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Monday, Mar 18, 2002

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James Tobin: An economist with a difference

T. C. A. Ramanujam

JAMES Tobin is no more. A PhD from Harvard, Tobin won the Nobel Prize for Economics in 1981. The award was in recognition of his pioneering work concerning the financial markets and their relation to expenditure decisions, employment, production and prizes. A leading exponent of the Keynesian School, Tobin was famous for his portfolio selection model of liquidity preference in which he postulated that an individual asset holder has a portfolio of money and bonds. Money neither brings any return nor imposes any risks. Bonds yield interest and also earn income. But income from bonds or stocks is uncertain and entails the risk of capital loss. Individuals desiring both high yield and low risk must make a trade-off in deciding their portfolio assets. In short, his advice was `Don't put your eggs in one basket'.

Tobin's views on business cycles were rather unorthodox. He thought stagnation was due to markets not clearing enough and attributed the cause to excess supply. His concern in economics was price stability. He authored the idea of converting the fiscal and productive assets of a company into their replacement cost instead of their original cost.

There has often been a running debate on whether economists have a role in framing government policies. Tobin was one of the foremost economists to have influenced American Economic policy. He was the "intellectual force" behind John F. Kennedy's tax cuts, which started the economic boom of the 1960s. President Kennedy had also invited him to join his Council of Economic Advisors. Tobin hesitated, calling himself "an ivory tower economist". Kennedy replied: "Does not matter, I am an ivory tower President."

Apart from Tobin, Kennedy's Council of Economic Advisors also included such big names as Kenneth Arrow, Robert Solow and Walter Heller. Their report on stabilisation and growth strategies in 1962 heralded the dawn of `New Economics'. He also came up with the theory of Negative Income Tax as a method to achieve the redistribution of income. Never an ardent admirer of the markets, Tobin was all for the active use of fiscal and monetary measures by the government.

In recent years, the late Nobel Laureate's name came into prominence when currency speculation destabilised economies worldwide. Motivated by a desire "to provide Keynesian economics with a more rigorous foundation", Tobin argued that a small tax on speculative currency transfers would curb short term speculation, stabilise currency markets, protect national autonomy and encourage a long-term approach to investment. This was seen as a means of protecting poorer countries.

Even at 0.25 per cent, the Tobin tax would have mobilised $200 billion a year, four times the current levels of assistance to developing countries in aid. As the movement in support of the Tobin initiative expanded in America and Europe, support came from the French and Belgian governments. Canada also backed the idea. However, the UK opposed the proposal and it was shot down by four votes in a 400-member chamber of the European Commission in 2000.

The UNDP in 2001 suggested the implementation of the Tobin Tax proposal to restrain short-term capital outflows. Voices have been heard in India for the introduction of a Tobin Tax on share transactions. Tobin suggested the idea to control cross-border foreign exchange transactions. Anti-globalisation protestors supported the idea en masse. Western democracies have seen the Tobin tax as a price worth paying to gain peace in the increasingly volatile dispute with anti-capitalist demonstrators. However, Tobin maintained that his proposal was meant only to dampen currency speculation and was not to be used as a fiscal tool to role back global free trade.

Tobin was immortalised in Herman Wouk's "The Cain Mutiny" as a "midship man with a mind like a sponge, and ahead of the field by a spacious percentage".

He was against tax cuts to boost a sagging economy. The current situation, he told Paul Krugman a few days before his demise, called for more domestic spending and not more tax cuts. Is Tobin's brand of economics relevant to Indian conditions? Yes and no. The focus of Indian investors and foreign investment need to be changed.

Policy changes can help change this focus — a small Tobin Tax would discourage `speculative' transactions in the secondary market, provided the tax is levied only on `secondary' market transactions. (Instead, the Government is even encouraging trade in `derivatives', which amounts to speculation.) It is undeniable that India escaped the consequences of disastrous free convertibility only after witnessing the devastation in East Asian economies that did not heed the advice of such economists as Tobin.

Mr Paul Krugman wrote in the New York Times last week: "Tobin was one of those economic theorists whose influence reaches so far that many people who have never heard of him are nonetheless his disciples."

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