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Terms of Trade | Reading Smith, Keynes, Kalecki can explain India

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India’s economic policy establishment and commentators who are favourably predisposed to it have been consistently forwarding a narrative about the post-pandemic Indian economy.

It is as follows: Unlike advanced economies, India did not give a large fiscal stimulus to cope with the adverse impact of the pandemic’s economic disruption (this is despite the fact that the lockdown imposed in India was among the harshest in the world). What the government did instead was to protect the most vulnerable through schemes such as limited cash transfers and offering larger food security benefits than what India’s National Food Security Act entails.

In fact, the extended food security benefits continue to be offered. The union cabinet extended them by another three months until December. This, it is argued, has prevented inflation from spiralling out of control in India unlike advanced economies and protected our macroeconomic fundamentals.

India’s policy framework

Superficially, the narrative does not seem to be off the mark.

Even with the limited fiscal support, the government’s fiscal deficit is significantly higher than what the Fiscal Responsibility and Budget Management (FRBM) Act entails and it will take some time to even bring it back to the fiscal glide path.

The inflation situation is relatively better in India than the advanced economies. Even the rupee has performed relatively better vis-à-vis the dollar when compared against other currencies, especially in emerging markets. While the Reserve Bank of India (RBI) has burnt a significant amount of foreign exchange reserves to protect the rupee — it only seems to have taken a hand-off approach recently — external account situation is far from precarious (once again relatively speaking). In fact, there is no reason to argue that the Indian economy, at least as of now, is facing an imminent crisis.

So far, so good. But this is where the gaps emerge.

India’s growth prospects do not look good going forward. Most forecasters, including RBI, see the economy losing growth momentum. By the time this column is read, the Monetary Policy Committee (MPC) would have likely made a downward revision to its growth forecasts.

Even though the pandemic’s disruption is behind us, the private investment engine of the economy is more stuttering than firing on all cylinders. None other than the finance minister Nirmala Sitharaman made this point earlier this month. “I would equally want to know from the Indian industry why they are hesitant (to invest)….We will do everything to get the industry to invest here..(but) I want to hear from India Inc what’s stopping you?,” she said.

What explains this sentiment hiatus between business leaders and political leaders about the state of the Indian economy? There is often a large gap between textbook wisdom and real world as far as economics is concerned. However, the present puzzle of the Indian economy and politics can be better understood if one were to reread some classics in macroeconomic theory.

Full employment and capitalism

The world of economics changed forever when two economists independently arrived at broadly the same conclusion in the 1930s.

Both John Maynard Keynes, a British economist at Cambridge and Michael Kalecki, then a relatively lesser known Polish economist of Marxist persuasion, demolished the old classical view that an economy will always work at levels of full employment, courtesy the interaction of forces of demand and supply in the market.

The classical view’s most vulgar articulation came from what is known as the Say’s Law which argued that supply always creates its own demand. In the real world, this was supposed to be achieved by the necessary equality between savings and investment.

Keynes picked a hole in this theory by arguing that because the acts of savings and investments are undertaken by two different actors (households for the former and capitalists for the later), there is no guarantee that the factors driving these decisions are on the same page. The capitalist, Keynes argued, will only make an investment if he sees future demand and profits for his products.

It is this pessimism about the Indian market which seems to be preventing Indian businessmen from investing. While this decision is primarily a question of sentiment, its repercussions could be self-fulfilling.

If the capitalist did not have the confidence about making investment, it would slow down future production, wage incomes and hence consumption demand, which in turn, would generate even greater headwinds for prospects of future demand and profits, thereby generating a vicious cycle of falling investment and incomes, Keynes argued.

The only way to protect the economy from this vicious cycle was to make the government manage demand by investing in the economy, he argued.

Kalecki, even though he used a slightly different framework – this 1976 The New Work Review essay by Cambridge economist Joan Robinson gives a lucid summary of the subject – largely came to the same conclusion.

Keynesian revolution; the backlash

Keynes’s ideas had a revolutionary impact on economic thinking and policymaking.

After the end of the Second World War, active fiscal management by governments delivered, arguably, the best phase of growth and prosperity under capitalism. That this phase is often described as the golden age of capitalism underscores this point.

However, the Keynesian revolution faced a coup d’état in the 1970s with the classical view of balanced budgets and inflation management (inflation being seen as a result of excess demand in the economy) making a comeback with a vengeance.

The 1970s oil shocks, and the inflation it triggered, played a role in rolling back of Keynesian demand management policies. But it also had deep ideological aversion to the state intervening in markets and handing out welfare to citizens.

