Government versus Markets – The Question of Persuasion

There is a growing voice of reason in India today that is passionately arguing that government interference in the economy is the primary cause of India’s lack of dynamism and prosperity. Those making this argument primarily draw their inspiration from the writings of classical liberals such as John Locke (a 17th century English philosopher and social theorist) and Frederic Bastiat (a 19th century Frenchman who is principally responsible for having introduced the concept of opportunity cost into economic theory) and of American libertarian economists such as Friedrich Hayek (1974 Nobel Prize winner) and Milton Friedman (1976 Nobel Prize winner). These intellectuals have argued, each in their own way, that free enterprise is the only possible means of creating widespread prosperity, and that the rule of law should be constituted in such a way that men and women can be free to truck, barter and trade as and when they see fit, without any kind of supra-individual authority (viz. the government) having a say in the matter. Those in present-day India that subscribe to this view essentially view government activity in the economy as not only unnecessary but also value-reducing. They propose, in effect, the idea that individuals know what is in their self-interest, and as long as an individual’s pursuit of self-interest does not infringe on the rights of others to pursue their self-interests, then a kind of human action emerges by which the common good is spontaneously delivered without any necessity of human design. Furthermore, this is the only way to achieve enhanced levels of well-being for all members of society as such a spontaneous order is, by... read more

‘Putting People at the Centre’ – by Prof. Neeraj Hatekar

People often are stubborn, miss out on advantageous deals, often procrastinate and sometimes act heroically. A lot of such behaviours puzzle the economist, because they appear to deviate from rational, utility maximizing behavior. But like all puzzles, they are in crying need of an explanation. Not only is this necessary to satisfy the intellectual urge, but sometimes important for policy as well. After all, if seemingly irrational decisions by individuals are standing in the way of improvements in their lives, then it is important to understand the reasons and provide the necessary nudges to push people into taking the correct decisions.   Behavioural economics is one such attempt. The area can be broadly defined as the area that seeks to understand the impact of psychological, social, emotional and cognitive factors on decision making by individuals. As you can well imagine, behavioural economics is a very active academic agenda and has given rise to a great deal of research in some of the world’s leading journals. It is obviously impossible to discuss even a fraction of the research is a small note such as this. I will only discuss an important concept in behavioural economics, i.e. loss aversion that will give the reader a flavor of how this subject helps us understand seemingly irrational decisions. Loss aversion is the idea that we value potential gains from a reference position less than potential losses from the same reference position. The function that maps potential outcomes into values is called the “value function”, a part of a construct called “Prospect Theory” that was introduced to economics in a famous paper by Daniel Kahneman... read more

Where has all the money gone – Lord Meghnad Desai

We have just been through the decision of the Federal Reserve Board to delay increasing interest rates from its low level near zero. For seven years now the US economy has floated on 0.5 % rate. Quantitative Easing (QE) as it is called was unimaginable ten years ago. It is an aggressive version of what used to be called Open Market Operations. The central Bank enters the market and buys bonds of sound reputation (AAA grading) and thus puts out cash in the hope that the cash would be spent either directly by the bond seller or through higher lending by the bank which sells the bond and puts the cash in its reserves. Traditionally such an operation would be a temporary move to be reversed later on when the situation warranted a tightening. But the crisis of 2008 was an unusually deep one. Normally a Keynesian policy of fiscal expansion with borrowed money would be the principal tool advocated by the textbook Keynesian model. But Keynesian theory for several reasons is perfect only for a closed economy with no access for the citizens to Capital markets abroad. The Government then cajoles or compels the Rentiers to buy its debt. With globalisation and open markets, citizens have freedom to invest their money anywhere and the Government is competing with other borrowers to attract the money. This requires the Government to show it is fiscally responsible and does not run unsustainable deficits. Since the crisis, fiscal stimulus has been absent. Obama did have a package of $ 850 billion soon after he came to office but the high Debt-GDP ratio... read more

The Tunnel Effect – By Prof. Abhinay Muthoo, Visiting faculty at MDAE and HOD Economics, Warwick University

Imagine you are driving in a two lane tunnel with both lanes headed in the same direction. All traffic is jammed as far as you can see – which is not very far. Suddenly the lane next to you starts to move. Initially you feel better, even though you are still stuck, because this signals to you that the jam has ended and your own lane will soon start moving too. But after waiting at a standstill and watching the other lane moving for some time, your feelings change. You become envious and furious. You and others stuck in the lane begin to suspect foul play. You begin to search for a way to address the injustice of the situation by drastic action – including making illegal moves, such as crossing the double line that forbids moving from one lane to the other. This is a parable for the economic times in which we live. In economic terms, we are all driving in the tunnel, and in every society – whether developed or developing – some people are surging forward, while others are stuck in a seemingly endless traffic jam.  The question is when their optimism about being on the cusp of progress will turn into the anger of being left behind. The “tunnel effect” was first articulated decades ago by Albert Hirschman, one of the world’s most original economic thinkers, who died in December 2012 aged 97. Fortunately for us, Hirschman’s keenly observed insights live on. Government leaders throughout the world would do well to consider the lessons that stem from this, Hirschman’s powerful parable of social and... read more

