December 15, 2008

These days newspapers are flooded with reports on the government sponsored economic stimulus package. Opinion and counter opinion on whether the package will deliver desired results are dime a dozen. I am also tempted to share my two cents.

The whole exercise of government bailout and stimulus package appears to give a suspense filled twist to the tragic economic drama unfolding before us. Will it work, will it not? This is the question on every lip that bothers even a bit about Economics. Unfortunately, these economic stimulus packages are not going to help much. Like a typical business cycle, the economy would hit the bottom and then gradually start the ascent once again. Stimulus package may help avoid the bumps but it is not going to bring the economy back on the track anytime in coming few months. It is because economy runs according to the laws of Economics; not by the whims and fancies of economic institutions, government agencies, central banks, or business houses.

Last five years were an economic merry go round kind of thing. Everything was rosy. Easy money was all around. It seemed like a never ending party. It was about arrival of India on the world stage. Stock market was running like a wild bull. Real estate prices were doubling every year. 25% salary hikes seemed normal. Banks were ready to hand out loans and credit card to every human standing outside suburban railway stations. Was anyone complaining then? No. Then why complain now? Just because the universal laws of Economics are threatening to bring our feet back to ground? The problem is not hard to guess – we made the mistake of spreading our legs beyond the size of the blanket! And now it hurts when someone is pulling the blanket itself away from our body.

Current government stimulus package is basically counter-cyclical and primarily aimed at helping the real estate sector thereby boosting demand. But it means that government is not willing to accept that there are serious problems in some sectors like real estate and banking. Why would it otherwise try to help it when it is clear that realty prices are too inflated? It is better to leave such things in the hands of Economics to get themselves corrected by the rules of demand and supply which is, in any case, going to happen, with or without government stimulus! For those with weak memory, in 1996 the housing sector went bust and prices crashed by almost 40%. Economics will ensure that this time too, prices would crash by 25-30% or more to even out the gap between demand and supply. Government sponsored economic stimulus may delay the crash, but they can't prevent price correction.

Similarly, India's dependency on services sector would show its dark side during this economic slowdown. India's consumption power of the last five years has come from money generated through services sector. Now it is the service sector which is getting hammered the most. This will have a chain reaction affecting the overall consumption leading to greater economic hardship.

Instead of unsuccessfully trying to prevent economic laws from taking their own course through bailouts and stimulus packages, the government should try to help them in correcting the abnormalities of economy to bring it to the just level before thinking on how to take it to the next higher level.

We should never forget that Economics, like death, is a great leveler!