Union Budget 2010-11: Too Many Gambles

Union Budget 2010-11: Too Many Gambles

Arun Kumar

CESP, SSS, JNU

Mainstream, March 5, 2010

Union Budget 2010-11 was expected to be an innovative exercise given the difficult circumstances in which it was being framed and that the most experienced politician of the present government was at the helm. There have been uncertainties about growth, high rate of inflation (especially in food items) and pressures for withdrawal of the stimulus. The Indian economy is recovering but the global situation remains uncertain given that the major world economies are plagued by persistent high rates of unemployment and even higher under- employment. Even the IMF is forecasting anemic recovery in 2010. Other experts are worried that the premature withdrawal of the stimulus in the advanced countries (and for this there is considerable right wing pressure) could lead to a double dip recession. Just as in 2008, this would immediately jeopardize Indian economy’s growth as well. This would certainly transpire if the stimulus is withdrawn in India also. After all, the FM has himself agreed in the budget speech that the stimulus helped India to maintain growth when in the rest of the world most economies were in decline.

Growth and Inflation: Background to the Budget

There appears to be an attempt at talking the economic sentiment up by constantly presenting a bright picture of the economy. This works some of the time but not all of the time. In 2007-08, it was argued that India would not be affected by the impending global crisis because it is de-coupled and that India would provide the stimulus to the rest of the world. As it turned out, Indian economic growth declined along with that of the rest of the world and the Indian policy makers were proved to be wrong. Could the policy makers again prove to be wrong in their belief that the economic growth will keep rising? Would the dream of 10% plus growth and that India would be the fastest growing economy in the world remain pipe dreams?

There are reasons to doubt the official growth rates being put out. It is stated that the rate of growth of manufacturing was 18.5% in December 2009 and that exports have started rising in the last few months so that the rate of growth is likely to have accelerated to 7.2% for the year 2009-10. If this is so, then for the previous year when industry as a whole was stagnant for more than 10 months, agriculture was showing zero or negative growth and large parts of the services sector were experiencing nil or negative growth (like, hotels, finance, real estate, air travel and commercial transport) then how could the economy have been growing at 5.1%? Be that as it may, only time will tell what the real story of growth for this period was.

The likelihood of lower growth (than official rate) in 2008-09 is corroborated by the tax data in the budget. The gross tax revenue for 2008-09 was projected at Rs.6,87,715 crores, in revised estimates but it turned out to be Rs.6,27,949 crores, about Rs.70,000/- crores less and in the actuals now released, it is Rs.6,05,298 crores, that is about Rs.82,000 crores less. Customs duties were less by about Rs.19,000 crores because of decline in imports, excise collections declined by about Rs.30,000 crores due to both the decline in output and tax cut and direct taxes were down by about Rs.44,000 crores.

This picture suggests that many parts of the organized sector, which pays the bulk of the taxes was in a state of decline in 2008-09. Reports suggest that the spill over effects of this decline on the unorganized sectors were strong. Consequently, employment in urban areas was impacted adversely due to these trends. The rural areas were spared due to the implementation of the NREGS. The corporation tax collections which were rising in the previous years at 25-35% hardly rose 10% (less than the GDP growth rate). This suggests that the additional purchasing power in the rural areas due to NREGS and loan waiver was not enough to stem the decline in the profits of industry. In other words, while these rural schemes only prevented the demand from falling rapidly but could not keep up the demand in the economy. Some use the argument that the share of consumption in the economy has risen to support their contention that consumption rose. This is not quite true since the share of consumption rose because the share of capital formation fell sharply and the two have to add up to one (if one falls the other has to rise). So the 5.1% growth remains a mystery.

Data from the Economic Survey 2009-10 indicates that in 2008-09, there was strong growth in three components of the economy belonging to the services sector – firstly, Transport, Storage & Communication (11.6%), secondly, Financing, Insurance, Real Estate & Business Services (10.1%) and finally, Community, Social and Personal Services (13.9%). How there could have been such strong growth in these sectors when Transport was down as indicated by automobile and especially commercial vehicle sales showing a down trend, finance sector was in a crisis globally and also in India and real estate, advertising and other business services were in a crisis and on the decline. Yes, communication and government services continued to grow as earlier but that could not have compensated for the general decline in all major sectors, like tourism, hotels, private education services and so on.

Since early 2008, inflation in food prices has plagued the economy even though the general rate of inflation based on the WPI was showing a declining trend since mid 2008 due to the global price trends. The severe drought in 2009 accelerated food inflation. However, the situation is puzzling given that the country had ample foodgrain stocks of 52.5 million tons of rice and wheat in July 2009 when according to buffer stock norms the requirement was 26.9 million tons. To begin with, the anticipated shortage of food grains during Kharif was about 16 million tons but now the shortage is anticipated to be only about 9 million tons. Even if the shortage was the higher figure, the buffer stocks were adequate to control the prices of cereals if not pulses. But the rice prices shot through the roof.

The government was slow in admitting that the drought was severe and that production would be short. Consequently, it was slow to intervene and the situation got aggravated due to inflationary expectations building up. In the past when the foodgrain output declined but stocks situation was good, prices rose but moderately unlike in 2009. The situation also deteriorated because now in the foodgrain markets, there are those with deep pockets who can hold stocks. Unfortunately, there is no data on private stocks so one can only guess how the speculators made a bad situation worse. Even then timely action by the government with its huge stocks could have kept the situation in check and prevented the private players from hoarding. In the case of pulses and oilseeds the situation is different since there is hardly a buffer stock for these and import of pulses is not easy.

It is not that per capita consumption of food has risen which could have raised demand and prices. The per capita availability (proxy for consumption) after peaking in 1991 at 510 grams per day has been down (by up to 20% in 2001). It has risen thrice to come close to the peak figure - in 1995 (495.4 grams), in 1997 (503.1 grams) and 2002 (494.1 grams). Each of these years corresponded to a good harvest. The lows were in the years of poor harvest. In 2008, the crop was good and NREGS and loan waiver had pumped in purchasing power but the net availability in 2008 remained low at 436 grams. In 2009, with a drought and lower production, less work on farms and lower incomes of the workers, the demand for foodgrains cannot have risen. NREGS may at best compensate for the loss of purchasing power of rural labour. The ruling high prices are likely to ensure that per capita consumption this year will be low.

The middle category of farmers do not go for NREGS so their demand could not have risen for this reason. They would have benefited from the farm loan waiver schemes and this could help them to retain their stocks and wait for a higher price rather than sell them immediately in the market. However, foodgrain procurement in 2008 was a record 54 million tons and even in 2009 Rabi season, it was good enough to leave 52.5 million tons of stocks in July 2009. So, loan waiver did not make a difference to the amount of foodgrain marketed by the farmers and this could not be a reason for the higher foodgrain prices. The situation could indeed have been different in the case of pulses and oil seeds.

Key Aspects of the Union Budget

The Union Budget projects expenditures of about Rs.11 lakh crores. It amounts to 18% of GDP and about Rs.10,000 per person. This is large enough to give something to every section of the population. No wonder, the FM announced, as is the case every year, allocation to every section of society – women, SC/ST, unorganized sectors, middle classes, corporate sector, farmers, small scale and so on. However, as the FM notes in the beginning of the speech, “The Union Budget cannot be a mere statement of Government accounts. It has to reflect the Government’s vision and signal the policies to come in future.”

The vision is incorporated primarily in the macroeconomic framework underlying the budget. It is also expressed in statements like, “ … the focus of economic activity has shifted towards the non-governmental actors, bringing into sharper focus the role of Government as an enabler”. It is this last statement that is crucial to understand the overall focus in the budget and the reason why the budget complicates the situation regarding the twin problems of sustained growth and inflation.

The stimulus provided by the high fiscal deficit and lowering of indirect taxes (in 2008-2009) are sought to be reversed. Services tax is being extended to more services. All this would jeopardize the possibility of sustained high growth as well as raise the already high rates of inflation. More than anything else, they would further fuel inflationary expectations and also lower demand resulting in slow down. Indeed excise duties could have been raised selectively on a few luxury products but an across the board rise would be inflationary. Further, the increase could have been postponed to when the economy was on a more firm footing.

Additional taxes could have been raised through increases in direct taxes rather cutting them. The loss of revenue due to this is about Rs.26,000 crores. This is being partially made up through increased indirect taxes. It was possible to raise more taxes through curtailing of tax expenditures of which a large part goes to the corporate sector. According to the Receipts Budget, the total concessions to all sections amounted to Rs.5 lack crores in 2009-10. While the FM is keen to lower the subsidies offered to the common man but he is not willing to touch the tax expenditures for the corporate sector and the well off sections.

