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So here we are again, at the doors of the IMF, begging for a bailout. Is this inevitable, part of an eternal cycle of boom and bust, written in our destiny? Some economists believe so, and argue that we should be permanently on an IMF program. It is well known to all, and openly stated by the IMF, that we purchase stability by accepting a slump or a recession in our growth. In contrast, Keynes, who discovered the solution to this problem, said that "The right remedy for the trade cycle is not to be found in abolishing booms and thus keeping us permanently in a semi-slump; but in abolishing slumps and thus keeping us permanently in a quasi-boom."

In order to apply the Keynesian prescription, we must understand the Keynesian diagnosis, which has been suppressed, and hidden from view, since it has the power to liberate the masses from the tyranny of the wealthy who run the world today. Paul Davidson has recently provided an easily accessible description of "The Keynes Solution: The Path to Global Economic Prosperity". We will try to summarize some his key insights in this brief article. The general public is in a better position to understand the Keynes solution compared to professional economists. This is because economic theory incorporates certain fundamentally flawed methodologies which make it very difficult to understand real world economics.

As Keynes wrote in the introduction of his magnum opus, "The composition of this book has been for the author a long struggle of escape ... from habitual modes of thought and expression. ... The difficulty lies, not in the new ideas, but in escaping from the old ones." Surprising as it may seem, the old ideas from which Keynes escaped continue to be the bedrock of modern economics, which retained none of the radical ideas of Keynes which had created a Keynesian revolution of thought in economic theory. Many major economists who had abandoned Keynes were forced to admit the continued relevance and vital importance of Keynesian ideas following the Global Financial Crisis, which took the economics profession by complete surprise.

Conventional economics today teaches us that "money is neutral" - that is, the quantity of money in an economy has no effect on the workings of the real economy. This would seem strange, even baffling, to the general public, since we all have an intuitive idea about the vital role that money plays. Keynes realized that economists were completely wrong about the role of money, and argued that money has extremely important effects, both in the short and in the long run, in complete contradiction to the idea of neutrality of money. It is worth noting that modern economic theory rejects this insight of Keynes, and continues to preach and teach the neutrality money. More amazingly, this theory is built into the models used to conduct monetary policy at Central Banks throughout the world. It is not surprising that none of these models were able to predict the Global Financial Crisis, since the central driving force of the economy is missing from these models.

At the core of the problems we face today is a fundamental conflict between monetary needs of the domestic economy, and the requirements of the international trading system. An expansionary monetary policy, which makes money easily available to investors is extremely important to generate growth for the domestic economy. However, when growth occurs, a disproportionate part of the extra income ends up in the hands of the wealthy. This is not entirely a problem, as long as this extra wealth is plowed back into the domestic economy. However, serious problems arise if this excess money goes out of the country. This can happen due to imports of consumer goods, or if the money is converted to dollars and sent out. In either case, the growing economy generates an excess demand for dollars which drains dollar reserves in the country, outstrips export growths, and leads to devaluations. The crisis created by shortfall of reserves can only be resolved by going to the IMF to borrow more dollars. In order to ensure repayments, the IMF imposes austerity, tight monetary policy, strict controls of government deficit, increase in tax revenues etc. - all of these measure are designed to break the economy's back, kill the impetus for growth, and thereby rein in the excess demand which led to the crisis in the first place. We could solve the problem by staying permanently on an IMF program, thereby keeping the economy in a permanent recession, like Greece, but this seems like a foolish solution.

Several coordinated steps need to be taken, to get to the Keynesian solution of a permanent boom, instead of a permanent slump. One important step is to note the a major source of the problem was created by the liberalization of the current account (freedom for exporters to hold and importers to remit foreign currency for trade in goods and services)carried out in 1988. If the Rupee cannot be traded for dollars, then an expansionary monetary policy will not lead directly to an increased demand for imported goods. An expansion in aggregate demand, when directed towards the domestic market instead of foreign imports, actually stimulates domestic production, and has beneficial effects on the domestic economy. The East Asian crisis illustrates the harms of premature financial liberalization (allowing free convertibility of currency for capital transactions, allowing in particular for export of financial assets).Famous economist Stiglitz reflects the current consensus view when he writes that "capital account liberalization was the single most important factor leading to the [East Asian Financial] crisis."

On this analysis, it would seem that all we need to do is to impose capital controls, and ban convertibility of Rupees, going back to the pre-1988 regime. In fact, the Government and the State Bank have made several recent moves towards restricting convertibility. However, there are a large number of awkward additional complications which must be taken into account, when attempting to impose capital controls. First of all, note that the move will be strongly opposed by the rich and powerful, who gain the most by the ability to freely convert excess Rupees into property and other investments abroad. They also have the greatest demand for imported luxuries, and disdain for cheaper domestic alternatives. Second, the multinationals profit hugely by being able to repatriate profits in rupees to dollars. Sincere desire to serve the public at higher levels will be required to ensure that the broad national interest prevails over the interests of a powerful minority.

In addition to political complications, it is important to note that international financial services are of vital importance to growth of the country. We cannot afford to cut ourselves off from the global economy. Whereas previously, capital account liberalization was considered synonymous with globalization, a clear distinction between the two has emerged in the literature in the wake of the East Asian crisis.

We must ensure relatively easy availability of international financial services, while imposing relatively strict capital controls. For example, multinationals must be allowed a reasonable amount of repatriation of profits, to make it attractive for them to invest. This allowance can be tied to export earnings, so that the net effect of FDI is not to drain foreign exchange reserves. In addition, bonus schemes which reward exporting firms which earn foreign exchange should be re-instituted. There many other known, tried and trusted ways of facilitating international trade without having capital account convertibility. Bilateral frame agreements were used in the Soviet trading block to avoid the need for foreign exchange reserves for international trade. This involves a government level agreement for a certain balanced level of imports and exports, based either on historical or on planned levels, with allowance for a moderate amount of slippage on either side. Larger than planned imbalances are to be rectified in one of a number of ways, which may include putting quotas on surplus imports to stay within the limits. By entering into such frame agreements, the need for foreign exchange reserves can be reduced substantially.

Breaking out of the seemingly eternal cycle of growth, forex deficit, IMF program, and recession, requires out-of-the-box thinking. Creative measures, many of which have not been listed here in the interests of brevity, may enable us to break out of this cycle of interrupted spurts of growth which have caused extreme damage to our economy.

Copyright Business Recorder, 2018


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