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Mainstream, Vol XLVII, No 25, June 6, 2009

Global Economic Crisis: Lessons for India

Saturday 6 June 2009, by B P Mathur


The global economy is today facing unprecedented crisis with falling production and job losses. Most advanced countries are already in the grip of recession and the economic outlook for the developing countries is deteriorating rapidly. To prevent economic collapse the governments of the US and other developed countries are giving massive bailout packages to their failing banks and other institutions and virtually nationalising them. There has been a return to Keynesianism even in the so-called capitalist countries, with the state taking an active role in stimulating economic activity and boosting demand. There is renewed interest in Marxism. Marx had predicted that the capitalist system is characterised by periodic booms and busts. Marx’s books are finding place in the best-sellers’ list and his home town, Trier in Germany, has once again become a place of tourist interest. The state’s direct intervention in the economy is in direct opposition to the ruling economic philosophy of the last three decades, characterised by an ideology of free markets, deregulation, liberalisation, privatisation and globalisation with the state exercising minimal interference in economic activities. The philosophy derived its inspiration from what is known as the Chicago school, whose chief protagonist was Milton Friedman and was powerfully advocated by the World Bank, IMF and WTO and given practical shape by Ronald Reagan in the USA and Margaret Thatcher in the UK in the 1980s when they came to head their respective governments. The current global economic meltdown has exposed the hollowness of the philosophy of unfettered capitalism with its belief in free and unregulated markets.

The present crisis is the result of an unsustainable global growth pattern that had been emerging since 2000. The growth was driven to a large extent by strong consumer demand in the USA, stimulated by easy credit and supported by a booming housing market, coupled with a very high rate of investment demand and strong export growth in some developing countries, notably China. Growing US deficits were financed by increasing trade surpluses by China, Japan and other countries that had accumulated large foreign-exchange reserves and were willing to buy dollar denominated assets. At the same time increasing financial deregulation, along with a flurry of new financial instruments and risk management techniques such as mortgage backed securities, collateralised debt obligation, credit default swap etc., encouraged massive accumulation of financial assets. They were sustained by a growing level of debts in the household, corporate and public sectors. The massive explosion of debt inevitably resulted in collapse of many established financial institutions, evaporating the liquidity and severely effecting the real economy.

The financial crisis has revealed major deficiencies in the regulatory and supervisory framework of financial markets. The US and other European countries have given huge stimulus package to revive the economy and restore confidence in financial markets in order to normalise credit flows. The leaders of the G-20 met in London on April 2 and have reiterated faith in an open world economy, with effective regulation and strong global institutions. The meeting reached an understanding on broad principles of financial supervision and regulation, particularly of hedge funds and rating agencies, and decided to establish a Financial Stability Board with representatives from all G-20 countries to oversee the health of the global financial system. A decision was also taken to augment the IMF’s resources. One has to wait and watch how these initiatives will bring stability in the global financial markets.

As a result of financial crisis, the international trade is contracting. Between 1990 to 2006, the growth of world trade was six per cent, which had outstripped the growth rate of world output of three per cent. In 2008 the growth of world merchandise trade decelerated to around four per cent. The WTO has predicted that the volume of global merchandise trade would shrink by nine per cent in 2009. The spectre of protectionism is haunting most countries, which may lead to serious depression in the economy.

Impact on Developing Countries

OWING to limited exposure to financial markets that brought down major banks in the USA and Europe, financial systems in most developing countries were initially shielded from any direct impact of the global financial crisis. Growing risks, however, emerged from other channels. Investors have started to pull back resources from the developing countries as part of the deleveraging process of the financial institutions of the developed world. External financing costs for the emerging market economies surged along with the tightening of the global credit market. The volatility of the foreign exchange markets has also increased substantially with the deepening of financial crisis. For many currencies in the developing countries, the earlier trend of appreciation vis-à-vis the dollar has been reversed. Currencies of countries which are commodity exporters have depreciated against the dollar substantially since mid-2008.

