Column : Bad economics, good politics
It is little surprise to those of us not living in Wonderland, that a relative price change in favour of those who own homes and against those who do not, could not justify a country spending more than its earning for so long. The consequences of excess are crisis. But Alice has not yet left the building. How do you think western politicians are proposing to get themselves out of this mess? By spending more than they are earning. The very same policies that got us into this mess are being proposed as the policies required to get us out.
When it is pointed out that the old fiscal rules of prudence are being thrown out of the window, the name of John Maynard Keynes is evoked. Keynes, who of course developed his economic ideas from studying liquidity in India, was at times a marvelous wit. He was supposed to have said in debate in the House of Lords, in response to someone who had accused him of changing his mind: “when the facts change, I change my mind, what do you do, Sir!” But Keynes wrote about how an activist fiscal policy could pull an economy out of a period of underconsumption. His subject was the 1920s British economy that had languished in depression for a decade with mass unemployment and substantial social deprivation. Adjusting to an end of over-consumption must surely be different to adjusting to a period of under-consumption.
After a period of over-consumption savings should be allowed to rise to help restore consumer balance sheets. The scale of today’s crisis is partly a result of this adjustment being pushed back and back as the US government tried to shore up consumption whenever it faltered from over-extended levels. Adjustment to the savings and loans disaster in the late 1980s was arrested by very low interest rates in the early 1990s. Ten years on adjustment to the dotcom collapse at the turn of the century was arrested by very low interest rates throughout the first decade of the new century and now, some seven years on, the levers of monetary and fiscal policy have been pulled hard to further arrest the adjustment of consumption. Should governments stand by as the economy skids? No. What governments should do is to ensure that while the excessive consumption was enjoyed by the rich, that it is not the poor who bear the brunt of the inevitable adjustment. The way to do that is to increase targeted welfare payments and construction expenditure. Investment and export growth can also be spurred to take up the slack from consumption. But the idea that the way forward is to boost consumer expenditure further, seems to miss the point of why we are where we are.
One retort is that it is all very complex and difficult to manage the economy out of recession. It is. But if western leaders want to know what direction to follow they need merely to follow their own sermons to Asian countries during the Asian Financial Crisis of 1997-98. Funnily enough, the western response to the Asian crisis was not—cut your interest rates, bail out your banks, boost fiscal expenditure and look to the west to share your burden of adjustment. It was not all the things that the US and UK have done. It was the exact opposite. Back then, the IMF and US Treasury officials told Asian countries not to pursue easy monetary policy and weak exchange rates, not to bail out “crony capitalism” and not to let fiscal policy get in the way of a needed adjustment in national consumption. It was unnecessarily harsh medicine that almost killed the patient. But it was all supportive of the necessary adjustment to lower consumption and raise savings. Indeed, Asian governments were better placed back then than the US, UK and other countries are today, to boost national consumption. Their fiscal positions were stronger.
When Indian investors want to know how to think of the future of western economies, they need to look no further than India. The British government has sized up the Indian economy and decided to replicate its worse bits. There is much that is broken in western economies, but I doubt very much that the way to repair it is for governments to engage in directed credit, meddle with any price they do not like and allow the government deficit to rise to 8% of GDP.
—The author is chairman of London-based Intelligence Capital and emeritus Professor of Gresham College in the UK
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