Developing Asia was until recently considered to be relatively immune from the global crisis for several reasons: the significant role of China as a regional economic leader and potential growth pole; the cushion provided by the very large external reserves that had been built up over the past six years by Asian central banks; the fact that most Asian governments had been following prudent if not downright conservative fiscal strategies that have focused on restricting government expenditure rather than raising taxes and consequently have generated very low fiscal deficits or fiscal surpluses.
Despite all this, the crisis has nonetheless operated directly to worsen fiscal balances in most Asian countries. Declining exports and the associated downturn (or deceleration) in economic activity have reduced tax revenues. And the need to bailout companies in distress, or provide tax and other incentives has meant that government expenditure has risen even in the absence of increases in direct public expenditure. The rising and then volatile prices of food and fuel have caused public subsidies to rise in countries in which these prices are even partly controlled.
All this has implied worsening fiscal balances even before any attempt could be made to increase government spending as part of a fiscal stimulus package to counter the crisis. Yet the ability of governments in the region to finance such increasing deficits is, unfortunately, constrained, despite their recent fiscal discipline.
Borrowing from private international sources has been negatively affected by the reversal of international capital flow. Sudden and occasionally unexpected balance of payment deficits have emerged because of the decline or slowdown in current inflows (goods and services exports as well as remittances). Fiscal expansion based on deficit financing has been constrained by the fear of inflation (even in economies where this fear is not warranted because of the existence of substantial unutilised capacity and lack of immediate supply bottlenecks).
It is worth noting at this point that the concept of fiscal space, which is increasingly used as a guide to future fiscal stance, should not be seen as determined by the existing levels of fiscal deficits or public debt. This is because fiscal deficits will be inflationary only if
l they involve an aggregate excess of expenditure over income, which in turn implies that the initial spending will not generate at least equivalent output through a multiplier process; and
l the economy cannot afford to import to make up any supply shortfalls that could hinder the multiplier process, which in turn implies that the country cannot access foreign exchange either through capital inflows or drawing down of reserves.
Only in situations in which both of these conditions are met can it be argued that the government does not have the fiscal space to provide a countercyclical stimulus. It is obvious that the existing level of fiscal deficit tells us very little about either of these conditions, except insofar as large deficits suggest that the limits to non-inflationary spending may be closer.
The evidence is clear that the crisis has involved growing fiscal deficits, or a change from deficit to surplus, in most Asian countries. The exceptions (such as Pakistan) are countries that have been forced to seek International Monetary Fund assistance and consequently have faced policy conditionalities that include reduction of fiscal deficits through stringent budget cuts even in the face of crisis. However, the change in fiscal stance, in terms of a marked increase in deficit to gross domestic product (GDP) ratio or a shift from surplus to deficit, has been evident only in relatively few countries, such as South Korea, Malaysia, the Philippines, Singapore and Vietnam.
In other countries of the region, the fiscal response thus far has been relatively muted, suggesting either that government feel or are constrained in particular ways or that the need for countercyclical macroeconomic measures is less keenly felt in these countries. Even in China, the country that has the biggest fiscal stimulus in terms of absolute value, the change has only been from a fiscal deficit of 0.4 per cent of GDP in 2008 to a projected deficit of 4.1 per cent of GDP in the current year.
A large part of that consists of actual spending by the government, rather than tax concessions, bailouts and other sops to the private sector. The infrastructure spending, which is part of the fiscal stimulus in China, is directed more towards the central and western regions, which were hitherto relatively deprived, and this is likely to rectify the regional imbalances that grew during the recent boom.
The other spending, especially on health and related areas, will not only improve conditions of life but also lead directly to more employment.
In India, of course, the fiscal deficit is already rather high relative to other countries in the region, with a projected deficit of around six per cent of GDP in the current fiscal year. But this does not mark an increase from the previous year, and a large part of it is because of tax and other concessions given to corporates. This is much less likely, than direct public spending, to have a positive impact on economic activity and employment or on general conditions of life of the people. There is a case for significantly increased public spending in the areas that matter: the employment guarantee, provision of affordable food for all, and education. It would be a great tragedy if the countercyclical measures that are still imperative for India are not designed to do this.
Dr.B.Mohammad Rafee M.A.M.Phil.,Ph.D. Researcher, Pedagogue Ph:+918951163373,9159615573 Email:basharafee@gmail.com Web:www.mohammad-rafee.blogspot.com
Saturday, September 19, 2009
The recent rise and demise of Keynes
One of the several consequences of the global economic crisis was a rehabilitation of the economics of John Maynard Keynes among policymakers and the mainstream economics profession.
As the extent of the mess caused by deregulated finance and its international ramifications became clear, Keynes’ prescient warnings of the dangers of allowing finance too much freedom were recalled.
At the height of the crisis late last year, his characterisation of the liquidity trap was recognised as being applicable to the core capitalist economies.
And most of all, his insistence on the need for public spending to bring an economy out of its unemployment equilibrium was not just accepted but also put into practice through fiscal stimulus plans across the developed world.
But it turns out that this rehabilitation was short-lived. In fact, the backlash against the revival of Keynesian economics has already begun.
As soon as some “green shoots of recovery” began to be observed — even if they were only baby weeds — commentators started emphasising the need for caution on the fiscal front, pointing to the dangers of the growth of public debt and generally calling for more fiscal discipline.
As a result, there is a real danger that the recovery may be extinguished even before it can fully display itself.
If this does happen, a major reason will be the continued power of financial lobbies to influence economic policy across the world, despite all their recent crimes.
