India’s Problem Isn’t Demand: How Most Economists Have Got It Wrong

India’s Problem Isn’t Demand: How Most Economists Have Got It Wrong

by Shanmuganathan Nagasundaram - Wednesday, October 9, 2019 12:10 PM IST
India’s Problem Isn’t Demand: How Most Economists Have Got It WrongShoppers at a department store.
  • What these neo-Keynesian suggestions will lead to is not demand, but ‘inflation and bubbles’.

    This demand is an imposter and, in the long run, it will collapse.

The recent slowdown in the Indian economy has been attributed to the slackening of demand by almost all economists. There’s near unanimity on the above diagnosis within the spectrum of neo-Keynesian economists – from Jayati Ghosh on the Left to Subramanian Swamy on the Right.

Of course, depending on where they lie within the above spectrum, their solutions could range from the “near Marxist” recommendation to triple Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) allocations, to an “understandable, but nevertheless incorrect” recommendation to abolish income tax for individuals. All this as a mechanism for boosting demand, which happens to be the apparent villain in this growth slowdown in India.

Let’s make just a couple of points before we turn to our main theme. First, I am in complete favour of abolishing income taxes, and a whole lot of other taxes as well. But let’s not use the pretext of weak demand. It should be done from the purely libertarian ethos of individual liberty and limited government. All that the current proposal would do is transfer the burden of corporations from income tax to inflation tax – which is a much more nefarious form of taxation.

So, prior to getting rid of income tax, one should work towards abolishing the inflation tax. In that sequence.

While writing this article, I am reminded of Ron Paul’s voting record in the US House of Representatives. There are any number of bills in which his voice will be the sole dissenting vote. When there’s unanimity between the ruling party and the opposition, it indeed takes some measure of conviction to stand against the crowd. The most celebrated case was when he voted against giving the Congressional Gold Medal to a fellow Republican, Ronald Reagan, whom he had a great personal admiration for. I have little doubt that had this 'demand theory' been put up for a vote, it would have had a similar result.

So, why is it never 'demand'? The entire branch of economics can be explained by starting from the axiom of how “we satisfy our unlimited wants by utilising our limited resources”. It’s never demand that’s the constraint, but always supply. But, of course, the above statement is still very cryptic, and so let me explain using a simple example.

Imagine an island where people are living in primitive conditions producing barely subsistence levels of food. Is there a demand for cars and cellphones on that island? Of course, since none of them own one, why not just give it to them in order to stimulate demand? Okay, forget cars or cellphones, why not give them clothing and soap? The point is that giving it would be charity and not business – and hence unsustainable.

Whether the cost of the charity is borne by the producing business or the government doesn’t alter the futility or immorality of such an action. In fact, government funding is far more insidious, as all sorts of 'pork' gets bundled with such a stimulus and the costs are unevenly borne by the people at the bottom of the pyramid – as is the case with all inflationary actions of the government. It really takes a massive leap of faith to believe that demand comes from a printing press.

So how does 'demand' really arise? There is this much misunderstood economic truism: “Supply creates its own demand”. For example, when those islanders start producing food and other marketable goods in excess of their personal consumption, then, by selling those products, they create demand for other products that they do not produce themselves – ie soaps and clothing or cars and cellphones. That then is the real meaning of supply creating its own demand.

The savings-investment-production cycle that leads to the supply of goods and services creates wealth, a part of which is used to purchase things – ie create demand for other desirable goods and services. And that is also the only way to create legitimate demand.

Now, what these neo-Keynesian suggestions will lead to is not demand, but 'inflation and bubbles'. This demand is an imposter and, in the long run, it will collapse.

Quite unfortunately, after nearly 38 years of a continuous central banking binge, we are in the long-run right now. While we have plenty of bubbles the world over, given that we are talking about the Indian economy in this article, the particular industries that are in bubble zone are rate-sensitive sectors like autos and housing.

Whenever we allow governments to manipulate interest rates (they are almost always lower than what the free market would price money at) or to direct credit to specific sectors, the end result is invariably bubbles. And bubbles are always looking for a pin and will eventually find one.

So, should we make these bubbles even bigger by following the same prescriptions that have led to the scenario today? The actions of the Reserve Bank of India and the recommendations of an entire spectrum of economists in stimulating demand will result in exactly the above scenario.

It’s quite sad that we do not have a single Ron Paul in our Parliament who can talk economic sense. Not that it has done much good for the US system, which is in far worse shape than the Indian economy, but at least plenty of individuals have learnt by listening to him.

The real solution for us is to allow interest rates to find their natural levels where it would hasten the liquidation of the malinvestments made so far. Let the chips fall where they may and allow markets to direct the resources to where they are most needed.

That is the only way to build a sustainable and robust economic growth model. And the beauty of this free market model, as history has repeatedly shown, is that this automatically ensures growth with equity. It’s only when the government steps in to ensure equity that we have situations where 1 per cent of people corner all the gains.

As far as the government/finance ministry is concerned, they should focus on balancing the budgets by dramatically downsizing their expenditures and deregulating the rather onerous structures that we have created for ourselves.

The growth mantra for the government is straightforward – downsize, deregulate and follow sound money policies. I think it’s a fair to assume that we are not doing any of the three. In fact, I would bet that we are going to get the exact opposite on all the three counts.

Shanmuganathan N is the CIO at Plus43 Wealth Advisors. He can be contacted at

Get Swarajya in your inbox everyday. Subscribe here.

An Appeal...

Dear Reader,

As you are no doubt aware, Swarajya is a media product that is directly dependent on support from its readers in the form of subscriptions. We do not have the muscle and backing of a large media conglomerate nor are we playing for the large advertisement sweep-stake.

Our business model is you and your subscription. And in challenging times like these, we need your support now more than ever.

We deliver over 10 - 15 high quality articles with expert insights and views. From 7AM in the morning to 10PM late night we operate to ensure you, the reader, get to see what is just right.

Becoming a Patron or a subscriber for as little as Rs 1200/year is the best way you can support our efforts.

Become A Patron
Become A Subscriber
Comments ↓
Get Swarajya in your inbox everyday. Subscribe here.

Latest Articles

    Artboard 4Created with Sketch.