Easier said than done, but govt has to balance three sectors of economy

The most important policy issue today is how the government can stop spending taxpayers money on labour and financial markets so that the real or production sector can pick up.

All economies can be divided into three major sectors: product or real sector, labour sector and the financial sector. It is the duty of governments to keep the three in rough balance between themselves. 

This balancing is not hard when the three sectors are booming or even merely doing well. It’s like an aircraft that’s in level flight experiencing some minor turbulence. The pilots only have to make small adjustments to the controls. 

However, it’s the opposite when some or all of the three sectors are doing badly. Then governments have to choose in which sector to intervene first to restore normalcy. The intervention takes the form of propping up the sector with taxpayers money. 

Since the late 1980s, most governments worldwide have sought to intervene in the financial sector first, then the real sector and only last in the labour market. 

India, however, thanks to democracy, has been an exception. It has been intervening in the labour sector first by ensuring that wages/salaries in the formal economy remain impervious to market conditions. 

In Marxian terms, this means labour has extracted the surplus rather than having had it extracted from it. This has had serious implications. 

For the private sector this means the wage bill remains the same or even increases slightly when there is demand slowdown. For the public sector and government employees the wage bill increases in line with inflation, which means higher taxes to pay these bills or more borrowing from captive banks. Both depress private savings, especially household savings.

If this is not bad enough, the financial sector, the other government favourite, is also not as flexible as it should be. This means the production sector is not only faced with a high wage bill but also a high interest bill. It just can’t cope. 

This the main reason why, in spite of the huge reduction in demand, it’s not been able to offer market clearing discounts. In other words, it too has a downward rigidity problem. 

The most important policy issue today is the extent to which the government can stop spending taxpayers money on the labour and financial markets so that the real or production sector can offer lower prices to increase purchases by consumers. 

Consider, as an extreme but politically impractical solution, what would happen if the government cut all wages and pensions by half and told the banks and NBFCs that it won’t pump money into them anymore. Instead, it tells the production sector that it will give them money to pay off their debts. This is because the time is long past when just lowering tax rates would do the trick. 

The answer is simple: the economy will revive and start growing more quickly once again. 

But we all know that for reasons of political correctness and competition, this is not going to happen to the extent needed if at all. So what’s the next best alternative? 

The finance ministry must recognise that the most productive part of the economy, namely the real economy, needs direct funds injection just as much as the other two sectors do. Indeed, I would argue that it needs it more because it is the most productive sector, unlike farming which is the least productive. 

We therefore need something that resembles a loan waiver for farmers. This, in turn, requires the government to savagely curtail other expenditure so that it can pay the banks what the real sector owes them. 

In other words, the government must recognise that there all three sectors needs direct funds injection, not just two. It’s exactly like having three children who have got injured in an accident. You can’t help just two of them.