Search the Internet          Tips  Sites: Finance, Investment

Economists versus administrators

Sudhir Mulji

One of the most confusing features of economic debates is the considerable disagreement on fundamental policy issues between economists and economic bureaucrats. Two prominent examples will explain the point.

At the recent NCAER (National Council of Applied Economic Research)lecture in New Delhi the deputy governor Y V Reddy skilfully defended and developed the policy of accumulating India's exchange reserves, but it was noticeable that not one economist, either in the audience or among all the expert discussants, could muster up a word of support.

In a parallel situation Tony Blair in Britain has argued that he would be pleased to be remembered in history as the man who took Britain into the Euro, but no economist has so far produced a minimal argument to support this policy.

In both the Indian reserves and the Euro case, each side pursues the same objectives.

All concerned recognise the value of stability for growth. But the administrators believe that stability will come as a result of plenty. It is relevant that Reddy was in charge of finding foreign exchange in 1991 when India was tottering between crisis and bankruptcy.

With scarcely a billion dollars in Reserves the task must have been hair-raising and this goes far to explain his preoccupation with the level of reserves.

To the economist however the issue is not the quantity of reserves but the failure to correct the exchange rate early enough.

It is relevant to note that almost the first action Manmohan Singh took post the 1991 crisis was to devalue the rupee twice so that the exchange rate moved from around Rs 18 to the dollar to Rs 32 to the dollar.

Nor has the devaluation halted since that date. Bimal Jalan to whom the credit goes for building Reserves has been devaluing the rupee surreptiously ever since. It has now moved to Rs 49 to the dollar, perhaps the largest move in any decade of Indian history.

Administrators argue that it is the substantial build-up of reserves that has provided the Indian economy with stability, but it could equally be argued that it is the flexibility of exchange movements that has been responsible for that stability.

In this controversy lies the first analytic disagreement between economists and administrators.

It is textbook economics that price movements adjust imbalances between supply and demand and thereby stabilise markets. There is no need to count the number of shekels in your counting house to ensure steadiness.

So long as prices are allowed to move freely, the exchange market, or for that matter the market for tomatoes, will find equilibrium.

Yet the mere fact that such propositions are textbook economics does not make them acceptable to economic managers. Reddy modified arguments from Keynes's General Theory of Employment, Interest and Money to explain the need for monetary reserves.

He claimed that there were precautionary and speculative motives as well as the normal transaction motive for holding on to reserves.

No one can deny the validity of these motives, particularly the precautionary one, but the fact of the matter is that if the quantity of assets to be held for such purposes were to be carefully calculated it might well come to be concluded that the quantity of the reserves was not justified, and that they are actually quite as much a consequence of coincidence of accidents as of the workings of those three motives.

The real question is not what we should do with the reserves but whether to take the opportunity they provide to scrap absurd regulatory laws like FEMA.

Time is right for us to scrap these war time Acts and for RBI to express its confidence in the Indian economy by making it plain that legislative shields are no longer needed. That such an action may well increase inflows is a separate matter to be considered later.

Thus far we have been discussing attitudes towards India's overblown reserves. Now we must turn the parallel controversy about the question of Britain's joining the Euro.

The common feature of the two controversies is a total absence of economic arguments combined with overwhelming support from politicians, administrators and perhaps even the proverbial man in the street.

There can be no denying that Indians who have for so long scratched around for a dollar or two, must now feel some degree of pride in knowing that foreign exchange is freely available.

In the same way there is perhaps a desire among the English who have for so long been looked upon as the poor of Europe to become part of an institution which will enable them to spend their future wage bill in Germany or France or anywhere else in Europe.

Yet these advantages are neither as dramatic nor as desirable as they are thought to be. The Bihari in Patna and the Mumbaiwalla may earn their wages in the same currency but the prices of goods in Patna and Mumbai may be very different.

To the economist the real flaw of a converged currency, or for that matter converged interest rates, is that it removes flexibility in economic management and adjustment.

The experiment with the Euro will be worth watching for Indians; if the lessons prove positive there are features that we can emulate, for we also have a single currency and inhabit a land as diverse as Europe.

If they prove negative, if the experiment does not succeed, the time will have come to consider building separate currency zones in India.

This is not the first time this suggestion has been made. The normal reaction of the "steel frame" is that such a policy would spell the destruction of India.

But whatever the merit of the steel frame it tends to have a wooden head. It is impossible for them to see that the present state of economic progress in India for our unity is more damaging for it is greater than our diversity allows.

Ultimately that is the danger for Europe; it is romantic to see the single currency as a great unifier, but there is no economic merit in the notion of a single currency.

Indeed it is not an economic idea. Different skills and endowments are perhaps better served by different currencies For historical reasons Britain has developed some unique skills; these are primarily trading abilities in contrast to the industrial and technical skills developed in the Eurozone. Perhaps that could prove to be an English strength.

For this reason economists remain unconvinced that a fixed and bureaucratic regime under the Euro will be remotely in English interests.

A fixed exchange rate and a converged interest rate will deprive England of the flexibility that is so essential for the use of their skills.

Economists understand the value of flexibility. Economic administrators prefer rigidity and certainty. That is the essence of the intellectual dispute between the two groups.

Powered by

ALSO READ:
The Rediff Budget Special
The Rediff-Business Standard Special
Money