The changes in the slabs of Personal Income Tax benefit only about 3% of the population and effectively about 1 % of those who pay significant amounts of income taxes. In contrast, the increases in indirect taxes adversely affect the entire population. The rise in the inflation rate consequent to raising indirect taxes is like a tax on the common man. For the poor, a 20% rise in the food prices is like a 13% tax on them. This is more than any benefit the budget could provide to the poor. The tax changes suggested in the budget reflect the government’s bias in favour of the well-off sections who are not really in need of any concessions given their high living standards compared to the poor and the lower classes.

Issues Related to Petroleum Product Prices and Taxes

Why the increase in the indirect taxes on petroleum products? It is being stated that this is to only reverse the tax cuts that were offered earlier and that too only a part of the tax cut is being restored. It is argued that earlier in 2008 the price of crude was high and that is why the customs duties were lowered in 2007-08. It is also being argued that the petroleum companies are running up losses at current prices and they need to be tackled. What is so sacrosanct about restoring earlier tax rates? Why can’t the indirect tax rates be permanently brought down? Finally, are the losses of the oil companies related to the excise and customs duties?

It is true that the lowering of the excise and customs duties resulted in less revenue for the government but that can always be made up from different sources. The direct taxes which are non-inflationary could be tapped and as suggested above, tax expenditures could be reduced for this purpose. This is also suggested in the Direct Tax code which is to be implemented from next year. Thus, there is nothing sacrosanct about raising the indirect taxes to get additional revenue that was earlier sacrificed by the government.

Some argue that GST requires a uniform rate of tax so that tax rates have to be brought in line with each other. However, in this budget the various tax rate changes suggested do not seem to have a pattern which would harmonize the rates. Further, why should they be harmonized to a higher rate and not a lower rate? Again, the loss in revenue, if the tax rates are lowered, can be more than made up through higher direct tax collections, say, by tackling the very large black economy. Hence there is no necessity that the FM has to move towards higher indirect tax rates.

Regarding the losses being suffered by the petro companies, these are not just due to the final price of the petro goods. The government treats these goods as a tax cow and levies high excise and customs duties so that higher prices are required to make a profit. If these duties are lowered, at lower prices also the petro companies can make a profit. In general it is desirable to keep petro goods prices high so that their consumption can be moderated and not only this precious good but the environment can be saved. However, in an inflationary period, these prices should not be raised since their inflationary potential is high.

An alternative would have been to raise taxes on all automobiles so that their prices could be higher and consumption moderated. Simultaneously, the prices of public transport could be subsidized to shift traffic to this mode. This way both travel of people and transport of goods could be cheap without an inflationary impact and the budget could have collected more revenue. But the elite and the automobile lobby oppose these steps. Thus, vested interests come in the way of a more rational policy. This also explains the macro vision of the budget.

Other Aspects of the Budget

Prior to the presentation of the budget the government had announced the move to curtail the fertilizer subsidies by moving to a Nutrient Based Subsidy (NBS) system. The real intent of the change is to cut the rising subsidy bill rather than any rationalization of fertilizer use. A play with words is being used to make this change sound reasonable and acceptable. However, in a difficult year for agriculture the time is not right to shift to a new system. In India, given poor governance and how businesses take advantage of deregulation to make a fast buck, the possibility is that fertilizer prices would rise and their consumption could decline leading to lower agricultural production. The opposite of what needs to be done.

This year’s Economic Survey suggests that food subsidy be managed through a voucher based system. Without a proper distribution system for vouchers, is this feasible? The potential for corruption could go up so that the scheme may work to the detriment of the poor. Have we forgotten how easily Telgi printed fake stamp papers and in educational institutions how easily fake income and caste certificates and degrees are presented to take advantage of concessions. The genuine people, the poor and the illiterate are then left out and the corrupt make a killing.

The problems in the country are basic and sophisticated solutions come a cropper. Putting a lot of money into new fangled high sounding schemes in the end has only complicated matters as has been seen in the case of issue of election cards. In spite of this exercise going on for the last 15 years, it is still facing difficulties. Usually the procedures in new schemes are so complex that even the literate are left floundering. Take the introduction of the simple tax forms; most people involved were literate but they found the procedures put in place difficult to follow.

The government is placing great faith in computer and IT based solutions like, UID, computerization of income tax returns, etc. One only need remember that if the spirit is not willing then machines cannot do much and their operation can be circumvented. A law is as much in letter as in spirit. The experience with PAN cards suggests that the crooked got multiple cards and the income department stopped issuing them. Similarly, in case of demat accounts people have been found to have up to 10,000 accounts. Banks in spite of the KYC requirements help the rich clients in various illegalities. In the ongoing Koda case, a bank branch enabled Rs.600 crores of rupees to be moved.

If those at the top are corrupt, how can it be stopped at the lower levels? In the US and Europe, there is far more computerization than in India, but tax evasion is taking place through various devices, like, use of tax havens, etc. It has been found that in spite of various regulations and computer controls, banks have been helping their rich clients to spirit money to tax havens.

Central Plan outlays are short by Rs.22,000 crores. Thus, the much trumpeted increase by 18 % has finally turned out to be an increase by about 12%, not too far ahead of inflation. This reduced the impact of the stimulus last year. Such shortfalls are an annual occurrence; expenditures are announced and then not spent to control the deficit. What reliability can be placed on the roughly 25% increase (on revised estimates) announced this year.

The chances of the budgetary calculus going wrong are much more because the revenue account estimates of expenditures are under estimated. Last year they increased by 15% over the previous year’s expenditures and Rs.22,000 crores more than estimated in the budget. This year they are slated to go up by only Rs.1,500 crores or about 0.02 % in spite of the interest burden rising by Rs.29,000 crores. In other words, all other items are likely to fall by Rs.27,500 crores. Partly, this can be attributed to the fact that in the previous two years the Sixth Pay Commission award related arrears were paid out to government servants and these were one shot payments.

The arrear increase was already captured by the budget for 2008-09 so why the increase of 15% in 2009-10? This was not just in the case of interest payments but in all the categories like, police, Defence services, social services, etc. This year none of them are to rise. Defence allocation is static but police are slated to fall by Rs.2,000 crores when major expansion is going on due to internal security problems and social services are allotted Rs.6,000 crores less even though major increases in expenditures are going on in education and health. There is no inflation indexing. Finally, subsidies are slated to fall by Rs.15,000 crores and this may turn out to be in error given the high inflation that confronts us today. This has the potential of upsetting the deficit figures as happened in 2008-09 and 2009-10.

Increase of Rs.5,000 crores for school education is welcome but is wholly inadequate if the nation is to seriously move towards the implementation of the Right to Education. Best school education for all children all over the country is a crying need so that all children have equal opportunity. Children of the poor drop out or do not go to the schools or even if they do go, the chances are that they get such poor education so that they have little chance of competing with the children of the well-off sections who get good education right through. The budget manifests a lack of will for moving in the right direction but then this is true not just of this budget but of all the previous budgets. There is a lack of political will in the nation.

Increase in NREGS is by Rs.1,000 crores when the poor are adversely affected by the food inflation and need higher incomes. There is demand to raise the wages paid to workers. Further, as is universally acknowledged, giving 100 days employment to one family member of a family is wholly inadequate so that the amounts need to be raised further. In contrast, the amount is not even inflation indexed so that next year the expenditures are likely to be higher.

All indications are that the deficit figures are likely to turn out to be higher than anticipated. It is fortuitous for the government that the deficit figures for 2009-10 are lower as a per cent of the GDP because of a rise in the GDP figure for the economy due to a revision of the base year. This statistical device would not be available in the next year and the deficit would turn out to be higher than anticipated.

Conclusion

Many of the assumptions in the budget exercise for 2010-11 seem to be problematic. It is taking a high risk in assuming a continued high growth in spite of the global uncertainties and in prematurely reducing the stimulus by raising indirect taxes across the board which would kick off inflation rather than moderate it. Even if the rate of inflation declines, food prices are already at a high level and unlikely to fall to last year’s levels so that the family budget is likely to remain under stress.

Due to the incorrect assumptions, the revenue deficit is likely to turn out to be higher and this will lead to larger borrowing and interest payments which would cause the fiscal deficit also to turn out to be higher and this could be a vicious trap. The budgetary arithmetic needed to be more transparent.

It is the retreat of the state that underlies the budget formulations and this is what has led to the complications in the budget process, like, the premature withdrawal of the stimulus. It is a pity that in this time of difficulties faced by the citizens the government is thinking of a retreat by cutting subsidies, disinvestment and so on.

