What does one mean by paradox of thrift?
The word thrift basically refers to the careful use of money. British economist John Maynard Keynes used the concept of the paradox of thrift to explain the economic conditions that prevailed in the aftermath of the Great Depression of 1929. After stock and commodity prices fell, the population at large started to cut back on its spending. If a single person cuts back on his expenditure, it makes tremendous sense. However, if a significant section of the population cuts back on its spending, there is a problem. This is because one person’s spending is another person’s income.
How does this apply in the Indian case?
Indians have been cutting back on spending since the beginning of this year. Everything from car sales to moped sales have collapsed. People are going slow on buying things as basic as biscuits and even innerwear, for that matter. Volume growth, or the number of packs sold, of fast-moving consumer goods, has reduced dramatically. This is the paradox of thrift at play. If a substantial section of the population cuts its spending, the income of another section of the population is impacted. This section includes everyone from big businessmen to the mom-and-pop store down the road. Overall, this isn’t good news for the economy.
How can businesses remain competitive?
Businesses fire people to remain competitive. This is playing out across the automobile and the auto-ancillary sectors. An increase in unemployment leads to a further cut in spending.
What is the way out of this conundrum?
With people and businesses not spending money, Keynes had suggested the government needed to act as the spender of the last resort. The only way out of this situation was for the government to spend more on public works and other programmes. Business lobbies have asked for a ₹1 trillion stimulus package to get the Indian economy going again. The trouble: government spending is not the most efficient form of spending in the Indian context. It takes time to reach people and there is corruption involved.
Is there a better way to tackle this situation?
Instead of spending money directly, the government could put money in the hands of people to spend. This can be done directly through income tax cuts and indirectly through cuts in the goods and services tax. It also needs to balance this loss in tax revenues by selling public sector enterprises and the land they are sitting on. This will ensure that the government doesn’t end up borrowing more and pushing up interest rates.
Vivek Kaul is an economist and the author of the Easy Money trilogy.