It is now well known that the dethroning and discrediting of Keynesian economics, especially in the last two decades of the 20th century, was closely related to the rise of the dominance of finance, both nationally and internationally.
This is a complex process calling for explanation in its own right. But there is no doubt that the growing political and economic power of finance played a role in three major ways: first, by rendering Keynesian policies far more difficult to engage in on a purely national level; second, by creating domestic conditions allowing for greater social tolerance of high levels of unemployment and greater intolerance of inflation; and finally, by constraining even the possibility of concerted expansion across the world.
Keynesian economics was originally developed for closed economies. The possibility of external trade did not alter the basic results or insights, although it did bring in the option of using external markets to compensate for insufficient domestic demand.
It also forced recognition of the fact that expansionary domestic policies designed to bring about full employment could cause external deficits which would have to be met somehow.
However, international capital mobility created an entirely new set of problems for such policies. Any attempt at domestic expansion could now bring about not only a trade deficit, but also a flight of capital and consequent pressure on the currency, forcing a retreat from such policies.
The experience of the Mitterand Government in France in the 1980s was the first glaring example of this in industrial countries; for developing countries, of course, it had long been a well-known fact of life.
But having tasted blood in this way, it was not to be expected that financial markets would give up the possibility of being able to control and influence economic policy-making through such movements. Indeed, the experience of the past two decades bears ample testimony to the power of finance in determining economic policies in both developed and developing countries.
This may be the single most important reason for the downfall of the Keynesian strategy, at least in its neo-classical synthesis form.
As long as financial markets remain open and capital can move across borders in response to policy changes or expectations, there are clear limitations to the use of Keynesian policies to attain full or near-full employment.
However, even Global Keynesianism, or the idea of co-ordinated economic expansion which will not cause punitive capital flight in any single country, faces constraints.
These also became evident in the 1970s, in the form of the inflationary barrier posed by the effects of such capitalist expansion on wages and commodity prices.
Thus, concerted expansion will increase demand for labour and for goods produced by primary product exporters (such as oil and other important raw materials and food) leading to a rise in their bargaining power.
If any attempt by these groups to raise their income share is then resisted by other groups, the result will be inflation. Not only can this be destabilising, it is complete anathema to finance.
It is this feature, which essentially amounts to a fight over distributive shares of income both across regions and between economic classes within regions, which is so critical in the present juncture.
Not only is it difficult for a single country — even the largest and most important one in the world — to embark on a sustained fiscal expansion with completely disregard for the response of financial markets.
It is even hard to think of a concerted expansion by major countries together, because of the fear of the consequent inflation.
So a growth process will be sustainable only if it forces some redistribution at the global level (through capitalist and/or rentiers accepting a decline in their income shares).
Otherwise the current unemployment equilibrium in the world economy as a whole will continue.
So the reason why Keynesianism is still not being accepted today goes beyond that fact that the basic insights are sought to be obscured by the miasma of half-truths forced upon us by financial institutions and market analysts.
It stems from a basic contradiction in the global capitalist system, which is the continued power of finance.
It is not enough, in this context, to regulate finance to make it behave better and more in accordance with society’s real economic requirements.
The power of finance itself must be broken, which is a much more difficult task. And so far there is little evidence that it is even being attempted.
As the extent of the mess caused by deregulated finance and its international ramifications became clear, Keynes’ prescient warnings of the dangers of allowing finance too much freedom were recalled.
At the height of the crisis late last year, his characterisation of the liquidity trap was recognised as being applicable to the core capitalist economies.
And most of all, his insistence on the need for public spending to bring an economy out of its unemployment equilibrium was not just accepted but also put into practice through fiscal stimulus plans across the developed world.
But it turns out that this rehabilitation was short-lived. In fact, the backlash against the revival of Keynesian economics has already begun.
As soon as some “green shoots of recovery” began to be observed — even if they were only baby weeds — commentators started emphasising the need for caution on the fiscal front, pointing to the dangers of the growth of public debt and generally calling for more fiscal discipline.
As a result, there is a real danger that the recovery may be extinguished even before it can fully display itself.
If this does happen, a major reason will be the continued power of financial lobbies to influence economic policy across the world, despite all their recent crimes.
It is now well known that the dethroning and discrediting of Keynesian economics, especially in the last two decades of the 20th century, was closely related to the rise of the dominance of finance, both nationally and internationally.
This is a complex process calling for explanation in its own right. But there is no doubt that the growing political and economic power of finance played a role in three major ways: first, by rendering Keynesian policies far more difficult to engage in on a purely national level; second, by creating domestic conditions allowing for greater social tolerance of high levels of unemployment and greater intolerance of inflation; and finally, by constraining even the possibility of concerted expansion across the world.
Keynesian economics was originally developed for closed economies. The possibility of external trade did not alter the basic results or insights, although it did bring in the option of using external markets to compensate for insufficient domestic demand.
It also forced recognition of the fact that expansionary domestic policies designed to bring about full employment could cause external deficits which would have to be met somehow.
However, international capital mobility created an entirely new set of problems for such policies. Any attempt at domestic expansion could now bring about not only a trade deficit, but also a flight of capital and consequent pressure on the currency, forcing a retreat from such policies.
The experience of the Mitterand Government in France in the 1980s was the first glaring example of this in industrial countries; for developing countries, of course, it had long been a well-known fact of life.
But having tasted blood in this way, it was not to be expected that financial markets would give up the possibility of being able to control and influence economic policy-making through such movements. Indeed, the experience of the past two decades bears ample testimony to the power of finance in determining economic policies in both developed and developing countries.
