One stylised caricature of economists’ ideological differences in matters of policy interventions is how people behave when they are ill. The human body is a complex system and gets out of order from time to time. If we have a bout of mild illness, there are two broad reactions. One set of people believe that they should not have any medications. Rest, lots of fluids and the body’s own healing mechanism would be enough. Others believe that they should avail of the gifts of modern medicine, take pills and go back to work. The first group faces the risk of prolonged ailment and the illness taking a more complicated turn. The latter group faces the risk of long-term side effects of modern medications that might do lasting physiological damage. To give medicines to markets or not to give — that is the trillion-dollar question.
In a similar fashion, ever since the Great Depression of the 1930s, economists have debated over policy interventions required to stabilise unwanted ups and downs in a market economy. Till about the 1920s, conventional wisdom had been that the market economy, left to its own devices, would always fully utilise a nation’s economic resources. In other words, persistent unemployment was impossible. The Great Depression changed all that, with one out of four workers being unemployed and yet a large number of factories and mills lying idle because the owners did not know whether goods produced by them would sell. It took the genius of John Maynard Keynes to revolutionise economic policy by advising governments to spend more by running budget deficits so as to create demand and boost output and employment. It worked with amazing results, although some have pointed out that had the spending not got an additional boost from the war in the early 1940s, the depression might have lingered. Active fiscal policy became the new conventional wisdom in market economies till about the early 1970s. By the late 1960s, Richard Nixon made a famous comment: “We are all Keynesians now.”
In the meantime, at the University of Chicago, scholars like Milton Friedman argued that fiscal spending was tricky since running large deficits added to the burden of public debt. Markets were best left to their own devices. Money supply should be increased as an economy grew so as to provide enough liquidity to finance a larger number of transactions. Some economists argued that the only way to stimulate an economy, if needed, was through monetary policy. Using this policy to reduce interest rates would stimulate fresh investments as the cost of borrowed funds would become lower.
Paul Samuelson and other scholars at the Massachusetts Institute of Technology and Harvard University argued that as long as there were unemployed resources in the economy, it made sense to increase fiscal spending and also reduce interest rates. These measures would increase employment and move the economy to full-employment, where all productive resources like labour would be fully utilised. Beyond the point of full-employment, any demand management through fiscal or monetary policies would result in inflation, since there were no idle resources remaining to be used. There was a short peace between Chicago and the MIT. A problem still remained: how would the policymaker know that full-employment was achieved and interventions would no longer be necessary? No economy, in real life, would ever have a situation where every single employment seeker was actually employed. There would always be people who were between jobs or workers who were voluntarily changing jobs. Was there a natural rate of unemployment that was notionally as close to full-employment as one could get?
By the early 1970s, the dominance of active fiscal policies began to erode as interventions became less effective and outcomes unpredictable. The world economy also received, for the first time, a supply-side shock in the form of the oil shock of 1973. Obviously, Keynesian demand management would not suffice. It was the turn of the scholars in Chicago to critique, in a big way, Keynesian wisdom. Robert Lucas, who later became a Nobel laureate, announced that no policy intervention was the best policy. Not only was it a rejig of the 1920s conventional, Classical wisdom but the new school also demonstrated that policy interventions actually did much damage to the economy as they created avoidable economic fluctuations and uncertainty. One had to learn to live with supply shocks, and not all of them were bad. For instance, technology shocks came in the form of unanticipated supply-side movements. However, these were supposed to improve the productive capacity of all resources in the economy.
The next three decades witnessed the rise of the New Classical school which prescribed no interventions to control business cycles. Their lesson was: ride the supply shocks as they arrive. The markets will take care of themselves. This was the era of the rise of the neoliberal ideology of fiscal balance, monetary policy focusing on price stability alone, deregulated domestic markets, and free international trade. The world was a globalised village where integrated markets ruled. According to this school, the days of business cycles were over.
Then came the financial crisis that shook the world in 2007-08. The shock affected both the demand and the supply sides of the global economy. It began in the United States of America and then spread across the world. The masters of the economic universe living on Wall Street came down on their knees. Suddenly, the Chicago playbook was of no use to policymakers. Demand had to be boosted massively, as would supply. Governments ran unprecedented budget deficits, while central banks poured money into the economy so much so that interest rates fell to zero and even turned negative. There were overdoses of policy interventions. Huge deficits meant the burden of public debt was going out of control. Massive injections of liquidity by central banks meant that inflationary pressures were rising. Medicines were not working, and the side effects of debt and inflation were playing up.
Then, even before the shock and awe of the financial crisis had subsided, Covid arrived out of nowhere, and crippled supply and employment the world over. Again, the policy playbook of Keynes or Friedman did not yield results. All economies now look remarkably vulnerable to shocks that damage demand as well as supply. The labour market has gone through many amazing changes, with technology dislodging the workplace as an institution. The lurking spectre of artificial intelligence and robotics has made almost every job insecure and uncertain. Extraordinarily large layoffs are being experienced in the most dynamic sectors of the economy, especially in technology and software.
One question being asked is this: are market economies unmanageable? Going back to the metaphor of taking medications when mildly sick, the emerging situation can be described as follows. Those who do not like taking medications are catching illnesses more dreaded than the simple flu. On the other hand, the pill-poppers are finding that standard medications are not working, while the side effects are taking a heavy toll. Are we all, like in Beckett’s famous play, 'Waiting for Godot'?
Anup Sinha is former Professor of Economics, IIM Calcutta
