Mumbai: Heavy regulation of its financial sector and economy may have helped India insulate itself from the global economic crisis, but such stability comes at the cost of lower long-term growth, former US Federal Reserve chairman Alan Greenspan said on Monday.

Broader perspective: Greenspan says the present-day crisis came from the post-Cold War structure, when millions of workers in countries such as India and China joined the global economy and saw growth rates rise. Chris Kleponis / Bloomberg

“If you have a heavily regulated financial system you can insulate yourself... China has done it, you have done it... (but) it is proven historically that the highest standard of living and economic growth have been observed in economies that are least regulated," he said through a video link from Washington, DC for a seminar organized by local brokerage firm Antique Group in Mumbai.

Greenspan said India’s decision to not embrace globalization fully was more a “political issue" than economic choice.

The 83-year-old former central banker oversaw the longest expansion in the US economy after the end of World War II, but his considerable reputation took a hit after the pricking of the housing bubble in 2007 that critics say his low-interest policies encouraged.

The former Fed chairman suggested that to catch up with China, India should focus on increasing productivity of its farm sector, thus freeing up farm workers to work in other value-added and high-productivity areas.

There are 1.5 million highly skilled Indians in the US without whom “we will have difficulty in staffing our high-tech infrastructure." “That is the kind of movement you need to bring in domestically to start closing the gap on China," said Greenspan.

According to him, the root of the present-day crisis lies in the post-Cold War structure, when millions of workers in countries such as India and China joined the global economy and saw growth rates rise. “Due to the lack of developing-world infrastructure to support spending, it induced extraordinary savings."

Real estate prices grew “dramatically" pretty much across 20 countries. Across these countries interest rates and inflation remained in the single digit for a long time, resulting in “extraordinary economic growth and thus building up of euphoria." “Risk became significantly underpriced," and “seemed negligible to so many people," said Greenspan.

“When you have some euphoria people go for significant risk; if not mortgages, they would have gone for something else," he said.

According to Greenspan, the asset bubbles are not easy to identify and deflate by policy action. “In econometric models, you can incrementally tighten monetary policy and defuse the amount of bubble... in real world it never worked that way and is counter-productive."

“It’s a mistake to believe that it (defusing the bubble) is a simple thing," he added.

Greenspan was critical of banks’ low capital base in the US and said that even in the 19th century, the capital requirement was as high as 20%. Now the capital requirement is 10% in the US, which is “wrong."

“We have to have a larger buffer than what we have now," he said.

“There is no substitute for capital," Greenspan said, adding that he believed the crisis was inevitable..

Greenspan also warned that if an effective “exit strategy" is not chalked out now to sterilize the increase in dollar liquidity and to shrink the balance sheet size of the Federal Reserve, there will be double digit inflation in the US as well as globally.