T

There are many reasons for such scepticism. In fact, it is surprising that the critical voices were not heard earlier and louder. After all, the notion that unregulated markets deliver socially optimal outcomes was discarded a long time ago even by mainstream economic theorists. As early as the mid-20th century, the assumptions under which the classic model of perfect competition delivered the best welfare outcome were acknowledged by neoclassical theorists to be so stringent as to be unrealistic and unlikely to apply in any actually functioning economy. By then, the insights of Michal Kalecki and John Maynard Keynes had already shown that private capitalist market economies, if they are allowed to function without relying on stimuli from the state accompanied by regulations that prevent excesses, are inherently unstable: prone to boom-bust cycles as well as to persistent unemployment.

The Keynesian revolution did more than create the discipline of modern macroeconomics: it also generated a policy framework in the developed world that allowed capitalism to grow in a regulated and stable fashion for at least two decades after the second world war before it came up against the inflationary barrier posed by rising wages and commodity prices in the 1970s. Thereafter, political economy shifts globally, and especially in the core capitalist countries of the North, brought about the widespread acceptance of a new economic policy paradigm, one that replaced the notion of market failure (and the associated need to control markets) with perceptions of government failure (with the associated requirement of freeing markets, as far as possible, from any controls). The associated rise of finance dramatically increased pressures for deregulating financial activity and enabled it to grow much more rapidly than could be justified by its actual intermediation between savings and investment.

The policy pendulum swung quite dramatically in the opposite direction, and with it, the absence of any proper theoretical justification for economic policies based on liberalised markets was simply ignored or even suppressed. Thus, the “efficient markets hypothesis” that has been used to justify financial liberalisation relies on assumptions that are little better than leaps of faith. And it simply ignores the far more potent theoretical critiques that have shown how financial markets are particularly prone to imperfection and market failure, because of asymmetries of information that are, in turn, associated with problems such as adverse selection, moral hazard and incompatible incentives of different players in the market. All these problems have been only too evident in the build-up to the current global financial crisis.

Similarly, now that protectionism is raising its head in the North, it is suddenly being recognised that the standard result that is often taken to be axiomatic – that free trade is always welfare improving – does not necessarily hold. But this argument has always been based on several unrealistic assumptions: perfect competition, production under constant returns to scale, full employment. Changing any one of these can lead to very different results, such as outcomes in which free trade is welfare-reducing for a particular economy even in static terms, or welfare-reducing for some group in the economy, or involving dynamic losses. This is most important for developing countries because free trade can thereby cause the economy to get locked into a pattern of production that is less progressive and does not provide increasing returns, involving lower income gains over time.

As is often the case, these deficiencies in the theoretical basis for the neoliberal economic policy paradigm are becoming more widely recognised now that the empirical reality is also so clearly against it. But in India we are behind the global learning curve. The government and several influential economists in the country still appear to believe that the process of liberalisation must be further intensified, even in financial markets where this is now known to be extremely dangerous, and even in ways that directly contributed to the financial crisis in the US and other countries. Thus, as states all over the world try to restrict the

Economic & Political Weekly

EPW

EDITORIALS

global transactions of multinational banks and insurance companies that have already caused workers’ savings and pension plans to disappear into black holes, the Indian state wants to bring in more foreign players with fewer restrictions.

All this can happen at least partly because public discussion on economic policy in India has not sufficiently interrogated the theoretical principles on which such policy proposals are made.

-

--

-

-

-

-

-

As a result, simplistic platitudes are still trotted out instead of carefully reasoned analytical arguments, and there is no attempt to recognise the specific conditions under which economic mechanisms are supposed to work. But if our economic policies are to even moderately be able to deal with these challenging times, we have to change this. The need is not to rethink, but just to think, carefully and rationally, about how economies actually work.

--

--

-

-

– –

--

march 7, 2009 vol xliv no 10

EPW

Economic & Political Weekly