Unifying the country via macroeconomic fundamentals to resolve economic crisis soon

If we want to increase capital formation and consumption allocation on a continuous basis, the only thing we have to do is expand the entrepreneurial base and entrepreneurial activity

By Hema Senanayake

There is no superhero in resolving the economic crisis we are in today. Also, there are not many different paths, models or approaches in resolving the crisis quicker. Macroeconomic fundamentals are like basic science. It has the power to unify our thinking around any subject. An Artificial Intelligence generated source explains that basic science is the quest for knowledge about how things work, from cells to ecosystems. The Dictionary of Britannica explains that science is a system of knowledge that studies the physical world and its phenomena with unbiased observations and experimentation. For me macroeconomic fundamentals are like science, and it can unify us in our thinking about economic governance. It can unify citizens and government, employer and employee, labour unions, students and almost all people, in resolving the economic crisis quickly. 

Let me begin with a very fundamental premise. No country will grow or come out of an economic depression, recession or even downturn, if it can’t continually increase capital formation and money allocated for consumption, subjected to one important condition which is that the capital reserve must be invested in producing products not for immediate consumption. Nobody can deny this. This is a unifying fundamental theory for any money-based exchange (market) economy. Let me briefly explain two parameters, mentioned in the above theoretical argument so we can understand it more accurately. Those variables are capital money and consumption money.

If you go to a restaurant and buy something to eat, then you pay some money for the meal. You spend that money without expecting anything other than food. After you consume food the money you spent is just evaporated. That money is called consumption money. The restaurant owner too, spends a certain amount of money to produce his product or service but in return he expects to receive a certain amount of money. Hence, the money spent by the restaurant owner is different from the money spent by the consumer. So, what the restaurant owner spent is known as capital in the form of money. Accordingly, in the economic system, there are two kinds of money allocations, namely, capital money and consumption money. 

Now, in view of the above fundamental theory, allocation for capital money and allocation of money for consumption should be increased on continuing basis for any economy to recover or to grow. The next logical question is from where these allocations originate. We have a unifying answer.

The said consumption allocation and capital money are originated from what is known as total proceeds of a country. “Total proceeds” is not Gross Domestic Product (GDP). It should be understood as follows. An entrepreneur can sell his output either to a consumer or to another entrepreneur and so should all other entrepreneurs too and sum of sales is known as total proceeds. So “total proceeds” is much larger number than GDP. However, total consumption money whether it is used by private consumers (households) or government via taxes or by entrepreneurs themselves, originates through entrepreneurial activity. Similarly, the money allocated for the capital that is being spent at present or for the capital reserve too, is originated from entrepreneurial activity, if we ignore the “virtual money” known as “debt money” created by the fractional reserve banking system under the current banking practice. This point is more accurate under the new Central Bank Act. Whatever the case is, we now understand that the capital allocation and the consumption allocation is originated from entrepreneurial activity. This is another unifying theory.

Therefore, if we want to increase capital formation and consumption allocation on a continuous basis, the only thing we have to do is expand the entrepreneurial base and entrepreneurial activity. 

The Government cannot do this, only the investors can do this, but the Government must set necessary conditions by handling macroeconomic variables prudently in order to ensure that investors – local and foreign – do expand the entrepreneurial base by investing. Therefore, the third unifying conclusion under macroeconomic fundamentals is that we need to expand the revenue generating entrepreneurial base essentially, not the size of the Government.

Now, the next logical question is, how do we expand or set the causes to expand the entrepreneurial base. Investors do not invest in real sector, if they do not have confidence at least on two things or two parameters. One is political instability. Even though this is an intangible parameter, entrepreneurs and investors have something defined by Keynes as “animal spirit” when comes to make investment decisions. Uncertainty about holding elections creates political instability. Jehan Perera recently wrote, “There is an uncertainty that prevails in Sri Lanka about the future of elections which is the topic of conversation everywhere, in the markets and supermarkets, over meals and drinks with friends and colleagues, whether the government will hold elections or not. This is the uncertainty that is going to undermine the country.” This is true. The animal spirit is working in all investors. Due to political uncertainty, they are not investing and do not invite their foreign partners to invest here. No expansion of entrepreneurial base. That is what political uncertainty does. 

The second is the stability of domestic currency and exchange rate. A lot of macroeconomic variables affect the stability of domestic currency and exchange rate. In addition, philosophical understanding of the monetary authorities directly affects the stability or instability of domestic currency. Entrepreneurs and investors know about this precisely. For example, if interest rate is low and private credit growth is high as a result of low rate of interest and if monetary authorities do not use macroprudential tools to contain credit growth, the currency instability takes place. Hence, mathematically we can say that stability of currency is a function of many variables. 

These macroeconomic variables can be handled only by the Government along with the Central Bank. In the first place, we need a government to do this job, to build up the confidence about the macroeconomic stability and its continuing efficacy to facilitate the expansion of entrepreneurial base from where total proceeds generate and from which capital allocation and the consumption allocation originates. This process determines the true growth of a country. So, this is a unifying understanding of macroeconomic fundamentals which can bring us together. I think this is the best option we have now and also when a new Government is elected. 

(The writer can be reached at [email protected].)