Arun Jaitley, Narendra Modi and Manmohan Singh in New Delhi. (Photograph: PTI)

The Politics Behind Our Economic Crisis

BloombergQuintOpinion

In 2008, India was being called a ‘miracle economy’ by some. It had grown at 8.8 percent for three consecutive years. Then the global financial crisis happened, and things went downhill for India – and got progressively worse over the next 10 years.

I just read an excellent new book, The Lost Decade by Puja Mehra, which takes a detailed look at all the economic decision-making that damaged India. More than that, though, it is a look at how “each time the country’s economy came close to returning to that growth trajectory, political events knocked it off course.” The book is about politics as much as it is about economics—and that politics is best understood through an economic lens: the lens of Public Choice Economics.

Public Choice teaches us that governments consist of individuals who respond to incentives just as the rest of us do. Mehra’s book is an affirmation of that, and she gives us a close look at the human figures behind the political mythmaking. What drove Manmohan Singh, P Chidambaram, Pranab Mukherjee and Narendra Modi to do the things they did? Given that their decisions affected millions of people – economics has humanitarian consequences – it is useful to understand the imperatives that drove them.

The Politics Behind Our Economic Crisis

From Crisis Management To Politics

India’s response to the global financial crisis, as Mehra describes it, was impeccable. Politics and economics were aligned here—no government can afford a collapse of the economy.

Also, just as in 1991, the political will driven by the crisis coincided with a team in charge that actually understood economics and was reform-minded by itself. If Chidambaram played a support role to Manmohan in 1991, he took the lead here as finance minister. In two months of firefighting after the crisis broke, he and his team of stellar technocrats ensured that, in Chidambaram’s words (to Mehra), “there was sufficient liquidity in the market; there was no run on any bank, which was my worst fear; and no bank collapsed.”

Then happenstance intervened. Two seemingly unrelated events drove us towards economic disaster. One, the Mumbai terror attacks led to a reshuffle in the cabinet, and Chidambaram was shifted to the home ministry. Manmohan took additional charge of finance. Two, Manmohan had to go in for a bypass surgery in January 2009, and Pranab Mukherjee was handed interim charge of the Finance Ministry.

Manmohan Singh, with  P Chidambaram and Pranab Mukherjee, in New Delhi. (Photographer: Pankaj Nangia/Bloomberg) 
Manmohan Singh, with P Chidambaram and Pranab Mukherjee, in New Delhi. (Photographer: Pankaj Nangia/Bloomberg) 

Chidambaram was expected to retake charge of the ministry, and was understood to be Manmohan’s choice. It was Sonia Gandhi who probably pushed Mukherjee through, and her incentives are easy to understand. One, she relied hugely on Mukherjee’s political acumen, but had passed him over for the post of prime minister in 2004. Mukherjee, in his book The Coalition Years, later spoke of how he was the favourite for that job. “I had vast experience in government,” he wrote, “while Singh’s vast experience was as a civil servant with five years as a reformist prime minister.”

Mukherjee had subsequently refused to join Manmohan’s ministry, but was cajoled by Gandhi to become first Defence Minister and then Minister of External Affairs. Now, with Manmohan indisposed, it made sense to elevate the bridesmaid of 2004 into the most important ministry.

The other incentive driving Gandhi’s choice was that of the forthcoming elections. Manmohan and Chidambaram were both focused on what the country needed. Mukherjee was a career politician who only focused on what the party needed. That’s exactly what the head of a party wants in an election year.

Mukherjee responded to the challenge in front of him by letting political imperatives override economic ones, not just until the elections but after it as well. Part of this was because he was actually old-school in this thinking. He had last been finance minister under Indira Gandhi, and as Mehra writes, was “locked in a pre-liberalisation mindset, negotiating a post-liberalisation economy. Mukherjee represented everything Singh had in 1991 proved wrong-headed and had dismantled. Even two decades after Singh had rid the ministry of the License Raj mindset, Mukherjee still swore by it and refused to give it up.”

Pranab Mukherjee is adminstered the oath of office by President APJ Abdul Kalam, on May 22, 2004. (Photograph: PIB)
Pranab Mukherjee is adminstered the oath of office by President APJ Abdul Kalam, on May 22, 2004. (Photograph: PIB)

Beyond the mindset, though, was the politics. One, Mukherjee backed away from a bunch of necessary reforms because there would be no short-term political benefit from them. Two, he increased fiscal spending, such as in the social sector, and the fiscal deficit went out of whack. (Here’s Mehra: “Accounting for social securities issued by the central government outside the market borrowing programme, the combined fiscal deficit worked out to about 10.8 percent.”)

When increased rural demand started leading to inflation, Mukherjee demanded that the RBI step in, saying, “I can’t do anything on the fiscal side because of political compulsions.”

