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Surprisingly good news by Ashok V Desai

India’s growth is not falling, although it is not as high as before

If there is a crisis, there should be economics to deal with it; what use are economists if they are not around to help out when things get bad? And it is not enough to have economics. There was plenty of economics in 1929. As output and employment plummeted, economists said, this is good. It will take the poison out of the body economic. Governments took economists’ word for it, and let the pain persist. Then John Maynard Keynes, who till then was quite well-behaved despite his brilliance, broke ranks and wrote a book which basically said that unemployment was not due to trade union monopolists asking for wages exceeding the marginal product of labour. If wages went down, so did demand for consumer goods and employment in their production. At the macro level, demand was not independent of supply. They went up and down together. Hence unemployment would not disappear through the working of the labour market even if it worked perfectly. To reduce it, he suggested injection of demand from outside — for instance, by increasing government expenditure or reducing government revenue.

That was too outré; no one took him seriously. But then came along the World War in 1939. Britain had to fight for its life; its government began to spend far beyond its means on armaments. The United States of America hesitated a while, but it too entered the war after the Japanese attacked Pearl Harbour. For the next three years, it ran budget deficits of one-fifth of gross domestic product. In Britain as well as in the US, unemployment declined, and then stayed low for decades. The Keynesian idea of reducing unemployment through deficit finance had worked.

That should have made it respectable. And in a certain sense, it did. All who learnt economics after the war read Keynes and imbibed his ideas. When I went to Cambridge in the 1950s, my teachers, Nicholas Kaldor and Joan Robinson, were working on an alternative to marginal cost theory. Piero Sraffa published his long-awaited Production of Commodities by Means of Commodities in 1960. The point of this brief book was that there were two factors of production, labour and capital; land had become unimportant in industrial economies. The two factors earned wages and profits, which together made up national income. Workers spent their wages on consumer goods. Only the rich people earned beyond their needs and saved. Profits were distributed to them in proportion to their investments. Entrepreneurs made investments; if total expenditure was to be equal to total income, their expenditure on investments had to be equal to rich people’s savings, which were their abstinence from expenditure. Thus, if the share of investment in income went up, so would the share of savings have to; and it could do so only if the share of profits went up. In this way, the investment-income ratio determined the distribution of income between wages and profits. This was the Keynesian theory of distribution. After he worked it out, Kaldor thought that he had worked out a substitute for the marginal productivity theory of distribution, which could then be discarded.

But it was not thrown away. Economists in both the US and Britain continued to teach the marginal productivity theory; if they did at all, they taught the Cambridge theory of distribution as a curiosum. They could do so because the policy priorities had changed. Instead of chronic unemployment, there were long periods of chronic inflation. This inflation was seen to be caused, or at least exacerbated, by trade unions’ pressure to raise wages. Earlier, inflation was believed to be due to aggregate demand exceeding aggregate supply. Now another type of inflation was seen, where prices were pushed up by wages; there was demand-pull and wage-push inflation. And the remedy for the latter was seen to lie in reducing the demand for labour and thus the bargaining power of trade unions; the way to do it was to have more unemployment. So unemployment came to be accepted as part of anti-inflationary policy; a minimum level of non-inflationary unemployment was considered desirable.

But it is difficult to define this level. It will be low if trade unions are docile; it will be high if they are aggressive. Many European countries brought trade unions and employers together and arranged deals between them; they thus tried to tame inflation through wage policy. It was tried in Britain, but worked badly. So it was given up in the 1980s. It was never seriously tried in the US. These two countries used macroeconomic policy to keep down aggregate demand, and kept down inflation, without being concerned about unemployment.

That worked well till the current slowdown. Now the American “recession”, defined as two consecutive quarters of decline in national income, has ended, so on that count the government can stop worrying. But unemployment continues to rise week after week, and is now approaching 10 per cent of the labour force. That brings up the spectre of jobless growth.

President Barack Obama long ago announced his intention of spending his way out of the downturn. But he follows a president who was equally spendthrift. Bush sent US troops to Iraq and Afghanistan, but he did not want to raise taxes. So he ran a deficit to finance the additional expenditure, and raised the national debt. Obama will be adding to that debt; conservative estimates project national debt to be touching 70 per cent of GDP by the end of his term. That gives his opponents another argument against his reflation plans.

We have had our own depression scare. Industrial growth began to fall from the 12 per cent peak it reached in March 2007, and had fallen close to zero by the beginning of 2009. Our government too increased expenditure enormously. It called it an anti-deflationary measure.

I doubt whether it was that; I think it was a ploy to win the general election. But I cannot deny the possibility that it worked. After being close to zero for months, June showed eight per cent industrial growth. I take GDP in the last four quarters, GDP in the four quarters excluding the last one, take their ratio, and exponentiate the ratio by four; that gives me a more stable indicator of growth than the official way of taking growth between the last quarter and the same quarter a year ago. Taken thus, production growth in the last three quarters to mid-2009 has been close to six per cent — much below two years ago, but still, it is not falling.

For a while, it was kept up by the spurt in government expenditure. But in the second quarter of 2009, it has been kept up by a fall in imports. As in old days before the reforms, the economy has been furiously replacing imports. The balance of trade has improved dramatically in the second quarter of 2009.

This is a welcome development, and one that should be helped. The best way to do so would be to influence the exchange rate. The Reserve Bank of India devalued the rupee for a while in early 2008, and then it stopped doing so. It should now resume downward pressure on the rupee.