The current FM is the most astute politician in this government and also the most experienced one (with no exceptions) and yet he has committed mistakes and is now facing a rising political opposition, including from the allies. It is a surprise that the Left and the Right have come together to oppose the budgetary provisions. The BSP, SP and RJD are seen on the same platform against the UPA. Why did he not anticipate this? Has he become so much a prisoner of the philosophy of retreat of the state (and its corollary, the promotion of the private sector) that he could not see the obvious and presented a flawed vision?

arunkumar1000@hotmail.com

 

Copenhagen and beyond: Environmental imperative for India

Copenhagen and beyond: Environmental imperative for India
by Arun Kumar

CESP,SSS,JNU
The Tribune December 16, 2009

The Copenhagen summit has brought the issue of rapid environmental degradation and climate change onto the centre-stage. Sceptics abound but evidence is growing of mounting environmental distress and weather patterns becoming highly variable and uncertain, leading to droughts, floods, melting of polar ice-caps and glaciers, growing intensity of cyclones and so on.
Of course, fluctuations in weather are normal both in the long and the short run, but experts opine that the current changes go beyond the observed historical patterns and are directly linked to the unprecedented scale of human activity. This last fact and that it is having visible effects on the environment is undisputed. The climate sceptics only contest that this is leading to a tipping point, which may cause a global disaster. They have faith in technology providing solutions, as in the past.
Scientists are working hard on ways to deal with the green house gases (GHGs) through sequestering. However, the environmentalists argue that the weather system and the earth itself are complex systems, which we only partly understand so that the visible deterioration can suddenly accelerate, giving us little time to react.
The world is confronted with growing damage to the environment (there is unanimity on this) because human kind equates its well-being with growing consumption. So, every nation, rich or poor, is in a race to increase production. Even the rich nations with historically unprecedented levels of consumption remain unsatiated and desire to consume more. In Europe, in spite of the Green movements, consumption per capita has increased. It is not just that their poor aspire to consume more but even their rich want to consume more.
The developing world ruling elite, brought up on the notion of modernisation being Western modernity, has blindly copied this model, including its consumerism. The elite in the developing world wish to quickly join the global elite, so they have embarked on a path of rapid increase in their consumption. Thus, consumerism, both in the advanced and the developing countries, is resulting in growing pollution.
The advanced countries, to reduce their own pollution, have increasingly encouraged the poorer countries to undertake the production of dirty goods - metals, chemicals, etc. Thus, the developing countries are polluting on behalf of the richer nations. They are competing with each other to increase exports and under-cut each other by overlooking environmental concerns. If all the people of the world were to consume like the average US citizen, several earths would be needed to support this consumption.
Pollution is taking a heavy toll on the poorest since they are at the edge of survival and depend most directly on nature itself. Food stocks started dwindling after 1999 and for some time food prices have been climbing steeply. While droughts have played a role, development- related factors like crops used to produce fuel and land being used for urbanisation or for providing services are no less important.
While the accumulated GHGs are mostly due to the past consumption by the rich countries, the current additions are substantial not only by the rich but also by the poor countries. This has come in handy for the rich countries (trying to maintain their own life-styles) to shift blame on to the large poor countries. They are demanding cuts by India where the largest number of the poor in the world reside. The Indian ruling elite argues that cuts will mean a slowdown of development and check elimination of poverty. Actually, the Indian ruling elite wishes to preserve its consumption, just as the rich nations wish to. The poor are only a bargaining chip.
There was a time when India used to give the lead to the rest of the world by taking morally correct and just stands as it did on the nuclear or trade issues. This position has now been given up in favour of narrow stands to protect our short-term interests. So, on the issue of environment we want to retain the right to increase pollution and, therefore, appear to be no different from others and are unable to assert strongly enough that the rich must consume less and pollute less to save the planet and help the poor.
Our elite has hardly shown concern for the poor in its mad rush for `growth at any cost, and to catch up with the West, with all costs to be borne by the poor and the environment. If we cut our emissions, we can set an example, especially to the rich nations to also drastically reduce their own consumption. It is possible that the rich nations will only use that extra space to increase their consumption further. Given that the environment is global, the problem would not go away. What would be the consequence of our emissions cut? Would we lag behind?
Indeed not. Our rapid growth (if the figures can be believed) is based on the growth of services, which has major components that have low-energy intensity compared to industry and modern agriculture. Further, if we focus on human development in ways other than growing consumption, like on education, health and culture, the output of material goods need not rise fast. The preservation of the environment itself leads to improved health and welfare.
For instance, we are using energy very wastefully and if we check this, we can have a given level of output at much less energy consumption. For instance, transportation needs much energy. In the pattern of development we have chosen, this need is being increasingly fulfilled by private motorised vehicles - cars and motor cycles. However, efficient public transportation can handle this at a fraction of the cost and less pollution, but the auto lobby comes in the way. We could also plan differently so that people could live close to their places of work and either walk or use bicycles and minimise motorised transport, wide roads, flyovers, etc, and save energy.
Our buildings could be environment-friendly, requiring less of cooling and heating. A large amount of energy is wasted due to non-standardisation of gadgets with consequent leakage, sparking and heating of the equipment and eventual burnout. If this is minimsed energy intensity would fall. Corruption leads to the theft of power from the lines in inefficient ways. Modern agriculture is energy intensive and polluting so that there is need for alternatives. Goods can be optimally moved through the railways, leaving only the short haul to the roads. We can promote collective consumption rather than private individual consumption.
In brief, even without sacrificing consumption, we can improve welfare and yet consume less energy. All this and much more was suggested in the Alternative Budget in 1994 but the elite has no place for it since it desires to have the Western life-style. If we can make people believe in their environment we may also convince them to consume less with even greater gains. As a nation, let us do what we can for our poor and our environment and for that we do not even need money or technology from the rich nations. This would show the rich nations up for what they are. Unfortunately, our elite lacks the imagination, has become more and more greedy and wants the easy wayout.

arunkumar1000@hotmail.com

Producing 10 civil servants every year: Can it be the goal of a VC?

Producing 10 civil servants every year: Can it be the goal of a VC?

Arun Kumar.

CESP,SSS,JNU

The Tribune, September 25, 2009.

A recently appointed VC of a prestigious University stated in an interview that one of his important goals is that the civil services coaching centre of this University should enable at least 10 students to make it each year. According to the story, he is enamoured of the idea because he along with 19 others made it to the bureaucracy in 1972 thanks to the Rau’s study circle - a creditable achievement for a coaching centre. However, can this be one of the important goals of a prestigious University? Alternatively, what does it convey about the leadership of a premier Indian University?

Should a University at all have a coaching centre for examinations of any kind, civil or uncivil? What does this indicate about both University teaching and our centralized testing for various jobs/careers? Why is it that the training at even the good Universities does not prepare students for passing entrance examinations? Equivalently, why is it that the competitive examinations do not test the students on the skills that they acquire during their routine studies in a good institution of higher learning?

The problem pervades the entire education system from the schools to the Universities. For entrance to the IITs or Medical colleges, etc., school students attend coaching classes during their 11^th and 12^th classes. The regular studies whether in private or government schools seems inadequate for preparing the child for the competitive examinations and thereby unduly burdens them. This has led to the phenomenon of Kota schools that prepare students for the competitions. Soon schools would come up in `Otak’ to prepare the children for entry into Kota schools. Where will the process end? Bright young children lose much of their childhood in this mad race and for what? Anything but learning.

Coaching institutions prepare their students to cram material to answer questions in competitive examinations – learning and understanding are incidental. When IIT and Medical students make it to the IAS and go to the training Academy in Mussoorie they feel lost because they have little exposure to the social sciences - a key ingredient into training good bureaucrats. These highly talented students with their enormous capacity to mug up pass the civil services examinations but this hardly implies an understanding of what they had mugged up. Skills needed to be a good doctor or a bureaucrat are at variance with each other. The training at the stand alone professional schools is narrow and it remains so because of lack of interaction with students of other disciplines.

Our Universities are unable to promote much learning amongst its students partly because the training in schools is indifferent and out of the pool of talent available, the best are siphoned away by the stand alone professional courses. Further, students who enroll in colleges and universities instead of attending classes spend most of the time preparing for something else. Why do students who work hard at coaching schools do not do so for the degree they enroll for?  Degrees hardly represent skills but are passports to getting jobs where the needed training is imparted on the job. Most teaching is insipid so that many students lose interest and exams are soul destroying. Many teachers are demoralized and go through the motions of teaching but have little interest in knowledge generation or the students.

The competitive examinations largely test the skill to mug up and reproduce. Mug books try to anticipate the likely questions and the successful candidates are those that can sort of predict the pattern of questions and provide standardized answers to them. Why do these examinations not test the logical abilities of the students and their capacity to grapple with difficult problems that have no ready solutions? That would be the real test of capabilities. This is tough and our students do not get this training in the institutions of higher learning. Our faculties who set the question papers have themselves never acquired such skills so they can neither teach this way nor set questions to test such skills.

The real task of the institutions of higher learning, like, the Universities or the IITs ought to be knowledge generation. While doing so they would also build capabilities amongst those who plan to go into other jobs, like, the bureaucracy or industry. Talent has to be filtered up so that the best go into knowledge creation. Unfortunately, at each stage there has been a reverse filteration of talent. The best minds (produced in spite of the system) are systematically siphoned out into jobs requiring lesser capabilities since they either pay more or have associated power.

