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How is economic pain shared during a crisis? Some recent data on the Indian labour market can provide a useful context.

Employment has normalized as restrictions on movement were eased by the government. However, the recovery has been uneven. Mahesh Vyas of the Centre for Monitoring Indian Economy wrote in Business Standard this week that informal jobs have returned, but formal jobs have not. He estimates that 17 million salaried jobs were lost in the quarter ended June.

A persistent puzzle is whether or not workers in the unorganized sectors have got back their old jobs at the same wage rates as before. Meanwhile, early corporate results for the first three months of the current financial year show that many large companies have slashed employee costs during the quarter. Companies in most sectors brought down wage costs by either cutting salaries or letting people go. A broader picture of the share of wages in gross value added will be available only when the Annual Survey of Industries for this year is released.

A lot of economic research has been done in recent decades on how exogenous shocks, such as the one we are facing right now, get amplified through the economy. In a report released earlier this month on economic growth in times of covid, J.P. Morgan economists Sajjid Chinoy and Toshi Jain wrote about two key amplification channels. A wave of corporate bankruptcies could hit bank balance sheets, create unemployment and reduce the economy’s productive capacity. The banks themselves will likely become even more averse to taking risks through lending. “The depth and duration of India’s slowdown will also hinge crucially on whether the covid-19 shock amplifies through India’s financial and labour markets," the two economists wrote.

This column asks a related question. As the economy hobbles back to normal in the coming quarters, who will help absorb the pain? The two obvious shock absorbers are the government budget and the banking system. The Indian government has kept much of its fiscal firepower dry so far. A lot of the early intervention has been focused on credit guarantees rather than direct spending, which is a good idea, given the need to prevent capital destruction.

However, higher fiscal spending will be needed to support aggregate demand as the economy gets back on track. As this column has argued earlier, since risk aversion among households and firms could lead to higher precautionary savings as well as demand for safe assets, such as government bonds, it is possible to support a higher fiscal deficit for some time. There is also some space for extra money creation by the Reserve Bank of India.

The other traditional shock absorber is the banking system, especially when banks act as an arm of the country’s fiscal authority by supporting growth through rapid credit creation. China is a classic example. Banks can absorb an economic shock in two ways—either by massive recapitalization at the end of the credit cycle, or by some form of regulatory forbearance in terms of less stringent accounting rules. The second, which the Indian central bank has chosen for now, is the easier though less sustainable policy option.

India entered the covid crisis with a weak fiscal balance and a stressed banking system, and so these two may have limits on their ability to absorb the covid shock. What are the other options? Here are three of them, though the list is not exhaustive. First, labour acts as a primary shock absorber through structurally lower wages. Second, companies learn to live with lower profit margins. Third, savers underwrite the gradual recovery through negative real interest rates in a system based on financial repression. (A friend who I discussed this issue with also pointed out that a significant burden may fall on the unorganized sector that is credit constrained.)

Each option comes with a few significant risks. For example, a sustained income shock will undermine domestic consumer spending at a time when corporate investments as well as foreign demand are weak. Lower corporate profits will eat into the ability of companies to deleverage. And negative real interest rates sometimes result in households moving their savings from financial assets to real assets such as gold.

The adjustment process after a period of economic stress is always complex. The links between different parts of a recovering economy have to be carefully traced. However, the challenge is not purely an economic one, and has important political-economy questions embedded within it.

A lot of the ongoing debate over India’s economic policy is whether our recovery plan should be focused on the supply- or demand-side. An equally important issue is whether it should be led by profits or wages. Choosing between the two is a complicated task. Higher real wages will lead to rapid growth in demand for industrial products, but also put marginal enterprises under immense profit pressure. Lower real wages will have the opposite effect. A similar tough choice has to be made in protecting the interests of either savers or borrowers when it comes to financial repression. Ideally, these choices should be made by the political system, rather than by economists.

Niranjan Rajadhyaksha is a member of the academic board of the Meghnad Desai Academy of Economics

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