This may be the single most important reason for the downfall of the Keynesian strategy, at least in its neo-classical synthesis form.
As long as financial markets remain open and capital can move across borders in response to policy changes or expectations, there are clear limitations to the use of Keynesian policies to attain full or near-full employment.
However, even Global Keynesianism, or the idea of co-ordinated economic expansion which will not cause punitive capital flight in any single country, faces constraints.
These also became evident in the 1970s, in the form of the inflationary barrier posed by the effects of such capitalist expansion on wages and commodity prices.
Thus, concerted expansion will increase demand for labour and for goods produced by primary product exporters (such as oil and other important raw materials and food) leading to a rise in their bargaining power.
If any attempt by these groups to raise their income share is then resisted by other groups, the result will be inflation. Not only can this be destabilising, it is complete anathema to finance.
It is this feature, which essentially amounts to a fight over distributive shares of income both across regions and between economic classes within regions, which is so critical in the present juncture.
Not only is it difficult for a single country — even the largest and most important one in the world — to embark on a sustained fiscal expansion with completely disregard for the response of financial markets.
It is even hard to think of a concerted expansion by major countries together, because of the fear of the consequent inflation.
So a growth process will be sustainable only if it forces some redistribution at the global level (through capitalist and/or rentiers accepting a decline in their income shares).
Otherwise the current unemployment equilibrium in the world economy as a whole will continue.
So the reason why Keynesianism is still not being accepted today goes beyond that fact that the basic insights are sought to be obscured by the miasma of half-truths forced upon us by financial institutions and market analysts.
It stems from a basic contradiction in the global capitalist system, which is the continued power of finance.
It is not enough, in this context, to regulate finance to make it behave better and more in accordance with society’s real economic requirements.
The power of finance itself must be broken, which is a much more difficult task. And so far there is little evidence that it is even being attempted.
Dealing with the global economic crisis
Everyone is anxious for the good days to return. Every day, economists, policymakers and politicians make predictions about when the economic recovery will start.
Are we all Keynesians now? When Paul Krugman asked the question in his preface to the 2005 edition of Keynes’ General Theory of Employment, Interest and Money, little would he have anticipated that it would hit the headlines around the world so soon.
As the enormity of the biggest economic crisis of the 21st century slowly sank in, nations scrambled to find quick solutions and committed billions of dollars to Keynesian-style public policy stimulus programmes — and sometimes to infamous bailouts of beleaguered financial giants.
President Barack Obama underlined the approach to the U.S. economy, the key to world recovery. On the eve of his inauguration he said, “There is no disagreement that we need action by our government, a recovery plan that will help jump-start the economy.”
However, to suggest that the debate has been settled would be unfair to the robust reasoning of the protagonists of free market incentives — the redoubtable Chicago School and the legatees of Milton Friedman and of the Austrian thinkers Friedrich Hayek and Ludwig von Mises. The Cato Institute published a full-page advertisement in leading newspapers in January. It was a statement signed by more than 200 economists telling Mr. Obama how flawed his thinking was.
The signatories included Nobel laureates Edward Prescott, Vernon Smith and James Buchanan and they did not mince words in telling the President that all economists were not Keynesians. More government spending by Hoover and Roosevelt, they said, did not pull the U.S. economy out of the Great Depression of the 1930s. Any belief that government spending could do the trick was just a “triumph of hope over experience.”
The present crisis has striking similarities with the Great Crash and the Great Depression, but also some fundamental differences. Now the world economy is more globally linked and so is the spread of ill-effects. Therefore, the need for closer cooperation and coordination in the recovery effort is far greater today.
The world waited expectantly for the G20 meeting in April to provide the healing balm. G20 came and went. Billions are now passé; trillion is the new idiom. G20 certainly lived up to this trend and committed a whopping $5 trillion to a booster dose by 2010. It acknowledged the importance of increasing the lending capacity of the international financial institutions. But it also left a nagging feeling that between rounds of cocktails, photo ops and polite and diplomatic country statements, it lacked the time to address some fundamental issues.
Take the need to closely look at the capacity of our international institutions to read early warning symptoms and initiate timely corrective actions. In 1955, John Kenneth Galbraith warned in his delightful book on the Great Crash of 1929 that Wall Street needed a close watch: “Wall Street, in these matters, is like a lovely and accomplished woman who must wear black cotton stockings, heavy woollen underwear, and parade her knowledge as a cook because, unhappily, her supreme accomplishment is as a harlot.”
With the nightmare of the Crash still fresh and the scars of World War II still visible, presidents, prime ministers, economists, diplomats — anyone who mattered in the world of financial policy — gathered at Mount Washington Hotel in lovely Bretton Woods in 1945 to work out systems and institutions that would ensure economic reconstruction and future stability. They hoped that the world would not have to go through that harrowing experience again.
And then 2008 happened, with astounding similarities. Financial overheating and meltdown created a crisis of unprecedented dimensions. And the institutions — the IMF, the ADB and the World Bank — so carefully built and nurtured to protect the world just failed to see the gathering storm. The IMF has been quoted as admitting that “Our warning systems within and outside the Fund were insufficiently specific, detailed or dire to gain traction with the policymakers.”
It is more than a coincidence that financial overheating was not the major problem in India as it was in the West. Different players try to take credit — prudent central banking policy and the presence of solid banking PSUs. It is interesting that many free market economies are seriously debating more control of the financial sector. Bo Lungdren, architect of Sweden’s bank rescue in the 1990s and head of the Swedish National Debt Office, told a congressional hearing that the government should consider bank nationalisation if needed to stem the deepening financial crisis.
