Opinion – Samuel Pessôa: Does fiscal adjustment cause growth or the opposite?

Does fiscal adjustment precede a growth cycle or vice versa? Orthodox economists think that a structurally sound fiscal situation is a precondition for a growth cycle. Keynesian economists consider that fiscal adjustment is caused by an increase in the growth rate.

The figure below, obtained from the IFI (Independent Fiscal Institution) website, shows the evolution of the central government’s primary surplus. Primary surplus is the balance between non-financial income and expenditure.

The growth cycle in the 2000s was preceded by a long and difficult fiscal adjustment. More recently, there has been a fiscal improvement since 2016, without the economy having resumed growth.

These two facts can be seen by looking at the “dots” on the graph, that is, the central government’s primary surplus. There are bars of three different colors on the chart: pink, blue and gray.

The pink bar represents the balance between non-recurring revenues and expenses, such as revenues from privatization and auctioning of oil wells. For example, the strongly negative pink bar in 2020 refers to emergency aid, an example of a non-recurring expense.

The blue bar represents the balance between income and expenditure that occurs according to the economic cycle. For example, at the low end of the cycle, expenditure on unemployment insurance increases, and income decreases. This is the cyclical component of the primary surplus.

The gray bar is obtained by residue. The difference between the observed primary and the non-recurrent and cyclical components is the structural component. The structural surplus is one that occurs under normal operating conditions of the economy. It is the relevant concept for assessing the solvency of the Treasury.

The structural primary peaks at 2.2% of GDP in 2003, drops to -0.4% in 2010 and to -2.4% in 2014. The fall in the structural primary long precedes our great economic crisis from 2014 to 2016.

The fiscal worsening was not well observed in real time as it was masked by the cyclical component, a consequence, among other reasons, of gains in terms of trade. And, as of 2010, by an increase in the non-recurring component.

The experience of the last 25 years clearly indicates that the orthodox view fits the data better. Fiscal tidiness precedes growth cycles, just as our great crisis was preceded by fiscal worsening.

In particular, the sharp decline in 2014 was not a consequence of the turnaround in the commodities cycle. This hit the public accounts in 2015. The worsening in 2014 was essentially the structural component.

Additionally, IFI data suggest that the fiscal policy of Lula’s second term was already unsustainable. The fact that the most popular government fiscal policy in our history has been unsustainable is a sign that our democracy has struggled to sustain long growth cycles.