IN the foreword, Y.V. Reddy, a former Governor of the Reserve Bank of India, states that the book is “unique in its approach, scope and perspective, and a rich contribution to the burgeoning literature on serious macroeconomics”. Anyone who goes through the volume will find that this is not an overstatement.
The book is a rare combination of sound economic theory and intimate knowledge of the formulation and implementation of economic policies. The authors are highly qualified academics who were also closely associated with policymaking.
Macroeconomics is now a familiar expression even for the general public, but a distinction between macroeconomics and microeconomics may be helpful to understand the argument of the book. Economics, as it was taught in universities for long until about the Great Depression of the 1930s, was about individual decision-makers, households and firms, and it maintained that left to them, and via the coordination of the market, the economy would function well. However, the Depression showed that workers were not able to find jobs at the going wage rate and there was excess capacity in firms.
The Cambridge economist John Maynard Keynes at that time pointed out that the basic problem was inadequacy of aggregate spending in the economy because of the “liquidity preference” of households, and that the solution was for the state to rectify the deficiency through its spending. From then on, macroeconomics, which deals with the role of the state and economic aggregates (growth, savings, investment, money supply, foreign exchange, etc.), has become the basis of economic policies. Developed economies (such as the United States and the United Kingdom) and developing economies (such as India, Indonesia and Brazil) differ in the emphasis on macroeconomic policies, and the book concentrates on the latter but does not exclude the former.
Policymakers consist of three categories of people—policy formulators, policy detailers and technocrats. The policy formulators are political persons (Prime Minister, Finance Minister et al). Policy detailers are competent in economics, statistics, history, philosophy and so on (Chief Economic Adviser, for instance). Technocrats have the responsibility to implement the policy. Of course, these are not exclusive categories. Often, policy formulators are competent enough to spell out some details as well. There have been rare instances of those who have combined all three. The authors belong to the second category, policy detailers, and they maintain that macroeconomic policy is not an exact science but essentially the art of the possible.
“Development” is the essence of macroeconomic policies in emerging and developing economies. However, it is a conveniently vague expression for policy formulators. Even when it is made more specific as “growth” or “growth plus”, for it to be spelt out as a policy statement it will have to be more sharply spelt out, such as “for whom?”.
What the book does is to go into the details of development as a policy objective. It will not be possible to go into all the details, but even a selected treatment will show the magnitude of the problem. For instance, which sector of the economy should get priority, agriculture or industry? And if it is the latter, should it be basic industries or consumer goods industries? Should the economy be a “closed” one, or should it be open to the rest of the world? Should employment generation be considered a special objective?
Or, consider the field of public finance. Gone are the days when it used to be held almost as a commandment that the government must “live within its means” and balance its budget. Deficit budgets have become common as a deliberate policy measure. But how exactly is it to be done? Reduce taxes or increase government spending? And if it is the latter, what are the modalities? If the government increases investment in the economy, will it “crowd in” or “crowd out” private investment?
An increase in public expenditure and aggregate spending may lead to a rise in prices. Is it desirable? Should increase in public expenditure be done by borrowing from the market or from the central bank or from foreign sources? Each of these options will have differential impact on the economy in general and on different sections of the people.
Similar issues will have to be considered when dealing with monetary policy and the role of the central bank. Monetary policy itself has a range of objectives—stability of employment and prices, economic growth, and balance of payments issues in the case of “open” economies. An important policy issue here is the extent to which the central bank should be independent in dealing with these matters. Complete independence can be ruled out because fiscal policies directly under the government also deal with the objectives indicated above.
But the central bank has certain specific responsibilities. Of these, the most important are determination of interest rates, issuance of currency, holding foreign exchange reserves and supervising banks and other financial institutions. Some of these, such as the determination of the interest rate, are periodic, but others are matters to be attended to every day.
The activities of a central bank will have direct and indirect bearing on the broader policy objectives of the country. A question that frequently comes up is the extent of autonomy the central bank should have, and the conclusion of the authors is: “We are of the firm view that cooperation with the government should be the raison d’etre of central banking”—a very reasonable and pragmatic position.
One of the most crucial policy objectives of most countries is dealing with the rest of the world. In the early decades after Independence, economic policy in India aimed to be that of a relatively closed economy, trying to avoid imports and providing a stimulus for industrial development. That position was gradually given up from the early 1980s, and with the reforms of 1991 India threw open its borders to foreign goods and foreign capital.
Today we compete with other countries in providing facilities for foreign capital to come in. We also have a long tradition of people going to other countries to work. In most such instances, they send a part of their earnings to India in the currency of the host countries. Whether it is the movement of goods (imports and exports), the movement of capital or of people, there is one thing in common: transaction between our currency and foreign currencies. The external value of the rupee depends a great deal on such transactions. If import of goods increases, our demand for foreign currencies will increase and thus make them costlier, that is, the rupee will become cheaper. Flow of remittances and of external capital will, on the other hand, strengthen the rupee. Some of these major decisions are not directly under the control of policymakers in India. Policy, therefore, will attempt to keep current account and capital account transactions under control and administer foreign exchange reserves judiciously.
The authors recognise that the major changes taking place in the global economy since the 1980s and the great financial crisis of the first decade of this century have brought to the fore new issues in macroeconomic policies. They have exposed the helplessness of monetary and fiscal policies to deal with such crises.
There has been a sudden and steep increase in the transactions in the financial sector: “The per day global transaction in the foreign exchange market would be U.S.$5 trillion, while the global inflows on account of FDI [foreign direct investment] would be around U.S. $3 trillion annually”; that is, the financial sector has become too big in comparison with the size of the “real” economy, and macroeconomic policies have so far been in the context of the working of the latter, with finance considered to be a facilitator of the real.
Apart from the bulging of the financial sector, the authors recognise a further problem that contributed to the collapse of 2008, that of the proliferation of a variety of new financial institutions, known by the generic name “non-bank financial institutions”, which are outside the reach of the policymaking authorities. They flourished while the going was good, some collapsed later, and others were rescued by the state to avoid total breakdown.
The treatment of the financial sector in the book is in line with the approach the authors had laid out, but there is a significant omission. Many studies by individual scholars and international agencies have documented a huge and rapidly increasing inequality of incomes and wealth along with accelerating financialisation of the economy. But the fact that the growth of finance has made it possible to augment wealth through transactions (buying and selling of claims to wealth) rather than through investment (that is, increase in productive capacity) does not get recognition in the book. Many of the non-bank financial institutions have been facilitators of such activities.
Another manifestation of the phenomenon has been the bloating of the services sector, especially in “emerging economies”, which calls for an inquiry into the nature of rapid growth of GDP (gross domestic product) in such economies.
Hence it is important to consider financialisation as a distinct phase of the evolving capitalist system and to view inequalities not merely as an ethical issue but as having an impact on capital formation, consumption patterns, employment and other macroeconomic aspects. It is to be hoped that in the next edition of the book there will be an examination of this phenomenon and its consequences both in short and long terms.