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Myths of our making-Pratap Bhanu Mehta
-The Indian Express

Too many of our economic prescriptions are based on dogma, empirical half-truths

It has become fashionable to say, following the conclusions of Michael Spence’s Growth Commission, that there is no single recipe for growth, only some common ingredients. Such a claim brings a due degree of modesty to what we do or do not know about growth. And at the very least, such a claim has the virtue of jolting us out of fatalism: there are no iron laws explaining success or failure. Lots of causal variables that we intuitively think matter, like education, political stability, good institutions or infrastructure, often turn out to be as much effects as the cause of growth. Lots of conjunctural variables like geo-strategic rents or global circumstances matter. And the one thing we have learnt over the last few years is that the causal correlation between any two variables is highly contingent; it depends on the circumstances. How much do interest rates affect growth? How much does decline in growth rates affect inflation? What is the relationship between agriculture wages and productivity? Many of the challenges of growth are about figuring our way through these kinds of relationships. Nothing can kill an economy better than a dogma or empirical half-truths masquerading as certainty.

Much of the public discussion about the economy is in a bit of an intellectual limbo. Some of this discussion is an artefact of noise: many bad arguments drive out good ones. Some a product of inevitable ideological differences: in the face of uncertainty, retreat to your simple convictions. Even in academic circles in India, there is more debate than dialogue. The former is oriented to cutting down arguments; the latter to figuring things out. There is a lot of extraordinarily good work in economics. Several were heroically warning against dangers that lie ahead. Nevertheless, with hindsight it has to be said that our political complacency about growth was legitimised by intellectual complacency. The stories we told, or failed to tell, have been as responsible for inducing complacency as political paralysis. It is often the economy, stupid. But behind the economy is a myth.

Think of the mystifications that did us incalculable damage over the last few years. The first was the so-called soundness of India’s banking sector. We patted ourselves on the back for surviving the global financial crisis without a banking meltdown. It turned out that we had a banking crisis of our own, with public sector banks recklessly concentrating credit and not taking political risks into account. And there is still no clear assessment of just how good Indian banks are at allocating credit, and how much of a constraint this will be on growth. God forbid there should be another crisis. But will you believe the government about the soundness of the banking system as easily as you did the last time around?

The second was the mystification that fiscal deficits either don’t matter or will be self-correcting. Now, the degree of deficit we can sustain is something to be carefully debated. But it is an astonishing fact that (a few exceptions apart) much of the official economics establishment, including the Prime Minister’s Economic Advisory Council, stayed silent, for all practical purposes, on the issue. Given that economies are, in part, confidence tricks, governments will understandably minimise downside risks. But it is still something of a mystery why it took a Kelkar from the outside to raise the alarm bells on how much of a soup we were in. The quality of economists in the establishment may be high, but the credibility of the system as a whole took a hit. And now we are in the awkward position of having to reduce deficits when growth is slowing.

The third mystification was about inflation. Again, with a few exceptions, we kept pumping up the idea that inflation was largely about interest rates. We would rather place the RBI in the middle of what was largely an ideological tug-of-war than get to the bottom of the stickiness of inflation. Much of the debate on inflation had an a priori cast to it, with slogans even most non-economists could parrot, like “supply side constraints”. But which ones mattered more and why? There were several intriguing hypotheses that were never fully examined. Harish Damodaran had been heroically arguing that rural wages are stickier now. In the past, lowering inflation used to be on the backs of lowering wages of rural poor. This is no longer possible. In welfare terms, this may be a good thing, but it means prices are stickier. Urjit Patel argued that the wealth effects of gold were such that people did not reduce consumption as predicted; other argued that asset prices like land were the principal cause, and still others argued, with some justification, that we did not have accurate enough data to say anything half reliable. But the certainty of prescriptions did not reflect the underlying tentativeness.

The fourth mystification was around manufacturing. India sensed rightly that it may not need to follow a conventional path in terms of manufacturing. But this plausible insight induced an extraordinary hubris, where we simply forgot to ask fundamental questions like: Can the rate of service exports keep up with the import bill if the demand for manufactured goods explodes? In short, will you always be at risk of running a current account deficit if you do not have a diversified manufacturing base? Second, what are the opportunity costs of not leveraging growing domestic demand to give domestic manufacturing a boost? To be fair, a manufacturing policy has been high on the discussion agenda. But most of what passes off as policy is old wishful thinking: it confuses manufacturing policy for a real estate policy. If only we set up enclaves here and there, problems will be solved. The nuances that go into thinking about the nature and character of our productivity growth are largely absent. This point is important because the fact is that industrial growth is sluggish. Even in areas where we should have more momentum, like textiles and automobiles, our advantage is slipping away. It would be catastrophic if the services dogma continues to undergird the de-industrialisation of India.

Restoring vibrancy to the economy will not be just a matter of top-down reforms. It will require a contagion of energy across many different sectors. Political paralysis can stymie that energy. But so can the stories we tell ourselves. Managing an economy, particularly an open one, is less like figuring out a theory, more like managing a chess board. Unfortunately, at the moment, we are playing chess with our hands tied on more than half the squares. We keep looking for the knight, when whole armies are being decimated.

The writer, president of the Centre for Policy Research, is contributing editor, ‘The Indian Express’