Modify the FRBM Law and spend more now: analysis
In Prime Minister Narendra Modi’s latest installment of “Mann ki Baat” on April 25, he called on citizens to treat the present moment as a yudh (war) against coronavirus disease (Covid-19). However, the government’s approach to the economy, under a lockdown for more than five weeks, has been anything but warlike. An economy is an emerging phenomenon, its trajectory is altered when it is affected by shocks. This requires a creative response from the concerned authorities when one occurs. Globally, we are faced with a situation that is not only abnormal, but by failing a providential reversal, our prospects as societies will be damaged. Public authorities in almost all democracies have recognized this threat and unleashed an unprecedented economic force. By contrast, in India, economic policy seems paralyzed, with no significant economic package yet announced.
The blockade that is being implemented amounts to an economic shock. Since there is no production, there are no means of income generation for the vast majority of Indians. This would be cause for concern, even if the loss is limited to a single period. But an economy exists in time. Today’s national income drives tomorrow’s spending, which determines tomorrow’s income. Therefore, the blockade is likely to have consequences that extend well into the future. Income is unlikely to recover to a predetermined level once it is raised. In fact, there is a possibility that we will continue to slide. Economic policy in a democracy is expected to address this possibility.
Recent world history has shown that there are diverse responses even among democracies in taking responsibility for the economy. Consider the responses of the United States (US) and Eurozone governments, respectively, to the global financial crisis in the past decade. An aggressive fiscal stimulus in the first meant that the United States recovered quickly, while the reluctant activism of the conservative European Central Bank and equally conservative governments has meant that an entire continent has fared poorly by comparison. This contrast suggests that Europe’s misery was of its own making; In the words of the Dutch macroeconomist Willem Buiter, “recessions are a choice.” It implies that it is within the scope of economic policy to determine the state of the economy by avoiding a collapse of aggregate demand. Could it be that our own future in India after the blockade is lifted gets closer to the experience of Europe rather than the United States after the global financial crisis?
Of course, as long as a blockage persists, the problem is not just one of aggregate demand, but it is the supply side that is affected first. But since wages not paid today reduce expenses tomorrow, a supply constraint could soon end in a recession in demand. Of the two branches of macroeconomic policy, namely monetary and fiscal, it is the latter that has the greatest potential once demand slows down. This feature, which is established in theory, is particularly relevant in the circumstances in which India finds itself. The economy has slowed for three years from 2017-18, after demonetization in late 2016. There is an explanation for this. In a slowing economy, private investors tend to be skeptical of earnings growth and are likely to make investments. Now growth is slowing further, impacting investment in the coming period, and so on.
Only the government can counter the slowdown in private investment. The Great Depression is estimated to have lasted a decade since 1929, ended only by World War II. The war had meant increased public spending, which restored economic activity. Nowhere was this more evident than in the United States, which launched itself into a period of extraordinary prosperity for three decades. It is important for us in India to learn from this period in world history and adapt our economic policies accordingly.
An obstacle in the path of renewal of economic activity after the closure is the Fiscal Responsibility and Budgetary Management Act (FRBM) of 2003. It links expansionary economic policy with a fiscal deficit limit of 3% of gross domestic product. This when the Center’s fiscal deficit was already at 3.8% in 2019-20. The government can, of course, amend it to allow for an emergency, like the one we are currently facing. Not modifying the Law is one of the sources of paralysis in current economic policy. It ensures that the government cannot expand its spending to combat the consequences of the spread of the coronavirus. Higher expenditures are required in four categories, first for aid, then for medical response, then for stimulating aggregate demand, and finally to increase public health infrastructure.
It is difficult to understand the government’s non-interventionist macroeconomic policy stance, one that borders on irresponsibility although shrouded in the rhetoric of fiscal rectitude. Never before has it been so true that, as John Maynard Keynes said: “Practical men who believe themselves exempt from any intellectual influence are generally slaves to some late economist.”
Pulapre Balakrishnan is a professor at Ashoka University, Sonepat and a senior fellow at IIM Kozhikode.
The opinions expressed are personal.