The global downturn has adversely effected the real economy in the developing countries. The developing countries as a group have been growing at a rate of around seven per cent for the last several years, but the growth has declined to 5.9 per cent during 2008, as per tentative estimates. A UN report forecasts that during 2009, the growth in the developing countries may slump to 2.7 per cent and would be 4.6 per cent in baseline scenario.1 Within the developing countries, Africa is facing a bleak future. The growth is expected to decelerate in 2009, as the contagion effect of the global economic slowdown spreads throughout the region, leading to weakened export demand, lower commodity prices and a decline in investment flow to the region.

The easy availability of speculative finance created havoc with the commodity markets. Hedge fund experts say that the price of oil then ruling at $ 130 to $ 140 a barrel, would have been half were it not for financial speculation. The flood of money which poured into commodity futures distorted the spot markets for physical commodities. In 2007 and early 2008 the prices of foodgrains such as rice, maize and wheat sky-rocketed despite abundant production. By September 2007, all international grain prices had doubled from their 2003 levels, the wheat price jumped to $ 400 per tonne, the highest ever recorded from a level of $ 200. The soaring food prices caused untold suffering and even riots in several developing countries, dependent on food imports as prices went beyond the reach of common man.

For the developing countries the global financial crisis is a great setback for poverty reduction and achieving the Millennium Development Goals. The tightening access to credit and weaker growth will cut into public revenues to meet the necessary investments into education, health and other human development goals.

The Indian Experience

THE tumultuous development in the past one year had a negative impact on the pace of economic activity in India as well. The economy, which was growing at eight to nine per cent, has slowed down. The tentative estimates expect the economy to have grown at around five per cent, though official estimates place it at more optimistic seven per cent. The stock market has lost 50 per cent of its value. The rupee has lost some 20 per cent of its value in terms of the dollar. There have been huge job losses in sectors of the economy with large export dependence, such as textiles and diamond cutting and polishing. No fresh recruitment and job creation is taking place even in the high-profile IT sector. The government has come out with several stimulus packages with additional spending on infrastructure and tax concessions.

It must, however, be said that due to adoption of a pragmatic economic policy, India has not been as adversely effected by the global meltdown as other countries which had fully embraced market capitalism. India adopted a policy of economic liberalisation in 1991, discarding the model of a socialist and closed economy. There was deregulation of the economy, most controls on setting up of new industrial units were removed, import tariffs were reduced and a policy of encouraging foreign investment was initiated. This helped India becoming a part of the global economic network and the industrial sector becoming globally competitive. The country achieved economic growth of 6.5 per cent during 1992- 2002, which jumped to eight-nine per cent from 2003 onwards, as compared to four per cent during four decades prior to 1991. While the economy was deregulated, key industries in oil, steel, mining and other sectors remained in the public sector. A large part of the banking industry in India is in state hand, which followed prudential norms in lending activity, avoiding the mistake of the developed countries, where the leverage ratio went as high as 30, well above the generally accepted ceiling of 10. India also took the saner path of not going for capital account convertibility on the foreign-exchange front.

US Economic Meltdown: Symptom of Deep Malaise

THE epicentre of the current crisis is the US financial system which saw explosive growth during the last three decades due to factors such as deregu-lation, technological innovation and growing international mobility of capital. Its hall mark is securitisation. Banks that once made loans and held on their books now pool and sell the repackaged assets, from mortgages to car loans. The investment banks created a variety of new products. They pooled asset backed securities, divided the pool into risk tranches, added a dose of leverage, and then repeated the process several times over. The derivative market grew at a stunning pace. The notional value of outstanding global contracts at the end of 2007 reached $ 600 trillion, 11 times the world output. The fastest growing was credit default swaps which allowed people to insure against failure of the new fangled credit products. From almost nothing a few years back the outstanding credit default swap grew to $ 60 trillion by June 2008.

