On September 25, Larry Elliott, the Economics editor of The Guardian, referred to a flagship report of the UN's trade and economic development body, Unctad. The report says that "2019 will endure the weakest expansion in a decade and there was a risk of the slowdown turning into outright contraction next year". The UN, according to him, has further warned that "(w)eaker growth in both advanced and developing countries means the possibility of a global recession in 2020 is a clear and present danger… "
Moreover, in Unctad's opinion, "(t)he slowdown in growth in all the major developed economies, including the US, confirms that relying on easy monetary policy and asset price rises to stimulate demand produces, at best, ephemeral growth, while tax cuts for corporations and wealthy individuals fail to trigger productive investment. "
The report covers the entire world, India included. On September 20, asset prices in Indian share markets registered a phenomenal rise following the government's decision to ease corporate taxes, the alternate minimum tax and so on. Quite obviously, this generated expectations of a rise in net profits and possibly higher dividends. The Sensex and Nifty galloped forward, even as the best known share market indices elsewhere in the world performed poorly on that very same day.
Is stock market euphoria a good economic barometer?
Many commentators announced that the stock market euphoria in India was a sign of incipient investment and economic growth, contradicting the Unctad view. Unctad may or may not be correct. Nonetheless, it is worth our while to try and clarify the reasons underlying its pessimism.
A useful starting point in this context is Chapter 12 of Lord Keynes' classic, The General Theory of Employment, Interest and Money, where he had observed "For my own part, I am now skeptical of the success of a merely monetary policy directed towards influencing the rate of interest. I expect to see the State (to take) an ever greater responsibility for … organising investment. …"
In his opinion, private investors should not be relied upon to cure problems such as economic slowdowns and unemployment. His reasoning was simple enough.
The sort of investment that is called for to lift an economy out of an unemployment and low growth trap is necessarily long-term real investment in productive assets. Let's agree to call these "factories", even though the word is far too vague to capture the diverse range of private investment activity. However, the word "factory" helps to distinguish between real long-term investment and stock market driven temporary financial investment in paper securities.
Long-term investment in factories depends on long-term expectations about the future of an economy in general and the investment projects in particular. Unfortunately though, we are pretty much ignorant about anything other than immediate events. Consequently, whatever long-term investment decision a private investor undertakes needs to be based on nonexistent knowledge about the future.
A common example illustrates the issue. Consider durable consumer goods, such as automobiles, residential flats and so on. Given the advantage of low interest rates, a person borrows money from a bank to purchase a residential flat. Within a year though, he discovers that the sewerage system for the building is clogged up due to construction defects. Further, most of his neighbours live abroad and rarely visit their apartments.
The person who had borrowed from the bank finds himself in an unenviable predicament. He will find it difficult to sell off his defective flat and at the same time his loan will need to be paid off. Similar stories can be told about investment in factories.
How accurate is future gazing?
In the total absence of a method of prediction, an investor will probably need to believe that far into the future, the world will continue to look the way it happens to look at the time he carries out the investment. However, all of us are aware that neither good nor bad times are likely to continue forever. An investor, therefore, can at best make a guess about the average future.
In other words, one will put one's money into a venture under "… the assumption of arithmetically equal probabilities (of good and bad times) based on a state of ignorance …" (General Theory, Chapter 12). This amounts to absurdity.
What then is the way out? The stock market, some believe, is an institution that acts as an anchor. To an extent it does so, but it leads simultaneously to a "… separation between ownership and management …" (General Theory, Chapter 12).
The stock markets revalue investments every day, with the result that new investments in factories may be held on leash if the prospective investor discovers that, for whatever reasons, ownership of a similar factory is being valued at a lower price by the stock market.
In this case, he will purchase the lower priced security and there will occur a mere change in ownership of old investments and a postponement, therefore, of new asset creation.
Further, stock markets facilitate speculation, viz. the activity of purchasing an asset with the sole purpose of selling it off at a premium. Speculators are least interested in the manner in which enterprises are run. Consequently, they may well reap profits, sometimes enormous, even if the firm whose shares they have acquired is not flourishing audit wise. Something similar happened during the subprime crisis that led to the liquidation of Lehman Brothers.
Though stock markets have their merits as well, and Keynes did recognise them, he was not particularly happy about investment turning into a byproduct of speculation.
Going back to the fundamental question then, what is it that governs private sector long-term investment? In Keynes' opinion, no rational calculation of streams of profits governs such investment, since the future streams are quite invisible.
It is the reverse of rationality therefore, termed "animal spirits" by Keynes that determines the course of investment. Animal spirits can be likened to a psychological state of mind that gives rise to a "spontaneous urge to action rather than inaction …" (General Theory, Chapter 12).
It is a sort of feel good factor if you will that does not fall within the ambit of textbook notions of rationality. A lower rate of interest of course will reduce the cost of investment, but whether it will arouse the urge to invest too is quite unclear.
Behavioural Economics and Keynesian thought
In this context, the growing importance of Behavioural Economics should lend fresh support to Keynesian thought. The essence of Behavioral Economics lies in questioning the very notion of rational economic agents, As the Behavioural Economics Nobel Prize winner Richard Thaler writes in his book Misbehaving, Keynes was "a true forerunner of behavioural finance".
If economic growth has to be revived via private investment, a solution may lie in "Nudge Theory" proposed by Thaler and associates. Nudges constitute a way of pushing private agents in desired directions, leaving all options open.
The government may well be thinking along these lines, for according to media reports, NITI Aayog plans to hire behavioural economists for its "Nudge Unit". They will try to understand behavioural changes necessary to improve the health of the economy.
This appears to be a far better course of action to stimulate private investment than policies aimed at boosting the Sensex or the Nifty. Difficult problems do not have easy solutions.
Dipankar Dasgupta is former professor of Economics, Indian Statistical Institute, Delhi and Kolkata.
First Published: Oct 7, 2019 11:08 AM IST
