“Demand-side impact can manifest if people start losing their jobs in significant numbers.”
The prime minister has announced a big package, but in the last two days what we have heard from the finance minister is the blueprint, which is not really focussed around direct spending. Do you think there is yet more to come or has this package been designed considering the fiscal constraints?
First, when we try to understand the package that has been announced, it needs to be seen in the light of a new vision that has been articulated by the Prime Minister. In some sense, there is an attempt to try and construct something equivalent of a ‘New Deal’ that President Roosevelt came up with during the Great Depression. Not only were there measures in terms of monetary, fiscal and liquidity, but more importantly there were a bunch of reforms as well. And reforms with the vision of a self-reliant India, or Atmnirbhar Bharat. Maybe later I can give some colour in terms of what I think of this as an economist because oftentimes people can mistake it to be equivalent to be something from the past, which is not what it is intended.
Given the vision and the pandemic, there is basically value to the package and it is constructed based on the following principle. The effect of the Covid pandemic is a war-like situation. But it is different from a war, as in a war demand suffers because of uncertainty. But since a war is going on, people will not travel that much, and tourism for instance takes a beating. A lot of discretionary or non-essential items basically do not get consumed as much, and there is a demand-side impact. But in a war what also happens is a huge supply-side disruption because factories get bombed and become rubble. That creates permanent disruptions on the supply side. In contrast, with Covid there are supply-side disruptions, but these are not permanent because no factory is getting reduced to rubble. What you have is a situation where the hands are not there on the machines yet and there is basically a temporary impact on the supply side. Therefore, if you think about it compared to a situation like a war, what needs to happen is a lot more focus on temporary liquidity so that firms can tide over their difficulties, and temporary inconveniences and distresses that firms are facing do not create permanent damage. That is one very very important aspect of the supply-side interventions. On the demand side as well, where there are essential items, those have been worked out.
More importantly, the demand-side impact can manifest if people start losing their jobs in significant numbers. Then obviously, they will not have the disposable income to spend. In which case you will have a significant demand impact. If you think about the demand-side measures themselves, they are basically trying to reduce any detrimental impact on unemployment. Here it is important to remember that not only India, but globally — for instance, if you take the United States — the number of people filing for unemployment insurance in the US is now at a historical high, even greater than that during the Great Depression. This is something that is a first order issue that every country has to grapple with by ensuring that supply-side concerns and liquidity concerns of firms do not lead to retrenchment of people. You are thereby also having a demand-side impact, but it is retaining demand in some sense by retaining the disposable income.
Secondly, those people who are likely to be affected — basically who become unemployed — their disposable income has been increased through not only the automatic stabilisers, but also through reduction in the PPF rates; reduction in basically some of the holidays that have been given. All these also then end up putting disposable income in the hands of the consumers. So that is how the measures have been thought about and at this point it is also good for me to compare it with other countries. Ever since March itself, we have been studying each country’s package threadbare and one of the big takeaways for us has been that countries have employed different portfolios of fiscal, monetary and liquidity measures depending on where they had greater space. India has done the same as well.
If you look at the fiscal and monetary side, as well as liquidity, we clearly had more space on the monetary side. Given that, we have a lot of state-owned institutions as well. By giving them capital, or through a guarantee, etc, we can leverage and have a far more significant impact without necessarily constraining our fiscal side too much because there is also a concern of possible impact on the ratings; which is why I had also mentioned in one of my comments that there is no free lunch. That is important to keep in mind.
So, I think eventually if you look at the policy package that has been brought in, it is a smart combination of the fiscal, liquidity and monetary keeping in mind where we have greater space. The other important part is that if you look at it from a macroeconomic point of view, when you give freebies versus when you basically give people the ability to retain and contribute, the latter is always a better idea. And this is a research in macroeconomics that shows that when you give freebies, that can make people lazy and in the medium-to-long run, shrink the supply because people may not produce enough. But when you give freebies, they do enhance demand. If you have a situation of increasing demand but supply shrinking, that can have an inflationary impact. But if you actually do not give freebies and instead enhance productive capacity, or retain productive capacity, at this point of time, given the Covid episode, it is far more important to retain productive capacity as much as possible by alleviating some of the temporary troubles. This can thereby ensure that there are not as many supply-side disruptions so that inflationary pressures do not build up. These are in some sense the core principles that have guided the stimulus package.
I am sure because of this crisis the shape of the economy will change and it is bound to change. When things normalise, how do you think the shape of the economy at least in India will change?
I have, even in normal times, always been careful about giving a prognosis on the future, especially during times like these. Everybody has to be extremely careful because we are dealing with a situation of unknown unknowns and so anybody’s assessment, including mine or someone else’s, it is important to keep in mind that there is going to be uncertainty. It is as if even a Wasim Akram, if he is bowling on a bad pitch, the way the ball will behave even Wasim Akram cannot fairly predict. Some balls may just basically shoot through and not rise at all and some balls may really rise to bounce a lot. That is the kind of situation we are in and that is why I want to mention that caveat. With that caveat in mind and I think whenever participants take into account what I am talking about, they should not just focus on what I am saying as my prediction, but keep in mind the uncertainty that I have actually talked about. That nuance is very important.
With that preamble now, let me say what are the important changes that will happen in the economy. For one, the sectoral allocation between services, manufacturing and agriculture may actually have an impact. From India’s perspective, this possibly is a good opportunity to do a reset and enhance the scope of manufacturing in the economy because social distancing raises some question marks on very key service sectors. Because compared to manufacturing, services is a sector which relies a lot more on interpersonal interactions. Therefore this Covid episode for the time that it lasts is likely to have a greater impact on the service sector than on manufacturing.
Because we are a population that has a large number of youth who need jobs, manufacturing is the outlet that can generate jobs. Together with companies that are actually in China, many of who want to relocate, these are some of the favourable conditions that are coming together for India to reset and increase its presence in manufacturing globally, but also within the country itself to have far bigger manufacturing presence and thereby create jobs.