Managing the Hydra

In Greek and Roman mythology there is a big monster called Hydra which has many heads. For every head chopped off, it grows two. 

But a very small real version also actually exists which is of interest to biologists because of this regenerative ability. This fresh water organism does not appear to die of old age, or even grow old. This is the sense I took away from this book. One of its authors is a good friend; the other I have not met. 

Had the book not been technically adequate, one could have said that the authors have tried to bite off more than they can chew. But that is not so and, therefore, one review of 800 words is not enough. This book needs at least three separate reviews, each dealing with one of the three sections that comprise it.

Section 1 is about the rise of finance, especially in the past 30 years.  It has become a major indicator and driver of the level and health of economic activity in a country. Its contribution to GDP has grown to an unprecedented level.

This has come to be known as financialisation where, to put it crudely — but effectively — money is used to produce more money and profits, rather than to produce more goods and profits. So pervasive has this phenomenon become that making money by trading in money has become a major part of overall economic activity. 

The authors say that the Federal Reserve of the US, and Alan Greenspan who headed it for 20 years, are to blame. They made the production of financial products displace the production of real goods by creating more and more money via their decision to keep its price low. They also aided the creation of ever-increasing debt whose repayment had to be helped by keeping asset prices high. And so on, in a round-robin game that culminated in what Rakesh Mohan, a former RBI deputy governor, calls the North Atlantic financial crisis of 2008.

Section 2 is about the consequences of financialisation, which are many. All of them add up to a clutch of perverse incentives and socially bad outcomes such as bad resource allocation; a rise in inequality via a disproportionate share of wages going to finance at the expense of others; and monetary policy getting captured by the ‘too-big-to-fail’ argument. 

Section 3 is about what to do about this state of affairs. There are several related prescriptions, not stated in any particular order of priority or preference. But they all add up to one unified thought: This nonsense has to stop, and monetary policy must lead rather than wag its tail to the diktats of American vested interests via what has come to be known as unconventional monetary policy. 

At the core of all this, says the authors, lies the problem that was first identified by William Buiter — guru of our own Urjit Patel — and then developed by Paul Tucker, a former deputy governor of the Bank of England. This problem is that all these guys who make monetary policy and the guys who benefit from it wield power without accountability.

The Rise of Finance:Causes, consequences, cures; V Anantha Nageswaran and Gulzar Natarajan; Cambridge University Press; Rs 750, 286 pages

The authors perhaps don’t know it but this issue was first flagged in during the course of a seminar on regulation 2002 by Yashwant Sinha. Who are these regulators, he asked, when it is we politicians who are accountable in Parliament? 

No one could answer his pained question. It is clear from reading this book that no one has been able to.

If the book suffers from a weakness, it is that it is virtually bereft of economics. Whether you can discuss money without some economic framework on which you drape your analysis is a moot point. You can, but should you?

The authors should consider doing so in the second edition, which I think will surely be there. It will give the book intellectual rigour, and thus strengthen its ap­peal. Indeed, the answer to their question — how did all this happen — may well lie in economics and its application to politics.

If I may suggest, the authors would benefit hugely from re-visiting Keynesian theory and that all important identity —Y = C+I+G+X-M — which has been driving both politics and economics since the 1960s. Milton Friedman’s groans and shrieks notwithstanding, this identity has codified fiscal dominance in democratic societies and nailed monetary policy to the fiscal cross. The reaction has been that if fiscal policy is there to serve the poor, monetary policy is there to serve the rich, a fact deeply lamented by the authors.

The rest, as they say in the Punjab secretariat, is detail di gal  — a matter of detail.