It is a curious twist of history that decades after Indira Gandhi’s bank nationalisation created a storm in India, the much criticised idea has found endorsement from capitalist economies under siege.
But the world does not yet have a very precise and authentic understanding of the depth of the crisis. There are tell-tale indications. Forbes’ 2009 list of billionaires tumbled. Figures in billions and trillions have been casually bandied around. An ADB report in March reported a loss of $50 trillion — equal to a year’s global GDP. The International Institute of Finance, Washington, DC, estimated that the U.S. household net worth had fallen from around $62 trillion in 2007 to $47 trillion now. Jeffrey Sachs says the decline in wealth in the U.S., Europe and Asia would be of the order of $25 trillion.
Just before the crucial G 20 meeting, the IMF came out with a grim assessment: for the first time in 60 years the world was experiencing economic contraction. In the last quarter of 2008, global GDP had fallen by an unprecedented five per cent. The economic crisis had “battered global economic activity beyond what was anticipated”.
The report refocussed attention on three key areas. First, the much talked about need for strong international policy response and coordination. Second, the importance of moving away from half-hearted sops to a strong, comprehensive fiscal and monetary stimulus. Globally, the IMF report reminded us, fiscal policy was still falling short of the two per cent of GDP stimulus the IMF thought was needed to tackle the situation. Third, it warned against ignoring the lessons of the past — “the rising spectre of trade and financial protectionism.”
These prescriptions are well known. The G20 pledged to “name and shame” protectionist countries and agreed to “act urgently” to conclude the Doha round. These are pious intentions; the intricacies of world trade regulations always leave enough escape routes for the real culprits.
At the G20 meeting in November 2008, when the dimensions of the crisis were still hazy, it was decided not to impose any restriction for 12 months. Yet a World Bank study has shown that since then 17 members of G20 and other nations have imposed a total of 47 measures that restrict trade. The European Union has provided new export subsidies of the type the world trade talks aimed to eliminate. Subsidies proposed for industry have proliferated, totalling some $48 billion. Ninety per cent of these are in high income countries.
The results are not hard to see. Just before the G20 meeting, Pascal Lamy, Director-General of WTO, pointed out that after continuous growth since 1982, global trade declined by nine per cent in 2008. “Use of protectionism measures is on the rise,” he warned, deepening fears of recession and belying the hope that trade could be used as the engine of recovery.
And yet at the G20 press briefing, Britain’s Prime Minister Gordon Brown used an assessment by Mr. Lamy to downplay the lurking dangers of creeping protectionism. The WTO report, he said, suggested that while there had been some violations of WTO norms by member-countries, these were not substantial.
The world would most sincerely wish it were so, but doubts will linger. In a critical situation of major job losses and social unrest, will President Obama and others have the courage to pursue a liberal trade agenda? The rhetoric of “Bangalore versus Buffalo” and the tax disincentives for American companies that outsource jobs tell their own story. Ironically, Federal Reserve Chairman Ben Bernanke says lack of political will constitutes the “biggest risk” to recovery.
Everyone is anxious for the good days to return. Every day, economists, policymakers and politicians make predictions about when the recovery will start, as if it were a 100m sprinter waiting for the starting signal.
The best of such statements can only be guesswork. In 1929, Galbraith writes, every day the worst seemed to worsen: “What looked one day like the end proved on the next day to have been only the beginning.” Public perception of government assurances was so low that every time officials made an optimistic statement, the market dropped. Things are not that bad as yet but they could be. This is no time for complacency.
Are we all Keynesians now? When Paul Krugman asked the question in his preface to the 2005 edition of Keynes’ General Theory of Employment, Interest and Money, little would he have anticipated that it would hit the headlines around the world so soon.
As the enormity of the biggest economic crisis of the 21st century slowly sank in, nations scrambled to find quick solutions and committed billions of dollars to Keynesian-style public policy stimulus programmes — and sometimes to infamous bailouts of beleaguered financial giants.
President Barack Obama underlined the approach to the U.S. economy, the key to world recovery. On the eve of his inauguration he said, “There is no disagreement that we need action by our government, a recovery plan that will help jump-start the economy.”
However, to suggest that the debate has been settled would be unfair to the robust reasoning of the protagonists of free market incentives — the redoubtable Chicago School and the legatees of Milton Friedman and of the Austrian thinkers Friedrich Hayek and Ludwig von Mises. The Cato Institute published a full-page advertisement in leading newspapers in January. It was a statement signed by more than 200 economists telling Mr. Obama how flawed his thinking was.
The signatories included Nobel laureates Edward Prescott, Vernon Smith and James Buchanan and they did not mince words in telling the President that all economists were not Keynesians. More government spending by Hoover and Roosevelt, they said, did not pull the U.S. economy out of the Great Depression of the 1930s. Any belief that government spending could do the trick was just a “triumph of hope over experience.”
The present crisis has striking similarities with the Great Crash and the Great Depression, but also some fundamental differences. Now the world economy is more globally linked and so is the spread of ill-effects. Therefore, the need for closer cooperation and coordination in the recovery effort is far greater today.
The world waited expectantly for the G20 meeting in April to provide the healing balm. G20 came and went. Billions are now passé; trillion is the new idiom. G20 certainly lived up to this trend and committed a whopping $5 trillion to a booster dose by 2010. It acknowledged the importance of increasing the lending capacity of the international financial institutions. But it also left a nagging feeling that between rounds of cocktails, photo ops and polite and diplomatic country statements, it lacked the time to address some fundamental issues.
