Economics has very few certainties left and that may not be a bad thing
When I began studying economics in the late-1950s, there were some solid certainties in the subject. We were all by and large Keynesians. Only the very odd person, Professor BR Shenoy, for one, or Milton Friedman, was known to be non-Keynesians. They were regarded as curiosities. We also knew that Keynesian Economics did not apply to India. What did was unclear. We had theories of surplus labour which had to be redeployed to spur growth. But the socialist theory was it was not labour but capital which was the resource to concentrate on. It was not Western economics but Soviet economics—the Feldman model which was relevant to India. Mahalanobis was obsessed about machines making machines. India concentrated on capital-intensive industries and neglected consumer goods. Many economists also thought population growth was the big obstacle to India’s development. Some form of birth-control was needed.
Twenty five years later, during the late-1970s, Keynesianism was under attack. Inflation was the big problem and monetarism was the new macroeconomics. Friedman was the new prophet and Keynes the father of our inflationary problem. Full employment was abandoned as a goal and fighting inflation became the priority. The Bundesbank, with its stern attitude against funding government budgets and strict anti inflationary policies, was every country’s dream central bank.
In India, nothing much had changed by then. The Janata government made a half-hearted attempt at trying Gandhian economics as the new planning strategy. Thankfully, it did not last long enough to do much damage. When Indira Gandhi returned to power, she changed tack. Borrowing from the IMF was alright. India did not look at what Deng Xiao Ping was doing and did not learn from China’s example. Rajiv Gandhi liberalised imports and borrowed from NRIs. This was soft socialism. But Rajiv did not reform the economy and the Mahalanobis-plus model collapsed in early 1991 as India faced bankruptcy.
Now, when we look at what economics looks like, it could be another world we live in. The Malthusian threat is gone; we boast of a demographic dividend. Foreign capital is welcome, indeed the solution for India’s growth problem. No one thinks in terms of machines building machines. Or planning with input-output tables. The Planning Commission has been abolished. What has taken its place NITI Aayog, as yet an unknown entity. But it will not be central to the economic strategy.
In developed economies, we no longer fear inflation. The real danger is the lack of inflation. Monetarists had told us that printing money was bound to cause inflation. Here we are, with the world flooded with money, thanks to the QE programme of the US Federal Reserve,the Bank of England and the Bank of Japan. Yet, no inflation. Central bankers are no longer watchdogs against inflation; they are cheerleaders who want inflation to revive.
The worst part of this reversal of fashion is that the Bundesbank which was used as the model for setting up the European Central Bank is now proving to be exactly the wrong model for the euro zone. There is limited opportunity for the ECB to stoke up inflation as its charter is grounded in anti-inflationary philosophy. Monetarism, once a success, has now become the obstacle in securing economic revival in the euro zone. If anything, the lack of inflation in face of the QE emission of money shows monetarism is no longer valid.
Any hope of stoking up inflation has been further dashed by the fall in oil prices. Here is another certainty of the last forty years gone. Since 1973 and the oil-price shock, all policy-makers have had the spectre of an oil price rise at the back of their minds. Energy policies have been built around the assumption that we may run out of oil; or that its price will reach $200. No one could have given you any odds on the price falling down to $50 as recently as January last year.
So, here we are with Keynesianism and monetarism discredited. Governments of developed countries can not use fiscal policy in face of their indebtedness. Their use of monetary policy is proving ineffective. The fall in oil prices will deepen the disinflationary environment. This is regarded as a catastrophe rather than an opportunity. Low GDP growth and low inflation are the medium-run prospect as far as the developed economies are concerned. Their demographics are bad. Indeed, they also would need a Malthusian boost to their population if they could manage it. Alas, no such luck.
Economics has very few certainties left compared to the days when I began the study of the subject. That may not be a bad thing. In day-to-day market analysis, no one uses grand theories. The world changes too fast to rely on any laws. If anyone does turn up with a new theory of economics, we shall be pleased. But we should know that the new truth will only be temporarily true. Have a happy New Year.
The author is a prominent economist and Labour peer