While the ideological roots of this theory was laid out by the likes of Friedrich Hayek, a legendry economist whose 1944 book The Road to Serfdom became a bible of sorts for liberals, the political punch was delivered by leaders such as Ronald Reagan and Margret Thatcher in the United States (US) and United Kingdom (UK).

Reagan’s campaign vilified people who lived on welfare alleging that they were draining and defrauding the exchequer and hence the people at large. The political rhetoric, as a 1976 New York Times article reported, was far from reality, but it did resonate with the people.

The outcome of the neoliberal order, as Nobel Prize winning economist Abhijit Banerjee tersely described to this author in an interview, was hurting the poor in the name of growth without any success in the meeting the stated objective of achieving higher growth.

When finance capital prevailed

The strongest manifestation of the neoliberal dogma can be seen in the dominance of inflation targeting in today’s world where big business, under the leadership of finance capital, insists that economic policy be prepared to undercut growth rates even if inflation is not driven by typical excess-demand situations.

Any failure to do this is sharply criticised without even bothering to explain what the consequences of even slightly higher inflation are.

This point was powerfully argued in Martin Sandbu’s Free Lunch newsletter in the Financial Times recently.

“So what if we had 3 per cent inflation for a while? The scourges of central banks’ supposed error have not done much to spell out, let alone quantify, what the cost would be. But what we do know is that more supply shocks are likely to happen. And some of those will be positive ones, which increase growth and reduce inflation.”

He goes on to add, “A policy of benign neglect — but to be clear, for these types of shocks, not traditional demand-driven inflation shocks — would amount to this: allowing inflation expectations to drift up a bit when external supply shocks raise prices (and not kill the economy to try to stop this), and then waiting for positive supply shocks to let them drift down (again without trying too hard to stop that). I am not pretending to have offered arguments that this would be the wisest policy. This is merely a first stab at answering the question “what would you do”. But it spells out what an alternative to the current policy would be. And given that current policy involves the loss of millions of jobs and billions in incomes, it rather behoves its advocates to clarify why they think the alternative of benign neglect is so much worse”, Sandbu writes.

Where Kalecki was right

The best and an extremely lucid explanation of this is in a 1943 essay written by Kalecki called Political Aspects of Full Employment. While the essay ought to be read in entirety by everyone, its crux can be explained by citing just one paragraph.

“This state of affairs is perhaps symptomatic of the future economic regime of capitalist democracies. In the slump, either under the pressure of the masses, or even without it, public investment financed by borrowing will be undertaken to prevent large-scale unemployment. But if attempts are made to apply this method in order to maintain the high level of employment reached in the subsequent boom, strong opposition by business leaders is likely to be encountered. As has already been argued, lasting full employment is not at all to their liking. The workers would ‘get out of hand’ and the ‘captains of industry’ would be anxious to ‘teach them a lesson’. Moreover, the price increase in the upswing is to the disadvantage of small and big rentiers, and makes them ‘boom-tired’”, Kalecki wrote.

What business wanted instead, Kalecki argued was a policy where “the entrepreneur remains the medium through which the intervention (to correct a slump) is conducted”, which could be “done by lowering the rate of interest, by the reduction of income tax, or by subsidizing private investment directly in this or another form”, where “if he (entrepreneur) does not feel confident in the political situation, he will not be bribed into investment”.

Anybody who has followed the Indian economy will realise that exactly the same tools have been deployed by the government to arrest the economic slowdown even before the pandemic hit. The government slashed corporation tax rates in 2019, brought down interest rates and announced credit guarantees when the pandemic struck and is now offering direct investment subsidy (as high as 50% of capex costs) to promote manufacturing under the Production Linked Incentive Scheme (PLI) in multiple sectors.

It is industry’s reluctance to invest, despite such incentives, which triggered the remarks recent remarks of the finance minister.

To be sure, India is not the only country resorting to such policies and many major economies, the US under Donald Trump and UK under Liz Truss for example, have tried giving tax concessions to big capital to boost growth.

Kalecki had no illusions about the inability of capitalism to achieve full employment. “Full employment capitalism will, of course, have to develop new social and political institutions which will reflect the increased power of the working class. If capitalism can adjust itself to full employment, a fundamental reform will have been incorporated in it. If not, it will show itself an outmoded system which must be scrapped”, he concludes in his essay.

The resilience of capitalism

Yet, capitalism has thrived. And this is the biggest question which all critics must answer.

Most of Kalecki’s work was done in times when socialism was a real world phenomenon and he himself was actively involved in socialist planning experiments. Socialism, provided one is willing to exclude the market capitalism models of China and Vietnam and failed states such as North Korea, does not exist in the real world anymore.

