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Crisis does not mark the end of free-market capitalism: economist

CHENNAI: The current global financial crisis shows the problems not of capitalism itself but those of capitalists who stretch the framework without worrying about consequences. While the current crisis is part of the cycle in capitalist economies predicted by theorists from Karl Marx downwards, it does not mark the death of free enterprise, said Raghuram Rajan, economist and former Chief Economist at the International Monetary Fund (IMF).

Speaking at a plenary session at Pan IIT 2008 at IIT-Madras, Dr. Rajan, who has been appointed Economic Adviser to the Prime Minister, said that for all the defects in the system, capitalism offered the best possible growth model for developing economies. “South Korea has faced four economic crises in the last 50 years, and North Korea has not faced even one. But the quality of life in South Korea is clearly much higher than that in North Korea.”

The current crisis was caused by over-exploitation of a financial instrument. Mortgage-backed securities were a means to leverage funds from investors with excess capital spread all over the world to provide particular services.

The fact that some of them were high-risk instruments was reflected in the higher interest rates they commanded. However, instead of making provision for the risk entailed by the issuing of these instruments, bankers had actually decapitalised their holdings by removing the surplus funds in the form of bonuses and fat pay cheques, Dr. Rajan said.

Even this would only have resulted in losses to investors like any typical crash, except that banks had themselves invested in these high-risk investments without too many safeguards.

India was affected by the recent problems in three ways: decline of U.S. imports of Indian products reducing export income, losses in the Indian financial sector due to linkages, and the effects of the monetary tightening that the government undertook in the immediate wake of the inflation that raged in the Indian economy due to various reasons.

While the Indian economy could rebound faster than the U.S and the European Union economies, and while India could still boast a reasonably positive growth rate when other economies were struggling with near-zero rates, this situation should encourage the government to undertake financial sector reforms and infrastructure improvement to avoid more severe crises in the future.

The Indian economy, not being as consumption-driven as that of the U.S., had a more serious problem with the lack of access to disadvantaged groups. Lack of affordable education, healthcare and opportunities to use the market to their own advantage denied whole sections of India the opportunity to enjoy the fruits of enterprise and innovation.

Politicians who provided a means for the poor to navigate the current flawed system and provided the poor with their basic necessities began to wield more clout in this situation, Dr. Rajan said.

To provide the benefits of growth to all sections of society, and to make the poor also stakeholders in the country’s growth, India should invest heavily in various infrastructure development projects.

There were strong incentives for people to ask for bailouts and sops in this situation, but taxes were already low enough in the country, and private enterprises should try and tide over the crisis by other measures, while the government used this opportunity to help the poor and the disadvantaged by building roads, schools and hospitals. If adequate measures were taken to ensure that nobody was left behind, India could become one of the top few economic superpowers in 20 years. But this would need heavy spending on public necessities, and the rolling back of frivolous subsidies on goods like fuel for cars, Dr. Rajan said.

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