This is a throw back to the days of the Raj which needed to produce clerks and not thinkers amongst the natives. In spite of sixty years of independence, we have not thrown away this yoke and restored the preeminence of thinkers in society. Civil servants have dominated over everyone else. So, society thinks nothing wrong in fixing salaries of University teachers in relation to the bureaucrat’s salary scales. The top dog has to be the Secretary to the government of India (the top of the pack of glorified clerks) and the salary of a teacher has to be several scales below that. In fact, the Chairmen and the members of pay commissions of University and College teachers have been Professors but none of them have protested at this preposterous idea and fixed the salaries of teachers in the lower scales. Indoctrination has been such that they have accepted the superior status of the clerks.

Many academics having failed to get into the bureaucracy or the corporate sector have come for teaching so that in their hearts they believe they are doing a lesser job and often lack motivation. Good teaching requires commitment. One inspired lecture is worth more than hundreds of insipid or often incompetent lectures that kill the interest of the students. That is why one cannot measure the productivity of a teacher as of a factory worker whose task is to perform routine and repeated tasks. One cannot measure output by how many students pass indifferent exams where little learning is required.

Few academics and even fewer bureaucrats and policy makers understand this overall picture and at times identify the problem as one of indiscipline – say, lectures and examinations not being held - but what of the content? Dissent is the basis of knowledge generation and ought to be cultivated systematically in the institutions of higher learning. However, this would be anathema to a bureaucrat and unthinkable to an Army General - their training militates against the spirit of a University.

Yet, our ruling elite readily appoints either these worthies as the VCs or those academics who have these tendencies either because of political convenience or as a reward for their subservience. The search committee members are compliant worthies willing to do the bidding of the political masters in the hope of getting plum postings – a patronage system all the way. Clearly, the role of institutions of higher learning is incidental for the elite class. No wonder the priorities of the VCs are typically things that are incidental (like, producing civil servants) to the main task of a University. If the future of the nation was not at stake one could laugh it off and today that is all we are able to do because the rot is deep.

arunkumar1000@hotmail.com

Swiss Bank Accounts: The US and Indian Approach

Swiss Bank Accounts: The US and Indian Approach

Arun Kumar.

CESP,SSS,JNU

The Tribune, August 28, 2009

Switzerland has reportedly told the Indian authorities that it would not give them names of Indians holding secret bank accounts in its banks while its largest bank UBS has agreed to give the US government names of about 4,500 US citizens who have accounts there. This is in addition to the 250 names it agreed to give in February 2009.

Switzerland is one of the possibly 77 tax havens in the world where rich individuals (from all over the world) keep their money from the prying eyes of their governments. The money kept can be from illegal activities (like, drug trafficking, corruption, etc.) or from legal activities to evade taxes. Even though tax evasion itself is an illegality but this is not considered to be criminality. Switzerland considers tax evasion to be a minor matter and can prosecute employees of any bank giving information about individuals indulging in tax evasion.

Money from criminal activities maybe routed to these accounts via shell companies or dummy companies - money laundering. Money is transferred from one account to the other and the previous account is closed and so on so that it becomes difficult to trace where the money originated from. Such activity is facilitated by bankers themselves, by legal firms and chartered accountants firms operating in tax havens. To make the task of tracing the origin of the money more difficult, money is sent from one shell company in one tax haven to another in a different country (as in the case of Bofors). Major banks facilitate such activities apparently by maintaining hundreds of companies in tax havens. Given this complexity and difficulty in tracing individuals who are evading taxes, how did the US succeed in extracting a concession from the UBS bank of Switzerland?

The short answer is hard work by IRS (the US government tax department) and the clout enjoyed by the US in world affairs. The story begins in mid 2008 with the indictment of Mr. Bradely Birkenfeld. He was a private banker acting on behalf of Swiss Banks. He accepted that he was servicing clients of these banks in the USA. This was illegal for a variety of reasons including encouraging the clients to violate US tax laws.

In the year 2000, IRS established the Qualified Intermediary (Q.I.) programme which required foreign banks to get US entities who wee their clients to file various forms to show their incomes. To overcome the consequent difficulty, the Swiss banks found ways of hiding the identity of the true owners of accounts with them through shell companies in other tax havens. Mr. Birkenfeld according to the court papers helped in facilitating all this, moving assets (like, bringing diamonds in a toothpaste tube), issue of credit cards for facilitating use of funds, showing money transferred to clients as loans by Swiss banks and so on. He accepted helping a real estate developer evade $7.2 million in tax and hiding assets worth $200 million. Mr. Birkenfeld was apparently one of the many private bankers used by the Swiss and others to get business from wealthy US clients.

Since UBS’s name cropped up, the US government next charged a top UBS executive of helping 20,000 US individuals hide $ 20 billion from the US government. As the case progressed the entire UBS bank was threatened with indictment. To stave off prosecution, UBS in February 2009 agreed to pay the US government $780 million and reveal the names of 200 to 300 US citizens holding secret accounts.

The US government next filed a case to get the names of an estimated 52,000 wealthy individuals who have accounts in UBS. The Swiss tried every trick in the trade to stall, like, saying this would lead to a diplomatic row or it would threaten the stability of the financial system in the world and so on. The US judge went to the extent of asking the US government whether it was willing to seize the assets of UBS and put them under another management. The Bank argued that revealing the names would be violative of Swiss criminal law.

The US government announced a voluntary disclosure scheme which allowed people with illegal accounts abroad to come clean by paying their taxes due and accepting light penalty. However, the judge did not consider this adequate and maintained pressure on UBS. Given UBS’s large operations in the US and the revelations being made by those using voluntary disclosure, it had to give in. An agreement was signed last week to give the US government between 4 to 5,000 names. The details are not fully available but perhaps the biggest tax evaders who most likely have operations in many tax havens have already shifted funds out of not just UBS but out of Switzerland (there have been reports to this affect).

Liechtenstein, another tax haven has come to an agreement to clean up its act. In 2007 a disgruntled banker revealed the names of those having accounts there. Governments have started prosecution based on the data made available. The Indian government which was initially reluctant to take the data being made available to it by the German government finally accepted it in March 2009 (under public pressure) and apparently preliminary investigations have started.

In the US, as more and more data is coming to light, prosecution is accelerating. On the basis of revelations, Mr. Schumacher and Mr. Rickenbach have been indicted on August 20, 2009 in Florida on grounds of helping US entities to hide assets and evade taxes. Jeffrey Chernick, John McCarthy and individuals referred to as J.E. and E.D. are mentioned in the indictment as those receiving ‘help’ from these gentlemen. The pace of prosecution is likely to increase as more data becomes available through voluntary disclosure and revelation of names by Swiss banks.

In India’s case, when some information is received, it is suppressed or the investigating agencies spoil the case so that prosecution is rare. From time to time, information does become available, like, in the case of Jain Havala or Bofors but this has never been systematically pursued or the case has been weakened. In India the rich and powerful have the clout to prevent justice from being done. In the advanced countries this seems to be far less.

A perusal of the revelations in the US show that banks with operations in tax havens or originating in tax havens are indulging in all manner of fraud in other countries. In India (given our laxity) they would be doing at least as much as has been revealed in the US. Given this, the least the Indian Government should do is to tighten control over such banks operating here. Further, all foreign banks should be made to give undertakings along the lines of Q.I programme. They must also be asked to give information about their subsidiaries and operations in tax havens so that their operations become transparent.

While the black economy in the US maybe larger in absolute amount, as a per cent of its GDP, it is small (5%) compared to that of India (about 50%). Thus, India is losing far more due to the adverse impact of the black economy. Further, the US receives funds from all over the world given its lucrativeness but India loses capital. So, a country that is short of capital has been exporting capital to the tax havens and the rich countries. Every time there is demand to unearth funds lying abroad there is a chorus, obviously orchestrated by the wealthy, that this would be futile. So, while we need to do more to tackle the menace we do far less than we can or what the other countries are doing.

arunkumar1000@hotmail.com.

           

           

Economic agenda Global crisis calls for fresh thinking

Economic agenda Global crisis calls for fresh thinking

by Arun Kumar
CESP,SSS,JNU

The Tribune May 25, 2009

The Congress as the dominant partner of the UPA is back in the saddle in New Delhi. It is being argued that there is a mandate for the new government to carry out some of what it wanted to do in its previous term but could not — privatisation or labour or insurance reforms. Has the public endorsed the UPA’s dominant economic agenda? Economic issues hardly came up in the election campaign because the Opposition lacked clarity on their importance.

The only economic issue that stirred the pot was the more than a trillion dollars of black wealth stashed abroad in tax havens by corrupt Indians — politicians, businessmen and others. As such, claiming endorsement is an overstatement. The mandate for the UPA is made up of victories in different states for different reasons. In West Bengal, it was the anti-people attitude of the ruling Left Front on the SEZ issue (like in Nandigram), the anti-farmer attitude in Singur and, more recently, in Lalgarh. In Kerala, it was the internal divisions in the CPM that helped.

