India's Reform Debate: Missing the point

India is marking 20 years of globalisation, and the simultaneous backward-looking outpourings of self-congratulation and angst have reminded me of a Japanese film called Rashomon . It talked about how truth has different versions even when told by witnesses. Each version in the film, while broadly agreeing with the other, contradicts it in some small way, casting enough doubt to prevent a firm agreement.

The Indian discourse on globalisation has been something like that tale because each hold-forther — or should it be holder-forth? — has held forth uni-dimensionally. So economists have talked about globalisation as if only growth and distribution matter.

Sociologists have talked about it in their peculiar argot. Historians have sought lessons from the past and come to overly cheerful or overly glum conclusions. Political scientists have spoken through clenched teeth about the state, sovereignty and the Treaty of Westphalia. Academics from law and scientists have ignored it; and politicians have said whatever nonsense comes into their mind at that moment.

Define and be done

But no one has defined it even though, in the current context, globalisation has meant only one thing: The export of capital by the rich countries to poor ones while forbidding the import of labour from them.

Whether this is a good thing or a bad thing depends on how you view the world — as a victim or a go-getter. In the event, the debate has become a free-for-all, and the semi-literacy of most NGOs has only added to the confusion.

I see no reason why I should not add to it, so here are two points I wish to put forth. One relates to exceptional periods in history, such as the 20th century; the other relates to how economic theory has dealt with the key issue that globalisation has exposed like a nerve in a rotting tooth: An excess supply of labour and capital both.

Exceptions

Until the end of the First World War in 1918, the world had been globalised in the real sense of the word — there were no restrictions on the free flow of capital and labour. The devastation caused by that War led to the different empires imposing capital controls of one sort or another to trap domestic savings within their borders so that growth could return quickly.

But trapping savings within large geographical areas represented by empires is one thing and trapping them within much smaller nation-states is quite another. What with this and that, by 1990, the world began to return to one part of the old normal: Free capital flows. But this time, thanks to the nation-state thing, which requires governments to preserve domestic jobs, labour flows could not be resumed. So, what we have is the biggest challenge to macroeconomic theory since the Great Depression. Specifically, the issue is this: How does the world minimise the imperatives of fragmented jurisdictions. This is what the G-20 is trying to tackle.

The Big Question

For this, the theory problem must be tackled first. If the Keynesian identity is accepted as an accurate depicter of the way the macro variables interact with each other; if business cycles are accepted as natural; and if random crises are an unpleasant fact of life, it is really the role of governments that becomes critical.

In that sense, Keynes remains intact but only in that one sense because, remember, neither did Keynes see a role for governments in saving banks from their follies nor was he a product of a world that comprised fragmented sovereign jurisdictions. The latter is the reason why governments are trying so hard to “coordinate” their policies and keep running into the Mexican Standoff problem. The crises in the EU and the US are a result of this.

India's rope trick

The benefits, or otherwise, of globalisation for India perhaps need to be analysed in this theoretical context, rather than the purely empirical one of supply responses. It would be wrong to minimise either the importance or the value of the latter because the objective of reform was an upward shift of the aggregate supply curve, and globalisation has been an important instrument in achieving that lift.

However, this only addresses the savings/investment problem in the Keynesian identity. What of Government?

That government expenditure has to act as the balancer to make up for movements in savings and investment is not in doubt.

But should it also help with the main target of the Keynesian solution, the consumption portion of aggregate demand, which is the other key variable in the identity?

This is what India is trying through its policies of subsidies and income support and it is very costly, not just in fiscal terms but also in terms of investment that does not come forth to help improve supply.

This, I know, is the old crowding out theory but I doubt if Keynes had reckoned with the marginal propensity of politicians to consume votes. Net-net, the time has come for some future Nobel aspirant to build in small sovereign jurisdictions into standard Keynesian theory to suggest a properly balanced role for G.

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