Capex gets a boost. Will economy rise?

The Union Budget saw a 33 per cent increase in capital expenditure (capex), building on the investment made in the previous year. An increase in capex impacts national income through the multiplier effect, which refers to the change in the final income generated by a change in initial spending. Simply put, it measures the change in national income that occurs when additional money is invested in the economy.

In India, earlier research has estimated that the capital expenditure multiplier is 2.45 and the revenue expenditure multiplier is 0.99. What this essentially indicates is that for every additional Rs 100 spent on capital expenditure, the national income increases by Rs 245 while, for every additional Rs 100 spent on revenue expenditure, the national income increases only by Rs 99. Common sense tells us that we need higher capital expenditures to unleash a larger multiplier effect and hasten the recovery process. This justifies the immense capex spending we saw in the last two years’ budgets. The GDP figures and the predicted growth rates also validate increased capex spending.

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Despite the improvement in GDP, the overall economic situation is not as positive as it appears. Particularly, the effectiveness of increased capital expenditure and its multiplier effect on reducing unemployment is uncertain. According to the data from the Center for Monitoring Indian Economy (CMIE), nine of the twelve months in 2022 marked an unemployment rate of 7 per cent or above, excluding January. The peak was seen in August at 8.28 per cent. While an increase in capital expenditure may have positively impacted the country’s GDP, it failed to create sufficient employment opportunities, as seen in the persistently high monthly unemployment rates.

Despite the optimism that the long-run effects of the capex boost will lead to growth, income, and employment, John Maynard Keynes’ (who formally introduced the concept of expenditure multiplier) famous quote, “In the long run, we are all dead,” warns us that the outcome may not be as expected. To be specific, for the Indian economy, the issue of jobless growth continues to loom as a major threat in the backdrop despite the capex boost.

Read | Budget 2023: Higher capex may be self-defeating

Many studies indicate that the multiplier effect is not effective in the long run due to changes in interest rates and tax rates. This brings us to the next major issue that the economy is battling: inflation. The twin problems of unemployment and inflation are not isolated issues necessitating distinct corrective policy measures. Rather, they are highly interlinked and hence need to be addressed jointly. On the theoretical front, the Phillips curve postulates an inverse relationship between inflation and unemployment. That said, the recent empirical evidence suggests otherwise. For instance, countries like the US and the UK have observed a flattening Phillips curve, i.e., the relation between inflation and unemployment has weakened over the years. A nuanced understanding of the interlinkages between inflation and unemployment is the first step in tackling these issues. Policies implemented without a clear understanding of the dynamic relationship between these economic variables are akin to aimless shots in the dark, with little chance of hitting the desired outcome.

No doubt, various factors, including the Covid-19 pandemic, the Russia-Ukraine conflict, and global inflation, have all exerted pressure on the economy. These external factors have overshadowed the initiatives taken in the previous budget and continue to pose a challenge to the problems of unemployment and inflation. Moreover, it is also a fact that the significance of the Union budget for the economy has declined as the role of the government in the economy has diminished in the past 30 years.

To put this in perspective, the total budget expenditure of Rs 45,03,097 is only a fraction of our country’s GDP, and with the implementation of the Goods and Services Tax (GST), the centrality of the budget has further declined. Nevertheless, it needs to provide a respite from the immediate challenges the economy and its citizens face. The general economic landscape raises doubts about the efficacy of Budget 2022–23 in managing unemployment and inflation. The current budget, which mirrors the same approach as its predecessor, is also unlikely to significantly improve the unemployment situation.

(The writers are assistant professors atTA Pai Management Institute, Manipal.)