The first budget of the Alliance Sociale stands in stark contrast to the previous government’s essentially Keynesian approach. At first sight, the term Reaganomics comes to mind, especially when one considers the proposed tax cuts, pro-growth supply-side policies and labour market reforms. Whilst it did not work well during the Reagan years (as decreasing taxes were not followed by reduction in government spending), Sithanen’s first budget wages war on wastage and inefficiencies.

Supply-siders believe that tax cuts would lead people to work harder and more productively, and that the resulting boost in economic activity would lead to an increase, not a decrease, in tax revenues. Theoretically, the long-run dynamics of this policy change appear attractive. A lower tax rate on income should increase the labor supply (taxes indeed discourage work since they lower the after-tax return from work, and they discourage both saving and investment, since they lower after-tax returns). Given the labour demand function, this increase in labour supply will increase employment, reduce the pre-tax real wage and increase the post-tax real wage. Lower taxes also increase savings and investment flows. In equilibrium, this will lower real rates of interest as more saving flows into capital markets, and raise investment. Over time this investment leads to higher capital, more productive labour, and higher output and wages.

But this is theory. Whether the new economic model will behave as expected and lead to a strong growth recovery remains to be seen. This is perhaps what Minister Sithanen refers to as “calculated risks.”

Pro-growth policies abound in the budget. It is expected that higher investment and growth rates will contribute to improving the incremental capital-output ratio, which is often used by foreign investors as a key indicator prior to investing in a country. Locally, the SME sector has been called upon to take risks, to invest without fear, and to capitalize upon the incentives being offered. It is commendable that Mr Sithanen’s budget will help to create an environment in which people will be willing to take risks. It is time the SME sector starts leading economic growth instead of following it. In the U.S., for instance, small businesses create two out of every three new jobs every year.

Interestingly, a few goals have already been scored by Mr Sithanen: the budget deficit, for one, is expected to revolve around 4%, down from 5.5%. However, one should not forget that budgetary measures are only instruments to achieve macroeconomic objectives. The magnitude of the real effects on core macroeconomic fundamentals (growth rate, price stability, unemployment, and balance of payments) need to be closely evaluated, monitored and adjusted as and when necessary to maintain the momentum.

Finally, it is important to ensure proper safeguards are in place to accompany the ex-post checks that will be conducted on new businesses, including foreign ones. Care should be taken to prevent rent-seekers from exploiting the transition from the old to the new paradigm.