Lessons from Economic History : Cutting Expenditure

Early 1990s: India, faced with a much-publicised balance of payment (BOP) crisis, had to turn to the IMF for help. The Washington-consensus, at that time, was to trim fiscal deficit (in layman terms, the Government's expenditure minus the Government's revenue) and go in for more balanced budgets. Thus, India was obligated to trim it's fiscal deficit.

Now, Government expenditure has two components - capital expenditure and current expenditure. I'm forgetting the exact difference between the two, but it goes somewhat like this - current expenditure includes things like salaries, subsidies etc. (which provide no long-term benefit) whereas capital expenditure would be on things like infrastructure projects etc (which provide benefit over a longer time span).

What India did at that time to reduce fiscal deficit was to cut capital expenditure. Almost two decades later, we see the results. The constraint to India's growth story today is the infrastructure shortfall, something that might not have happened had there been no reduction in capital expenditure.

Reducing this lesson to an individual level, a college student too is faced with two kinds of expenditure - current expenditure (movies, food etc), and capital expenditure (clothing, books, stationery etc). Unfortunately, what often tends to happen is that faced with a budget constraint, the average student tends to cut down both expenditures in an almost equivalent proportion. However, as the story above shows, capital expenditure should not be cut down that easily.

Again, that is contingent on certain conditions. Primary among them (and again drawing from India's economic history) is the utilisation of capital. Often, to utilise capital expenditure (eg books) effectively, you need to have a consistent current expenditure (eg. food). Hence, there is a certain 'optimal balance' between capital and current expenditure, and I suppose it will take everybody not less than three years to find that out.