The empire strikes back

 Issue 22 - Jan 2009

Bibek Debroy

JOHN MAYNARD Keynes is back in fashion with a vengeance. Economists have talked about global macro-economic imbalances ad nauseam, with high consumption and current account deficits in US primarily in mind, and the reverse elsewhere in the world, such as Asia. The dollar’s role as a de facto international currency, flexible exchange rates, capital account convertibility and the International Monetary Fund’s role are thrown in. If these issues are revisited, and a World Financial Organisation contemplated, then that’s a tribute to Keynes and his role in shaping the initial Bretton Woods regime. 

However, it isn’t the case that these imbalances caused the present global financial crisis. That trigger was provided by domestic regulatory failure in the United States. Had it not been for that, we would have continued to debate global imbalances for another twenty years and eventually, self-equilibriating mechanisms for correction would have emerged. Note that savings rates have increased (before the crisis) in the United States and declined in East Asia. Keynes is back in fashion for a different reason too. Jokes about economists never agreeing are clichéd. In a way, these originate with Keynes, more accurately with what Winston Churchill said about Keynes. Churchill said that two economists always gave him two opinions. Unless one of them happened to be Keynes, in which case, he got three opinions. 

Ordinary non-economist mortals have every reason to complain about confusion. No one disputes need for prudent regulation, though the content of regulation needs debate. Perhaps investment banking needs to be separated from other banking operations. Perhaps there should be caps on leverage ratios. But can one regulate ratings by credit rating agencies? However, what is happening in developed economies goes much beyond regulation and its content and overturns the wisdom of the last thirty years. After the East Asian financial crisis, it was fine for banks in Indonesia and South Korea to be closed down and for interest rates to be jacked up to exorbitant levels. But that medicine can’t be applied to developed economies—banks and financial institutions must be nationalised and public money used to bail out private vices. These kinds of sentiments are associated with the name of John Maynard Keynes, who wrote during a period of depression and unemployed resources.  Indeed, there are situations where monetary policy does not work.  And Keynes therefore advocated use of fiscal policy 

Developed countries can do what they want. As long as they do not want bail-out resources from India. Thankfully, India isn’t China, Saudi Arabia or Japan and is not in a position to offer money. But in this reverse swing of the pendulum, the empire has struck back with a vengeance in India. The empire of state intervention never withered away in India. It only dithered for a while. 

Liberalisation is the antithesis of discretion. Thirteen is an unlucky number. Today, there is gloom and doom in India about the slowdown. Regardless of the composition of the new government in 2009, and with a slightly different nuance, these are thirteen reasons to feel gloomy about the cause of reforms. The empire has struck back.