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Updated: April 28, 2014 21:31 IST

Policy-driven economic stagnation

K. Subramanian
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DOMINANT FINANCE AND STAGNANT ECONOMIES: Sunanda Sen; Oxford University Press, YMCA Library Building, 1 Jai Singh Road, New Delhi-110001. Rs. 1200.
DOMINANT FINANCE AND STAGNANT ECONOMIES: Sunanda Sen; Oxford University Press, YMCA Library Building, 1 Jai Singh Road, New Delhi-110001. Rs. 1200.

Once believed to happen only in developing economies, this disease is now endemic to advanced countries too

In recent years, debates on globalisation have turned more realistic and less strident. In the earlier years, i.e. until 2008 when the great economic crisis erupted, those on the side of the ‘angels’ advocated it with a messianic zeal. They had no doubt about the march of globalisation and the manna it would shower on the world, especially on its poorer cousins. They formulated theories and econometric models to fortify the agenda and set them into precepts for developing countries. At bottom was their faith in the free market. It was further reinforced by their addiction to the “efficient market hypothesis” (EMH) which posited that markets had complete information and could deploy capital in the most efficient way. All that governments had to do was to sit back and enjoy the goodies flowing from the market.

By the time the Asian crisis of 1997 erupted, the case for global capital flows had lost its flavour. The IMF was faulted for failures, both to foresee the crisis and to help out the distressed Asian economies. In a famous article in Foreign Affairs (The Capital Myth: The difference between Trade in Widgets and Dollars, May/June Issue 1998), Jagdish Bhagwati drew attention to the folly of applying free trade concepts strictly applicable to merchandise to capital flows.

Four years later, Joseph Stiglitz who was eased out of the World Bank over his differences on the Fund’s policies in handling the Asian crisis shocked the world by publishing his book, Globalization and Its Discontents. As a Nobel Laureate in Economics, he questioned the role of the market and explained how especially in developing countries the invisible hand works most imperfectly. He made out a strong case for government intervention to improve the market outcomes. The IMF was not amused!

Despite reverses and recurring crises, the advanced countries, in league with the IMF/Bank, would persist with their capital myths and devise newer architectures (derivatives and credit default swaps) to suit changing conditions. Greenspan and Ben Bernanke admired them as “innovations” which provided greater stability to the financial system. Then, to their dismay, the gravest crisis of the century blew over their face in 2008 and upset their composure and shook their faith in free market theories. Five years and trillions-dollar bailouts later, the U.S. and European economies are yet to recover. Much of the blame is laid at the doors of unfettered capital flows and the manner they destabilised global economies.

Divided discourse

In India, the national discourse on globalisation or the so-called “reforms” has been marked by a divide: those for and those, generally the Left, against. The ideology and arguments of those on the right are invariably the pale mimics of western, especially Fund/Bank inspired, research lacking in relevance and realism. The attacks from the Left, however well-intentioned, are based either on mechanical Marxism or on populist emotions. However, it is not reckoned that students of Marx who imbibe his socio-economic insights and the historical sweep of economic forces can provide an alternative analysis. The book under review by Sunanda Sen comes under this genre. It is a compilation of papers written over four decades. The earliest paper dates back to 1967 and the last to 2013. They cover, as the author says, “the evolving pattern of global finance and related institutions over the last half century.”

The compilation has been arranged thoughtfully to capture the facets of the crisis in context and within a larger taxonomy developed in the introductory chapter. Three chapters (3, 4 and 5) study the nature of capital flows, their paradoxes, constraints and asymmetries. Five others (6 to 10) examine the nature of capital flows and provide new interpretations within broader Marxian or neo-Keynesian metrics. The last section (chapters 11 to 17) deals with the implications of capital flows in the Asian context. Special attention is paid to two major Asian economies, viz. India and China.

The analysis is highly scholarly and has been done with a detachment rare among alternative theorists. Indeed, Sunanda’s reach transcends the borders of traditional Marxism and reaches into other disciplines and makes it all the more incisive and enjoyable. However, it is a dense or difficult book for the average reader.

The pace of capital flows in recent decades has been reinforced by policies, advanced by both national governments and multinational institutions, advocating and implementing policies which are guided by the dominant interests of global finance. “As a result, concerns pertaining to industry and employment have been pushed to the back seat, with consequences which hardly generate growth and development in the real economy.” The latter day push on excessive financialisation has bred, in its turn, newer ways of hedging risk such as derivatives, etc. More and more money is made through such devices and the momentum is self-perpetuating. In the process, industry which has lower rates of return is neglected. Thus, dominant capital results in economic stagnation. Earlier accepted wisdom was that this happens only in developing economies.

As Sunanda argues, the disease is endemic to both advanced and developing economies. Expansion of the financial sector does not lead to expansion in the real sector and the growing disparity between the two may finally disrupt the financial boom itself.

There is an alternative interpretation of India’s financial crisis of 1991 (Chapter 2). It was portrayed a major crisis for India by the ‘reformers.’ All the factors which weighed with Moody’s in deciding to downgrade India’s credit rating were all short-term liquidity factors which guide foreign investors, especially to safeguard their balance sheet and asset values. They did not take into account the exogenous factors such as recession in OECD, rise in dollar rate against most currencies, etc. The message in brief is that for developing countries the composition of flows is more important than short term flows.

Alternative perspective

The book provides an alternative (non-mainstream) perspective of the great economic crisis. It is developed in the light of the theories of neo-Keynesians and Hyman Minsky. The argument is that “the financial boom in the global economy… could not last in the absence of investment with real asset formation.” It contests convincingly the EMH as well as the prescriptions flowing from it.

Applying the same paradigm, Sunanda offers a totally different perspective of the Asian crisis of 1997. She does not buy the stereotyped explanations such as balance sheet mismatches. She details the situation which prevailed in each country (Thailand, Malaysia, Indonesia and South Korea) and explains how they shared common features such as excessive capital flows entering speculative spheres of secondary stocks and property markets. In the last stages, an abrupt end to the financial boom came when they “experienced sharp declines in exchange rates, capital flights and liquidity crunches in the respective domestic economies.”

The book has several chapters which deal with the challenges posed to countries like India and China by excessive, short-term capital flows. It elaborates how they have to calibrate their monetary policies to buffer the impact of sudden shifts in capital flows to safeguard their interests. In her view, both have lost their autonomy in differing degrees and their policies sacrifice, at the margin, the developmental dimension. According to her, China is better placed to deal with these than India. The specific point made about India is that India’s accommodative policies such as sterilisation, bond issues and build-up of foreign exchange reserves create a heavy interest burden which eats up welfare allocations in the context of stringent fiscal constraints needed to placate foreign investors.

In our view, this book is a landmark publication in the genre of monetary research. It is the life time work of an economist who has unswerving attachment to scholarship and public values.

DOMINANT FINANCE AND STAGNANT ECONOMIES: Sunanda Sen; Oxford University Press, YMCA Library Building, 1 Jai Singh Road, New Delhi-110001. Rs. 1200.

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