Sudhir Mulji: A Keynesian election

Manmohan Singh needs Keynesian policies to fight joblessness

In his introductory remarks to the fourth NBER-NCAER conference at Neemrana last year, Suman Bery observed about India: "There is a paradox of a grave fiscal situation that is not showing up in either high inflation or in external debt."

He was expressing surprise at the anomaly that on adding up central and state fiscal situations together, the deficit was as high as 10 per cent of the GDP without any of the expected adverse effect on prices in spite of the stimulation of a steady decline in interest and tariff rates.

To Keynesian economists there is no paradox in this outcome for they do not relate the size of the fiscal deficit to inflation or indeed to external debt.

According to their thinking the phenomenon commented upon by Bery simply reflects the fact that in an unemployed or under-employed economy the prospects of high inflation from fiscal expansion are unlikely.

To put it in Keynes's words, in conditions of surplus capacity "it is probable that the general level of prices will not rise very much as output increases, so long as there are available efficient unemployed resources of every type".

It has been the fashion to postulate that such Keynesian stabilities were only relevant to the developed world, where industries have already been developed so that resources of every type are available; but from Bery's remark and subsequent developments it would seem that the Keynesian analysis may be applicable even to developing countries with a substantial labour surplus that cannot be adequately employed.

Orthodox economists doubt the significance of this proposition, particularly to India. They would argue that there are few unemployed resources that can be described as efficient. Even if they were to concede that there is potentially surplus manpower, they would argue that they could not be confident that this could be brought into the production system without making heroic assumptions.

On the contrary they say that we are so short of resources, that we need greater savings. As Shankar Acharya recommends (Business Standard, May 25) we should ensure "a reduction in revenue deficits of the public sector which could help to fund more productive private investment".

But the connection he assumes between public dis-saving and private investment is not obvious. For as Bery pointed out to the Neemrana delegates, "private investment has been consistently low in spite of high domestic household savings". It cannot therefore be a lack of savings that is acting as a constraint on private investments.

Acharya is obviously aware of that; for he goes on to suggest, "the climate for industrial investment (domestic and foreign) has to be improved so that manufacturing recaptures the dynamism of the mid-1990s".

It is unclear what he means by "the climate for industrial investment". Clearly these climactic changes are not of a kind that can be switched on and off like an air-conditioner. Nor is it very obvious that there is much the government can do to improve private investment in competitive markets.

Certainly low interest rates help. Ignoring this was the mistake made by the authorities in the second half of the 1990s.

In trying to curb the boom of the early 1990s they gave a signal that interest rates will go up "" to avoid "contagion" from the South Asian economies "" but in doing so they failed to master the Keynesian precept that "the remedy for the boom is not a higher rate of interest but a lower rate of interest!

For that may enable the so-called boom to last. The right remedy for the trade cycle is not to be found in abolishing booms and thus keeping us permanently in a semi-slump; but in abolishing slumps and thus keeping us permanently in a quasi-boom" (General Theory).

The price that the NDA paid for this inaccurate economic analysis was to throw us into a semi-slump. Some readers may recollect that I had at the time proposed a 5 per cent drop in interest rates to dramatically reverse the developing slow-down. This recommendation was naturally ignored and we fell into a semi-slump.

Such a state of semi-slump would not be very excruciating for an economy moving away from full employment, but is extraordinarily painful for an economy with a growing population that is permanently adding to its potentially unemployed.

Politically, the cost of that error in the mid-1990s has now been paid by the NDA in an unexpected reversal of its majority.

Vajpayee talked of public investment in infrastructure and highways, only to be thwarted by a well-entrenched economic bureaucracy. Sonia Gandhi was able to destroy the "India Shining" propaganda simply by pointing out to the unemployed that there was nothing shining for them.

Two fundamental mistakes were made by the permanent economic bureaucrats advising the NDA and they could well be repeated by the new Congress-led coalition. The first is an error in economics in understanding the nature of private investments. The second is political a failure to see the connection between public and private investment.

To look at the mistake in economics first, the theory that a sufficient accumulation of savings can induce private investment is a spectacular delusion. Private sector investment depends mainly on expected profits.

Any entrepreneur will tell you that he is not able to persuade colleagues to invest simply by showing them that money is available. It is profits that drive private enterprise not an amplitude of savings. For as Keynes pointed out "the engine which drives enterprise is not thrift but profit". (Skidelsky on Keynes, 2003)

The authorities can do little to create profits. But what they can do however is to change effective demand, either by public investment or by prodigious expenditure.

Conservative and sensible finance ministries are horrified at this solution for they fear that the supposed public investment will simply dissolve into wasteful expenditure. They have therefore forged two defences to resist these views.

The first is by what Keynes described as a "pure logical delusion" (Skidelsky) that is to ignore the distinction between savings and investment. It enables them to systematically argue the crowding out theory that any additional public investment would be at the expense of existing investment. This provides "a cure for unemployment by first assuming...that there is no unemployment to cure".

The second argument is that loan-financed public expenditure is a way of this generation robbing future generations; the burden of the national debt is said to carry on as a burden for future generations.

This proposition again is a logical error for as Abba Lerner pointed out in the 1930s the debt repaid will also be paid back to a future generation and not to the present one. There will be redistribution of wealth and income in future generations but no inter generational change.

Manmohan Singh has for long defended the Treasury view from a profound apprehension that there is not a sufficient circumspection among political leaders in dealing with public funds.

But as prime minister he now has to tackle the political issue that the jobless are not going to wait any longer. He needs public investment and deficit financing. He needs Keynesian economics.

sjmulji@aol.com