Coronavirus Lockdown XVII: The economics behind India's Rs 21 lakh crore package
by Prasanna MohantyThe package is completely aligned to self-professed agenda of the IMF of limiting fiscal spending, relying on liquidity and credit to households, privatising government-run companies and more deregulations for private enterprises. This agenda has brought immense grief to a large number of countries to be comforting
By now it is clear that a very small fraction of India's Rs 21 lakh crore economic package to fight the COVID-21 impact - 7-9% of the package or 0.75-1% of its GDP - is the fiscal component, the rest being liquidity measures.
In designing its economic package, India ignored repeated suggestions from top economists to increase fiscal spending and provide cash support to the poor. Instead, it chose to outsource the job to banks and financial institutions which would be helming the collateral-free loans, credit guarantee schemes and new funds (liquidity measures) being proposed.
The moot question is why did the government choose a fiscal austerity path?
What economics are at play here?
Fiscal austerity: Limiting fiscal deficit and public debt
Fiscal austerity is a key principle of neoliberal economics (called orthodox, conservative, or ultra-right) that gained currency since 1970s.
Multilateral lending agencies like the World Bank and International Monetary Fund (IMF) have been imposing it on countries seeking bailouts, and in the case of European Union (EU), it is a binding condition under the Maastricht Treaty of 1992 that created the union.
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There are two critical components to austerity: (i) limiting fiscal deficit to 3% of GDP and (ii) limiting public or government debt-to-GDP to 60% of GDP of a country.
For India, the IMF has mandated a fiscal deficit limit of 3% for decades. Its 2017 "Fiscal Rules at a Glance" does not mention any public or government debt-to-GDP limit for India, though such limits are prescribed for many countries. There is, of course, an 'escape clause' for the fiscal deficit limit for 'exceptional circumstances' which allowed India to reset its fiscal deficit target at 3.5% for FY21. The IMF rulebook says it has been setting fiscal limits for 96 countries since 1985.
But the IMF is not a solo player. There are international rating agencies too which play in tandem. Upsetting rating agencies mean risks to foreign investment inflow. One such rating agency, Fitch Ratings, issued a virtual warning to India on April 27, saying that its debt-to-GDP ratio is likely to be 77% in FY21, up from 70% in FY20. It reminded India that it had affirmed 'BBB-' in December 2019 when at 70% its debt-to-GDP ratio was more than the 'BBB' median of 42%.
The IMF may not have set a borrowing limit for India, but the Indian government follows the IMF regime and hence while allowing states to expand their borrowing limits from 3% to 5% of their state gross domestic product (SGDP) as part of the economic package, it set four conditions or reforms for doing so, just like the IMF. These reform conditions are: universalisation of one-nation-one-ration-card, improvement in ease of doing business, power distribution reforms, and reforms in urban local body revenues.
Do fiscal numbers work?
Do these numbers (3% for fiscal deficit and 60% for debt-to-GDP ratio) work?
Economics professor and a well-regarded authority on the subject Mariana Mazzucato of the University College London (UCL) says no, they don't. In fact, she is unambiguous in her view: "These numbers are taken out of thin air, supported by neither theory nor practice" (in her 2018 book 'The Value of Everything: Making and Taking in the Global Economy' (page 235). Nevertheless, she points out how the 'troika' of the IMF, European Central Bank, and European Commission have been pushing countries to adhere to these numbers and penalising them for violations (page 234).
She gives the example of Greece and Italy to drive home her point. Between 2010 and 2017 Greece received a bailout on the condition of cutting government expenditure but such cuts turned its recession into a full-blown depression because the problem was too structural to be solved by a simple austerity measure. "Rather than decreasing Greece's debt, the lack of growth (due to lack of fiscal spending) has caused the debt/GDP ratio to rise to 179 per cent. The cure is killing the patient", she commented.
In the case of Italy, for two decades its budget deficit had rarely exceeded 3% yet it had a high and rising debt-to-GDP ratio of 133% in 2015, a year when its GDP grew by 1% after three successive years of austerity. Why? She explains that a part of the reason was inadequate investment that raised GDP, such as vocational training, new technologies, and R&D. To make matters worse, prolonged squeeze on fiscal spending weakened demand and lowered incentive to investment.
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As for debts, she writes, a 2010 article in the American Economic Review by two economics professors Carmen Reinhart and Kenneth Rogoff claimed that when the size of government debt rises over 90% (much above 60% set by multilateral lending agencies) economic growth falls. This finding found support and guided policymaking in both the UK and the US.
