The Hindu Business Line : Downward spiral

One company’s cost saving is actually a sales opportunity lost by another. The airline just lost a passenger; the hotel lost a customer for a room night and the poor tourist taxi driver did not earn his wage for the day. And so on.

K. Venugopal

The economy is a peculiar animal. Like a feral horse it can kick you when you least expect it. Till a few months ago, every businessman seemed to have money and spoke of how he was going to make much more. Money was spent without let, and yet everyone seemed to get more of that back as income.

How things have transformed. The spectre of the financial meltdown across the globe is now driving many people and businesses to cut back on their spending.

Cost saving

Let us take the case of a software company in Bangalore which having seen its clients in the US take a somersault is now ultra-cautious about its revenue prospects. Remaining ahead of the curve is always an excellent idea. So it decides to ask its managers to tighten their belts. Travel budgets are the easiest to cut.

So out with 20 per cent of the usual spend. What does that mean for managers? Don’t make the next trip to Delhi to meet the sales staff; do the sermon over the phone. Save not just on the air ticket but on the expenses on the hotel room, and on the taxi bill. The belt is tightened and there is much smug satisfaction in those plush office cabins about how much cost has been saved.

The problem is that the story does not end when those rupees are saved. One company’s cost saving is actually a sales opportunity lost by another. The airline just lost a passenger; the hotel lost a customer for a room night and the poor tourist taxi driver did not earn his wage for the day. The petrol/diesel bunk that serves the taxi lost a part of its day’s business. And so on.

As many more belts tighten, many more airline seats, hotel rooms and taxis stay empty; their owners face erosion in their earnings. They may end up firing their employees soon enough. Some do it with publicity as Jet Airways did (and took so much political flak as to retract); most others do it quietly as some finance companies have done. What is certain is that these employees will now have less money to spend till they find their next job (it is harder to burn up savings). That means fewer cars or two-wheelers sold.

Vehicle manufacturers postpone the investment they had planned in capacity expansion as the risk is perceived too high. Their vendors follow suit. That means producers of factory equipment go without the orders they were hoping for. They drop prices and forsake profits. The vicious cycle accelerates. The economy heads into a recession.

How can this process be stopped in its tracks, and then reversed? Free market logic suggests that prices will drop so much all round as to induce concerted buying again, but then consumers with a diminished income stream seldom can summon the confidence to spend as they would in normal times.

Government intervention

This is when champions of the free market concede that governments need to intervene, using their sovereign power to inject new money into the system.

Franklin Roosevelt famously did that to get the United States out of the Great Depression of the 1930s spending Government money funded by Budget deficits on public works, generating employment and generally putting more purchasing power in the hands of people.

“It is going to cost something to get out of this recession this way, but the profit of getting out of it will pay for the cost several times over,” said Roosevelt in April 1938 during one of his many “fireside chats” over national radio.

The Finance Minister, Mr P. Chidambaram, is going down the same path. He has used the monetary levers to bring down the cost of borrowing; he has also sought to enlarge Government spending with Parliament approving the supplementary demand last month.

It is not just the government employees who are looking forward to the increased wages and the arrears awarded by the Sixth Pay Commission amounting to Rs 21,000 crore that will be paid to government staff in the next few weeks. Hyundai Motors, for instance, has just extended the special finance scheme it opened for government employees in October for one more month in anticipation of the wage bonanza.

It sold 3,000 cars under the scheme last month and hopes it can sell many more once the Government delivers the new pay cheques.

When will consumers in this country once again regain the confidence in their future incomes to dig into their wallets now and buy all the goods and services being produced? And when will the idling factories, trucks and aircraft get to work at full pace again? For now, no one seems to know.

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