In Tamil Nadu, it was the Sri Lankan situation that tilted the balance. In Andhra Pradesh and UP, the multi-cornered contests helped and in Maharashtra the undermining of the Shiv Sena by the MNS and so on. This is not to argue that there was not a 2 per cent swing of votes in favour of the Congress and that this is important in multi-cornered contests, but that this is not a massive swing as is being made out and used to push for pro-business policies.

The business lobbies are reading in the victory a chance of getting more concessions. However, if anything, the swing in the rural areas is due to the implementation of NREGA and loan waiver schemes in the last phase of the UPA regime. It may be recalled that these schemes were launched under pressure from the liberal and left opinion in the country and were opposed by the corporate lobbies in the UPA. So, the mandate is for the pro-poor and not pro-business policies.

The mandate is being misinterpreted deliberately but worse, the policies being pushed for by the vested interests are a prescription for aggravating the economic crisis which has deepened globally. We cannot escape it because we are far more integrated with the world today than earlier. The government has managed to keep under wraps the actual economic situation by repeatedly harping on the rate of growth being above 6.1 per cent and that things would improve in six months — keep the lollypop dangling.

Currently, large parts of the economy are experiencing negative growth — the industrial sector, exports, agriculture and major segments of the services sector like transportation, retail trade, real estate, finance and tourism. Thus, the current (and not the average) rate of growth will be close to zero, if not negative. If any projections are to be made, these need to be made from the current trends and not the average of the past year.

Recent reports indicate that the US, Japan and the Euro zone are going deeper into recession, and the IMF in its last report suggested that currently we are at the beginning of the crisis. So, things are likely to get worse in the coming year(s). Chances of a recovery seem to be slim, in spite of the massive fiscal deficits created the world over. The recent sharp rise in the stock markets does not necessarily reflect a turn-around because they have not proved to be good indicators of the health of the economy. They have risen several times during the last one and a half years only to fall steeply.

The work of the new government is now cut out — to stop the economic slide and the steeply declining employment. While inflation rates are low, food prices are still rising. This is bad when wages are under pressure due to rising unemployment. The retrenchments started with the ad hoc and temporary workers which do not show up in the statistics. After the Jet Air fiasco of mass retrenchments, now companies are retrenching permanent staff members piecemeal.

Today the fiscal deficit is over 12 per cent of GDP and likely to climb as the tax revenue collection falls short. According to the RBI data, the corporate sector’s post-tax profits fell by 17 per cent in April-December 2008-09 while they rose by 28.6 per cent in the comparable period of the previous year. Worse, in the third quarter of 2008-09 they fell by 53.4 per cent, indicating a deepening slowdown. A few sectors may be doing well, but one swallow does not make a spring.

Due to the slowdown, corporate tax collection, the largest source of taxes now, is likely to fall short of the targets. It would also mean less excise duty collection (in addition to the decline due to the duty cut announced). Further, due to the rapidly declining imports, customs duty collection would also fall short. For the states there would be less sales tax collection, etc. Due to the decline in the real estate activity, transfer changes will also show a drop. Therefore, there would be little scope for the government to offer more concessions to businesses without worsening the fiscal deficit further.

It is also known that concessions (including in taxes) may not increase the demand but a rise in government expenditure certainly does so and especially in labour- intensive sectors. For this, taxes need to be increased, otherwise deficit would rise further. This strategy would also mitigate the difficulties faced by workers. As argued in these columns last year, preventing unemployment from worsening is important to control social and political problems because once they take hold in a society, economic policies become ineffective.

Indira Gandhi in 1971 got 352 seats and Rajiv Gandhi in 1984 got 414 seats but both lost the mandate within three years. Today, the Congress has only 200-odd seats and if problems grow the UPA allies have shown that they can quickly act pricey and/or switch sides, aggravating the situation.

The deepening global crisis requires new thinking. US President Barack Obama has already argued for creating jobs in Buffalo rather than in Bangalore. There is a rising tide of protectionism and this is not going to end soon. There is also talk of reform of the IMF and the World Bank, and re-architecturing of the global financial system. We have to work out our stand on all this. There is no time to make mistakes and learn from them because of the speed of the evolving global crisis.

Alan Greenspan, who was considered “God” by the financial markets and who was the Fed chief from the late eighties onward, has admitted that he was wrong and that financial markets are not self-correcting. So, the free market ideology is in for a major overhaul.

Further, in the US and elsewhere, assets are getting socialised with the government buying into major companies both from the financial and real world. This can only rise as bankruptcies increase. So, if we do not have policy makers whose mindset is different from that which has been in evidence in the last 18 years, we quickly race towards a deeper social crisis.

arunkumar1000@hotmail.com

Tackling the Current Global Economic and Financial Crisis: Government Intervention has to go Beyond Demand Management

Tackling the Current Global Economic and Financial Crisis:

Government Intervention has to go Beyond Demand Management

Arun Kumar

CESP, SSS, JNU.

Published in Economic and Political Weekly, March 28, 2009. Vol. XLIV No. 13. Pp. 151-7.

The Downturn: Some Facts

The world is currently witness to unprecedented almost daily adverse economic news. The US budget deficit is set to triple to $1.75 trillion, the largest ever, from last year’s figure of $450 billion. Bank of England has fixed the lowest interest rates since it came into being in 1634. Toyota has announced its first ever losses in its  history. The largest housing mortgage companies, Freddie Mac and Fannie Mae, the largest insurance company, AIG and banks like Citibank exist because they were rescued with hundreds of billions of dollars pumped in by the US government.

Major world economies are in recession or their rates of growth have plunged. In the last quarter of 2008, the US economy declined at more that 6% per annum, Euro zone contracted by 1.5% and Japan contracted at an unprecedented 12% per annum. Britain Russia and Canada are in recession while the Chinese, Brazilian, S Korean and the Indian economies have slowed down rapidly. Smaller economies like Spain, Mexico, Ireland, Iceland, Singapore, Greece, Ecuador, Hungary, Latvia, Pakistan, Ukraine, etc., are in deep trouble. This is happening in spite of the massive bail out packages put together by various governments. The US alone according to one estimate has put together a package of more than $8.8 trillions and already spent $ 2 trillion (NYT, 2009). The total commitment (not all spent) by all governments is in excess of $ 11 trillion.

Companies like AIG that got $150 billion and Citibank that got $300 billion of bail out up to November 2008 are now asking for more funds (Lorr, 2009). In spite of the massive bail out, AIG has now posted the largest quarterly loss ever ($62 billion) by any US corporation. These were entities that were considered `too big to fail’ up until June 2008 but now they are failing rapidly. The speed is startling. Companies of their size would have earlier collapsed over many years but they are now failing in months and weeks. Supposedly healthy companies like the Japanese bank Mitsubishi needed more capital within months of trying to rescue Morgan Stanley. Before Obama’s bailout strategy has got going, its assumptions about the extent of collapse are proving to be incorrect (Goodman,  2009).

Analysts are stunned by what they are witnessing. Most of them are constantly behind the curve. The IMF for a long time did not admit that a recession is around the corner and finally pronounced that that was indeed the case in November 2008. The US Fed Chief after suggesting that things were not too bad admitted that there was a deep systemic crisis in September 2008 and even then hoped that things would turn around soon. On February 23, 2009 in the Senate hearings of the Banking Committee, he has accepted that 2009 will not see the end of the recession and a recovery may occur in 2010 (even this is conditional on the assumptions being right) (Rampell and Healy, 2009).

Even economists like, Joseph Stiglitz and Paul Krugman who were skeptical of what was going on in the financial markets had not anticipated the speed of the collapse. While now in hind sight it seems obvious given the size of the financial bubble that a collapse was inevitable but no one had worked out what needed to be done if the collapse started. Today, analysts are groping in the dark to work out an explanation and a possible solution to the growing problem. Stiglitz (2009b) states:

"We are moving in unchartered waters. No one can be sure what will work. But long-standing economic principles can help guide us. Incentives matter. The long-run fiscal position of the U.S. matters."

The main question is whether the ongoing crisis of capitalism is basic and requires a fundamental change in the system or is it merely a financial crisis which can be tackled by the government even if with some difficulty? Most analysts, some of the well known ones being Stiglitz and Krugman, fall into the latter category. While Stiglitz believes that a better designed package is necessary (Stiglitz, 2009b), Krugman (2009) argues, it needs to be large enough to have an effect. Both think there will be pain but the economy will turn around. Bhaduri (2009) also argues for a massive Keynesian intervention on employment but is uncertain whether this is going to happen.

