Central Banks

India’s flawed stimulus plan equates to ‘one plus zero equals two’

PUBLISHED : Monday, 30 January, 2017, 3:55pm
UPDATED : Monday, 30 January, 2017, 10:55pm

[Indian] Finance Minister Arun Jaitley will unveil a budget on Wednesday that analysts say will aim to offset the impact from the so-called demonetisation programme with stimulus measures.

Business, January 30

You could pretty much have predicted that early twentieth century quack theories would once more prevail in the Indian economy when Raghuram Rajan stepped down as governor of the Reserve Bank of India (RBI) in September.

And they have.

It was in fact on the advice of the post-Rajan RBI that two months later the Indian government announced it would take the 500 and 1,000 rupee banknotes out of circulation.

The reasoning, such as it was, behind this loopy idea held that people were using cash payments to hide their tax obligations. No matter that it is the efficient grey economy in India which allows the inefficient formal one to keep creaking along, the efficient one must be eliminated in order that bureaucrats may have more tax revenues to waste.

Which in India they most surely do with their tax revenues.

But now that the cost to the workings of the economy has become apparent, the central planners in Delhi have reached down through history to find another loopy idea, commonly (but probably falsely) attributed to John Maynard Keynes, to wit that one plus zero equals two.

The theory holds that if government wishes to make people spend money (and government always thinks this is a grand idea) it must first take their money away from them and then spend that money itself.

This is called a stimulus measure on the reasoning that a stimulus is imparted to the economy when a bureaucrat spends money but not when you or I do so. The bureaucrat, says the theory, magically makes a zero increase in the amount of money spent turn into twice the original sum. Hence one plus zero equals two.

In fact, of course, economic activity is given a stimulus whenever anyone spends money. There is no real increase in spending when a bureaucrat first takes the money out of the economy through taxes or borrowings and then puts it back in again. One plus zero equals one, always has done and always will.

The theory arose out of the notion that occasionally, very occasionally, government spending might slightly speed up recovery from a recession by giving people a comforting nudge that it is OK to spend again.

It has yet to be conclusively demonstrated that this ever happens but these circumstances are invariably claimed to be present and the theory valid whenever government seeks to prop up popular support with a stimulus programme. I cite the present example of India.

In fact stimulus of this sort actually poses the danger of slowing down an economy. Economic activity is created when people spend money, but sustained growth depends on them spending it wisely. This is done when as many people as possible can buy the goods and services they most want at the lowest possible prices.

The difficulty here is that spreading the benefits widely this way is not particularly showy and it’s a big show that the bureaucrats mostly want when they take control of the spending.

This used to mean, and in some parts of the world still does mean, big statues of the local political heroes. Now it more generally means bridges, tunnels and fancy palaces of culture that serve the rich. Well, the poor would only trample mud on the carpets, you know.

Thus, in order to waste no time in wasting money, let me propose to the government of India how to structure its stimulus programme. What you need to do, Mr Jaitley, is to start digging, with no implement more advanced than a pick-axe, ten separate railway tunnels from Delhi to Antarctica.

On this project you can offer work to hundreds of thousands of people in high class infrastructure investment with no prospect of this employment ever ending. Start some more tunnels to the North Pole if you think it may do so.

What a wonderful stimulus this will exert on the Indian economy; jobs for anyone who wants a job, showy too and a world first, one in the eye for Dubai with its world’s tallest building.

Come back, Mr Rajan, your country needs you.