Dr. Arvind Subramanian’s (Chief Economic Advisor to Govt.) Reading list

1) Joseph Conrad, Nostromo, A Tale of the Seaboard. 1904. (336 pages) Understanding Development 2) Philip Gourevitch, “Alms Dealers: Can you provide humanitarian aid without facilitating conflicts?”The New Yorker, 2010.  Manna and Economic Development: Foreign Aid 3) Jared Diamond, Guns, Germs and Steel, 1997. Geography and Development 4) Giusepe de Lampedusa, The Leopard, transl. by Archibald Colquhoun, 1958 Understanding economic development Richard Hofstadter, The American Political Tradition: And the Men Who Made It, 1948 Formative histories and development 5) Ryszard Kapuściński, The Emperor: Downfall of an Autocrat, 1983 [Formative histories and development Ethiopia] 6) Ian Morris. Why the West Rules-for Now: The Patterns of History and what They Reveal about the Future. Picador, 2010. Broad Facts on Economic Development 7) V.S. Naipaul, The Writer and The World: Essays, 2003 Formative Histories and Development [Argentina, Mauritius, Guyana, Congo, Cote d’Ivoire] 8) Thomas Piketty, Capital in the twenty-first century, Harvard University Press, 2014. Inequality and Development 9) Michela Wrong, I Didn’t Do It for You: How the World Betrayed a Small African Nation, 2006 Manna and Economic Development [Eritrea] For a detailed list please go to... read more

Beyond GDP: The Importance of High-Quality Early Childhood Education and Care

Traditionally, a country’s Gross Domestic Product or GDP has been the dominant metric of its progress, but in the last couple of decades, a number of objections have been raised against its use as a measure of economic and social advancement. Among the principal ones are that GDP overlooks economic activity such as household work or the work of a stay-at-home parent, does not factor in the environmental impacts of economic decisions, and offers no account of economic inequality so that much of society might be worse off even as it gets richer. In the light of these objections, a number of new indices of progress have appeared on the scene, such as The Legatum Institute’s Prosperity Index and The Social Progress Imperative’s Social Progress Index. These new indices include purely economic measures such as per capita income but also factor in such variables as governance, personal safety and security, education, health, social inclusion and ecosystem sustainability.   One missing element, however, in these new indices is the contribution of households to economic production. This might be understandable given that few countries have attempted to evaluate the goods and services that are typically exchanged inside of a household. And yet, this fact may hide a deeper misconception, which is that the household has traditionally only been viewed as a site of consumption. But, as authors like Riane Eisler (in Real Wealth of Nations: Creating a Caring Economics, 2008) have pointed out, the household is a crucial site of production as well. The functions performed in a household are those of caring and care-giving, and these are productive functions because... read more

A Proposal for Demat Gold – By Dr. Ajit Ranade, Chief Economist Birla Group & Member Academic Board MDAE

  A significant portion of household savings is in the form of gold. This could be jewelry, coins or bars. There are no accurate estimates of just how much gold savings (or wealth) resides with households. This is partly because much of it is simply inherited for generations through bequests, and never enters any official records (barring wills and testaments). This holding represents wealth, but if it is never sold or mortgaged or liquidated, it does not become part of India’s financial system. This stock of gold keeps rising continuously every year with fresh accretion. India does not “produce” fresh gold. It is the highest importer in the world. During 2014 India imported 843 tonnes. In previous years, imports have been around 1000 tonnes annually. In the middle of 2013, due to a rupee crisis, the government imposed heavy controls and high import duty on the import of gold, and hence demand came down somewhat. But in the first quarter of 2015, demand is up again by 15%. China and India together accounted for 54% of global demand for gold in the first quarter of this year. The troubling aspect of gold demand is that it is unproductive investment. More than half of India’s national savings does not go into the financial system, i.e. through banks and capital markets. It is parked in gold or real estate. This reduces the loanable funds available to fund new growth and job creation. To increase the depth and scope of the financial sector in India, it is essential that the gold savings be converted to financial savings. It is not as if... read more

Thoughts on British Elections – By Lord Meghnad Desai, Chairman MDAE

The elections in UK have just delivered a verdict which surprised everyone. The Conservative Party, which was the major partner in the ruling coalition, has returned with an absolute majority, much against the predictions of all the pollsters. British economic policy since 2010 has been a challenge to standard macroeconomics. In a deep recession, which had struck in 2008 after the Lehmann Brothers collapse, conventional wisdom would have been that the fiscal policy should be expansionary. The Budget should be in deficit. The government should borrow to stimulate the economy until recovery takes place. George Osborne, who became Chancellor of Exchequer in 2010, took the view that the need was for a tight fiscal policy, reducing the deficit to zero within one Parliament. The Debt GDP ratio had long before exceeded 40 %, which is the norm for EU economies. Of course while the deficit stayed positive, debt would go on rising. But it was still worth cutting the deficit which had reached 10% of the GDP, almost the same size as Greece, which was then having difficulty borrowing. The norm until then had been to rely on growth and increase government spending in line with the growth of GDP. For a while, even during the years of prosperity, government spending had been rising faster than GDP. Now there was no growth of GDP and government spending had to be reduced. This went totally against the Keynesian orthodoxy which is what most politicians of a certain age group have been brought up on. Austerity was not popular. It meant cutting public spending steadily for five years. The biggest items... read more

Thoughts on Economics – By Niranjan Rajadhyaksha

“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us…” — A Tale of Two Cities Economics has been in turmoil ever since the global financial crisis. Even the Queen of England was perplexed enough to ask economists at the London School of Economics: “Why did nobody see the crisis coming?” There has been no clear answer since then. What happened in 2008 has led to savage attacks on the state of economics on the one hand and honest attempts at soul searching on the other hand. Will all this overdue turmoil lead to a new age of hope in economics? Let us first look at one example of a savage attack on the dominant economics consensus before the financial crisis. Paul Krugman wrote in January 2009 that we are living in a dark age of macroeconomics. He further explained that was distinguished the Dark Ages in Europe was not that they were primitive but that knowledge from the past was lost. What Krugman was in effect saying is that modern economics has suffered because of a loss of memory: what earlier economists said was forgotten by the profession. Krugman contentiously wrote elsewhere that there was no useful addition to the stock of macroeconomics knowledge since the mid-1970s. There... read more
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