Kumar (2009) argues that the crisis is a fundamental one because of the flawed financial system in which restoration of faith is difficult. Since the financial system is fundamental to the functioning of the capitalist system, the current crisis will bring down the capitalist system as we have known it. In this paper we analyse the fiscal and monetary policies that have been adopted by the various governments the world over and why they are not having the effect they were expected to have. The governments have exhausted the tools of economic intervention available to them but the situation is worsening rapidly.

Krugman and Stiglitz are arguing that during the depression of 1929-30s, we learnt how to overcome such downturns so the crisis can be overcome. Stiglitz has said that today no one can afford to not be a Keynesian just as till 2007 no one could afford to be seen to be a Keynesian. Businesses who have been votaries of markets and minimum government intervention till recently are unashamedly demanding massive help from governments and cannot anymore oppose Keynesian policies. However, socialism remains a dirty word and therefore government intervention has tended to be half hearted (See Krugman, 2008). Most policy makers are from the world of finance for whom saving the real companies is less important than saving the financial world.

Theoretical aspects of Demand and Downturn.

This is not the first major crisis faced by capitalism so that many believe that just like the earlier crises were weathered by capitalism, it has the resilience to overcome this one also. Capitalism has gone through many business and trade cycles which cause output in the economy to fluctuate, perhaps, not in text book fashion.

Economic theory uses the multiplier-accelerator interaction to explain fluctuations. Since there are other accompanying factors/changes, the cycles are not regular. Since the understanding of Keynesian economics developed in the mid-thirties, the down turns have been moderated with counter cyclical interventions by governments. Rapid technological changes taking place in the last century led to investment booms and changes in productivity so that modified the cycles.

Given the practical difficulties, it is hard to identify a pure recession or a depression in an economy. Ideally, recession should imply output level falling below the trend (average) level and a depression when it falls considerably below that level. However, given the difficulty in identifying these clearly, a recession is now defined as two or more consecutive periods of decline of output (negative growth, even if the output is at a high level).

A precise definition of these terms in terms of investment and capital stock in an economy is possible (Kalecki, 1971:11). It is pointed out that there is a crucial difference between investment decisions and delivery of plant and equipment. The latter is what results in a rise in capital stock. He argued that there is a time lag between the two and this leads to a cycle in a capitalist economy. In the early part of a depression, investment decisions move towards a low while capital stock is falling but is still above its average level (in a cycle). In a recession, the investment decisions fall rapidly but because delivery of equipment is still above the average level, capital stock keeps rising and thereby depresses investment decisions even faster and slows down the economy rapidly. These changes reflect in changes in output to give the cycle. Consequently, in a recession, the level of output is at an average but falling rapidly while in a depression the output level is low but falling or rising gradually.

The functioning of cycles is based on what Domar (1946) described as the `dual nature of investment’. Namely, investment not only raises output through the multiplier it lowers potential opportunities for investment by creating additional capacity. As output (O) rises, through the accelerator, investment (I) rises but as capital stock (K) rises, I falls. It maybe written as,

I  =  a. O  -  b. K.  Where a and b are both positive constants. Different time lags between the three variables lead to different kinds of cycles.

Domar suggested that technological obsolescence leads to demand problem along the steady state path of a capitalist economy and makes the path unstable. Kaldor (1960) in a simplified model of cycles introduced expectations of capitalists into the analysis. He suggested that the economy goes from high to low levels of activities due to cumulative changes in expectations. Keynes (1973) suggested that counter cyclical fiscal intervention would help overcome the downturn. However, Kaldor pointed out that once a down turn starts, then even government intervention cannot prevent its occurrence. He argued that government intervention is needed in the early part of the cycle but even then eventually, the down turn would take place.

In the Keynesian framework, the down turn is a result of shortage of demand. In this context Rosa Luxemburg had argued that the existence of an export market can mitigate the demand shortage in a capitalist economy. Tugan Baranovsky had argued that if investment takes place for the sake of investment, then demand in a capitalist economy can be maintained. Kalecki critiqued these arguments (Kalecki, 1971: 146-155). He argued that Rosa Luxemburg’s argument is flawed since it is not the export market that causes an expansion of market but the export surplus. Regarding Tugan-Baranovsky’s argument, he argued that investment is an unstable process and the demand problem cannot be escaped (similar to Domar’s argument). Kalecki suggested that creating a war machine is a possibility to make machines for the sake of machines because they can be periodically destroyed (like, in Orwell, 1990). Hence rising defense expenditures could keep up demand even if it invariably results in imperialism and the military industrial complex. This also overcomes the problem raised by Domar (1946) of rising capital stock raising productive capacity which then depresses investment.

Kalecki (1971) argued that it is the budget deficit of the government that adds demand to the economy and not just government expenditures. This was also Keynes’s understanding. A down turn in a capitalist economy may also be formulated in terms of Marxist notion of overproduction. Namely, a rise in the potential production above what is demanded so that spare capacity appears and this then makes the accelerator to stop working and investment declines pulling down the output level with it. This is basic to capitalism and cannot be overcome for all times.

In brief, the various ways of understanding down turn in capitalist economies and their management by governments through demand creation explain some aspects of what happened during the earlier down turns. Question is whether they adequately explain what is going on currently since 2006.

Lessons from the Depression

The current crisis is also different from the great depression of 1929-33 (See, also, Mankiw, 2008). The economies then were less integrated that they are today. Mobility was much less and agriculture and primary goods production was the mainstay of most economies in the world. A large part of the work force was employed in agriculture. Finance was important but to a lesser extent than at present because a substantial amount of production was still in the local economies in small or family units. MNCs were growing but had not become the behemoths that they have become today with global reach. The stock markets were important but their reach was much more limited and only a tiny per cent of the population was involved in them.

In the great depression, the stock markets, output and employment all collapsed as business confidence declined and investments froze. Banks failed in large numbers as businesses collapsed. That was due to the shortage of demand. The problem was compounded by the conservative monetarist stance of the policy makers. This is also a problem today where the world of finance has dominated over policy making for the last 30 years.

To meet the challenge, it was considered appropriate that the budget be balanced by the government. Thus, as the crisis deepened and revenues fell, government expenditures were curtailed rather than raised to counter the demand fall. As a consequence, demand fell even further and the depression became deeper. Further, it was thought that investment is inadequate because of lack of profitability so that wage cut was propounded as a measure of boosting profitability. This only resulted in the further fall in demand. Investment which always comes with a time lag never materialized because of excess capacity. Thus, employment and wage rate both fell leading to the further decline in demand (Kalecki, 1971: 26-34). It is only the New Deal and the rapid rise in the public expenditures irrespective of the deficit in the budget that helped the economy out of the depression.

Downturn in the US Economy in 2008

Rising disparities in a capitalist economy lead to a shortage of demand (over production) and to a down turn. In the recent past, the tendency for over production has been countered by the wealth effect due to rising asset prices. This has been especially true in the US where the savings propensity has dropped sharply since the mid Eighties to almost zero in the middle of the present decade (See Kumar, 2009). The US could do this due to the dollarization of the world economy which enabled it to export its deficits (in trade and the budget) since the rest of the world was willing to lend to it. It became the largest debtor nation of the world.

While the earlier downturns were a result of the slow down in demand, the crisis of 2008 has a different basis. It originated not in a slowdown in demand but a financial crisis which triggered a crisis of trust between borrowers and lenders and therefore a fall in asset prices. This led to massive bankruptcies in various financial and production units. Thus, it is a supply side created crisis unlike the earlier ones. Subsequently, it has also manifested itself as a demand side problem as unemployment and housing foreclosures rose in the US. Other economies, dependent on exports to the US, it have experienced a fall in demand. Given this sequence, can the crisis be overcome by boosting demand?

This is unlikely, since the supply side collapse is continuing. Hence, this downturn is different from the earlier ones since the great depression and perhaps including it. While countries, like, China and Germany which depended to a large extent on exports or countries, like, Britain and Iceland which were involved in the same kind of financial leveraging as the US, this may not work, for a few countries which do not face either of the above two problems, domestic demand may be boosted to partly mitigate the problem. However, today, it is not so easy to boost domestic demand quickly since the structures of most economies are now outward oriented and these structures cannot be changed quickly.

In 2008, the rate of growth of the world economy and of the US was positive till almost the middle of 2008 and its fall is not as sharp as in 1929. The decline in the stock markets was gradual to begin with and picked up speed later (See, Kumar, 2009). Unemployment has risen but not so precipitously. The policy makers and analysts have been surprised because they were in a denial mode. This time around, the fiscal deficits all around have been allowed to soar to unprecedented levels. This may have temporarily slowed down the down turn but the decline is continuing. This is the other surprise. It may be argued that the stimulus is inadequate (Krugman, 2008) or that there is a lag effect and that matters will improve. But, the signs are that the collapse is deepening. That there is a difference from the earlier down turns or from the depression of the 1929-33 needs to be understood. For this a better understanding of the current crisis is needed.

