Market, Regulations and Finance: Global Meltdown and the Indian Economy edited by Ratan Khasnabis and Indrani Chakraborty; New Delhi and New York: Springer India, India Studies in Business and Economics, 2014; pp 266, price not indicated.
This is a book of articles on finance and the macroeconomy of India after the global financial crisis, written by those who have a perspective that the editors broadly describe as having a commonality with post-Keynesians. To me the essence of this approach is to stress that in a monetary production economy, the level of economic activity is set by the level of effective demand and that this is usually not consistent with full employment. The capitalist system based on free market principles is, in this view, inherently cyclical and unstable.
Indeed, the first article in the book on an Indian perspective on monetary policy by Dilip Nachane argues that since financial markets in India are far from efficient, an excessive reliance on market discipline of financial institutions, emphasised as one of the three pillars by Basel II, is of limited value. This well-argued chapter makes a case for deposit insurance premia that are risk-based rather than flat-rate, and the introduction of mandatory subordinated debt in bank capital requirements so as to restrain risk-taking by banks. There is also a case made out for monetary policy targeting asset prices, as a central bank should not be a bystander whilst an asset boom is in progress and a Good Samaritan once the boom goes bust. Whilst stated starkly, in operational terms this leads to conflicts between the objectives of monetary policy.
The difficulty for a central banker is in identifying an asset price bubble which would require better information than is available to the markets, and then after that the central banker has the added task of disinflating the asset bubble while avoiding the business cycle side effects. Rather than assign this task to monetary policy it may be more appropriate to deal with asset bubbles as part of macroprudential policies with measures such as reserves, margins, and credit limits. Two committees in India recommended divesting the Reserve Bank of India of its bank supervision responsibility as this conflicts with monetary policy. Nachane takes a more nuanced view that access to bank-specific information enhances the efficiency of monetary policy, especially as India is a bank-dominated financial system.
Reflection on the Crisis
The articles by Subir Gokarn and Pronab Sen are reflections on the crisis. Gokarn identifies the lessons that the crisis had for monetary policy—the link between monetary policy and inflation—especially when asset prices can amplify the business cycle, the space for unconventional tools such as quantitative easing, and the importance of communication and managing expectations. Amongst the important lessons for corporate governance that he stresses is the impact of large bonuses to employees for delivering large profits which incentivised inordinate risk-taking. Finally, his remarks focus on how bankruptcies in one jurisdiction quickly spread to other parts of the world and dent policy autonomy. The paradigm shifts he focuses on are the introduction of the goal of financial stability for monetary policy, the adoption of macroprudential regulation, and compensation that contributes to profit without increasing risk. The recognition that countries can use capital controls to dampen currency volatility and get a hold back on steering their monetary policy is also identified as a paradigm shift of globalisation.
Pronab Sen argues that three things stand in India’s way of achieving high growth by relying on investment. First, the crisis caused an adverse shock to the savings of the corporate sector and of the government. He stresses the need to reduce revenue deficits so that the pace of infrastructure development can be stepped up. Second, an important cause of growth is entrepreneurial talent which requires skill development, especially in the SME (small and medium enterprise) sector. There is also a need for efficiency improvements through innovations that are possible through incubation centres on larger scales so as to have an economy-wide impact.
Finally, important interventions for fostering inclusion such as the Mahatma Gandhi National Rural Employment Guarantee Scheme (MGNREGS) are important as, apart from their attention to needs, they also provide support to greater risk-taking activities. With the demise of development financial institutions and given that India is severely under-banked there is a lack of risk assessment and project appraisal skills in the banks, making them more vulnerable, and also a reduction in funds available for working capital, especially of small business enterprises. He accordingly advocates banks issuing bonds in the market to provide for term loans and corporates being encouraged to raise long-term funds in the market.
Partha Ray’s paper on recent global commodity prices is the first empirical paper in the book. He estimates a VAR (vector auto-regression) model to examine whether the movement in global commodity prices is due to increased global demand for commodities, primarily from emerging economies such as China and India, speculation in commodities markets, or, the presence of global liquidity due to the pursuit of expansionary monetary policy by the advanced economies.
He points out that government support for ethanol production and the extremely large increase in commodity derivatives in recent years has a direct role in global food price increases. He shows convincingly that an increase in global stock prices, either because it has wealth effects or enables more risk-taking, boosts commodity prices. Stock prices and low global interest rates explain a very large—35% of commodity price—variance. Thus lax monetary policy and speculation together have influenced global commodity prices. It implies an increased requirement for policymakers to pay attention to global spillovers.
Fiscal Consolidation, Inflation Targeting
Pinaki Chakraborty argues that India’s fiscal reform outcome is due to the revenue buoyancy of both the centre and the states. He finds that per capita revenues have a positive relationship with development spending and a fiscal responsibility act dummy though not significant has a positive and significant impact on development spending once the per capita revenue variable is dropped in the estimation exercise. He interprets this to mean that fiscal consolidation was due to revenue buoyancy. However, a single regression equation cannot take care of the reverse causation that exists. It is well known that state development expenditure is an important determinant of the state GDP which in turn determines the revenues that accrue to government. Hence it is possible to argue that fiscal reform outcomes were due to sensible government expenditures rather than revenue buoyancy.
