Column

Is the worst over for the world economy? Or for India? The US Federal Reserve chairman Ben Bernanke announced two months ago that he had seen “green shoots” of recovery. The shoots included a skimpy recovery in consumer spending, and a reduction in the speed with which home sales were falling.

That, plus the fact that Chinese growth has picked up, gave the market enough reason for a rally. Many stock analysts, in fact, announced the start of a new bull market. In India, a political development — the massive win of the Congress-led UPA — has emboldened bulls to jump over the moon. Many research reports — from UBS, Macquarie Bank and Barclays Capital — have talked of an economic recovery in the second half of this financial year, timed beautifully for the government to claim credit for the same.

Wish things were that simple. If central bankers, finance ministers, economists and market analysts were that good at predicting the future, we would not be in the current economic mess. Barring a few economists — who, too, may have just been lucky with their predictions — almost nobody had any idea of how quickly the world economy would crumble in less than six months.

For much of 2008, former finance minister P Chidambaram was claiming that India’s economic fundamentals were sound when inflation was soaring in the first half of the year. Then, suddenly, as the world economy collapsed, we saw headline inflation fall equally dramatically. Given the complex nature of the global economy, it is highly unlikely that governments and central bankers actually know how to manage the economy.

Alan Greenspan, once lionised as the best central banker ever, turned out to be completely wrong on his assessments of the risks from new-fangled financial instruments. He is now widely criticised for letting the markets boom when he should have raised interest rates. The previous US treasury secretary, Hank Paulson, probably did the right thing when he allowed Lehman Brothers to go belly up last September — for the wrong reasons. He wanted to send the message that the US financial system was strong enough to weather a few bankruptcies.

What he ended up achieving was upending the whole financial system. He tipped the world economy from slowdown to wholesale recession. However, he cannot be blamed for that. If he hadn’t allowed Lehman to go bust, the pretense that everything was all right with the financial sector would have continued for some more time, making things worse.

What I am driving at is this: governments can try to fix things, finance ministers can tinker with incentives and penalties to get people to behave in a certain way, but ultimately there is no certainty that the medicine will cure. This is because economies, like markets, are driven by the same manic-depressive emotions that drive stockmarkets — though in a less obvious way. In a stockmarket, when the sentiment is down, even good stocks go abegging; when the mood is buoyant, even penny stocks soar.

The same thing happens with economies. Till about a year ago, nobody was willing to believe that we were in the midst of an economic crisis. Then suddenly, Lehman Brothers happened and everyone cut back on everything: banks refused to lend, people stopped spending, companies stopped hiring, employees saw emoluments falling, exacerbating the downward spiral. This is the reason why all governments have had to spend like crazy to avoid a repeat of the miseries of the Great Depression.

But will excessive government spending alone do the trick? It may stave off a collapse, but stores up trouble for the future. The huge amounts of cash pumped into the global economy could — when growth resumes — bring huge inflation, forcing governments to again stamp on money supplies and raise interest rates. It is worth recalling that the Great Depression was cured not only because of huge government spending, but a gradual improvement in the health of the economy over several years. Just as excessive eating can be cured only with some amount of fasting, the global economy will have to tighten its belt till it can cure itself of past excesses.

In short, governments can ease the pain here and there, but ultimately the economy will have to set itself right. US consumers will have to become savers instead of spenders, the Chinese will have to become spenders rather than savers, the dollar will have to come down to reasonable values, and Europe will have to become more competitive before the world stabilises itself.

As for our own Reserve Bank, it should do nothing. Trying to cut interest rates any further is foolish when banks will anyway not lend much to risky consumers. Cutting rates is no longer useful. Rather, it will deter savers. The best thing the RBI can do is to allow banks to find good customers the old-fashioned way: slowly and surely. Forcing them to lend will only lead to a shaky banking system.

The government should focus more on improving the efficiency of spending instead of just throwing money at the problem. We don’t need another broad-brush stimulus package or unfocused infrastructure spending. It is high time central bankers and governments realised that they are not god. They are risk-managers, and they should stick to sensible policies, and leave it to the people to do the rest.