Explaining the Origins of the Current Crisis

It is generally argued that the crisis has originated in the financial sector due to the failure of the sub-prime assets, especially in the housing mortgage markets. But the question arises, why did the sub-prime assets get created? Further, if the capital gains had continued to be positive, then these assets would not have collapsed so why did capital gains start declining? There is also another explanation of the financial crisis which suggests that there was a Ponzi scheme that has now failed (Sen, 2008). This implies fraud. While a certain amount of fraud is likely (like, in the Madoff affair and the failure of the Stanford Group or the Satyam affair closer home), this cannot be the total explanation of the collapse of the financial system and alternative explanations are possible

Kumar (2009) has shown that the present crisis originated in the interaction between the real and financial sectors and that it is linked to the architecture of the financial sector and the world economy. It is argued that over the last thirty years, disparities in a large number of countries (US, China, India, UK, etc.) have risen (George, 2008) and led to a tendency for overproduction.

In the US economy, in particular, this has been countered by the increased demand through wealth effect (Bhaduri, 2009) due to the massive amounts of capital gains in the financial markets. Consequently, the savings rate in the US has been declining (Economic Report of the President, 2008). The US could do this because of the dollarization of the world economy and the willingness of the world to hold the surplus dollars and give loans to the US economy (Kumar, 2008).

However, this also set into motion a counter tendency of increasing amount of the surplus generated in the US economy accruing to foreigners who owned progressively more and more of the capital in the US. Further, the huge profits of the owners of financial capital were siphoned out through tax havens (See the recent admissions by the UBS bank of Switzerland and the news of MNC banks having a large number of subsidiaries in Tax havens). These factors along with the rising war effort and internal security expenditures since 2001 led to the reduction in the funds available for generating of more and more of financial assets in the US.

The growing deregulation of the financial markets resulted in the runaway speculation in financial assets and the build up of the financial bubble by allowing very high degrees of leveraging. As argued in Kumar (2009), the tendency for the leakage of the surplus of the economy (pointed to above) was countering this tendency. Thus, it has been argued that the financial bubble suffers from knife edge instability. Since the rate of return on financial assets is largely dependent on the capital gains (or losses) it can either grow or collapse. It is pointed out that there is an asymmetry in this so that the bubble grows slowly but collapses quickly. The reason is that the returns on financial instruments are a multiple of the capital gains due to the leveraging. Higher the leveraging, higher the rates of return. That is why the entire real economy becomes inadequate to pay the profits on the financial assets and the bubble can only survive if the profits are reinvested into the financial assets for the bubble to grow.

Further, as the capital gains fall, the returns also fall precipitously and funds begin to move out to other assets (like, speculation in commodities, etc.). At this point the bubble starts to collapse and returns turn negative so that a vicious cycle of withdrawal of funds is set up and the collapse is rapid. Consequently, investors in these markets (most people and companies with surpluses) suffer large losses.

Capital gains started falling in 2006. Even before that happened, to boost the financial markets the sub prime assets were created. These posed no problem as long as the capital gains were positive but as soon as they turned negative, these assets started to collapse and aggravated the decline in capital gains which then fed back into the loop of decline. That is why it was suggested earlier that the crisis starts in 2006.

Leveraged buying also involves borrowing and lending across institutions. Thus, the balance sheets of most institutions get interlined and this is referred to the `interlocking of balance sheets’. If one institution suffers losses and is not able to repay its creditor then it adversely effects the latter and that effects others, etc. A chain of failures is set up. Since the entire financial system (Investment banks, auditors, credit rating agencies, etc.) operated with the same model and the investors (individuals or firms) followed their advice, the collapse has become systemic and not remained confined to a few entities.

The problem is compounded by the requirement of  `mark to market’. That is, losses have to be brought on to the balance sheet of the companies. Since leveraging leads to large amounts of financial exposure, even small per cent losses in capital values lead to large losses in relation to own capital. Hence, the own capital of any company resorting to high leveraging gets wiped out and they become bankrupted and need fresh infusion of capital.

In brief, the interlocked balance sheets of companies and the requirement of `mark to market’ has turned a large number of companies bankrupt. It is a different matter that the losses may not be recorded all at the same time and the losses keep appearing in the balance sheets quarter after quarter. The problem is further aggravated due to the decline in the stock markets and the decline in the value of stocks of companies. This reduces the capacity to raise fresh capital. All this is visible in the case of the financial institutions and other companies that have been provided bail out packages in the last year or so. Huge packages given to them have disappeared in weeks and months, into black holes, with no trace at all.

This has vitiated the situation for the entire system because no one knows which company will fail next. Consequently, trust has evaporated and the financial institutions do not know who to lend to. If they lend to a company which has a lot of toxic assets (assets that have lost value and are continuing to lose value) it may not be able to repay and then the lender will be the next one to fail. However, this lack of trust has also led to the difficulty in raising working capital and therefore to difficulty in paying salaries, etc., and to running down of output and employment.

The financial crisis has triggered massive foreclosures in housing and to a decline in the stock markets. This has set the wealth effect boosting demand into reverse gear and it is now driving consumption down and aggravating the demand problem. Thus, the demand problem has come after the financial crisis was triggered off by problems in the real economy in the US. Bhaduri (2009) also argues that the problem is not just demand.

With the decline in the financial markets leading to the decline in the stock markets, even healthy companies that were not involved in the financial markets have suffered losses in valuation. They have also faced working capital problems so that good assets have turned toxic. Further, as US markets declined it has had an affect globally on all financial markets so that the problem has become a global one.

Ineffectiveness of Government Policies

Since early 2008, when the crisis was perceived by the policy makers to have begun (prior to that for quite sometime, they were in a state of denial, see NYT, Interactive, 2008.) governments have tried many kinds of measures. They may broadly be classified as monetarist and fiscal. Among the monetarist measures, we have seen cuts in cash reserve ratio, lowering of interest rates, lending of money by Central Banks, providing loan guarantees, etc. Fiscal measures include investments in companies, cutting taxes, giving support to social sectors and increasing expenditures on things, like, Science (See NYT, 2009 for a break up of the proposed interventions in the US amounting to $ 8.8 trillion).

In spite of cuts in interest rates to unprecedented low rates and massive infusion of liquidity all over the world, the various economies  are not only not showing signs of revival, the crisis is deepening. Monetary policy cannot do more because interest rates cannot be cut any further. There seems to be a liquidity trap. Since risk is perceived to be very high, lending at almost any reasonable interest rate will perhaps not cover the risk of the lender. Further, for the borrower, since demand has fallen and as a consequence, profitability has sharply declined, a slight fall in interest rates (which is all that is possible in today’s regime of low interest rates) is inadequate to boost profits to a point where investment demand can revive.

Increased liquidity being made available seems to be unable to get credit flowing because of a lack of trust (as argued above). It is being used by the entities who are getting the funds to protect their own balance sheets. Hence there are complaints that credit has frozen (Goodman, 2008). In Kumar (2009) this has been captured as the fall in the money multiplier and transactions velocity of money to unity and the economy entering a liquidity trap.

Tax cuts in today’s situation of difficulties will not lead to increased spending but to increased savings (Domar, 1946 has also argued similarly in the context of his growth model and shortage of demand). Further, to the extent the tax cuts go to the well off sections, since their savings propensity is high, this will not boost demand much. The underlying idea of tax cuts is that it will also provide incentive to invest more. However, since the crisis is also in the financial sector and risk and uncertainty are very high, expecting investments to pick up is a non-starter.

The question is, can fiscal policies work under this situation. Kaldor (1960) has argued that government intervention can only work if the cumulative expectations have not turned negative. Thus government can prevent a down turn only if it intervenes early. In the present situation since the policy makers have been in a state of denial, they have been behind the curve and intervening timidly hence the problem has gone beyond their control.

Today, there is a fall in investment, consumption and exports for most economies. The only boost is through rising fiscal deficit. But this cannot overcome the fall in demand in the private sector. Unfortunately, if the fiscal deficit is a result of transfers to the capitalists, the effect is lowered (Kumar, 1999).

Beyond Demand Management

Further, given that there is a deep crisis in the financial sector, the little bit of demand boost due to the fiscal deficit cannot overcome the rising bankruptcy in major sectors of the economy. Even if demand is created, production maybe difficult to revive since many companies are going bankrupt. In this context, it is important to remember that Kaldor (1960) suggested that eventually, after enough plant and equipment has been depreciated away, cumulative expectations turn again and an upturn does occur completing the cycle. However, in the present circumstances, the implication of the above argument of bankruptcy of large number of companies is that even this may not happen without a major rearchitecturing of the entire production and finance system.

As pointed out in Kumar (2009), while the asset side of most businesses has collapsed, the liability side remains as it is. The peculiarity is that in a book keeping sense, most businesses maybe bankrupt while the real asset base of the economy is intact. The issue is who owns these assets? Few would do so any more since most of those who owned them are now bankrupt because of their paper losses. Further, these losses are legally covered by contracts with someone else, hence they are not fictitious. The problem is then systemic and a resolution difficult.

