Opinion | Macroeconomics may not have the answers we are looking for

A former finance minister, recently out of jail, accused the National Democratic Alliance (NDA) government of being “clueless” on the economy. He may be right. However, the question one needs to ask is whether even highly rated economists are better clued in.

Given the huge failures of macroeconomic policymaking over the last 25 years, with growth not delivering enough jobs and inflation refusing to rise no matter how much interest rates were cut or public spending raised in Europe, the US and Japan, we need to question our touching faith in macroeconomics.

In India, we have seen economists promise high growth (i) if the fiscal deficit is magically brought to 3%, (ii) if GST is implemented “correctly”, (iii) if trade tariffs are cut to the bone, (iv) if taxes are cut, or (v) if inflation is kept low by keeping interest rates high. Now, we are being told the opposite—that we need more fiscal latitude and lower rates to get growth up and boost consumption. The macro forecasts in 2016 on the impact of demonetization ranged from 0.5% of gross domestic product (GDP) to 3.5%, suggesting that these predictions were no better guided than apes throwing darts at a dartboard. Someone was sure to get close to the bull’s eye.

Not for nothing did the late John Kenneth Galbraith remark that the only function of economic forecasting is to make astrology look respectable. Like astrologers, macroeconomists get things right occasionally because they are lucky, as was the case with former US Federal Reserve chairman Alan Greenspan, who was seen as the man with the Midas touch as long as the US economy stayed in its so-called “Goldilocks zone”—high growth with low inflation. After 2008, he was widely accused of not doing enough to prick the sub-prime bubble in time to prevent financial carnage. After he fell from grace, we began extolling our own Raghuram Rajan for predicting the coming collapse. However, Rajan did not necessarily have a better crystal ball than Greenspan, for all doomsayers know that good times do end some time. They just don’t know when.

Macroeconomics gained popular appeal in the 20th century because of two factors: one was the emergence of US from the Great Depression by following broadly Keynesian policies, and the other was the invention of mathematical modelling in the heyday of the US’s post-war industrial boom, when economists such as Wassily Leontief used input-output analysis to make macroeconomics seem like the physics of social sciences, capable of predicting precise changes in economic direction.

However, faith in macroeconomics is on shaky ground. Another kind of disruption is creeping up on the global economy, one led by huge leaps of productivity, thanks to technology that is drastically driving prices down. These changes could even be reducing GDP, as gains in quality are often left uncaptured by the financial economy.

In India, for example, we have seen the cost of telecom services crash, with voice calls nearly free and data costs down to a fraction of earlier levels. Has this qualitative change pushed GDP up or down? Post-demonetization and digitization, the financial services industry derives more bang for the buck from the same infrastructure. Business expansion needs very little additional investment in overheads.

In many technology markets, there are free versions available of high-priced software. You can buy Microsoft Office, but you can get a similar service from Google Docs free—albeit with some loss of quality. The Internet of Things (IoT), where sensors are being embedded in more and more products, will at some point make the entire service sector support jobs redundant. There is a huge collaborative economy for free products, from free publications on the web to electronic marketplaces that let borrowers and lenders, buyers and sellers, do business at zero or low cost. Bigger changes could occur once people change their mind about owning products. This is happening with cars, as app-based taxi services proliferate. It could happen in hospitality and home ownership, too, as millions of underused properties are put up for rental, both for long-term use and holiday homestays.

In his book, The Zero Marginal Cost Society, author Jeremy Rifkin speculates that high connectivity, cheap logistics and local renewable energy generation could reduce demand for many things that people now pay good money for. Cheap net connectivity will enable people to produce and exchange goods and services for free or barter. He writes: “As the marginal cost of producing goods and services moves toward near zero in sector after sector, profits are narrowing and GDP is beginning to wane. Even those items still being purchased in the exchange economy are becoming fewer in number as more people redistribute and recycle previously purchased goods in the sharable economy, extending their usable lifecycle, with a concomitant loss of GDP.”

If macroeconomics has not delivered even in a highly monetized economy, why will it deliver once large parts of the global economy shift away from production for exchange to production for shared usage?

R. Jagannathan is editorial director, ‘Swarajya’ magazine