Ghosts of economists past

The Great Depression, as it was called, gave birth to the ideas of John Maynard Keynes who defined the problem in a completely new way, and created an apparatus for addressing it. If people spend less and save more, say on account of insecurity about the future, this would trigger a chain effect which would mean less demand for industry output. If this persists, industry would have to curtail output and lay off workers, further exacerbating the demand deficit. In consequence, there would be a mismatch between planned saving and investment. To combat this, the government would have to undertake direct investment, even if it leads to a fiscal deficit. Government intervention would be temporary, since once the economy is back on track, government revenues would go up and it could pull back on direct investment. Governments all over the world including India have used Keynesian concepts to stabilise their economies, thus averting the Marxian prognosis.

Coming to the recent collapse on Wall Street, it is in Keynes’s spirit that the Bush government has intervened with a 700 billion dollar bail-out, the biggest in history. Is this Keynes revisited?

In a sense, yes. Keynes had visualised government investment in public works: even if it meant spending on digging holes and filling them. The present bail-out is to rescue the largest investment, insurance and mortgage banks which have behaved irresponsibly and hardly deserved to be rescued. It will protect the small investors who are innocent of high finance, while letting those responsible for the crisis off the hook, and prevent the US from a deep recession.

According to Galbraith, America in the early 19th century “discovered banking as an adolescent discovers sex”. A rash of unregulated private banks followed, leading to bank failures till the Fed was established in 1914. Decades later, Milton Friedman concluded that it was the monetary failure of the Fed which worsened the Great Depression. In the 1980s, there was the Junk Bond crisis.

Now we have a massive leveraging of unsustainable debt threatening a global meltdown. The burden on the U S exchequer may well exceed a trillion dollars. This is akin to the government having dug holes through inadequate financial regulation now stepping in to fill them. Let us hope financial reform will follow fast.

Many believe that the bailout by the US government is a steptowards socialism. This is nonsense, since the intention is to reprivatise in the future albeit with an altered architecture of the afflicted institutions. One wonders how Milton Friedman, diehard proponent of an unfettered market economy would have reacted? He would probably say, let the undeserving die and let the government mind its own business. The market will correct itself.

Friedman, the father of the monetarist school, is deeply entrenched in the minds of the Republicans. Yet, it is Bush who has made this unprecedented intervention, meant to prevent a domino effect on more financial institutions. Sadly the contagion has already spread and India will not be unscathed.

Yes, the Indian financial markets are reasonably well regulated, the global exposure of our financial institutions is limited and the fundamentals are strong. However, since India is now integrated with the world economy, negative sentiments have already begun to impact our stock markets and the inflows of FII and FDI. This will adversely affect our growth rate. Will Marx have the last laugh?

The writer is an industrialist and economist