Can some agency retrace each of the steps in the creation of the financial assets and reverse this process so that the debts to each other can be cancelled? As pointed out in Kumar (2009), this is improbable if not impossible due to the process being akin to random walk where there is micro reversibility but macro irreversibility. Some fundamental changes in the system would be required, namely, property rights would have to be derecognized. This would be akin to nationalization of the entire economy. Today, when infusion of simple equity by government in financial institutions is resisted on grounds of `nationalization’ how much more resistance would there be to elimination of property rights even if it is a one shot affair. Capitalists would fear that this would become a precedence for all times to come and could happen later also without benefit to them.

The logic of the argument presented above is that most businesses as we know them would close down as losses come on to their balance sheets. In some cases this would occur rapidly while in other cases this may take time. High degree of leveraging and capital losses on assets implies that losses on the books of most businesses are far greater than their owned asset base.  

The implication also is that apart from the government who else would buy these companies with losses on balance sheets. Further, as the stock markets continue to decline, capital losses would only grow. In the event, at the current market prices, buyers would be few and prices can only fall so that markets would remain bearish for the foreseeable future.

However, it also needs to be asked, even if the government and Central Bank guarantees and bail outs are spread to all companies, would their resources be adequate to the task. Since the size of the financial collapse is a multiple of the capital base of the real economy, even the government after nationalizing all the assets in the economy cannot put in the resources to take over all the businesses.

Conclusion

The paper points to the depth of the crisis confronting the global economy. It points to how cycles originate and how recession and depression can be more precisely defined in terms of investment decisions and capital stock rather than the current definitions in terms of output. It also presents the various ways of understanding demand deficiency which was the underlying feature of the earlier downturns in the capitalist economies. A resolution of the problems faced then was possible with demand management using Keynesian tools. This paper argues that the current global economic crisis is different from the other crises experienced by capitalism in the past. Hence the lessons learnt from the past may not be applicable to solving the current crisis. The arguments presented in the paper imply that capitalism faces a basic crisis so demand management alone will not work. Even more radical solutions, like, by George (2008) based on tackling poverty and environmental degradation, etc., will not work. What we do in the future is not the issue. Question is what do we do  now? For instance, one implication of this paper is that we need redistribution but that is not on anyone’s agenda today.

The present problem is a culmination of the trends in the real economy over the last few decades which have resulted in the emergence of the financial bubble that turned into a financial crisis since 2006 and reacted back on the real economy, affecting it more and more since mid 2007. Thus, it is argued here that fiscal policies (or monetary policies) would have worked in the present crisis if demand was the problem. But, since that is not the crux of the problem, these policies are not producing the results expected and are unlikely to be successful.

This is because of the current inter-relationship between the real and the financial capital which is leading to all around bankruptcy of businesses. Real assets exist but their current owners are mostly bankrupt due to paper losses. Further, there is loss of trust in the system and the financial sectors have lost their capacity to facilitate production. Productive capacity exists but the arrangements that allow it to function fully are increasingly breaking down. The breakdown in the financial arrangements cannot be reversed in an orderly manner. It is suggested that it might require the dismantling of the entire system of property rights to correct it – that would pose a fundamental challenge which at present would be unacceptable to the capitalists and therefore, the resolution of the present problem seems difficult if not impossible.

                References:

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Interim Budget 2009-10: More an Election Manifesto, Less A Budget

Interim Budget 2009-10: More an Election Manifesto, Less A Budget

Arun Kumar

The Tribune, February 18, 2009

A Budget is more about the year ahead, and not about the years past. The interim budget for 2009-10 lauds the performance of the UPA government in the last four years. It ignores the negatives in this period. Further, it glosses over the considerable negative news in 2008 which called for action. It looks as if the budgetary allocations are sharply up but the big increases were last year and they are merely being maintained.

The positives are the high rate of economic growth, a low rate of inflation, high growth in exports, rapid flow of foreign capital, build up of foreign exchange reserves, good growth in agriculture, implementation of NREGS and many social sector schemes. Given the high growth rate, revenues increased sharply so that there was scope of spending more on critical schemes. However, critics have argued that not enough was done given the potential and the crisis in the lives of the poor. Be that as it may, the list is impressive.

What are the omitted negatives? Given the nature of growth, dependent on services sector, privatization, displacement of the unorganized sector production by the organized sector, rapidly growing pollution and high amounts of displacement, it was over estimated by the official statistics. For similar reasons, inflation was underestimated. No wonder, while the government claimed low rates of inflation, the citizen complained of high inflation - perceptions differed sharply. However, disconcertingly, growth led to growing disparity in the economy. While the corporate sector backed by massive concessions did phenomenally well with profits more than tripling, the status of the Aam Admi, the supposed focus of the Congress (I), stagnated or declined.

Disparities of every description increased - between the rural and urban areas, backward and forward states, agriculture and non-agriculture, capital and labour and organized and unorganized sections. This is what fuelled the rapid increase in the savings rate in the economy by an unprecedented 15%. The rising profits also fuelled a rapid increase in the investment rate by a similar amount. However, it also made the growth path unstable because it became dependent on a narrow segment of society. It is this feature that has led to a sharp decline in India’s growth rate in the last six months. As soon as the incomes of the elite sections and the profits of the corporate sector were hit by the global crisis, both consumption demand and investment rate declined triggering the down turn.

Currently, exports are declining rapidly because of global recession, industrial growth has turned negative and large segments of the services sector are declining or slowing down. The result is that the current rate of growth of the economy (not the average) is close to zero if not negative.

The budget supports this contention when it projects a 2% nominal growth in customs and excise duties (at unchanged rates). Adjusted for a 4% rate of inflation, this would suggest a 2% contraction for this segment. A 6% nominal growth is expected in Service Tax so the real growth would be 2%. Finally, the growth in income tax and corporation tax is projected at 10%. Like last year’s figures which were based on optimistic projections and have now fallen substantially short this year’s figures are also likely to be overstated. If even the optimistic projections are as low as they are then India’s growth is likely to be negative.

Amongst the other negatives, one may count the rapid increase in the revenue and the fiscal deficits for the current year (2008-09) from the budgeted figures of 1% and 2.5% to 4% and 6% respectively. These unprecedented increases were anticipated by the experts because of the over estimation of revenues and under estimation of the expenditures on pay revision, farmer’s loans, petro-goods subsidies and so on. Thus, FRBM Act has been given a quiet burial. It is not surprising that at the first hint of a crisis for the elites, this apparently stringent act has been relegated to the dust bin while till last year when funds were needed for the Aam Admi, this act was cited as an impediment.

The Congress (I) has also suddenly discovered the farmers as the heroes. The last many years when they were committing suicide at record rates, they were hardly the focus of attention. Now that demand has to be raised quickly to counter the downturn, they are seen as the saviours. Because of their poverty, they will spend much more and create a market. Clearly, they do not matter in their own rights but as an adjunct to the non-agriculture sector – the real concerns of the rulers of the country. It is a pity that the FM says that 60% of our population lives in the villages when that figure is closer to 70%. It is surprising that the figures given in the budget speech are sometimes in numerals and at other times in mixed numerals and words. It perhaps indicates a hurried job.

This brings us to the final point as to why the budget did not announce a package to deal with the rapid slow down in the Indian economy. Almost the entire world is admitting that their economies are in recession or in rapid decline. Every country is announcing big bail out packages. The USA has announced till now (in various forms) trillions of dollars of bail out (several years of India’s national income) and China has announced a package of Rs.29 lakh crores over two years.

         We continue to announce that we will have 7.1 per cent growth this year and that next year 9 per cent is achievable while everyone else is expecting a worse year. Given our current trends, the government is in a state of denial and that is why it is content to announce packages of Rs.40,000 crores and Rs.20,000 crores. The RBI’s release of liquidity just about compensates for the decline due to fall in foreign exchange reserves. Where is the urgency?

The government claims that it is a vote on account and no new policy measures could be announced with a new government due to take over soon. But the government has been announcing measures outside the budget all the time and given the unprecedented crisis, the like of which we have not seen in our lifetime, expenditures in critical areas could have been boosted and governance tightened up. In 1991, when the Narsimha Rao government took over in the midst of a crisis, it acted undemocratically and in haste, with little time to reflect and the poor had to suffer. A repeat of this is likely.

The non action and denial mode maybe explained by the party’s desire to win the coming elections by projecting a positive image of its performance. Admitting that the situation is grim and acting strongly to prevent it from deteriorating may have been seen as a self goal by the ruling party. Clearly, between the party’s interest and the national interest, the former won hands down. There is another twist in the tale or tail. If the New Economic Policy strategy is admitted to fail, the blame for that would also go to its initiator, the party and the present PM. This may trigger demands for accountability so brazening it out for a few more months is a safer strategy.

arunkumar1000@hotmail.com