The innovation of modern finance generated great profits for its participants.2 The faster the money went round, the larger the financial sector loomed in the rich countries’ economies. The share of financial-service industry’s profit in the total American corporate profit, which was around 10 per cent in the early 1980s, jumped to more than 40 per cent at its peak last year. Yet all the profit was cornered by a handful of people at the top, creating vast inequality in the society. From the 1930s to the late 1970s the wealth disparities in the developed countries declined sharply, but the globalisation of finance reversed this trend. The top 0.1 per cent of the Americans earned 77 times of the income of the bottom 90 per cent in 2006, compared to 20 times in three decades from 1947 to 1979. During the last three decades from 1979 to 2007, the median income of the American male worker has stagnated around $ 46,000, according to the Census Bureau despite rising productivity. This is in spite of the fact that the number of hours worked by the average American worker has risen by 20 per cent since 1970. Families were able to make ends meet because more women worked and because they were able to borrow money. Encouraged by cheap credit households borrowed money to maintain a lavish life-style. The country’s household debt rose steadily from 80 per cent of the disposable income in 1986 to almost 100 per cent in 2000 and soared to 140 per cent by 2007. With household savings practically zero Americans have sustained their high living standard by borrowing, landing themselves as well as the economy into the debt trap. The US Government has been incurring huge debt to finance its expenditure. In fiscal 2008, it had a deficit of close to $ 455 billion. In fiscal 2009, the budgetary deficit will soar to $ 1.5 trillion, in excess of 10 per cent of the GDP, if we reckon the fiscal stimulus package which is in the pipeline.

The chief executives and top managers of the financial companies and MNCs secured for them fabulous salaries, bonuses and incentive payments, which had no relation to the profit of the company. Horrific stories of their drawing astronomical payments running into millions of dollars and maintaining lavish life-styles with private jets and palatial villas at exotic holiday destinations, appear in press everyday. It was pure greed that was driving the top corporate executives. It was this greed that spurred the US corporations to move production operations abroad to take advantage of lower wages and higher profits on the ground that they would become ‘competitive’ in a global market. The real beneficiary has been China where most of the industrial production from the USA has shifted. America has virtually become de-industrialised. Distinguished economist J.K. Gailbraith has observed: “Ideas come to be organised around what the community as a whole or a particular audience finds acceptable. To a very large extent, we associate truth with convenience—with what closely accord to self-interest.”3 It was the American corporates’ self-interest that was responsible for giving practical effect to a free and open trading system, though it played havoc with the US economy and transferred millions of jobs abroad.

The USA is having a continuous current account deficit for the last quarter of a century, due to the export-import imbalance. As the largest economy of the world with infinite appetite for goods, it suited every country of the world to export to the US. In the post-war years the export-led growth, enjoyed by Japan, South Korea, the Asian Tigers and in recent years China, was inextricably linked to the US market. Its huge trade deficit, financed by surpluses generated by China, Japan and petro-dollar rich Arab countries, has landed the economy into a serious problem. China has now surpassed Japan as the world’s largest holder of foreign exchange reserves. Most of these reserves, of the order of more than $ 1 trillion, are invested in US treasury securities, making the country vulnerable to Chinese pressure. If China withdraws its reserves, the dollar will crash.

The China Factor

THE downslide of the US economy is accompanied by phenomenal growth of China as an economic power. China’s rate of growth has been averaging 10 per cent per year for the last three decades and it has now become the second largest economy in the world in terms of PPP. China has emerged as a centre of world manufacturing, an export power house, generating a surplus of $ 300 billion annually. It is going aggressively in Africa and Latin America and investing in oil and mineral industries. Rich with cash, its state-controlled firms are buying up prestigious firms in the developed countries. It has an accumulated foreign exchange reserve of $ 2 trillion and has become a major actor in world currency and financial markets. While the developed world is in the grip of recession, China is still expected to grow at 6.5 per cent this year. With growing economic clout China has started flexing its muscles in the international arena, as was evident in the recent G-20 meeting in London.

India has to be particularly wary of China’s growing economic might which has wide geo- politico implications. China has been claiming sovereignty over Arunachal Pradesh and lodges protest when the President of India visits the place. It has secretly helped Pakistan to become a nuclear power. It views the Dalai Lama’s presence in India with suspicion and his espousal of greater autonomy for the Tibetan people with hostility.

India: Challenge of Pragmatic Economic Policy

INDIA should not view China’s emergence and the US’ economic decline with equanimity. India has a long-term interest in the stability and health of the US economy. As a liberal and genuine democracy, it is in India’s interest to see that the US re-emerges as an economic power. While India has no control over play of global economic forces, it must follow a pragmatic policy so that it becomes a strong and vibrant economy.