But in 2013, when a Ph.D. student at the University of Massachusetts Thomas Herndon tried, he couldn't replicate the finding. The student found a simple spreadsheet error and inconsistencies in the countries and data cited. The professors wrote articles defending their general results while accepting the spreadsheet error.
She gives many examples with data to support her contention that these numbers don't work. There is more to economics than these 'magical numbers'.
In 2016, the IMF also admitted that fiscal austerity is self-defeating.
Its three top economists carried out a multi-country study 'Neo-liberalism: Oversold?' in which they concluded: "However, in practice, the episodes of fiscal consolidation have been followed, on average, drops rather than by expansion in output."
Earlier this month, Nobel laureate Joseph Stiglitz told the US that "the true danger is austerity..." while suggesting measures to reviving its economy.
He explained that lower government spending would constrain GDP growth and cause a higher debt-to-GDP ratio, contrary to what fiscal austerity seeks to achieve. In 2014, he had said "austerity has failed" while writing on the Eurozone's political economy.
Why a smaller or limited government
Fiscal austerity is a part of the IMF's agenda which seeks to limit the role of government.
Top three IMF economists explained neoliberal economics in 'Neoliberalism: Oversold?'
They write that "the neoliberal agenda" is based on two main planks: (i) the first is increasing competition, achieved through deregulation and the opening up domestic markets, including financial markets, to foreign competition and (ii) second one is a smaller role for the state, achieved through privatisation and limits on fiscal deficits and debt.
A strong push for limiting the role of government came in 1980s from multilateral agencies like the IMF Prof. Mazzucato calls it "backlash against government" and writes that in part it was driven by the notion that economies should worry more about 'government failure' emerging from 'Public Choice' theory associated with American economist James McGill Buchanan.
Buchanan was awarded the Nobel for economics in 1986 when Ronald Regan was the President. Regan and Margaret Thatcher of the UK pioneered the neoliberal political economy.
She says there were two major consequences of the public choice theory: (i) a wave of privatisation through sale of government assets and outsourcing, first in the UK and then the US new sets of regulatory bodies between state and market players (ii) rise of private finance initiative (PFI) to fund public activity, like building hospitals (like India's PPP model) and outsourcing to private providers to run a wide range of services.
The lesser-known aspects of limiting government
In 2017 came shocking revelations about the life's work of Buchanan.
Nancy McLean, professor of history and public policy at Duke University, North Carolina, accessed private papers of Buchanan after his death in 2013 and wrote 'Democracy in Chains: The Deep History of the Radical Right's Stealth Plan for America'.
She reveals the dark side of the US's radical right movements that sought to undermine the state in which Buchanan played the backroom-boy role. These included movements to dismantle and privatise social security, public healthcare, and education, tax cuts for the wealthy, and weakened environmental protections, etc. Buchanan also played a key role in designing the disastrous economic policies of Chile's military dictator Augusto Pinochet (1973 to 1990) which ruined the country's economy and people.
Revelations include training academics, lawyers and others and setting up institutions to push corporate interests with the objectives of altering power relations, weakening pro-public forces, government, constitution and democracy, in collaboration with powerful businesses.
It now makes sense when Prof. Mazzucato starts one of her chapters with this extraordinary observation: "Economics emerged as a discipline in large parts to assert the productive primacy of the private sector". ('The Value of Everything', page 239)
Privatisation of government-run companies
Two of India's economic packages (May 16 and 17) specifically talk of privatisation and ease of doing business. Privatisation includes entry of private players to strategic areas, disinvestment, or outright sales, again a part of the IMF's agenda.
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The May 16 package includes 'structural reforms' listing private participation in coal and other mining activities, defence production, aviation, space research, particularly in "planetary exploration", privatisation of airports, power distribution and atomic energy sector.
The May 17 package talks of enhancing the ease of doing business - a World Bank project - decriminalisation of Companies Act defaults etc. It also says that a new policy would be notified for privatising strategic sectors.
The new policy would limit PSUs in each strategic sector from one to four and privatise or merge the rest.
Reliance on liquidity and financial institutions
India's liquidity-heavy design is in sync with 'financial deepening' the IMF pushes as its second plank of the neoliberal agenda.
A large and growing financial sector has been sold as the magic formula for high growth. The IMF admitted in its January 2020 study, 'Finance and Inequality' that beyond a point financial deepening (growth of financial sector) worsens inequality and then causes financial crises. During the crisis, inequality falls but then goes up again (the graph below).
