The political economy of independent India passed its first watershed in 1991when it switched from four decades of pursuing a socialistic pattern of society and self-sufficiency behind high tariff walls to letting the market prevail and integrating with the rest of the world. Less than two decades later another watershed seems at hand.
Such major historical changes come at a cost. The Great Depression, which took its human and material toll, led to realizing the role of government spending in evening out business cycles. The need for human betterment after paying the price of the Second World War led to the welfare state. The oil shocks and stagflation of the seventies led to the belief that the market knows best. The course correction in India in 1991 came after an economic crisis that brought the country close to sovereign default.
Interestingly for India, the present crisis did not originate here but was brought to its doorsteps through the domino effect made possible by globalisation, and will eventually affect it the least. It also has fewer lessons to learn than some others and is in the happy position of finding itself vindicated on some of the policies it had followed by going a bit against the earlier reigning orthodoxy. But importantly, there are also significant lessons for India.
The most obvious lessons for everyone are on the financial regulatory side. One is the need to regulate the entire financial sector and not leave large gaps so that significant parts of it go unregulated. Two is the need to step in to prevent asset bubbles from growing unrestrained once a bubble is clearly visible. The orthodoxy that the market should be left to discover asset prices and correct itself now stands discredited in light of the damage done by the housing bubble in the West. Three, do not allow new financial products to come in unless you (the regulator) have understood what they are and how to keep an eye on them. In these three areas India has chosen the right course despite global pressure to deregulate more.
But a more substantial lesson falls in the rest of the policy domain and here the Indian learning experience needs to progress further. A paramount need and practice has emerged globally in the last few months — to protect jobs and prevent distress, by throwing orthodoxy out of the window. In ordinary times developed economies let their safety nets take care of the jobless, but during a crisis of such magnitude as has now afflicted the world, a new ball game is emerging. It is fascinating how western countries are nationalising banks to prevent social turmoil resulting from financial collapse when, during the Asian financial crisis, banks were made to close down in Indonesia, resulting precisely in such social turmoil.
The need to protect jobs, if need be through drastic fiscal action by not looking where the budget deficit is going, has now been put at par with the need to control inflation. So the new paradigm that has emerged is that monetary and fiscal policy must work together, there is no such thing as the autonomy of monetary policy in its single-minded pursuit of inflation targeting. At the end of the day the government of the day is in charge and the monetary and fiscal authorities have to sit together to evolve the policy that will deliver. The Indian central bank was never totally independent and should not be. In ordinary times monetary and fiscal authorities have to maintain macro-economic stability and, in exceptional times, have to break as many rules as they need to in order to maintain social stability.
If the cardinal goal of governments in developed countries is to prevent large-scale or high unemployment, that in developing countries is to steadily and rapidly increase the supply of jobs under conditions of price stability. This has to be done without getting excessively arithmetical about the money supply or the fiscal deficit. There is a need to keep experimenting with what will work as situations keep changing. An inflationary episode in an overheated economy is one thing, inflation driven by high prices of imported commodities existing side by side with adequate capacity is another.
China’s early emphasis on enhancing its human capital and subsequent emphasis on building the physical infrastructure, partly through easy bank finance while fudging the money supply figures, appears to be a triumph of pragmatism over orthodoxy. Such an approach again appears to be at play with its announcement of a half-a-trillion dollar stimulus even as India appears to dither on the same front. When truck makers are paying workers to stay at home, banks should surely be ordered to lower their own truck finance rates and help NBFCs do so, and money should pour in to build more highways. In a situation like this the autonomy of banks and the finance ministry’s fiscal responsibility targets should be temporarily relegated to the basement.
The new focus needed is to realise that fiscal responsibility and monetary prudence are not enough. High growth, without putting people and infrastructure first, is not enough. The current global crisis offers an opportunity to temporarily turn a blind eye (at this juncture a downgrade hardly matters) to orthodoxy and go for active infrastructure building and work for better health and educational attainments. In fact, that should always be the primary goal.
