Give any casual observer a budget, Federal or State, and ask them to score it, they will ask with a smart look, “What is the Capital Expenditure of the budget?”
Why?
Everyone in Nigeria has been repeatedly told by analysts that if a budget has more funds earmarked to capital than recurrent expenditure, then that budget is better. Why? Well, the perception is that Capital Expenditure, e.g., new roads, are better than Recurrent expenditure such as salaries.
Recurrent expenditure means expenditures that are recurring in nature, i.e. spending that is consumed, whose benefits last for only a limited period. It includes salaries and pensions, fuel for cars, newspapers, etc.
Capital expenditure is mostly investment in assets that are used over time in the provision of goods or services to the taxpayers. This will include the provision of ports and rails whose economic lives go beyond months. The real difference is the impact of both spending; while salaries are paid in cash and the taxpayers have immediate economic use, roads are built over time but their economic impact last longer.
So, roads are “good” …salaries are “bad”? well not really, but you get the point.
Okay, what about airports? If Lagos and Benue both got Paris Club refunds of $10 million each, what should they spend on? Are expenditures on building airports good or bad? Remember the perception, capital expenditure is “good” it grows productivity, and “recurrent” expenditure is “bad.” So?
For instance, consider the plan by Benue State to build an airport for N38b. Yes, Thirty-eight Billion Naira. Do you think spending N38b to build a new airport in Benue State is a good idea?
Still can’t make up your mind? Want my opinion? If Lagos was building an airport, it’s good, if Benue is building an airport, it’s bad, all things being equal.
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Why?
Lagos has 38% of Domestic air traffic and 73% of international air traffic as at Q4 2017, as reported by the National Bureau of Statistics. Benue State is the largest producer of yams in Africa, but low in air travel when compared to Lagos State. Every Naira spent by Lagos State to build more airport infrastructure to connect those passengers to airports across Nigeria means more productivity gains for travellers via Lagos State.
To use economic lingo, Lagos has a comparative advantage in air travel, Benue has a comparative advantage in agriculture. So, Capital expenditure to build an airport in Lagos is “very good”, but “not so good” in Benue. Remember both have limited resources.
Okay, what about a yam processing plant? Lagos has a large yam eating population, should Lagos State invest in a new Capital project to develop a yam processing factory in, say Badagry? Is this capital investment “good”? Of course not.
Why?
Benue is Nigeria’s largest yam producing state, recording an average of 1.5 million tubers annually. Zaki Biam yam market in Ukum LGA Benue State is the largest yam market in West Africa. Benue State produces more yam tubers than Lagos State. Any investor in this yam processing plant in Lagos must pay to transport yams to Lagos? It’s cheaper to process those tubers in Benue, then transport finished products to the Lagos market—less weight, less waste, more productivity, more profit. So another lesson, a yam processing plant in Lagos is “not so good”, but “very good” in Benue. Building a yam processing plant in Benue State can create the necessary commerce to facilitate and fund the operations of an airport in Benue State.
What’s the overall lesson? Not all capital projects are economically viable or good.
Again, using our example of Lagos and Benue States, where should the Federal Government invest in building an affordable apartment complex? Lagos or Benue? Kosofe LGA or Ukum LGA? Again, an investment by Lagos State in affordable housing has a larger impact than similar investment in Benue State.
Why? Because the rate of rental demand and thus price rise is higher in Ikeja LGA, for instance, than the rate of increase in Markudi LGA in Benue State. This is a no-brainer. However, what if both State governments decided to subsidize housing for all State employers by increasing allowances in recurrent expenses, would such a recurrent expense in Lagos State be bad? I don’t think so. Why? A housing allowance subsidy payment in Lagos State will drive consumption and economic growth by freeing up disposable income for Lagos residents.
Now that we have that principle locked in, let’s ask another personal finance question. Which “budget” makes more economic sense to you the individual? A capital project to build a new house or recurrent cost to pay rent? In other words, should you commit a large sum of capital to build your own home, or would you simply place those funds in a bank and pay rent?
The answer depends on two variables: the annual cost of rental and the risk-free rate. I’ll explain.
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If you work in a state, and the annual rate of rental increase is less than the average return on a “risk-free” instrument, e.g. a 365 Day T-bill, then you should spend on Recurrent expenditure, i.e. rental, because you make more by placing that rent cash in a bank, paying rent later and making a profit off the spread. However, if the annual growth in rentals exceeds the average return on “risk-free” instruments, then its advisable you do a Capital expenditure and buy a home. Simply put, you may not need to own a home, it all depends.
So back to our question on scoring a budget. We cannot simply measure effectiveness by “Capital” or “Recurrent,” the real measure is “impact” viz a viz costs. The Federal, State and personal budget must have an impact as the key driver. Will this spending be simulative? Will it raise living standards? Will it make tomorrow better?
Those are the real questions.