Economic policy is a 20th century idea that we owe largely to John Maynard Keynes. For Keynes, “policy” had two principal objectives — first, to deal with the problem of uncertainty and instability; second, to deal with the problem of inequity.
Indeed, all policymaking is about governments trying to address these two objectives in the most rational manner possible, within a given political framework. Keynes was deeply committed to democracy, but equally to institutions that were guided by rationality. The central bank, in his view, ought to be a “professional” body guided by rationality, while “government”, in a democracy, is expected to be a political entity that has to balance the rational with the popular, if not the populist.
Keynes’ greatest biographer, Robert Skidelsky, tells us that when Keynes found the economy caught in a downward spiral, he took the view that “the short-run instability of capitalism was a greater threat to the social order than any long-run inequity in the distribution of wealth and income”. (Robert Skidelsky, John Maynard Keynes, Volume 3: The Economist as Saviour, 1920-1937. 1992. Page 223).
Every finance minister faces the dilemma of addressing the twin concerns of instability and inequity in crafting his budgetary strategy. If policies aimed at reducing instability and uncertainty also have the added benefit of reducing inequity, or policies aimed at reducing inequity have the benefit of reducing uncertainty, the finance minister of the day can go to bed early and sleep well.
When the Manmohan Singh government chose to waive farmers’ loans, step up funding for social welfare programmes and undertake a range of public investments as part of its “fiscal stimulus” agenda in 2008-09, it also improved the climate for economic activity and dealt with the challenge of uncertainty. It was a classic Keynesian policy intervention.
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The dilemma that Skidelsky refers to, between the imperatives of reducing short-run instability and uncertainty and addressing the long-run challenge of social and economic inequity, did not manifest itself as clearly then as it does now.
Reading the large number of columns published across the financial media in the run up to the Union Budget this year, one dominant fact comes through. Almost every known economist, be it a former policymaker, or a scholar in a think tank or an analyst with a private firm, almost everyone (and certainly all Business Standard columnists who have appeared in these columns in the past fortnight) is convinced that the big message that Union Finance Minister Pranab Mukherjee must send out through his budgetary strategy for 2011-12 is one that would impart stability to the Indian growth process.
The three dimensions of growth stabilisation that the macroeconomic strategy underpinning the Union budget is expected to address in the current context are: a lower rate of inflation, lower revenue and fiscal deficits and a lower current account deficit.
Equally, the political leadership in a democracy would want any budgetary strategy to also meet the demands of social and economic equity.
Is there a conflict between the economics of stabilisation of growth and the politics of inclusive growth? In a developing country like India with a large number of poor and unemployed there need be no such conflict. Pro-growth policies can be pro-poor. Indeed, that is the essence of the strategy of “inclusive growth”.
However, if the government’s idea of “pro-poor policies” is to spend more money on social sectors and subsidies, then it remains to be seen how it will address the immediate challenge of improving its fiscal balances, of reducing inflation and bringing down domestic and external debt. The space for social sector spending can get constrained.
A classic Keynesian response to such a situation would be to raise taxes on the rich to pay for the spending on the poor. But no one expects a reversal of the liberal tax regime that has been put in place, though the introduction of a goods and services tax (GST), in the way it is likely to be structured, would help raise the tax to gross domestic product (GDP) ratio.
If the choice before the finance minister is a stark one — of fiscal stabilisation vs social spending — what should his response be? The overwhelming professional economics opinion seems to be that there is no immediate political pressure to step up revenue expenditure (without a proportionate increase in revenues collected), while the most important policy signal that must be sent out is one of fiscal responsibility that would contribute to economic stability.
Keynes had once famously said, “Perhaps the chief task of economists at this hour is to distinguish afresh the Agenda of government from the Non-Agenda; and the companion task of politics is to devise forms of government within a democracy which shall be capable of accomplishing the Agenda.” (Emphasis in original, Skidelsky, page 226).
Keynes strongly believed in the innate dynamism of private enterprise, viewing governments as facilitators rather than obstructers. His focus on the “animal spirits” of enterprise — “a spontaneous urge to action rather than inaction”, as he put it — underscores the importance today of policy that stabilises the growth process and keeps these animal spirits alive.
There is growing concern all around that in the past year political developments and political management in the country have increased the level of uncertainty and have dampened entrepreneurial “animal spirits”.
Taken with the concerns of economists about instability caused by inflation, rising deficits and debt, this environment of uncertainty can be debilitating if it is not nipped in the bud.
Dealing with the sources of economic instability and political uncertainty is vital to the stabilisation of the growth process. That is the macroeconomic and political challenge facing the Union finance minister this month.