Take the need to closely look at the capacity of our international institutions to read early warning symptoms and initiate timely corrective actions. In 1955, John Kenneth Galbraith warned in his delightful book on the Great Crash of 1929 that Wall Street needed a close watch: “Wall Street, in these matters, is like a lovely and accomplished woman who must wear black cotton stockings, heavy woollen underwear, and parade her knowledge as a cook because, unhappily, her supreme accomplishment is as a harlot.”
With the nightmare of the Crash still fresh and the scars of World War II still visible, presidents, prime ministers, economists, diplomats — anyone who mattered in the world of financial policy — gathered at Mount Washington Hotel in lovely Bretton Woods in 1945 to work out systems and institutions that would ensure economic reconstruction and future stability. They hoped that the world would not have to go through that harrowing experience again.
And then 2008 happened, with astounding similarities. Financial overheating and meltdown created a crisis of unprecedented dimensions. And the institutions — the IMF, the ADB and the World Bank — so carefully built and nurtured to protect the world just failed to see the gathering storm. The IMF has been quoted as admitting that “Our warning systems within and outside the Fund were insufficiently specific, detailed or dire to gain traction with the policymakers.”
It is more than a coincidence that financial overheating was not the major problem in India as it was in the West. Different players try to take credit — prudent central banking policy and the presence of solid banking PSUs. It is interesting that many free market economies are seriously debating more control of the financial sector. Bo Lungdren, architect of Sweden’s bank rescue in the 1990s and head of the Swedish National Debt Office, told a congressional hearing that the government should consider bank nationalisation if needed to stem the deepening financial crisis.
It is a curious twist of history that decades after Indira Gandhi’s bank nationalisation created a storm in India, the much criticised idea has found endorsement from capitalist economies under siege.
But the world does not yet have a very precise and authentic understanding of the depth of the crisis. There are tell-tale indications. Forbes’ 2009 list of billionaires tumbled. Figures in billions and trillions have been casually bandied around. An ADB report in March reported a loss of $50 trillion — equal to a year’s global GDP. The International Institute of Finance, Washington, DC, estimated that the U.S. household net worth had fallen from around $62 trillion in 2007 to $47 trillion now. Jeffrey Sachs says the decline in wealth in the U.S., Europe and Asia would be of the order of $25 trillion.
Just before the crucial G 20 meeting, the IMF came out with a grim assessment: for the first time in 60 years the world was experiencing economic contraction. In the last quarter of 2008, global GDP had fallen by an unprecedented five per cent. The economic crisis had “battered global economic activity beyond what was anticipated”.
The report refocussed attention on three key areas. First, the much talked about need for strong international policy response and coordination. Second, the importance of moving away from half-hearted sops to a strong, comprehensive fiscal and monetary stimulus. Globally, the IMF report reminded us, fiscal policy was still falling short of the two per cent of GDP stimulus the IMF thought was needed to tackle the situation. Third, it warned against ignoring the lessons of the past — “the rising spectre of trade and financial protectionism.”
These prescriptions are well known. The G20 pledged to “name and shame” protectionist countries and agreed to “act urgently” to conclude the Doha round. These are pious intentions; the intricacies of world trade regulations always leave enough escape routes for the real culprits.
At the G20 meeting in November 2008, when the dimensions of the crisis were still hazy, it was decided not to impose any restriction for 12 months. Yet a World Bank study has shown that since then 17 members of G20 and other nations have imposed a total of 47 measures that restrict trade. The European Union has provided new export subsidies of the type the world trade talks aimed to eliminate. Subsidies proposed for industry have proliferated, totalling some $48 billion. Ninety per cent of these are in high income countries.
The results are not hard to see. Just before the G20 meeting, Pascal Lamy, Director-General of WTO, pointed out that after continuous growth since 1982, global trade declined by nine per cent in 2008. “Use of protectionism measures is on the rise,” he warned, deepening fears of recession and belying the hope that trade could be used as the engine of recovery.
And yet at the G20 press briefing, Britain’s Prime Minister Gordon Brown used an assessment by Mr. Lamy to downplay the lurking dangers of creeping protectionism. The WTO report, he said, suggested that while there had been some violations of WTO norms by member-countries, these were not substantial.
The world would most sincerely wish it were so, but doubts will linger. In a critical situation of major job losses and social unrest, will President Obama and others have the courage to pursue a liberal trade agenda? The rhetoric of “Bangalore versus Buffalo” and the tax disincentives for American companies that outsource jobs tell their own story. Ironically, Federal Reserve Chairman Ben Bernanke says lack of political will constitutes the “biggest risk” to recovery.
Everyone is anxious for the good days to return. Every day, economists, policymakers and politicians make predictions about when the recovery will start, as if it were a 100m sprinter waiting for the starting signal.
The best of such statements can only be guesswork. In 1929, Galbraith writes, every day the worst seemed to worsen: “What looked one day like the end proved on the next day to have been only the beginning.” Public perception of government assurances was so low that every time officials made an optimistic statement, the market dropped. Things are not that bad as yet but they could be. This is no time for complacency.
Capitalism & the economic crisis
Financial capitalism will undergo the most radical changes. Acceptable capitalism would require more regulation.
The current financial crisis has raised several questions regarding the future of capitalism. What will be the shape of capitalism in the coming decades? Will it undergo radical changes or will the changes be only marginal?
