Reflections on the global economic crisis

The hindu Mar 9 2009

A terrible recession is sweeping the world, playing havoc with the lives of millions of people. Each day comes news of job cuts, decline in consumer spending, and the downward trend of the stock market. All sorts of explanations and cures are being offered. Some say it is due to greed. Others blame sub prime mortgages, hedge funds, derivatives, monetary policy, or interest rates. To my mind, these are superficial explanations.



An economic recession is a feature of an industrial, not agrarian, economy. In agrarian economies, too, there were such catastrophes, but these were due to natural calamities such as drought, flood, and epidemics. An economic recession is a feature peculiar to industrial economies.


There have been recessions every eight or ten years since the 18th century Industrial Revolution but recoveries followed shortly. There was, however, one Great Depression, which lasted from 1929 to 1939. It was ended only by the Second World War, which claimed 50 million lives. The War generated massive demand for armaments, supplies to armies and affected civilian populations, and capital for reconstruction.


We now witness a Second Great Depression, and its sweep is wider than that of the 1929 Depression. While the latter affected mainly America and Europe, the present crisis affects the whole world.


The principal cause of an economic recession is the lack of sales, which in turn is due to the lack of purchasing power among the masses. There are other causes, but these are incidental. A large part of the world’s population is so poor that it hardly has any purchasing power. Even the developed countries have many poor people.


As the industrial economy develops, industries tend to become larger and more capital-intensive. This is necessary for them to face the competition in the market, otherwise their rivals will do it and drive them out of the market, by underselling them. The process is inevitable in most industries, but it leads to large-scale unemployment, since many workers in a labour intensive industry are laid off when it becomes capital intensive.


Now the worker, apart from being a producer, is also a consumer. A worker in a steel factory does not consume steel, but he and his family consume food, clothes, shoes, and so on. When he loses his job, his purchasing power is drastically hit. When large-scale unemployment occurs (because industries increasingly become more capital intensive) the market correspondingly contracts. While production increases, sales decrease and this leads to a recession.


Thus the very dynamic of an unregulated industrial economy is that by the inevitable process of its growth, it keeps destroying its market. The goods produced have to be sold. But how can they be sold when people have lost their purchasing power owing to unemployment?


Mass production must be accompanied by mass consumption. By taking purchasing power out of the hands of mass consumers, industrialists deny themselves demand for their products that would justify reinvestment of their capital accumulation in new plants – which would also provide employment. Thus while productive capacity keeps rising, demand contracts until the system self-destructs.


Before the Great Depression, large-scale employment was generated by a high level of debt in the form of mortgage debts and so on. The same happened recently. But this cannot continue endlessly. A time comes when people cannot repay their debts because of unemployment or a cut in real wages. Then debtors curtail their consumption, which reduces demand, and the producing units have to close down or cut production.


In modern economies, most businesses require loans for their normal operation. Banks retain a fraction of their deposits (5 per cent or less) and give out the rest as loans. When the banking sector does not work properly because of defaults by borrowers, businesses do not easily get loans. They then curtail production and lay off workers. Consequently, they require less raw material and other supplies. Hence their suppliers reduce their output and lay off workers. The same then happens to the suppliers of these suppliers, etc. In other words, a chain reaction sets in (known as the multiplier effect in economic theory).


If manufacturers cannot sell, they cannot generate enough revenue to repay loans. The business goes bankrupt and the bank finds in its hand non-performing assets. Hence banks want to lend less. This becomes a vicious cycle. Depositors panic because some banks would have collapsed. They withdraw their money, and more banks collapse.


The economic recession is thus caused by the reduction of purchasing power among the masses, which is due to the very dynamics of unregulated growth. Productive capacity has been enhanced enormously, but the majority of people are too poor to be able to buy.


The problem, therefore, does not relate to increasing production, but increasing the purchasing power of the masses. Production can be increased several times because there are tens of thousands of engineers, technicians, and so on, and there are immense reserves of raw materials in India. But the goods produced have to be sold. How can they be sold when the people are poor or unemployed and have very little purchasing power?


The problem is also not how to increase demand. The demand is there but people do not have the money to purchase goods. In India, for instance, 70 per cent of the people live on incomes of Rs. 20 a day. This is not sufficient even to buy necessities such as food or medicines, not to speak of durable goods.


The solution to the economic crisis lies in raising the purchasing power of the masses. How this is to be done requires a great deal of thinking and discussion, and all serious thinkers must address this problem facing India, and the world.


To my mind, one of the methods to resolve the economic recession is to reduce taxes drastically. The purpose of imposing taxes is to generate revenue for the state so that it can perform its functions. If rates are reduced, the prices of goods will go down and people can buy more. In other words, by reducing taxes we increase purchasing power. That will be an important step to resolve the crisis.


No doubt the government needs tax revenues. However, that revenue should not exceed what is genuinely required. There is a lot of waste of public funds owing to mismanagement, corruption, and so on, because of which the Government expenditure gets grossly inflated. Wastage of public funds should stop, which means stamping out corruption, mismanagement and wastage. This calls for strict accounting of public funds and vigilance by the public, including professionals.


In a country like India with its immense poverty and income disparities, the current tax rates seem inequitable and unjust. The maximum rate of 30 per cent for all income over Rs. 5 lakh needs to be reviewed, and a more realistic sliding scale of income introduced for those in higher income groups. It is absurd that the income tax rate for a person making Rs. 5 lakh or Rs. 100 crore a year is the same.


On top of this, those who play the financial markets are not required to pay any taxes on long-term (12-month) capital gains or on dividends, making the Indian financial market perhaps the most tax-free in the world. Even for short-term gains, unique tax exemption vehicles (via Mauritius and so on) have been ingeniously evolved. It is rules and regulations like this, specially crafted for the rich and affluent, which are increasing income disparities.


The Indian situation is that while we have increased the number of billionaires, the poor have become poorer and even the middle class is finding it difficult to make ends meet because of rising prices. This could lead to widespread social turmoil and social disturbances. It is unfair to the vast masses of our people and it will not be tolerated much longer.


Society owes subsistence to all its citizens either by enabling them to work on a reasonable wage, or ensuring a livelihood to those unable to work. The great French thinker Jean-Jacques Rousseau observed in his Discourse on Inequality: “Nothing can be farther from the law of nature, however we define it, than that… a handful of people be gorged with luxuries while the starving multitude lacks the necessities of life.”


In Maharashtra, hundreds of thousands of farmers have committed suicide and are still doing so, while one industrialist is reported to have built a 40-storey building for his residence. This state of affairs cannot continue much longer.


Unfortunately, most people are silent about this terrible plight of our people. Those who should be speaking out are mostly beneficiaries of the present system and hence do not want to disturb it. This is the time for patriotic intellectuals to break the pattern and speak out. They must study economic theory and read the books of economists such as Adam Smith, Ricardo, Marx, and Keynes, or at least some commentaries on them. This will enable them to better understand the economic crisis, so that they can propose measures to alleviate it.