The President signed the 2022 budget into law on 31st December 2021. This is commendable as it marks the alignment of the fiscal year to the chronological year..
The Budget for 2022
The budget breakdown is as follows
- Capital Expenditures N5.4 trillion
- Recurrent Expenditure N6.9 trillion
Is Capital expenditure better than Recurrent expenditure?
When you ask any Nigerian their views about the budget, the go-to rule is to ask, “what percentage is allocated to Capital Expenditures.”
You hear this all the time from the average Nigerian, “our budget is 60% capital expenditures”. This is good because Nigerians have been told that recurrent expenditures like salaries are inferior to capital spending like airports. The reason is simple: Nigeria has an infrastructure deficit, and roads and bridges are capital; thus, spending to build more roads is a good thing all the time. Right? Jigawa State building an airport will serve the state better than paying salaries? Correct.
Well, not exactly; Economics is not one size fits all.
The Multiplier Theory
In economics, there is a concept called the Multiplier. A Multiplier, according to Investopedia, refers to “an economic factor that when increased or changed causes increases or changes in many other related economic variables.” A multiplier, therefore, amplifies the base value of something else. The most famous multiplier theory is the Keynesian Multiplier theory. Keynes postulated that the injection of government spending created a proportional increase in overall income for the population, and this income is either saved or consumed. We get our marginal Propensity to Consume (MPC) and Save (MPS) with this theory.
In summary, if the government injects N100 into a town, and the Marginal Propensity to consume is 80%, then the consumers will spend N80 and save N20. That N80 consumed or spent becomes income for a new set of consumers. In this way, a chain of spending occurs in the economy, with each additional increase in revenue more minor than the previous. A key point, a change in consumption can only happen if there is a change in income.
Lagos airports versus Benue yams
Lagos has 36% of Domestic air traffic and 70% of international air traffic. So, it is okay for Lagos to build more airports to connect those passengers to airports across Nigeria, But not for Jigawa State. Lagos has a comparative advantage in air travel to use economic jargon, but Jigawa does not. The funds invested in an airport in Lagos will have a higher multiplier value in Lagos State via spending on hotels, taxis, catering etc.
Zaki Biam yam market in Benue State is the largest yam market in West Africa. Benue is Nigeria’s largest yam producing State in Nigeria, recording an average of 1.5 million tubers annually. So, Benue has a comparative advantage in yam farming. If Lagos invests in a Yam processing plant in Lekki, this will be a capital expenditure; this is good? Of course, it is cheaper to process those same yams in Benue than transport finished products to Lagos, with less weight, less waste, more productivity, more profit. The multiplier effect of a yam processing factory in Benue far exceeds its impact in Lagos State.
So Capital or Recurrent?
So back to Jigawa, if the State has $1m in cash, should they invest in a new airport that is capital in nature or invests in paying salaries, which is recurrent. Which of these government expenditures will have the most significant impact on residents in Jigawa? An airport or an increase in the minimum wage?
According to Keynes, households will consume and save for any income level but in different percentages. Where there is more consumption or in an economical language where the propensity to consume is higher, and the economy has spare capacity, with a low tendency to import, then there is a higher multiplier value. In other words, if Jigawa wants to grow her economy, she can inject capital into the economy. This cash injection to the residents of Jigawa will increase spending and consumption in Jigawa, creating demand for goods like meat, TVs, and schools. This new demand then creates new jobs to meet that demand, which makes new incomes for the newly employed, creating new demand. On the other hand, the airport will also hire many. Still, it will be used as much as simply giving the cash away, i.e., which multiplier is higher, the inputs for that airport are imported, so the demand is not created in Jigawa.
Look at Japan; their economy is stuck in a low growth deflation because Japan’s marginal propensity to save is very high. Japan Times reports that, on average, Japanese people saved 44% of their income in the five months through to August 2020, up from 33%. So, if you gave everyone in Japan $1,000 rather than spend, they would have saved $440.
For context, this was the period of covid nineteen handouts, as the Japanese people got a cash grant, they did not spend, then banked it. Thus their economy has slow growth. Japan, for instance, has seen the potential growth rate stagnate at below 1% for the past two decades compared to 1.8% in the US, according to Nikkei Asia.
In summary, capital expenditure must be tied to competitive advantage and have a positive multiplier effect to be better than recurrent expenditure. In some states, simply paying a higher wage can spur economic growth faster and broader than a capital project.
What is the overall lesson? Not all capital projects are good but remember; you must do the math. Suppose the multiplier value of recurrent expenditures is low, in that case for example, the economy is close to capacity or rising demand can cause inflation, then it may be better to do traditional infrastructure to boost productivity. Keep in mind that investment in infrastructure will boost productivity in the long term, but like Keynes said, “in the long run, we are all dead.”
