The Present Recession

Times have indeed changed. When I was a young undergraduate some 40 years ago, the general perception among economists was that Keynes had saved capitalism from the ravages of communism. In contrast, last week I heard a distinguished editor describe Keynes as the most wicked and immoral man in economics. He said that Keynes had taught governments to deceive. That he had encouraged budget deficits proposing that they be financed by public debt and then wiping them out with debased paper money. This destroyed the virtuous habit of saving because it was rendering savings worthless through deliberately engineered inflation. As an example of the harm done, it was argued that there was widespread arbitrary redistribution of wealth in Britain during the 70s as a consequence of the supposedly Keynesian policies that the country had adopted in the 50s and the 60s.

I write supposedly for it is far from clear that the policies were particularly Keynesian; however economic points are not the ones I wish to pick at. It is the morality of inflationary policies that needs to be re-examined. It is conventional wisdom to claim that inflation is a great evil in all circumstances. Undoubtedly, inflation reduces the value of cash balances, but the notion that all bank deposits are the fruits of a hard-working middle class is the sort of myth that government bureaucrats love to propound. One should not accuse them of selfishness but it would be a mistake to lose sight of the fact that they have most to gain from sound money and stable policies. They are the ones with fixed incomes that rise in value when prices are falling and vice versa. This powerful group is always for stable prices.

Yet the immutable benefits of stability must be called into question every now and again. It is perhaps dreadful that so vicious an instrument as inflation should lead to redistribution of income. In sobre stable societies such ideas seem both unethical and offensive to the sensibilities of worthy public servants, but in poor India, with her rising population and her 300 million people below the poverty line, is stability necessarily desirable? Can we honestly say we have reached a state of bliss that ought to reflect permanent distribution of future incomes?

For those with a different sense of morality from my distinguished friend, the haunting problem of this country is one of a dynamically growing population rising at the rate of 15 million people per annum. How are we going to ensure a stable life for these extra millions that emerge from our mothers bellies? In these circumstances, the merits of a stable society recede in the background against the looming crisis of a burgeoning and impoverished society. For us Keynesian waifs, the true criterion of good economic policy is not how much better or more stable our rates of growth are compared to previous years, nor frankly how large or small these ephemeral budget deficits are, but how much output is lost by government policies that impinge on production.

It is clear that if future generations are to have some semblance of hope, the Indian economy has to run even to stand still. And if that is the need of the hour it is of little value to be prescribed tight monetary policies which reduce inflation but stifle growth. Stability and non-inflationary growth is great if you do not need a job to survive, but if you do, you can only dream about the opportunities lost.

The real conflict in economic policy making is growth with stability against faster growth with instability. For generations Indian finance ministries have been chirping away in self praise at their rectitude. They deserve the congratulations of IMF and World Bank economists; but whether it has done any good to India is a matter of grave doubt.

It is in this context that we must look to the present recession. Rakesh Mohan, the highly astute director-general of NCAER, traces our slow-down (Economic Times, May 15) to the tight monetary policy following the higher rate of inflation in May-June of 1995. As always happens, tight money policies work with a lag. While inflation fell from double digit figures to 4 or 5 per cent in the first half of 1996, interest rates continued to be maintained at high levels. Consequently, real interest rate rose to a formidable 14 to 15 per cent and with the usual lags the growth rate, it has slowed down. High real interest rates entirely damaged corporate profits which like Humpty Dumpty fell off the wall. Now all Chidambarams men cannot put him together again. The finance minister tried very hard with a most generous budget, but the short recovery has proved to be nothing but what traders refer to as a dead cat bounce a recovery with no life in it.

To return to Rakesh Mohans analysis. His piety prevents him from telling the next part of the story accurately. Low corporate profits have damaged business confidence and company balance sheets. Managers are busy shoring up the figures before they think of fresh investment, and interest rates have not come down sufficiently to revive animal spirits. Indeed, the fall in interest rates has been accompanied by a sharper fall in the marginal efficiency of capital.

In their explanations none of the captains of industry will dare to bell the cat. After all it would be improper to confess that in times like these, a short inflationary stimulus is probably needed. Yet so afraid have we become of mentioning the unmentionable that this kind of sentiment cannot be echoed. Instead, Rakesh Mohan has to assure us that a revival is on the way because interest rates have fallen; but what matters as well is the relative fall in profits.

In this game of prediction most of us have limited skills. It is difficult to know where to look for the sure sign thatLe bon temps viendra. Normally such signals emerge from the stock markets but to look there is now unfashionable. Unlike finance ministers who tell us they lose no sleep whether markets go up or down. I continue to look upon them as harbingers of the future silently gathering and collating a great deal of information. And so far they have not signalled a robust economy.

We need to pull out of this thoroughly unnecessary recession. We have been put into it by the government being to sensitive of its own borrowing requirements. Because the authorities could not control their deficits and refused to countenance the prospects of inflationary pressures, they have punished industry. Some call it crowding out, but I prefer the phrase muscling in. The way out is not just reduced interest rates but higher producer prices to revive investment.