Great Depression and after
In this context, it is worthwhile to go back to the 1930s and find out how the measures taken to address the Depression changed the contours of capitalism. It may be noted that the policymakers were mostly inactive immediately after the onset of the depression. Any action taken by them only deepened the crisis. It was nearly four years before action was taken and the measures came to be known as the “New Deal” in the United States. As a consequence, capitalism underwent changes in three important directions. First, there was a clear recognition of the role of the state in economic activities. The government’s involvement in public works programmes became a critical element. Second, a wide range of social security measures became an integral part of the system. Once again, there was a clear recognition of the need for the state to provide social security. These programmes took several forms, including unemployment relief. Third, the financial system underwent a radical restructuring. The banking system was subject to stricter regulations, including the separation of banking from non-banking and non-deposit-taking financial activities. Some of these trends were reinforced in the post-World War II period. There were fears of recession as the war came to an end. The role of the state in economic management thus continued to expand. Public expenditure as a proportion of GDP which was 18 per cent before World War II rose to 40 per cent in 1980.
The 1980s, and more especially the 1990s, saw an expanding role of the market. The process of deregulation started in many areas. But the economy during this period also expanded enormously. The exuberance of the system came to a halt only last year. The current financial crisis also is a child of this exuberance.
Features of current crisis
Three aspects of the current economic crisis deserve attention, as we look at the future. First, the crisis did not originate in the real sector of the economy. It was triggered by the excesses of the financial system. Fixing the financial system has thus become the first priority. Second, policymakers have also to address some fundamental issues such as the persistent current account deficit in the U.S. and the low and declining savings rate in the advanced countries, particularly the U.S. Unless the U.S. economy is put on a sounder footing, concerns will continue to arise regarding the strength of the dollar and this has implication for its use as a reserve currency. Third, globalisation has proceeded on a rapid pace in the recent period. While this resulted in better allocation of resources, particularly investment, among different countries, the emphasis on efficiency which is the outcome of globalisation also led to the accentuation of inequalities among and within countries. Globalisation spreads both prosperity and distress. It cuts both ways. Global institutions will have to play a more decisive role in taming globalisation. Each country will have to decide on the extent of openness with which it is comfortable.
Regulatory failure
What stands out glaringly in the current economic crisis is the regulatory failure in relation to the financial markets. Some parts of the financial system were either loosely regulated or were not regulated at all. This resulted in ‘regulatory arbitrage’ with funds moving from the more regulated to the less regulated segments. The second was the failure of the regulatory authorities to understand fully the implications of the various derivative products. The regulators did not exercise the required degree of oversight and control. Financial capitalism will be the one that will undergo the most radical changes in the coming years. The scope and nature of the regulations will receive the maximum attention. Micro prudential indicators will have to be supplemented by system-wide prudential indicators.
In a way, it is ironic that the regulatory failures should have occurred at a time when intense discussions were being held in Basel and elsewhere to put in place a sound regulatory framework. Capital adequacy provisions will have to be revisited so that the quality and quantity of overall capital in the financial system is enhanced. A counter cyclical capital adequacy regime may have to be introduced. Some understanding will also have to be reached among countries on how to control institutions which operate across countries and globally. Many agencies are currently engaged in evolving a new set of regulations to cover all segments of the financial system including “shadow banking” and credit rating agencies. One can thus expect to see a reversal of the trend towards deregulation with a move towards a tighter control over the financial system. Standards of regulations will have to be globally consistent and a need for an international authority to oversee the implementation of the regulations within countries may become imperative.
State and market
The structure of capitalism in any economy depends on the respective roles assigned to the state and the market. The boundaries between the two have been changing over time. There can be a further shift in the context of the current crisis. In any economy, the state can play three roles in relation to economic activities — as a provider of marketable goods and services; as a provider of public goods and services and; as a regulator.
The role of state as a provider of marketable goods and services has been going down. This trend may continue. Even though as part of crisis management, some of the leading industrial countries have injected capital into private banks, this may only be a temporary phase. There is no intention on the part of governments to participate in the management of these institutions. The state’s role as a provider and facilitator of public goods and services may grow further. Even here, there are many experiments going on in terms of joint participation of the public and private sectors. While the broad goals are set by the government, the delivery system is handled by the private sector. Public interest concerns are transmitted through appropriate covenants.
It is in the area of the state as a regulator that one will see significant changes in the coming years. Regulation of markets, more particularly financial markets, will assume importance. The regulatory failure seen in recent years needs to be corrected. There will be a restraint on financial innovations. Runaway financial innovations which are dysfunctional in character can do more harm than good. This is a lesson that we can draw from the current fundamental crisis.
Course of globalisation
Globalisation as a process of connecting countries and communities will continue. International trade in goods and services will continue to expand. Even in the current crisis, analysts have been warning against countries adopting protectionist policies. However, the coming years may see restrictions being put on financial flows. Developing countries may not want to see unfettered freedom in the flow of funds. This will also slow the process to capital account convertibility. Which may cease to be the cherished objective of the developing countries.
Thus, in the final analysis, the fundamental characteristics of capitalism may not undergo any big change. Markets will continue to play an important role but what will emerge as a consequence of the financial crisis will be greater control and regulation of the markets in general, and financial markets in particular. The productive sectors of the economy have not shown any basic weakness. In fact many industrially advanced countries have seen an improvement in productivity in recent years. It is the failure of the financial system that has affected the productive sectors. The excesses of the financial system are the ones that need correction. Acceptable capitalism would require more regulation.
The current financial crisis has raised several questions regarding the future of capitalism. What will be the shape of capitalism in the coming decades? Will it undergo radical changes or will the changes be only marginal?
