Q&A: David Vines, Research Director, PEGGED

'Liberalisation can't manage itself'

PEGGED is an unusual acronym for a European project that includes in its research ambit integration of trade and migration of labour. Research director David Vines, also an adjunct professor of Australia’s Centre for Applied Macroeconomic Analysis, says the relevance of Politics, Economics and Global Governance: The European Dimensions in times of the threat of a double-dip recession, when multilateral trade negotiations have taken a back seat, will be revealed in a month’s time to EU officials. In an interview with Jyoti Mukul, Vines, who was in Delhi to deliver the K B Lal Memorial Lecture on “Duty of Care and Ethical Issues in Finance”, says the benefits of liberalisation far outweigh the risk of corruption. Edited excerpts:

 

At a time when India is celebrating 20 years of reforms, charges of corruption have occupied the public mind. How real is the popular suspicion of the private sector?
It is partly a question of India’s history. It is really extraordinary how, from the model of economic management practised under Nehru originally and the first 25 to 50 years after World War II and after Independence, things have changed radically now. It is no surprise that there will be some corruption in the move to a more privately managed system. The real question is whether the political leadership is ready to restore confidence and that aberrations that occur would be dealt with so that this does not become a normal practice. Liberalisation brings a large number of benefits. The right thing to do is to focus on the benefits and seek ways of ensuring that whatever corruption happens is small and well managed.

The slowdown proved that India’s regulatory norms were in place but should there be tighter governance and regulatory mechanisms?
Speaking of my own country, US and UK, everyone is aware that tighter governance is necessary in the financial system compared with the loose governance over the period of 15 years in the run-up to the crisis. On that issue, the Indian economy fared very well because the financial sector was well regulated and supervised. The same is true in other areas of economy. It is a fantasy that liberalisation somehow manages itself. Liberalisation happens well when there are good frameworks of policy and strong political leadership provides good framework.

How good is the regulatory framework now?
It is managing remarkably well. The economy did well as a result of this and now the need is to prevent too much capital, which is causing a lot of difficulty in Brazil and Australia as capital runs away from Europe and, again, the regulatory structure is well placed to do that.

The rupee is depreciating and RBI had to intervene on Wednesday. Besides, markets are not performing well. Would you still predict a flight of capital towards India?
It is important to separate what is happening in India from what is happening in the rest of the world. The very fact that there has not been much inflow when interest rates have been raised is probably a good sign. India also faces a significant difficulty with inflation. The inflation rate is now much higher than the interest rate. It is difficult to bring the inflation rate down without having to raise interest rates further. A well-insulated international capital market is useful in those circumstances.

How do you see the new crisis in the US and Europe unfolding?
It is going to impact the whole world because the current recovery from the crisis of two or three years is fragile. We face three risks. The first is the US problem. Second, the European problem. Third, inflation. In the US, the stimulus package should be extended but there are political hurdles to that. There needs to be great confidence that the public deficit should be closed in the future — the Democrats want to do so by raising taxes and Republicans by cutting entitlements so that uncertainty blocks the ability to do fiscal expansion. Even when fiscal expansion occurs, it creates uncertainty of the future and the whole world is looking for leadership in the US to solve this.

In Europe, I strongly believe that the only way forward is with greater German leadership. Many are alarmed at Germany having created the system and then leaving it when it is in difficulty. Suppose my children are in difficulty and I say that maybe it is time for them to leave the family. When I put this to the German people, they are unwilling to see it this way. They say it is not a family but a club so people can decide to leave, but that is not the right way to think. Europe is not a club of equals and Germany is the central powerhouse of Europe and should take responsibility. And that will mean further debt write-downs in Greece, essentially managed by the Greeks and Germans rather than the Germans throwing out the Greeks and watching when Greece defaults. Anyone who says that this is well managed is a lunatic. That is a Lehman rerun. We just do not know how underlying derivatives will work if Greece defaults. The only way they can grow again is through a very significant wage cut. This would requireGerman leadership and political courage in Greece.

India too is talking of regional trade integration. Is there a lesson for it from the EU experience which is seeing a lack of leadership when crises have dawned?
What Europe has done is not understand what kind of integration is possible by separate nation states. Trade integration is extremely valuable for a region but monetary integration is ridiculous for a group of sovereign states with independent fiscal policies. I was firmly opposed to Britain joining the European monetary union for this reason. Colleagues and I worked actively against this. A really good way of understanding this is the union between the US and Canada — completely free trade and separate currency and that should be the ambition for India. What’s more, if Britain was part of the EU monetary union then the global financial crisis would have been quite possibly catastrophic. That’s because when George Bush decided to go on holiday and not notice the financial crisis and leave it to other people — Paulson was incompetent – the leadership in the four months from the Lehman collapse until April the next year was managed by Gordon Brown in London. It was a great achievement for him. If Britain had been in the Eurozone, it would have had a currency crisis and would have been unable to lead the world at that time in that way.

How relevant are groups like WTO and European Union?
The failure to push WTO onwards is an extremely bad thing but the opportunity becomes more important at the regional level. The failure of G20 to address WTO and push it forward is a real failure, a big one. But macro-economically, I think the existence of G20 has made it more possible to avoid the double dip recession than if G20 were not there. Officials over the last six months have been seriously working on, first, trying to assist the US and European Union from the outside to solve their domestic problem and to work out how to rebalance the world economy so that the continuing current account deficits and imbalances are resolved without growth slowing. And this means putting more pressure on China and on Germany to have more expansionary policies. That would not have been possible without G20.