On its industrialisation path, India did not follow the oft-given advice of the Western world, that trade liberalisation is good for a country irrespective of its level of development. India, like China, followed sequenced industrial and trade strategies which had considerable success in expediting industrial development and growth. While export expansion can help in expediting economic growth, the same cannot be said about import liberalisation. There is no systematic relationship between a country’s average level of tariff and non- tariff restrictions and its subsequent economic growth. On the other hand sub-Sahara African and Latin America countries, that followed the orthodox reform agenda under the structural adjustment programme administered by the IMF and World Bank, which led to indiscriminate trade liberalisation, had to face the consequence of deindustrialisation and marginalisation of the their economies in the international division of labour. The experience of the developing countries during the last three decades makes a compelling case for the relevance of infant industry protection and other policy intervention for industrialisation and development. Only a calibrated and managed trade policy seeking to aggressively promote export-orientation, as pursued by the East Asian countries, may produce favourable outcomes, rather than the one which passively promotes imports.

Agriculture in the developing countries is particularly vulnerable to competition from abroad. India was a huge importer of foodgrains during the 1950s and 1960s, was going around the world with a begging bowl and susceptible to international pressure. Cheap PL 480 food imports from the USA in the fifties and sixties had a deleterious effect on India’s wheat economy, created price repression and farmers lost interest in its production. During the Indo-Pak war of 1965, the USA stopped food supply as a political offensive, and forced the country to give attention to foodgrains production. The leadership provided by Prime Minister Lal Bahadur Shastri and Agriculture Minister C. Subramanian, coupled with the development of a high-yielding variety of wheat and price support for farm products, spurred agricultural production in the country and brought about national self-sufficiency.4 Today India is able to feed not only over one billion people, but exports high quality rice and occasionally wheat.

When India attained independence and launched its Five Year Plans in the fifties to seventies, it gave emphasis on heavy and strategic industry with state support and protection. It did not forget its colonial history. In the heydays of the British Raj the doctrine of free trade provided theoretical justification to keep India as an agrarian economy, specialising in production of raw cotton and jute due to abundance of cheap labour and supplying the same to the textile mills of Lancashire and Liverpool! As Barat Brown summed up, “Britain’s industries were reared behind protective walls, nourished on imperial tribute and encouraged by the destruction of competition from the East. But once established they no more needed protection, plunder and protected markets.”5 Protection became a drag on development. “free trade was the instrument of Britain’s industrial supremacy holding back development elsewhere”.

Today seeing the plight of the developed countries where numerous industries are being closed, unable to face competition from China and other countries, it is important to remember the two hundred years history of industrialisation. The development of the world’s wealthy nation was driven by industrialisation with initial protectionism, government intervention and strategically timed introduction of free trade and investments. In the 19th century the German industry thrived under protection and state support. The US economy was the most protected, but was among the fastest growing economies of the world until World War II. The above point is being made not to make out a case for a closed and protected economy, but to emphasise the fact that blind adherence to the free market philosophy, which has the potential of destroying established domestic industries and creating job losses and social unrest, is an unsound policy.

India liberalised its economy in 1991, after three decades of industrialisation under heavy state hand and closed market conditions. This spurred the industries, both in the public and private sectors, to record greater efficiency. Indian industries have become global players and they have acquired firms in the developed countries in high technology areas and demonstrated their competence. Indian IT firms are world leaders commanding a substantial share of outsourcing business. Prof Dunning, a distinguished authority on the subject, observes, “It is not the countries with least government intervention that performed the best, but those who have worked with firms and markets to promote efficient allocation of resources under their jurisdiction.”6 He underlines the fact that significance of the government is likely to rise in the coming years, as industrial competitiveness is likely to become the number one item on the political agenda and the determination of competitiveness rests on the ability of a country to provide the right economic and cultural environment for its firms to be innovative and productive. Today the biggest challenge facing the government is to put in place a policy which makes the industrial sector efficient and globally competitive.

