The need of the hour is the injection of demand through direct fiscal action by governments across the world.
The current world economic crisis is perceived almost exclusively as a sequel to the collapse of the housing bubble in the United States. This certainly has been its immediate provocation, but an important structural factor underlying it must not be overlooked: the stimulus for booms in contemporary capitalism has come increasingly from such bubbles. The U.S. whose size and strength make it, in the current regime of trade liberalisation, the main determinant of the pace of expansion of the world economy, has increasingly come to rely on such bubbles to initiate and sustain booms.
John Maynard Keynes, writing during the Great Depression, had suggested an alternative stimulus, namely, a comprehensive “socialisation” of investment, whereby the state acting on behalf of society always ensured a level of investment in the economy, and hence a level of aggregate demand, that was adequate for full employment. This entailed not only a jettisoning of the free market system in favour of state intervention, but also restraints on the free global mobility of finance, since meaningful state intervention could not be undertaken if the nation-state faced internationally-mobile capital. “Let finance be primarily national,” he had said.
The Keynesian stimulus was adopted in the post-war period, during what has been called the “Golden Age of Capitalism.” But the process of globalisation, involving above all the globalisation of finance, which began during the period of Keynesian demand management itself, put an end to that stimulus, and removed a host of regulatory measures that characterised the Keynesian regime. Boosts to aggregate demand now come increasingly from the stimulation of private expenditure, associated with the creation of bubbles in asset prices, rather than from an adjustment of public expenditure within the context of reasonably stable asset prices. Not surprisingly, the frequency of financial crises, associated with the bursting of these bubbles, has increased greatly after 1973. The current crisis underscores the need for a new stimulus. Till now, governments have only injected liquidity into the system for stemming the crisis. They initially planned to do so by purchasing “toxic” securities, but eventually had to inject liquidity against equity, through part-nationalisation of financial institutions.
But such injection is not enough. Credit does not start flowing simply because banks can access more liquidity; there has to be adequate demand for credit for viable projects by solvent borrowers. This is absent. Since the injection of liquidity does not improve the solvency of firms saddled with “toxic” securities, the risk associated with lending to them remains prohibitively high. Besides, the anticipation of a recession makes borrowers chary of borrowing and lenders chary of lending.
This anticipation derives from several factors. The bursting of one bubble is not necessarily succeeded by the immediate formation of another. Moreover, the very scale of the current financial crisis gives rise to an anticipation of a prolonged recession. Finally, since the recession has already started, the prospects of crisis-prevention now through the usual monetary instruments (including liquidity injection) appear distinctly dim. The mutually reinforcing tendencies, of increased liquidity preference on the part of private individuals and institutions, and of the real economy sliding downwards, have already started, and will continue, unless governments now act to inject demand into the economy directly.
The third world countries will not escape the effects of this crisis. Many of them whose financial systems are still not sufficiently “opened up” will escape the direct impact of the world financial crisis, but they certainly will have to face the impact of the recession of the real economy. Their export earnings, both merchandise and invisibles, will be hit, causing unemployment and output contraction on the one hand, and foreign exchange crisis, exchange rate depreciation and accentuated inflation on the other. (The latter will be aggravated by the outflow of speculative capital that had come in earlier to the “newly emerging markets” under the aegis of Foreign Institutional Investors).
Two areas are of special concern here. One is the inevitable decline in the terms of trade for primary commodities that will occur in a recession, which will push cash-crop growing peasants into even greater distress. The other is the loss of food security over much of the third world that will inevitably occur.
The loss of food security will occur for several reasons: first, the loss of foreign exchange earnings owing to the decline in exports and in the terms of trade will cause a decline in foodgrain availability in food-importing countries. Secondly, even if food availability is somehow maintained, the decline in the incomes of exporting peasants, small producers and the unemployed will mean inadequate purchasing power in their hands to buy necessary food. And thirdly, if the terms of trade of non-food primary commodities decline relative to food, as has been happening, then both the above problems will be greatly aggravated.
There is a tragic irony here. The booms fed by asset price bubbles not only did not benefit the large mass of peasants, petty producers, agricultural labourers, craftsmen, and industrial workers in the third world, but were actually accompanied by an absolute deterioration in their living standards. This happened not despite the boom but because of it. With the interlinking of global financial markets, asset price booms in the U.S. tended to produce stock market booms, and more generally financial sector booms, even in third world countries, where banks and other financial institutions withdrew from productive sector lending to speculative lending, from rural lending to urban lending, and from agriculture and small-scale sector lending to consumer credit to the affluent, and loans against securities. This damaged the productive base of the peasant and small-scale sector. Secondly, the changed role of the state in the new dispensation where it was more concerned with supporting the financial sector boom than with sustaining peasant and petty production, entailed a withdrawal of state support from the latter sector: input subsidies, the price support system, essential public investment, and state spending on rural infrastructure and on social sectors were all drastically curtailed, to the detriment of the entire small producer economy.
Between 1980-85 and 2000-05 the per capita cereal output in the world declined absolutely by 8 per cent, which also meant an absolute decline in per capita world cereal consumption. But since, taking both direct and indirect consumption into account, the advanced countries witnessed an increase, the decline was particularly sharp in the third world. Even China and India which experienced remarkably high GDP growth rates, did not escape this trend.
Paradoxically, this decline was not accompanied by any rise in relative cereal prices. In fact between these two years the terms of trade of cereals vis-À-vis manufacturing in the world economy declined by nearly 40 per cent, which suggests that the squeeze on the purchasing power of the masses in the third world was even greater. The other side of the speculative boom therefore was a drastic squeeze on the living standards of the masses, especially in the third world (which is why describing the U.S. as the “locomotive” of the world economy is so inapposite: this locomotive while pulling some coaches, pushed back some others). But even though the third world masses suffered from the effects of the speculative boom, they would also suffer additionally from the effects of its collapse.
The need of the hour is the injection of demand through direct fiscal action by governments across the world. For activating governments for this, two conditions have to be satisfied. The first is control over cross-border financial flows, for otherwise governments will continue to remain prisoners to the caprices of globally-mobile speculative finance capital. The second is the setting up of an international financial facility, operated on principles different from the Bretton Woods Institutions, which not only makes concessional finance available to developing economies, but also enables them to substitute long-term loans for their current short-term borrowing.
The general objective of larger government spending must be the reversal of the squeeze on the living standards of the people everywhere. In India, China and other third world countries, however, in addition to welfare state measures, larger government expenditure has to be oriented towards a substantial increase in agricultural, especially foodgrains, output.
In short, the new paradigm must entail inter alia a foodgrain-led growth strategy (on the basis of peasant, not corporate, agriculture), sustained through larger government spending, which simultaneously rids the world of both depression and financial and food crises. The trade and financial arrangements of the world economy have to be oriented towards achieving this end.
(Based on a presentation by Professor Patnaik at the United Nations General Assembly on October 30 as a member of the Interactive Panel of the UNGA on the Global Financial Crisis.)
6 months ago