‘Inflation isn't bad... keeps labour demand up’
Cutting interest rates will hardly help revive the massive demand deficit in the economy, claims ABHIJIT BANERJEE, the co-winner of the Sveriges Riksbank Prize in Economic Sciences — popularly, the Nobel Prize in Economics — this year, along with Esther Duflo and Michael Kremer. In India to promote his book, Good Economics for Hard Times: Better Answers to Our Biggest Problems — co-authored with Duflo, to whom he is married — Banerjee spoke to Rajesh Kumar about concerns of global and Indian economy. Edited excerpts:
We are in a situation where global growth is slowing and policymakers don’t seem to have too many tools to reverse it. Will it get worse?
Some of this is self-inflicted. Right now, the US is kind of breaking every rule of international conduct and if he (President Donald Trump) wins, it is going to get worse. If he doesn’t win, some of the stuff against Chinese technology companies will continue because they are actually politically popular. But, on the trade war, we might be better off and that’s going to help. There is slowdown that is already happening — the Chinese economy is slowing. The US grew extremely fast for a couple of years; it is going to slow automatically. So, that to me is already predicted. Now on top of that, whether we will see further slowing depends a bit on the US elections.
In the Indian context, at one point, with reforms such as the goods and services tax, the Insolvency and Bankruptcy Code, and an inflation-targeting framework, it looked like India was going in the right direction. What, in your opinion, went wrong?
I never thought inflation targeting at that level of inflation was a good idea. I have always been an opponent of it. We benefited a lot from inflation in a way, to keep the economy lubricated and growing. Given that we have downward-sticky prices, I feel inflation is not a bad thing, as it kind of keeps the labour demand up. Given that the wages don’t fall, you have to do something to make the real wages flexible.
We had very low real interest rates. Now, we have much higher interest rates and that is a big problem. Now that we are in a kind of a demand deficit, it is harder to revive anything by cutting interest rates a little bit. My view is that with inflation targeting, the pressure on support prices has something to do with demand slowdown.
But are agriculture prices not linked to global prices, which have been weak in the last few years?
That is probably right, but we also happily ban exports… look at the terms of trade. You can take out global trends, you will still find terms of trade effect against Indian agriculture. The global effect is a small part of that.
You have said India is facing a demand deficit. India is running an actual Budget deficit of close to 10 per cent of gross domestic product (GDP). If there is still demand deficit, it can be argued that the problem is much deeper.
It may well be a deeper problem, but that was not
the point I was making. You had this large and growing deficit for a long time, partly in effect because the economy was otherwise slowing.
The government sector has been the one happy spot in the economy. So I don’t disagree, and the deficit has grown, in part as a response to that.
Nonetheless, there is a monetary side to this. The real interest rates have gone up a lot and the real interest rates are a key player… so there seems to be a monetary element in the story, and that seems to be important in also the government’s ability to borrow. If fact, for a long time, we had a large deficit and the debt-to-gdp ratio was falling. And that is a great situation to be in.
You have supported the idea of raising the income-tax (I-T) rate for the super-rich, but history shows that higher rates lead to more evasion.
We have had a history. On the other hand, I think we are getting better and better at collecting. We should not assume that the leakage will be constant. We are getting better. The information systems are better. We can’t live with the tax-to-gdp ratio that we have, we know that. That’s the point you made about 10 per cent deficit. You can tweak things, but you are not going to get 10 per cent back. We need taxes.
The credibility of economists was dented significantly after the financial crisis and the problem still continues. Do you think the kind of work that you have done with the randomised controlled trials will help restore some credibility for the profession?
More importantly, people want economists to also pronounce on other things. I think we should expose our ignorance and say this is what we know… and explain why it is difficult to predict things. Try to say that given the circumstance, here are some of the problems we identify and say these are probably the things that can be done, but we don’t know if it will get you the exact desired result.
In your book, you have said that every economics student learns that there are large aggregate gains from trade. But you have raised some questions as well. What would be your advice to the government as it is about to sign a regional trade agreement?
Whether or not GDP goes up as a result of being more open to trade is not what we are actually arguing. We are saying that there are predictable people who will lose a lot. The reason why we don’t take that into account is that we think resources will move. If the labour is cheap, capital will come. That’s not what we see. Because we don’t see it, we can anticipate that certain groups are going to get hammered. We should take preemptive action. And think of ways to handle that.
You have argued in favour of Universal Ultra Basic Income in the book. Is it a feasible idea, given the kind of Budget and political constraints, because some of the subsidies will have to be rolled back?
I think the political constraints are less serious. People also know that these subsidies are leaky and wasteful. I think they don’t believe the government. Partly, the government needs to build credibility. We need a mechanism which makes it clear that when the government promises X, it gives you X. Credibility is central to this.
But the government has given income support to farmers without cutting other subsidies. And that’s the fear some people have that it will work this way.
I understand that fear. But that’s not entirely true, because they did take something. Support prices were kept flatter. So the government actually first took it away and then came back to compensate. I don’t think that’s the best process. Support prices drove terms of trade for a while and they decided not to do that. And then just before the last election, they came back and said we are now going to compensate you partly.
You have also said in the book that people are often unable or unwilling to move to take advantage of economic opportunities. Will programmes like basic income and the Mahatma Gandhi National Rural Employment Guarantee Act (MGNEGA) not slow labour movement?
They are very different. Basic income is unconditional. So if I move from agriculture to being an urban construction worker, my basic income doesn't go away. The MGNREGA is very different, and there is evidence that it slows down migration to the cities.
Portability is critical in basic income. If it is not portable, it is going to distort. So basic income will not affect migration. In a sense, it might encourage it. When I first go to the city, I don’t know if I will find a job and might be riskaverse. But if I have a basic support, I might actually move and take that risk.