Agriculture holds the key to the country’s prosperity. It provides employment to more than 50 per cent people of the country supporting half the population, but its share in the GDP is only 20 per cent. There is huge agrarian distress due to declining productivity and higher costs of input—the government’s policy intervention being limited to giving input subsidy and minimum support price for some category of foodgrains and agriculture products. There is need for massive public investment in agriculture infrastructure such as irrigation, farm machinery and equipment, seeds, post-harvesting handling and processing and R&D to make agriculture dynamic and the mainstay of the economy. India with its vast population must adopt a conscious policy of becoming fully self-sufficient in foodgrains production, not only in rice and wheat but also in oilseeds, pulses etc. It must resist pressure from the WTO and developed world to open up its agriculture market. The last round of the Doha trade talk collapsed due to the resistance put up by the developing countries. There is considerable duplicity in the developed countries’ behaviour in global trade in agriculture products. The EU gives billions of Euros as subsidy to its farm output and dumps cheap products in African and other developing countries’ market virtually destroying many of its crops with disastrous ramifications on the economy. The US’ production cost of cotton is twice the international price but it protects its 25,000 well-off farmers by giving huge subsidy, who dump the cotton in the international market, which destroys the livelihood of some 10 million farmers in Mali and other African countries for whom cotton is the main source of livelihood.

Our agriculture and industrial development policy should be determined by the unique requirement of India’s teeming millions and should not become a prisoner of defunct economic ideas. Development has to be done with a human face with the realisation that people are both the means and end of development. A belated recognition of the fact that the people are the real wealth of the nation and development is more about building human capabilities has been made in development literature, with the UNDP taking the lead. Building human capabilities in terms of investment in education, health, social security etc. should be at the core of the development philosophy. Therefore policies such as those related to the Special Economic Zone (SEZ), wherein some big business houses in league with land mafia acquire rich agriculture land at cheap rates, and throw the hapless farmers out of livelihood and permanent penury, should have no place in the development philosophy. What we need is equitable and people-centred development.

Future Direction—the Middle Path

POLICY-MAKERS all over the world are groping in the dark, trying to find a solution to the current crisis and what is the best economic model to build a stable economy. It needs to be remembered that there is nothing like a pure capitalist or socialist path of economic development. Capitalism, with its philosophy of free and unregulated markets, leads to concentration of wealth in the hands of few causing widespread social disparity. It also encourages individual greed and avarice. On the other hand socialism, in its practical operation, implies control over the means of production and distribution by the state, though the philosophy of socialism when originally postulated had its roots in the doctrine of equality and liberalism. The economists for a long time suffered from the illusion that the state acts as a platonic guardian of the people. They forgot that it is the politician and the bureaucrat who control the machinery of the state and their main aim is to exercise power and authority with scant regard to the people’s welfare. We should therefore avoid becoming victims of the doctrinaire ideology.

The Eastern philosophy gives a strong message to deal with the current problem. Gautam Buddha had advocated the Middle Path, in which he offered a harmonious, balanced life, steering between the two extremes of self-indulgence and total abstinence. The Bhagwad Gita extols the virtue of moderation and balance in all our activities: ‘To him who is temperate in eating and recreation, in his effort for work, and in sleep and in wakefulness, Yoga becomes the destroyer of misery.’ (VI.17) What we need today is a Middle Path, a healthy and judicious mix of the free market and socialist ideology, the market and the state working in harmony and in tandem to have the ‘right development policy’. We should therefore design policy initiatives which take care of the welfare of the vast majority of people living in this country, fulfils their basic wants and gives them a dignified and respectable life to live.


1. United Nations, New York, 2009: World Economic Situation and Prospects 2009.

2. The data in this section has been taken from The Economist (London), various issues.

3. J.K. Gailbraith, The Affluent Society (Penguin Books, 1958), pp 17-18.

4. See B.P. Mathur, Foreign Money in India (Macmillan, New Delhi, 1989), for a detailed elaboration

5. Michel Barett Brown, After Imperialism (Heinmann, London, 1963), p 52.

6. John H. Dunning, ‘Government-Markets-Firms: Towards a New Balance’, The CTC Reporter, No 31, Spring 1991, pp. 2-7.

Dr B.P. Mathur is a former Director, National Institute of Financial Management, Deputy CAG and Additional Secretary, Government of India and worked in several economic ministries. A Ph.D and D.Litt in Economics, he has been Visiting Faculty several national level Institutes and is the author of books on economics, finance and governance related issues. His e-mail is:

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