Bailing out an ocean

First, there were serious macroeconomic concerns which had remained under-addressed for some time. Structural imbalances arising out of low savings and high consumption in the US and relying on savings of others, particularly China and Japan, could not continue for ever. Even for a dominant economy like the US, a combination of high current account deficit with high fiscal deficit was overdue for a correction. The debate on the current crisis overlooks the need to redress these embedded structural imbalances. These will inter alia imply tha consumption levels in the US need to be better aligned with their propensity to save.

Second, the current bailout package can only worsen the US fiscal deficit. The prices at which these toxic assets are eventually sold may be lower than the cost of acquisition. A significant scaling back on defence expenditure would reqire a broader consensus after the election. Rising fiscal deficits also circumscribe commitments on tax breaks and new expenditure programmes. Thus the rhetoric generated in the electoral debate might not translate into practice.

Third, it is ironic that the IMF has suddenly woken up with a start. In a recent interview, its managing director Dominique Strauss-Kahn stressed the need for wider international consensus to address the current turmoil. This is characteristic of Bretton Woods institutions which react well after the event but still seek to play a constructive role. They promise to become more vigilant in future, commit to greater reform and pledge to reinvent themselves, but once the crisis blows over it goes back to business as usual. Under the IMF charter, it is expected not only to review government policies but also the regulatory environment in so far as they affect overall stability and growth, as well as suggest appropriate diagnostic measures. Clearly this crisis did not happen overnight and the Fund8217;s surveillance mechanism failed to detect it, much less raise any alarm. There is no doubt that this turmoil will have serious contagion effects elsewhere. Strauss-Kahn is right that the Fund should play a bigger role but who is listening to it? Has the institution been refashioned to detect, prevent, mitigate and enforce a new set of rules that would undoubtedly be necessary?

Fourth, the moral hazard questions go beyond regulatory failures. It is even broader than assignment of responsibilities, the poor judgment of rating agencies whose objectivity was compromised while seeking collateral business, and ethical issues in determining the compensation of CEOs and senior management. They raise issues of a more conscionable burden-sharing between taxpayers, ordinary shareholders and those responsible for running these companies. Any response which solely vindicates the critique that while profits are private, their debts are public, will lack credibility. To what extent should the taxpayers pay for the failed judgments of rating agencies, regulators and the senior management of these institutions?

Finally has market economics been buried for a while? While the pundits of high finance obviously have a lot to explain and correct, it would be unwise to draw exaggerated conclusions. The broader principle that while markets cannot play God, they remain the most efficient arbiter of resources, foster innovation, and enable competition to improve productivity, cannot be abandoned in haste. No doubt minimising market imperfections, improving regulatory oversight, objective assignment of risks and emoluments which better balance rewarding entrepreneurship with a sense of fairplay and equity remain policy challenges. These serious moral concerns need to be addressed in an appropriate manner. However in emerging markets like India it would hurt growth if the broader approach to improve the cost and quality of financial intermediation through competitive market economics is totally reversed. No doubt, policies and their pace must be nuanced to suit specific country needs. In the short run, easing liquidity constraints, encouraging inward capital flows and shoring up confidence will remain critical. However sound judgments cannot be replaced by transient panic. Maturity lies in drawing the right conclusions.

The writer is a member of Rajya Sabha