A riches to rags tale

Lead review

When the global economies nosedived in 2008 in the wake of financial crisis, economists were caught napping. They had no clue on the impending disaster or on how to respond to the crisis. Economists faced a tough time explaining why they failed to predict the financial crisis. It was also a time for introspection for them to find out why various theories and streams of economic thought failed them. The crisis triggered demands in academic circles for revised economics curriculums based on reality with less mathematical abstractions.

In this backdrop, Meghnad Desai, eminent economist and Labour Party member of the House of Lords, offers a fascinating perspective on the crisis and the recession that followed while striving to unravel why economists always fail to forecast a financial crisis. From a historical angle, Hubris: Why Economists Failed to Predict the Crisis and How to Avoid the Next One traces the roots of booms and busts that have characterised world economies. The book also throws light on the leadings figures of different schools of economic thought. The thrust of Desai’s argument is that economic life must be understood in terms of business cycles rather than equilibrium. A period of growth and prosperity is followed by a downward phase.

Desai argues the case for economists to have a different approach to the history of economic thought. As no single paradigm can resolve all economic crises, the author wants economists to have a fresh look at the many available theories and approaches. This may offer insights for preventing future economic disasters. Conceding that “economics is a difficult and uncertain subject”, Desai asks whether economics is a dismal science. Economic systems are too complex for academics or forecasters to predict accurately what will happen. He wonders whether economics is in touch with the real world.

Desai finds that for most of the last two centuries it was the laissez faire policies that ensured stable economies. The Great Depression of 1930 was a watershed. The enormity of the crash can be gauged from the fact that it took 25 years for the Dow Jones to return to its pre-Depression peak. Economists of the day believed that solution to the crisis lay in the market. The best course was non-intervention by the government. As the economy sank deeper and deeper into crisis, the Keynesian theory of state role in ensuring economic stability gained acceptance. “He proposed public investment as a solution when private investment was too shy to undertake new enterprise,” writes Desai.

Keynes had the upper hand till the crisis of 1970s when his theory failed to tackle stagflation. While Keynesian theory was on the ascent, there were also discordant notes. Keynes played down the role of money. He ignored dangers of inflation and the increasing role of financial markets in the growth of national economies. The situation paved the way for the return of the old classical theory. The post-war boom created an illusion that good times would last forever. And it was this “hubris” or conceit that led the world to the crisis. When the financial crisis struck, economists were at a loss. Warning signals were ignored. Though Reserve Bank of India Governor Raghuram Rajan, who was the chief economist at IMF, had alerted about the crisis in 2005 but had been rejected as a “luddite”.

Desai asserts that the 2008 crisis was the result of excessive borrowing by families and businesses. With easy availability of cheap credit, consumers could get into debt much more easily. Thousands of families in the US-owned houses through mortgages believing that prices will only go up. With the failure of regulatory agencies, time was ripe for the bubble to burst. Desai argues that in such a situation cutting taxes or increasing government spending would only add to the debt crisis.

Part II of Hubris looks at the roots of the Great Recession. Desai explains how economists missed the signs during the 90s and incorrect attribution of reasons of low inflation in developed economies. New technology and globalisation were continually transforming the financial world. Desai doesn’t see good prospects for the developed economies for the next 20-25 years. He states that these economies face the prospects of slow growth and stagflation. But he is upbeat on emerging economies such as India’s. “India has slowed down in growth but is expected to bounce back to its previous rate of around 7-8 per cent and may grow even faster if it uses its demographic dividend,” Desai writes.

Hubris is a seminal work invaluable for students of economics as it lucidly presents economic history to explain the factors that led to Great Recession. It also interests the reader who is fascinated by economic and financial upheavals. But a lay reader may find parts of the book too taxing.

Hubris
Meghnad Desai
Collins Business
2015, pp 416, Rs 399