The Hindu Business Line : Alternative growth model needed

It was no fault of theirs because credit markets and financial engineering ran amuck and caused a collapse of historic proportions. Not irresponsible governments or central banks.

While the immediate policy responses involve interest rate cuts, boosting liquidity and government spending, the issues are much more serious.

Crisis of capitalism

We are really facing a crisis of capitalism in its present form, revolving around free markets, trade liberalisation and dismantling investment and capital flow barriers.

The Asian crisis, the collapse of the Nobel Prize winners-backed hedge fund, LTCM and the sudden bankruptcy of Enron (considered the poster boys of modern financial markets and the New Economy) in the late nineties and early 2000s, muddied the waters of free market, but not for long.

Wall Street had discovered two money machines: securitisation and credit derivatives.

The first enabled loans to be quickly offloaded to investors, which, in practice, meant the primary lender need not bother about credit quality, while the second offered default protection in securitised loans.

It seemed financial engineers had defied the laws of nature in devising ‘AAA’ rated instruments offering ‘AAA’+ returns and, best of all, complete safety of capital. It all seemed too good to be true and was.

Imbalances

Cheap Chinese goods boosted US imports. But China’s export dollars were not spent.

They were ploughed right back into Treasuries, keeping their yields artificially low and defeating the Fed’s interest rate tightening.

So, real economy imbalances too played a part.

As far as emerging economies are concerned, free capital mobility does accelerate growth through an asset price boom.

The price paid is the heightened risk of an abrupt crash if and when asset prices implode, as has happened now.

Is there an alternative (other than reversion to socialism)?

If it is agreed that the excesses of the financial sector pose systemic risk, ways must be found to curb them. The case for controls on capital flows into financial assets and markets in emerging economies seems compelling because much of the profits stem from simple arbitrage or a wall of foreign money and add no value to the real economy.

Income and wealth inequality increase as the benefits of the created asset boom are cornered by the propertied classes and the less fortunate find even a basic necessity such as housing unaffordable.

More needed

The Government and the RBI have done well to slash interest rates, inject liquidity and announce stimulus measures.

But there is as yet no realisation that our growth path does not lie in aping the consumer societies of the West. Quite simply, the world’s natural resources constrain that.

A viable and sustainable growth model is needed. Are we up to the challenge of thinking differently?

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