Rohit Azad and Anupam Das argue that inflation targeting is not likely to work in developing countries as a decline in capacity utilisation does not affect the rate of inflation in such countries unlike that emphasised by the New Keynesian Phillips Curve. They argue that there is an absence of workers’ bargaining power due to a reserve army of labour and so at best they can achieve a constant real wage. A constant real wage is actually strong bargaining power and not its absence. In an economy where there are unorganised workers who do not have bargaining power, such workers face an income deflation in the face of inflation whereas organised workers who at best are a fraction of the workforce would be able to negotiate a constant real wage. They put forth an ad hoc approach to pricing power where below a certain limit of capacity utilisation there is price cutting and above an upper limit there is collusion.
Such a specification requires more justification rather than a statement of assertion. The empirics are also ad hoc as such pricing power regimes are assumed to be smooth 1% jumps below or above the normal or potential output levels. For India then they find, for instance, that the regime is one of weak pricing power. However, what they find in the data could well arise because a central bank did not raise the policy rate enough in response to an increase in inflation—in India, for instance, for six years since 2007 the real policy rate was negative. In such a scenario the relationship between real output and inflation would appear to be weak whereas in reality that is not the case.
Parthapratim Pal and Atulan Guha use the Cambridge Alphametrics Model to understand the impact of a Republican policy of reduced government with larger emphasis on private sector initiatives versus a Democratic policy of increased fiscal spending and protectionist trade policies. They argue that Democratic policy works best for the US because it increases employment due to the investment/GDP ratio increasing to about 18% of GDP. These results are arrived at through the assumptions made which are biased. In the Republican policy, the investment/GDP ratio was marginally higher at 20% but it is claimed that this is tenuous because it will be associated with a credit boom that has the conditions of a financial crisis. In the Democratic policy, when there is an increase in the current account deficit due to government spending they assume there will be a protectionist policy response whilst in the Republican there is no scope given to a policy response to the credit boom. This asymmetry in modelling delivers the results that are preferred.
Subhanil Chowdhury takes up the important issue of why employment in India has not kept pace with growth and why most workers in India are in the informal sector. He argues that the high growth rate of consumption of the top decile of the population has led to an increase in the growth of durable goods and services. The rich being imitative of the lifestyles of the advanced world has resulted in the introduction of innovations from there into our economy, the productivity of which is at a faster pace than the growth of GDP, thus displacing labour. Though inequality has grown, it is a stretch to relate the consumption pattern of the rich to employment outcomes.
The Great Recession of 2008 was not accompanied by a reduction in consumption of the rich to the extent of the reduction in output as such individuals drew down their assets (or increased liabilities) to finance established consumption patterns—thus consumption propensities were high as reported by the author. As the economy’s prospects improve the rich would build up their assets again and the incremental consumption propensity would tend towards the average consumption propensity. Moreover the increased productivity in the economy is not due to high net worth individuals’ consumption patterns but rather due to the reorganisation effect of upgrading production in response to liberalisation and the heat of competition. This raised the demand for skills that are complementary with new technologies and a substitution of regular with casual employment as the technology made many jobs routinised.
Indrani Chakraborty studies the profitability of group-affiliated firms against stand-alone firms and asks how corporate savings has influenced profitability since 2002. In the CMIE database used by the author there was substantial entry of new firms in the early 1990s to the extent of a doubling of the number of firms in the database. Thus studying the decade of the 1990s along with the 2000s would have been useful. Since 2001 the author finds that the share of stand-alone firms has decreased, though they are still dominant at 57% of firms. The author finds that group affiliation is not beneficial in that firm profitability would have been higher if the pre-2002 capital structure had been maintained. One wonders if the result would hold if instead of annual data four or five year averages of the data on profits were taken so that firm ability to maintain profits over longer periods could be understood.
Kaushik Bhattacharya studies price deviations across regions in India for rice, sugar, washing soap, and kerosene. He finds that price deviations are highly persistent. Higher order lags could have been estimated as the coefficient of the one period lag is close to unity. Nevertheless it demonstrates that local factors such as local taxes or entry barriers are important determinants of price deviations across regions.
Surajit Mazumdar asks why India’s industrialisation effort has faltered and why has its growth been about construction and services. He looks at the interaction of capital flows and a low-wage economy where the demand constraint has not been faced by services and construction. The narrow spread of the benefits of growth is argued to be detrimental to industrial growth.
Finally Surajit Das, Sukanya Bose, and N R Bhanumurthy examine three main channels—the import channel, the price channel, and the fiscal channel—to understand the implications of international oil price shocks during the Twelfth Five Year Plan. Their demand side structural macroeconometric model shows that the greater the pass-through of international oil prices in the economy and the lower the government subsidy, the lower is economic growth through the standard multiplier effect on the economy. They accordingly argue that any reduction in oil subsidy should be offset by an increase in capital expenditure. This result arises because there is no supply side in the model in the spirit of post-Keynesian economics. In a more general set-up a reduction in the subsidy and deficit would reduce crowding out and the cost of credit and improve investment expenditure and potential output, thereby offsetting some of the negative implications.
What is true of demand models in the short run is not necessarily true as time runs its course. That said this is a book which provokes and raises a number of issues that researchers and policymakers will be grappling with for a long time to come.