Business Today (Coronavirus Lockdown XVI: Why India should be wary of excessive push for liquidity or credit) explained how financial deepening is risky and should be handled with caution. Too much liquidity and household debt were the primary contributors to the 1929 Great Depression and 2007-08 Great Recession.
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One of the saner voices of the 1929 Great Depression era, economist Ludwig von Mises had this to say about the subject in 1930s: "Credit expansion cannot increase the supply of real goods. It merely brings about a rearrangement. It diverts capital investment away from the course prescribed by the state of economic wealth and market conditions..." ('The Causes of the Economic Crisis').
The first few years of 1929 crisis saw a rise in liquidity and did no good, until John Maynard Keynes stepped in to prescribe demand-side solutions. Post-depression, Keynes is said to have claimed that even paying men simply to dig ditches and fill them up again could revive the economy (Mariana Mazzucato, The Value of Everything, 2018, Penguin, page 260)
In India's context, liquidity measures like cutting headline interest rates or Rs 1.45 lakh crore corporate tax cut did not stop the GDP growth to slip before the pandemic. The futility of liquidity infusion would be clear from the following graph.
Has neoliberal agenda worked elsewhere?
The world is full of countries which underwent immense pain directly as a result of this neoliberal agenda.
The examples of Greece and Italy in more recent times have already been narrated. Plenty of literature exists on how this agenda destroyed the people and economies of Argentina and Chile, worsened the East Asian crisis of 1997, caused food riots in Indonesia (1998) and Bolivia (2000) and riots over domestic gas in Ecuador (2001).
Some of these accounts come from Stiglitz, and others from investigative journalist Greg Palast, and many others. Stiglitz was World Bank's chief economist during 1997-2000 and was fired for criticising its policies that damaged countries that received its bailouts.
As an insider once, Stiglitz brings lesser-known facts out.
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He often describes 'privatisation' as "briberisation" and explained to Palast why when the latter sought to know why national leaders don't object to the sell-off of state industries to private operators (as World Bank-IMF seek).
"You could see their eyes widen" at the prospect of 10 per cent commission paid to Swiss Bank accounts for simply shaving a few billion off the sale price of national assets", writes Palast in his 2002 book 'The Best Democracy Money Can Buy' (page 51).
Stiglitz also provides one insight into why the IMF does what it does while knowing that its agenda has harmed many countries.
In an interview to The Guardian in 2002, he said the IMF made "two big errors" in 1990: (i) it bowed to Wall Street's demand for new markets by making its loans conditional on opening up financial markets and (ii) prescribed a mix of fiscal austerity and high-interest rates for the countries in the speculators firing line.
The relevant part of the article is reproduced below.
World Bank-IMF and India's liberalisation
India was also forced to adopt the World Bank-IMF's agenda in 1991 when it sought a bailout from its foreign exchange crisis. The liberalisation that followed brought high growth. But it is not as black-and-white a story as it is often presented.
For one, Manmohan Singh, then finance minister, was selective in applications. For example, he didn't go for an outright sale of PSUs, one of his successors, Atal Behari Vajpayee, did. How that has impacted India calls for a separate article.
For another, Manmohan Singh realised mistakes of his liberalised regime and did a course correction as Prime Minister during 2004-14.
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He went for "inclusive growth" and brought a series of progressive laws, like the rural job-guarantee law MGNREG Act of 2005, Forest Rights Act of 2006, Food Security Act of 2013 and a new land law of 2013.
The MGNREGS and Food Security Act are two of the most significant tools now to provide real relief to pandemic-hit people. So are his two other initiatives, direct benefit transfer (DBT) and zero-balance, no-frills bank accounts (now renamed).
India has undergone a significant change since the days of Manmohan Singh. For example, absolute poverty fell in India until 2015, but has started rising now as the Niti Aayog's December 2019 report pointed out. Business Today's 'Budget 2020: Niti Aayog shocker; Poverty, hunger, and income inequality up in 22 to 25 States and UTs' provides a detailed account of it.
The need of the hour is to take stock of ground realities, think afresh policies and priorities that better suit India's interest.
Calling the Rs 21 lakh crore package as a means to make India 'atmanirbhar' (self-reliant) but basing it entirely on the decades-old IMF agenda that has caused immense pain to far too many countries does not really sound convincing or comforting.