A quote from a finance ministry official in Mehra’s book sums it up perfectly: “[Mukherjee’s] world of finance was one in which you collect what you can. Rob the rich, spend it on programmes which are politically important. The finance minister’s job essentially was that of a tax collector, and then expenditure, according to the political economy priorities that had been chosen.”

The people of India bore the brunt of Mukherjee’s poor decisions. “Within 24 months of Mukherjee’s entry into the finance ministry,” Mehra writes, “the GDP growth rate crashed from 8.9 per cent in 2010-11 to 5.5 per cent in 2012-13. […] India went from being a miracle economy to one of the ‘Fragile Five’ economies.”

The picture that emerges from Mehra’s book—and of all of Mukherjee’s own autobiographies, to be honest—is of a man who does not understand (or care about) economics, and what is good for the people at large. But he does understand what will be politically beneficial for the party he is part of, and what will increase the heft of the state itself. In other words, everything he does puts party over nation, and state over society. Despite the damage his policies caused to the lives of millions of people, he is not necessarily a bad human being. Given his incentives, this is all rational behaviour.

A Brief Recovery – And Then Politics Again

Fortuitously, Mukhejee’s personal ambition gave the nation a reprieve, as he manoeuvred his way into the presidency. Chidambaram returned to the finance ministry with the economy in near-crisis, and once again took a bunch of hard decisions that he knew could have a negative political impact. He summed it up himself in Mehra’s book: “Fiscal deficit was sharply reduced. The current account deficit had in fact been contained substantially by squeezing. Some very harsh decisions were taken, which of course affected growth and it did not give us the kind of advantage that we should have got if inflation had been lower.”

The UPA lost the 2014 elections. I don’t have an answer for why Chidambaram did not respond to the same incentives that drove Mukherjee, but I can speculate. Maybe his superior understanding of economics gave him a better sense of what was at stake here. Maybe, as one of the architects of the 1991 reforms, he wanted to safeguard his legacy. Maybe he thought the elections were lost anyway, and wanted to enhance his personal standing in the circles he was part of. Whichever explanation you prefer, we know that he did the right thing – and then paid the price for it.

Narendra Modi is adminstered the oath of office by President Pranab Mukherjee, on May 26, 2014. (Photograph: PIB)
Narendra Modi is adminstered the oath of office by President Pranab Mukherjee, on May 26, 2014. (Photograph: PIB)

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Narendra Modi came to power with the expectation that he would be a reformer. But politics got in the way soon enough. Mehra’s book has a large chapter that outlines how the politics of the time shaped the economics, and this following excerpt sums that up well:

“[A] series of political blows left the government in shock. Following the twin debacles of 2015, 2016 brought more defeats. Out of five state polls held in 2016—in Tamil Nadu, Puducherry, Kerala, West Bengal and Assam—the BJP won only one: Assam. In response, it backtracked from its entire economic reforms agenda: putting on hold, diluting or stalling planned corrective measures for land acquisition, labour, insolency and banks. Stunned at the unexpected directional drift, a key government economist handpicked by Modi told me in a private conversation, ‘Centre was already to the left in India. Now, even the right has shifted leftwards.’”

To add to this, Arvind Kejriwal lay claims to ‘the anti-corruption mantle.’ Within Modi’s inner circles, thus, “a hunt was launched for a ‘politically-saleable’ scheme.” The key words here, you must note, are ‘politically-saleable’, which matters far more than economically sound. And thus, as Mehra describes, Modi arrived at demonetisation.

“Eager to discard its ‘pro-business’ tag, the BJP decided to invest in a ‘pro-poor’ image too. The quest ultimately led to demonetisation which, it was decided, would be marketed as an assault on the rich and on hoarders of black money. The political appeal of a scheme to sponge off the rich was irresistible.”

People wait in line outside a bank branch in Delhi on  Nov. 25, 2016. (Photographer: Anindito Mukherjee/Bloomberg)
People wait in line outside a bank branch in Delhi on Nov. 25, 2016. (Photographer: Anindito Mukherjee/Bloomberg)

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Of course, as was obvious right then, these justifications were nonsense. Demonetisation was the largest assault on property rights in human history – and the BJP won the state elections that followed in Uttar Pradesh by a resounding margin. And that brings me to a question that follows every public choice economist: if bad economics can be good politics, then can we blame the the politician for responding to his incentives?

How do we sort out this incentives problem? The answer lies not in electing better people, but in building a better system with better incentives. We would move in the right direction if we removed government power in areas where it has no business meddling, so that it can do less damage. We should make governance as local as possible, so that there is a stronger link between power and accountability. And yes, it would help if voters were more educated about the impact of economic policies on their lives, for which reading my columns, and Puja Mehra’s excellent book, would certainly help.

On that note, I recently had Mehra on as a guest on my podcast, The Seen and the Unseen. Listen in!

Amit Varma is a writer based in Mumbai. He has been a journalist for a decade-and-a-half, and has won the Bastiat Prize for Journalism twice. He writes the blog India Uncut and hosts the podcast The Seen and the Unseen.

The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.