In Prime Minister Narendra Modi’s latest instalment of “Mann ki Baat” on April 25, he exhorted the citizens to treat the present moment as a yudh (war) against the coronavirus disease (Covid-19). However, the government’s approach to the economy, under lockdown for over five weeks, has been anything but warlike. An economy is an emergent phenomenon, its path altering when it is buffeted by shocks. This calls for a creative response by the authorities concerned when one occurs. Globally, we are facing a situation that is not just abnormal but, failing a providential reversal, is set to damage our prospects as societies. Public authorities in almost all democracies have recognised this threat and unleashed unprecedented economic force. By contrast, in India, the economic policy appears paralysed, without no significant economic package announced yet.
The lockdown being implemented is tantamount to an economic shock. As there is no production, there are no avenues of income generation for a vast majority of Indians. This would be cause enough for concern even if the loss is confined to a single period. But an economy exists in time. Today’s national income drives tomorrow’s expenditure, which determines income the day after. So the lockdown is likely to have consequences that extend well into the future. It is unlikely that incomes will bounce back to some predetermined level once it is lifted. In fact, there is the possibility that we will continue to slide. Economic policy in a democracy is expected to address this possibility.
Recent world history has shown that there are varieties of responses even among democracies when it comes to assuming responsibility for the economy. Consider the responses of the United States (US) and by governments in the Eurozone, respectively, to the global financial crisis in the last decade. An aggressive fiscal stimulus in the former meant that the US recovered briskly, while reluctant activism by the conservative European Central Bank and equally conservative governments has meant that a whole continent has fared poorly by comparison. This contrast suggests that Europe’s misery was of its own making; in the words of the Dutch macro-economist Willem Buiter, “recessions are a choice”. It implies that it is within the reach of economic policy to determine the state of the economy by preventing a collapse of aggregate demand. Could it be that our own future in India after the lockdown is lifted will be closer to the experience of Europe rather than the US after the global financial crisis?
Of course, as long as a lockdown persists, the problem is not just one of aggregate demand, for it is the supply side that is impacted first. But as wages not paid today lowers tomorrow’s expenditure, a supply restriction could soon end up as a demand recession. Of the two arms of macroeconomic policy, namely monetary and fiscal, it is the latter that has greater potential once demand slows. This feature, which is established in theory, is particularly relevant under the circumstances India finds itself in. The economy has been slowing for three years since 2017-18, following the demonetisation in late 2016. There is an explanation for this. In a slowing economy, private investors tend to be sceptical of the growth of profits, and are likely to contract investment. Now growth slows further, impacting investment in the next period, and so on.
{{/usCountry}}Of course, as long as a lockdown persists, the problem is not just one of aggregate demand, for it is the supply side that is impacted first. But as wages not paid today lowers tomorrow’s expenditure, a supply restriction could soon end up as a demand recession. Of the two arms of macroeconomic policy, namely monetary and fiscal, it is the latter that has greater potential once demand slows. This feature, which is established in theory, is particularly relevant under the circumstances India finds itself in. The economy has been slowing for three years since 2017-18, following the demonetisation in late 2016. There is an explanation for this. In a slowing economy, private investors tend to be sceptical of the growth of profits, and are likely to contract investment. Now growth slows further, impacting investment in the next period, and so on.
{{/usCountry}}Only the government can counteract slowing private investment. The Great Depression is reckoned to have lasted for a decade from 1929, ended only by World War II. War had meant greater public expenditure, which restored economic activity. Nowhere was this more in evidence than in the US, which was launched into a period of extraordinary prosperity for three decades. It is important for us in India to learn from this period in world history and to tailor our economic policies accordingly.
A hurdle in the path of the renewal of economic activity post-lockdown is the Fiscal Responsibility and Budgetary Management Act (FRBM) of 2003. It ties expansionary economic policy to a fiscal deficit limit of 3% of the gross domestic product. This when the Centre’s fiscal deficit was already at 3.8% in 2019-20. The government can, of course, amend it to allow for an emergency, like the one we face at present. Not amending the Act is one of the sources of the paralysis in economic policy today. It ensures that the government cannot expand its spending to battle the consequences of the spread of the coronavirus. Greater expenditure is required in four buckets, first for relief, next for the medical response, then for an aggregate demand stimulus and, finally, for ramping up the public health infrastructure.
It is difficult to fathom the non-interventionist macro-economic policy stance of the government, one bordering on irresponsibility though wrapped in the rhetoric of fiscal rectitude. Never before has it been as true that, as John Maynard Keynes said: “Practical men who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.”