Global economic crises have a way of imparting useful lessons.
When the Covid-19 pandemic hit the world, the fiscal stimulus strategy of Franklin Roosevelt to resuscitate the US economy from the quagmire of depression in the 1930s was replicated by almost every country.
The East Asian crisis of 1997 due to the unregulated flow of capital has made many developing economies like India wary of embracing full convertibility of their currencies.
The US subprime crisis of 2007-’08, which busted the myth that Big Banks Do Not Fail, has made countries more cognisant of the importance of regulating banks effectively.
But how does one deal with the tariff tantrums of US President Donald Trump? Retaliate against the US with high tariffs like China, or demurely wait and watch like India? This man-made crisis seems to have befuddled the best of analysts.
It brings to mind the “beggar thy neighbours policy” adopted by many countries during World War II, when the fixed exchange system under the gold standard crumbled. Countries started imposing import tariffs, introduced import quotas and resorted to competitive currency devaluation to boost their domestic economies, regardless of their impact on trading partners.
As the war was ending, the establishment of the International Monetary Fund in 1944 resuscitated the gold standard, reinforced the fixed exchange rate system and made the dollar the premier global currency. The General Agreement on Trade and Tariffs in 1948 progressively reduced barriers to promote free trade.
Since then, the US has been at the forefront of building international institutions to promote its idea of global economic stability and encourage free trade – it was the real victor of World War II. But the foundations of these institutions are being shaken by a president who wants to Make America Great Again by walling itself away with tariffs.
Trump claims that all other countries have been “ripping off” the US. But as US political scientist Joseph Nye observed, “He is so obsessed with the problem of free riders that he forgets that it has been America’s interest to ride the bus.”
Global crises have often resulted in systemic improvements in economic governance structures. The economic depression in the USA in the 1930s showed up the fallacy espoused by the classical economists that economies return to a natural state of equilibrium. British economist John Maynard Keynes rightly flagged the importance of generating additional employment through public investment to boost effective demand.
Roosevelt gave life to these groundbreaking ideas by introducing the “New Deal” programme of massive public investment, coupled with a slew of social security measures, to fuel the US economy. His architecture of a welfare state stood the test of time.
When the Covid pandemic struck in 2019, a great many countries realised that Keynes was still relevant. The generous fiscal stimulus offered by governments, in addition to rapid vaccination campaigns, revived business and curtailed unemployment.
In India, for instance, the collateral-free loans to small and medium enterprises by the government and the increase in allocations to employment programmes like the Mahatma Gandhi National Employment Rural Guarantee scheme helped put the most vulnerable on the path to recovery.
In 1997, the East Asian crisis was largely due to an economic bubble fueled by hot money, or capital that moved quickly between markets in search of the best returns. It brought to the centrestage the importance of regulating capital inflows, particularly hot money from foreign institutional investors.
India had debated whether it should move to full capital convertibility – the ability to convert rupee-held assets into foreign ones without restrictions. In the end, policy makers concluded that the country was not ready for this. India seems to have benefited from the lessons of the East Asia crisis.
The subprime crisis of 2007-2008 in the US and its contagious impact on other countries clearly showed the widespread failures in financial regulation, including the US Federal Reserve’s failure to stem the tide of toxic mortgages and dramatic breakdowns in corporate governance.
Former governor of the Reserve Bank of India Raghuram Rajan, in his book The Fault Lines, emphasises the importance of effective risk management and the need for better regulation and oversight. The crisis led to a slew of reforms in the international banking architecture. The Basel III regulations in 2010 ensured that the global banks raised their capital adequacy levels, improved risk management practices and promoted financial stability.
In the US, the Frank Dodd Act that year called for improving accountability and transparency in the financial system, protecting consumers from abusive financial practices and preventing future financial crises.
India needs to be wary of following Trump advisor Elon Musk’s advocacy of the “wholesale removal of regulations”. India was able to navigate through the global financial crisis of 2007-’08 due to its sound banking regulatory structure. It also waded through the pandemic years skillfully because of its commitment to the welfare of the most vulnerable.
To ride out the tsunami triggered by Trump, India should follow the Chinese model of fashioning itself into a global manufacturing hub and investing more in quality education, skills and technology.
It is not our ranking in global GDP that will enable us to face such a crisis but the quality and capability of our manpower, who will have the skill sets in the manufacturing and service sector to compete globally.
Satya Narayan Misra is Professor Emeritus (Economics) at Kiit University in Bhubaneswar.