Great Depression and after
In this context, it is worthwhile to go back to the 1930s and find out how the measures taken to address the Depression changed the contours of capitalism. It may be noted that the policymakers were mostly inactive immediately after the onset of the depression. Any action taken by them only deepened the crisis. It was nearly four years before action was taken and the measures came to be known as the “New Deal” in the United States. As a consequence, capitalism underwent changes in three important directions. First, there was a clear recognition of the role of the state in economic activities. The government’s involvement in public works programmes became a critical element. Second, a wide range of social security measures became an integral part of the system. Once again, there was a clear recognition of the need for the state to provide social security. These programmes took several forms, including unemployment relief. Third, the financial system underwent a radical restructuring. The banking system was subject to stricter regulations, including the separation of banking from non-banking and non-deposit-taking financial activities. Some of these trends were reinforced in the post-World War II period. There were fears of recession as the war came to an end. The role of the state in economic management thus continued to expand. Public expenditure as a proportion of GDP which was 18 per cent before World War II rose to 40 per cent in 1980.
The 1980s, and more especially the 1990s, saw an expanding role of the market. The process of deregulation started in many areas. But the economy during this period also expanded enormously. The exuberance of the system came to a halt only last year. The current financial crisis also is a child of this exuberance.
Features of current crisis
Three aspects of the current economic crisis deserve attention, as we look at the future. First, the crisis did not originate in the real sector of the economy. It was triggered by the excesses of the financial system. Fixing the financial system has thus become the first priority. Second, policymakers have also to address some fundamental issues such as the persistent current account deficit in the U.S. and the low and declining savings rate in the advanced countries, particularly the U.S. Unless the U.S. economy is put on a sounder footing, concerns will continue to arise regarding the strength of the dollar and this has implication for its use as a reserve currency. Third, globalisation has proceeded on a rapid pace in the recent period. While this resulted in better allocation of resources, particularly investment, among different countries, the emphasis on efficiency which is the outcome of globalisation also led to the accentuation of inequalities among and within countries. Globalisation spreads both prosperity and distress. It cuts both ways. Global institutions will have to play a more decisive role in taming globalisation. Each country will have to decide on the extent of openness with which it is comfortable.
Regulatory failure
What stands out glaringly in the current economic crisis is the regulatory failure in relation to the financial markets. Some parts of the financial system were either loosely regulated or were not regulated at all. This resulted in ‘regulatory arbitrage’ with funds moving from the more regulated to the less regulated segments. The second was the failure of the regulatory authorities to understand fully the implications of the various derivative products. The regulators did not exercise the required degree of oversight and control. Financial capitalism will be the one that will undergo the most radical changes in the coming years. The scope and nature of the regulations will receive the maximum attention. Micro prudential indicators will have to be supplemented by system-wide prudential indicators.
In a way, it is ironic that the regulatory failures should have occurred at a time when intense discussions were being held in Basel and elsewhere to put in place a sound regulatory framework. Capital adequacy provisions will have to be revisited so that the quality and quantity of overall capital in the financial system is enhanced. A counter cyclical capital adequacy regime may have to be introduced. Some understanding will also have to be reached among countries on how to control institutions which operate across countries and globally. Many agencies are currently engaged in evolving a new set of regulations to cover all segments of the financial system including “shadow banking” and credit rating agencies. One can thus expect to see a reversal of the trend towards deregulation with a move towards a tighter control over the financial system. Standards of regulations will have to be globally consistent and a need for an international authority to oversee the implementation of the regulations within countries may become imperative.
State and market
The structure of capitalism in any economy depends on the respective roles assigned to the state and the market. The boundaries between the two have been changing over time. There can be a further shift in the context of the current crisis. In any economy, the state can play three roles in relation to economic activities — as a provider of marketable goods and services; as a provider of public goods and services and; as a regulator.
The role of state as a provider of marketable goods and services has been going down. This trend may continue. Even though as part of crisis management, some of the leading industrial countries have injected capital into private banks, this may only be a temporary phase. There is no intention on the part of governments to participate in the management of these institutions. The state’s role as a provider and facilitator of public goods and services may grow further. Even here, there are many experiments going on in terms of joint participation of the public and private sectors. While the broad goals are set by the government, the delivery system is handled by the private sector. Public interest concerns are transmitted through appropriate covenants.
It is in the area of the state as a regulator that one will see significant changes in the coming years. Regulation of markets, more particularly financial markets, will assume importance. The regulatory failure seen in recent years needs to be corrected. There will be a restraint on financial innovations. Runaway financial innovations which are dysfunctional in character can do more harm than good. This is a lesson that we can draw from the current fundamental crisis.
Course of globalisation
Globalisation as a process of connecting countries and communities will continue. International trade in goods and services will continue to expand. Even in the current crisis, analysts have been warning against countries adopting protectionist policies. However, the coming years may see restrictions being put on financial flows. Developing countries may not want to see unfettered freedom in the flow of funds. This will also slow the process to capital account convertibility. Which may cease to be the cherished objective of the developing countries.
Thus, in the final analysis, the fundamental characteristics of capitalism may not undergo any big change. Markets will continue to play an important role but what will emerge as a consequence of the financial crisis will be greater control and regulation of the markets in general, and financial markets in particular. The productive sectors of the economy have not shown any basic weakness. In fact many industrially advanced countries have seen an improvement in productivity in recent years. It is the failure of the financial system that has affected the productive sectors. The excesses of the financial system are the ones that need correction. Acceptable capitalism would require more regulation.
