called “wage growth,” the budget deficit reached nearly 5% of GDP in 2019.

Now, as several times in the past, we have the same problem of excessive deficit. This time, the excessive amount was officially noted by the European Commission even before the pandemic. We have to cut the deficit now, not only because the Commission is demanding it, but also because revenues are not rising again this year, as they were when inflation accelerated from more than 8 percent in 2021 to more than 16 percent in 2022.

After four years of poor fiscal policy, guided by a dubious economic theory called “wage-led growth,” the budget deficit reached nearly 5 percent of GDP in 2019. We were in such bad shape when the pandemic almost doubled the budget deficit, and Russia’s start of war against Ukraine made it difficult to bring it down to 6.2 percent of GDP in 2022.

How can we further reduce the budget deficit, given the relatively high inflation in the world and the war in Europe, which has been going on for more than a year? The first thing that comes to mind is Hemingway’s remark in 1935 in Notes on the Next War (he observed the First World War as a writer) that inflation and war are the panacea for bad management. nation In the short term, these solutions work, but in the long term, they depress you. OK, but what does bad governance mean in a Western democracy?

From the point of view of the classical liberal, democracy is poorly governed when the balance between the two forces (economic and political) is shaky, that is, when the liberal component in society is reduced. Redistribution by governments is ever-increasing, financed first by higher tax rates and then, if we assume that the tax base is already widened, by increasing public debt.

At some point, however, redistribution grows to such an extent that, socially, tax rates are too high to be increased, and spending is too sensitive to be cut. In other words, too many resources are taken from the private sector for redistribution. The result is that the freedom and economic power of the private sector is relatively diminished.

Read the full article and comment on it on Lucian Croitoru’s blog

N.Ed: Lucian Croitoru is the chief adviser on monetary policy to the head of the National Bank of Romania