5 per cent GDP growth: Proximate, underlying and theoretical reasons

The ship of the Indian economy is sinking because it is taking water from a hundred holes in its keel. These will take a long time to be fixed

So the Indian economy grew by just 5 per cent in the first quarter of this financial year. This reminds me of a favourite question in history exams.

This was “Distinguish between the underlying and proximate causes” of some event, say, the French Revolution or the Bolshevik Revolution or the First World War or whatever.

Such a question, to the best of my knowledge, was never asked in questions papers on economic history which had a brief flowering between 1950 and 1980. It has now disappeared from the curricula.

Had it been taught, there might have been some people who would have tried to distinguish between the underlying and proximate causes of the current global slowdown, of which India’s slowdown is but a part. But since there is no one, let me try.

Proximate causes

Today even a news anchor can talk about the proximate causes of the slowdown.

These, being proximate, can be several and range from demonetisation, to the ban on cow slaughter, to GST, to the trade war between America and China, to poor administrative processes to judicial delay, to a slowdown in credit flow, to the government’s inability to prime the industrial pump, to the overvalued exchange rate to the high interest rates, to state governments’ incompetence to policy failures, blah blah blah….

The result is a babble that would have done the Tower of Babel proud. No one can figure out what is being said. So 0/100 is richly deserved.

What also emerges from this is that the ship of the Indian economy is sinking because it is taking water from a hundred holes in its keel. These need to be fixed.

But that is going to take  long time. So we have to be patient before the ship sets sail again.

Underlying causes

What’s happening now has been a long time coming, at least 11 years if not a couple of years more. Basically, the problem began in the early 1990s when Alan Greenspan, the then chairman of the US Federal Reserve, decided to flood the world with dollars. This made global money cheap.

Simultaneously, China did two things to speed up its industrialisation. It seduced American firms, which could now borrow cheaply, to invest in China; and it started running huge fiscal deficits which it financed by keeping its currency undervalued.

Over the next 15 years, this resulted in two things: massive overcapacity and massive debt in all major countries.

Something had to give in 2008 it was the debt problem that imploded first. So to use the capacity in use, the G20 countries that accounted for 85 percent of global output, decided to run up more debt. Now even that has imploded.

Result: global slowdown and a massive debt crisis for the G20. Like the Indian economy, this too will take time to mend.

The theoretical issue

Back in November 2008, I wrote that the Keynesian solution of government spending to bring back demand had been corrupted by Wall Street to mean save the financial sector. It is the too-big-to-fail argument.

The problem since then has been that in the effort to save the financial sector -- which runs mostly on greed and fraud -- governments have run out of money to save the real sector. Donald Trump’s trade war is because of this.

There are two ways out of this logjam. Either governments stop intervening completely and revert to the pre-Keynesian days or they stop saving the financial sector and focus on the real sector.

Neither solution seems possible right now but in the end, as we shall see, it will be forced upon governments. It is better therefore, that they do so voluntarily than be left with no option.

Those who choose the real sector will be doing the right thing; those that choose the financial sector will bring ruin to the country as has happened in Latin America to so many countries.