Where does this leave textbook critiques of capitalism by academics such as Kalecki in terms of political praxis?

Even if one were to digress from the macro and perhaps esoteric question of capitalism’s resilience, how does one explain the fact that the Bharatiya Janata Party (BJP) has enjoyed a significantly successful political run in India despite an economic slowdown and the subsequent economic disruption by the pandemic? Is there any economic rationale to these developments?

This column has discussed in the past why the opposition’s efforts to mobilise voters on issues such as inflation or using old-school tactics such as trade unions have failed to draw popular traction while underlining that a big spike in inflation could damage the BJP’s political prospects in the 2024 elections.

However, there is an additional point to be made here, which is timely given the fact that the union government has made yet another extension of the additional food security benefits till December 2022 despite a significant fiscal cost. Many commentators have pointed out that the targeted delivery of welfare benefits has been crucial in building Narendra Modi’s political stock among India’s poor voters and acting as a Teflon coating for the BJP from opposition’s attacks of it being in cahoots with big business. What explains the political success of these welfare programmes for the BJP?

The Adam Smith intervention

Ironical as it may sound, remembering Adam Smith, considered to be the pioneer of laissez faire economics by many people, can throw some light on this question.

One of the many original insights of Smith was on the question of what should be considered as the poverty threshold.

“A linen shirt … is, strictly speaking, not a necessary of life. The Greeks and Romans lived, I suppose, very comfortably though they had no linen. But in the present times, through the greater part of Europe, a creditable day-labourer would be ashamed to appear in public without a linen shirt, the want of which would be supposed to denote that disgraceful degree of poverty which, it is presumed, nobody can well fall into without extreme bad conduct”, Smith wrote in his classic The Wealth of Nations.

While some people may scoff at the idea, the Indian government’s approach in the pandemic was to set the criterion for not being “ashamed” to appear in public at having two square meals a day and perhaps getting manual work under the Mahatma Gandhi National Rural Employment Guarantee Scheme (MGNREGS) in villages.

By repeatedly extending the additional food security benefits, the government has been signalling that it is committed to protecting this entitlement until the economic situation has improved. In a way, the scheme’s extension is also an admission by the government that the situation has not improved to levels it would have liked.

To be sure, Smith’s ideas on poverty can be also be used to explain the current government’s immense success with asset enhancing welfare schemes such as provision of toilets, cooking gas connections, houses, piped water and even bank accounts. The implicit logic which is evoked is whereas previous governments did not help the poor who had to suffer the indignation and shame of not having access to these amenities, the current government has almost universalised these provisions and deserves political support for doing this even if it cannot deliver on high growth and employment.

The predicament of critics

To say that that the political opposition as well as critics of capitalism are a besieged lot will not be an overstatement. Right-wing political formations, from the BJP in India to political figures in UK and recently Italy, are enjoying dominance. Even the return of a Donald Trump-like politician in the US cannot be ruled out entirely.

Even left-leaning political formations seem to be facing reverses where they should not be. The rejection of a new constitution in Chile – the New Left Review described it as “the most progressive constitution ever written in terms of socio-economic rights, gender equality, indigenous rights and the protection of nature” – which elected a left government recently is an example, with the rejection sentiment was bigger in low-income neighbourhoods.

What is the answer to these otherwise counter-intuitive political realities?

This is hardly a question a column like this one can answer. For what it is worth, it is useful to conclude with a quote from Argentine political theorist Ernesto Laclau’s book Politics and Ideology in Marxist Theory.

“It might be asked why, if popular-democratic ideologies do not exist separately from but are articulated within class discourses, we cannot proceed directly to a study of the latter as such, and leave aside an analysis of the former. The answer is that such an emphasis would eliminate what is most specific to the ideological class struggle — the attempt to articulate the same interpellations in antagonistic discourses. It is precisely because ‘the people’ can never be totally absorbed by any class discourse, because there is always a certain openness in the ideological domain, whose structuring is never complete, that the class struggle can also occur as ideological struggle. To suppose, on the contrary, that class ideologies constitute a closed and perfectly consistent bloc is to reduce the conflict between them to a purely mechanical clash which could hardly be characterised as ideological struggle’. To deny the dialectic between ‘the people’ and classes would be, then, to deny the ideological class struggle”.

It is by returning to these theorists and thinkers that perhaps we can unravel the mystery of Indian political economy.

Every Friday, HT’s data and political economy editor, Roshan Kishore, combines his commitment to data and passion for qualitative analysis in a column for HT Premium, Terms of Trade. With a focus on one big number and one big issue, he will go behind the headlines to ask a question and address political economy issues and social puzzles facing contemporary India.

The views expressed are personal



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