A key idea of John Maynard Keynes, one of the greatest economists of the 20th century, who is widely credited with helping the world recover from the Great Depression, is proving to be a curse for the world. Without going into the nitty-gritty of theory, Keynes, in simple terms, said that when aggregate demand is low, and the economy is in a vicious downward spiral, the state would be wise to spend more and put money in the hands of people so that the economy revives. He advocated the boondoggle, that is paying money to people to do useless work in order to avoid an economic depression.
The problem with Keynes’ formulation was not that it was wrong – governments must do something when people are in distress – but that politically, it gave almost all governments a licence to print money whenever the going was tough. It’s almost never about tightening one’s belt, or living within one’s means, which is what common sense would dictate.
What Keynes’s (deliberately) misunderstood theory has essentially enabled is the steady expansion of the state based not on income or tax revenues, but pure debt. Before we discuss why that is bad, let us consider the outcomes – whether the risk was worth it. Has the mindless expansion of spending made states more effective or economies more productive? Has debt-fuelled economic growth enabled the creation of millions of new jobs and spread incomes all around? Has the creation of the big welfare state delivered public goods like law and order, improved educational and health outcomes, reduced terrorism, or improved public infrastructure? We are in the middle of two wars that could turn global any time, and terrorism is far from being defeated. Barring some exceptions, the world is not in a happy place in terms of overall education or health outcomes.
Debt fuels inequality
India has spent a lot on infrastructure, but one can hardly say that law and order is any better today than it was a decade ago. Our public debt is a high 82.5 per cent of GDP. If one looks at West Asia, Europe and North America, law and order does not look any better, and terrorism is showing no signs of waning. Technology has concentrated wealth in the hands of a few by destroying middle-skill jobs that can be easily automated, and income and wealth inequality has increased.
A caveat: We are not talking about redistribution of wealth or higher income taxes, but merely noting the fact that this inequality is fuelled by debt, as we saw after the 2008 banking and financial collapse. To ward off another economic depression, the US Fed (and other central banks) brought interest rates to near-zero levels and splurged on borrowings. The original crisis, brought on by Wall Street’s buccaneering ways and imprudent bank lending, was fought by issuing trillions of dollars of new debt, which in turn fuelled a stock market bull run, making the very people who precipitated the crash even wealthier. When no one pays any price for his mistakes, you are sending the message that there is a safety net for the rich. The resultant inequality will exacerbate social tensions everywhere.
The last few economic crises, from the 2008 meltdown to the eurozone crisis to the Covid-19-induced collapse in economic activities, were not tackled with a mix of belt-tightening and targeted spending, but a massive general increase in public debt. The US alone is adding approximately $2 trillion in national debt every year which is more than half of India’s current GDP. Debt-to-GDP ratios are soaring, with the US at 123.3 per cent, Japan at 254.6 per cent, France at 111.6 per cent, and India at 82.5 per cent. The world has printed money to get itself out of every ditch it got itself into, but the eventual reckoning cannot be avoided as no country can endlessly take on debt without sparking off unwelcome outcomes.
The current public debt of the world is around $97 trillion, against a debt-fuelled global GDP of $105 trillion. That gives us a global public debt-to-GDP ratio of 92.3 per cent. It is fast approaching the 100 per cent figure where it will become unsustainable as interest costs outrun every other kind of development expenditure. The post-war world was fuelled by debt, and the situation worsened after 2008. Between 2010 and now, the global public debt figure has just doubled, and both the US and China are planning on providing further stimuli by taking on more debt. Among major economies, India is an outlier. Finance minister Nirmala Sitharaman publicly said in her last Budget speech that she plans to bring down the debt-GDP ratio steadily. If the INDI Alliance had come to power, the debt-GDP ratio was sure to have grown further, given the kind of welfare commitments made.
We must look at the downside of debt-fuelled growth. Excess currency printing keeps loss-making and nearly dead companies afloat, tying up capital without creating new jobs. Ruchir Sharma, global investment strategist and author, says that nearly 20 per cent of US companies are “zombies”, companies that are kept artificially afloat by state support or unsustainable debt. It may not be any different here.
In India, expensive poll promises – the income guarantees to women, farmers, youth, etc – will not only be economically unsustainable at some point but will actually destroy potential jobs. During the 2024 Lok Sabha elections, the Congress party promised to create three million government jobs by filling up vacancies without asking itself why any popular government would not do the same if it were fiscally possible.
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Lessons from welfare politics
The fact is government jobs cannot be grown due to fiscal pressures. When welfare/subsidy expenditure expands in any category, the sector’s job-creating potential contracts. When Air India was kept afloat by government subsidies, it brought the rest of the aviation industry’s viability down. When OROP (one-rank-one-pension) was introduced, it became impossible to continue Army recruitments in the normal way as 53 per cent of the defence budget is being spent on personnel and pensions. Agnipath – the short-term recruitment scheme for soldiers – was inevitable.
Huge welfare expenditure has forced Karnataka to delay infrastructure spending and new projects. Haryana would have faced the same problems if the Congress had won, given its grand welfare promises. Not that the BJP is doing any less. In Maharashtra, where an assembly election is due next month, the Mahayuti government has massively ramped up welfare handouts.
Both central and state governments, which can create a fair amount of high-quality jobs, cannot any more do so on scale because their welfare spending is going through the roof. India has good growth – at least in the short term – only because it ignored advice from economists and financial columnists to spend over the top during Covid. The rest of the world did the opposite and is paying the price now.
The lessons to draw are simple.
One, you cannot wish away economic problems from time to time; they cannot be tackled only by printing money. You are merely kicking the can down the road, not solving a problem. Belt-tightening for some time has to be the norm.
Two, the more the state becomes bigger by borrowing, the less efficient it will be. This is because the state cannot easily sack people or use them efficiently to deliver healthy outcomes from the deployment of public debt. In most cases, states must shrink debt (at least in relative terms) so that there is space for private initiative, innovation, and efficient spending. A rupee left in private hands will deliver more bang for the buck than a rupee handed over to the government.
Three, when welfare spending breaks the bounds of rationality it will reduce the state’s own capacity to create jobs in the public sector. Free food for the poor may be needed to ward off hunger and malnutrition, but free bus rides for women or free power (and even free water, as in Delhi) are surely welfare indulgences that meet the definition of “revdis”. Whatever is given free, and for very good reason, must be targeted.
Electoral democracy has a tendency to make politicians misuse taxpayer resources to win polls, and for this reason alone, one nation, one election (ONOE) is worth considering. But more than ONOE, the state must shrink its appetite for debt, and let people, companies and other organisations use the same money better. This applies to India, and even more to the rest of the world. Tightening belts without ignoring real poverty is the key.
R Jagannathan is editorial director at Swarajya magazine. Views are personal.
(Edited by Zoya Bhatti)