Wednesday, September 2, 2009
Containing inflation a challenge: RBI
New Delhi: With food price inflation in double digits, the Reserve Bank is faced with the daunting task of keeping inflation in check, the bank Deputy Governor K C Chakrabarty said.
Concerned over the rising food prices he said, "The food price inflation is already around 10 per cent. Our key challenge is how to keep the inflationary pressure low."
Speaking at an event of the Institute of Banking, he dwelt on a range of issues from drought to interest rates to government borrowings and said the country would continue to grow at 6 per cent-plus.
However, he pointed out that if the "drought affects the agriculture growth, it will partly affect the growth number".
On interest rates he ruled out any further cuts and said the central bank could even reverse its expansionary stance if the drought-induced inflationary prices go out of control.
"I don't think today anybody is expecting interest rates to come down further," he said.
Admitting the huge government borrowing to have exerted some pressure on interest rates, which have "already gone up a little-bit," he said he expects interest rates to be stable as of now.
Concerned over the rising food prices he said, "The food price inflation is already around 10 per cent. Our key challenge is how to keep the inflationary pressure low."
Speaking at an event of the Institute of Banking, he dwelt on a range of issues from drought to interest rates to government borrowings and said the country would continue to grow at 6 per cent-plus.
However, he pointed out that if the "drought affects the agriculture growth, it will partly affect the growth number".
On interest rates he ruled out any further cuts and said the central bank could even reverse its expansionary stance if the drought-induced inflationary prices go out of control.
"I don't think today anybody is expecting interest rates to come down further," he said.
Admitting the huge government borrowing to have exerted some pressure on interest rates, which have "already gone up a little-bit," he said he expects interest rates to be stable as of now.
Global economy returning to normalcy: PM
New Delhi: Prime Minister Manmohan Singh said the global economic downturn which had affected Indian economy as well, is now coming to an end with slow return to normalcy.
"We have been through a difficult year because of the global economic downturn which is only now coming to end with a slow return to normalcy in the months that lie ahead," Singh said in his opening remarks chairing the meeting of the full Planning Commission, which is assessing the economy and status of Integrated Energy Policy (IEP).
"The country has also seen poor monsoon," he said, adding it would be useful for the Planning Commission to present its assessment of the overall economic situation.
Besides, members of the Planning Commission and its Deputy Chairman Montek Singh Ahluwalia, the first meeting of the full panel in the second term of UPA government is being attended by more than a dozen ministers including Finance Minister Pranab Mukherjee, Agriculture Minister Sharad Pawar and Home Minister P Chidambaram.
Facing the ripple effects of global financial crisis, India's economic growth slipped to 6.7 per cent in 2008-09 from about 9 per cent in the previous fiscal. The growth, according to the Planning Commission, is expected to fall further to 6.3 per cent in 2009-10.
"We have been through a difficult year because of the global economic downturn which is only now coming to end with a slow return to normalcy in the months that lie ahead," Singh said in his opening remarks chairing the meeting of the full Planning Commission, which is assessing the economy and status of Integrated Energy Policy (IEP).
"The country has also seen poor monsoon," he said, adding it would be useful for the Planning Commission to present its assessment of the overall economic situation.
Besides, members of the Planning Commission and its Deputy Chairman Montek Singh Ahluwalia, the first meeting of the full panel in the second term of UPA government is being attended by more than a dozen ministers including Finance Minister Pranab Mukherjee, Agriculture Minister Sharad Pawar and Home Minister P Chidambaram.
Facing the ripple effects of global financial crisis, India's economic growth slipped to 6.7 per cent in 2008-09 from about 9 per cent in the previous fiscal. The growth, according to the Planning Commission, is expected to fall further to 6.3 per cent in 2009-10.
India-Swiss talks on black money in Dec
New Delhi: India will begin in December its first round of consultations with the Swiss Government on tracing black money stashed by Indians in banks in that country, but there is no guarantee of prosecution of offenders on the basis of information secured from them.
Finance Ministry sources said that Indian officials will have their first round of discussions with officials of Swiss Government to evolve a legal system that will enable India to trace black money stashed in tax havens in that country.
They said that such a system could be evolved through a Double Taxation Avoidance Treaty (DTAT) with Switzerland on the model of the agreements reached with countries of the Organisation of Economic Cooperation and Development (OECD).
But, the sources said, that while DTAT could lead to information being secured from Switzerland in specific cases in which individuals would have violated laws in India it cannot guarantee that such persons could also be prosecuted for that offence.
This is because, they point out, that in a similar case in April, Germany gave information in a case where an individual had violated tax laws and on the information given by the German government tax due from him was also collected.
But Germany gave the information on the specific condition that no prosecution would be launched against the individual and the government had to comply with that condition, the sources said.
Finance Ministry sources said that Indian officials will have their first round of discussions with officials of Swiss Government to evolve a legal system that will enable India to trace black money stashed in tax havens in that country.
They said that such a system could be evolved through a Double Taxation Avoidance Treaty (DTAT) with Switzerland on the model of the agreements reached with countries of the Organisation of Economic Cooperation and Development (OECD).
But, the sources said, that while DTAT could lead to information being secured from Switzerland in specific cases in which individuals would have violated laws in India it cannot guarantee that such persons could also be prosecuted for that offence.
This is because, they point out, that in a similar case in April, Germany gave information in a case where an individual had violated tax laws and on the information given by the German government tax due from him was also collected.
But Germany gave the information on the specific condition that no prosecution would be launched against the individual and the government had to comply with that condition, the sources said.
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