India’s economic challenge: A matter of philosophy

The divide between the Keynesians and the Chicago school is as intense and often antagonistic as the Sunni-Shia, Catholic-Protestant or Thelakarai-Vadakarai Iyengar divides.

Now the only dispute on national income is how much will be the contraction. The Union Finance Ministry hopes there won’t be any. The IMF has officially said it will be 4.5%. The rating agencies predict a contraction of 6.8%, while many more are suggesting something closer to 10%. How do we deal with is now? The government of India has tended to be “conservative” in its outlook and has made no serious suggestion on economic stimulus. What it calls a stimulus is actually not a stimulus. The problem is more philosophical.

Keynesian economics is a theory that says the government should increase demand to boost growth. Keynesians believe consumer demand is the primary driving force in an economy. As a result, the theory supports expansionary fiscal policy. The Chicago School is a neoclassical economic school of thought that originated at the University of Chicago in the 1930s. The main tenets of the Chicago School are that free markets best allocate resources in an economy and that minimal or zero government intervention is best for economic prosperity. They abhor fiscal deficits.

The only reason why the actual stimulus package is only Rs 63,000 crore is the obsession with fiscal deficits by Chicago economists such as Raghuram Rajan and his former student, Krishnamurthy Subramaniam, the present CEA. They are true disciples of the Washington Consensus to judge countries like India by the fiscal deficit size. The instruments used to beat countries like India into submission are ratings agencies such as Moody’s, which just downgraded India. We shouldn’t lose too much sleep over it. India is hardly a borrower abroad and is more of a lender holding $490 billion as reserves.

That's why the CEA, when asked about a big stimulus, said: "There are no free lunches!" That's exactly what Milton Friedman said. But they quite happily ignore that the biggest deficit financed economy in the world is the USA. Raghuram Rajan told Rahul Gandhi on his video conference that a stimulus of Rs 65,000 crore would suffice in the present situation. Nobel Laureate Abhijit Banerjee and former CEA Arvind Subramaniam suggest a stimulus package like those of the USA or Japan. The USA has just announced a stimulus of over $3.5 trillion or over 15% of its GDP. Modi’s stimulus is a mere 0.3% of India’s GDP.

Many serious economists regard fiscal deficits as a positive economic event. For instance, the great John Maynard Keynes believed that deficits help countries climb out of economic recession. On the other hand, fiscal conservatives feel that governments should avoid deficits in favour of balanced budgets.

The fastest growing economies in the world, and now its biggest - USA, China, Japan and most of Western Europe - have the highest debt/GDP ratios. Japan's debt/GDP was over 253% before the latest stimulus of 20% of GDP. China's debt is now over 180% of its GDP. The USA’s debt/GDP is close to 105%, yet it is raising $3 trillion as debt to get out of the Covid quagmire. India's debt/GDP ratio is by contrast a modest 62% and yet it intends to pump in a mere 0.3% of its GDP as stimulus!

Pump priming the economy by borrowing per se is not bad. It is not putting the debt to good use that is bad. Nations prosper when they use debt for worthwhile capital expenditure with assured returns and social cost benefits. But we in India have borrowed to give it away as subsidies and to hide the high cost of government.

To give an analogy, if a family has to make a choice of borrowing money to fund the children's education or to support the man's drinking habit, the rational choice is obvious. The children's education will have a long-term payback, while the booze gives instant gratification. But unfortunately, our governments have always been making the wrong choices

If borrowed money is used productively and creates growth and prosperity, it must be welcomed. What we want to hear from the government is not about fiscal deficit targets, but economic growth, value addition, employment and investment targets.

So, what can Modi do now to get us out of this quagmire? If the regime abhors a stimulus financed by deficit financing, there are other options that can be exercised. But he is hamstrung with a weak economic management team with novices as the two key players, the Union Finance Minister and the RBI Governor.

India has over $490 billion nesting abroad, earning ridiculously low interest. Even if a tenth of this is monetised for injection into the national economy, it will mean more than Rs 3.5 lakh crore. At the last count, the RBI had about Rs 9.6 lakh crore as reserves. This is money to be used in a financial emergency. We are now in an emergency like we have never encountered or foresaw before. Even a third of this is about Rs 3.2 lakh crore.

There are other sources of funds also, but tapping these will entail political courage and sacrifices. Our cumulative government wages and pension bill amounts to about 11.4% of India’s GDP. After exempting the military and paramilitary, which is mostly under active deployment, we can target 1% of GDP by just by cancelling annual leave and LTC, and by rolling back a few DA increases.

The government can also sequester a fixed percentage from bank deposits, say 5% of deposits between Rs 10-100 lakh and 15-20 from bigger deposits for tax-free interest-bearing bonds in exchange. The ten big private companies alone have cash reserves of over Rs10 lakh crore.

There is money in the trees, and all it needs is a good shake up to pick the fruits. The pain of the lockdown must not be borne by the poor alone. The government can easily target 5-6% of GDP or about Rs 10-12 lakh crore for the recovery fund as an immediately achievable goal.

This money can be used to immediately begin a limited Basic Income scheme, by transferring a sum of Rs 3000 per month into the Jan Dhan accounts of the BPL people for the duration of the financial emergency; fund GST concessions to move the auto and engineering sectors in particular; begin emergency rural reconstruction projects to generate millions of new jobs and get our core infrastructure sectors like steel, cement and transportation moving again.

Getting money to move India again is not a huge problem. What comes in between are the philosophical blinkers. Call it Chicago economics or the Gujarati mindset.

Views expressed in the article are the author’s own