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One of the things which is of major concern today is that banks may not be safe. Till the other day, only Rs 1 lakh in a bank account was insured. In the most recent Budget, this sum was raised to Rs 5 lakh. And even that did not seem to provide adequate comfort.

But maybe I was talking to the wrong set of people. After all, not too many people have more than Rs 5 lakh in their bank accounts. No matter what you have in your account, if you are suddenly denied access to it, as and when you want, it can feel quite rough. Consequently, you might think twice before keeping your hard-earned cash in banks.

More worrying, such bank crises keep happening quite regularly. It is Yes Bank now but it was the Punjab and Maharashtra Cooperative Bank last September. Not only banks, but airlines such as Jet Airways, Kingfisher and the famous travel agency, Cox and King’s, folded up, leaving people suddenly without jobs and literally stranded.

Investors in institutions such as DHFL and ILF&S found their investments disappearing due to, to put it politely, “mismanagement”. Or slightly earlier, we were faced with scams originating from the actions of the late Harshad Mehta or to the collapse of Satyam Computers. The last time there was a financial crisis was in 2008 when markets in East Asia collapsed. Are we seeing something similar now? And are such collapses of the stock markets cases of market failure?

American economist Kenneth Arrow, writing about the 2008 crisis, said: “…the failure of the markets for various kinds of derivative securities to perform properly is an essential element of the current financial crisis”. People attribute the current collapse in stock markets to the coronavirus. Maybe it is so. Time will tell what is happening now: how much of it is because of the world-wide meltdown and/or whether local problems have had a say.

People may be tempted to attribute the apparent disconnect between what one studies in textbooks, where everything is supposed to work out nicely and cleanly, and what one notices in real life as described above to the inadequacies of what we have taught our students or the theory itself. I shall argue that whatever one sees around us is exactly as the textbooks should have led us to expect.

The current economic paradigm prevalent the world over has been referred to as the SLP regime by Dani Rodrik. This means:

  • Stabilise (government expenditures have to be kept to low levels)
  • Liberalise (allow trade to take place between countries without significant friction in the form of tariffs or taxes)
  • Privatise (in the sense that government or the public sector should not get into producing goods and services).

The SLP regime is usually taken to originate from Adam Smith. However, much before him, Chanakya had advocated that markets should be allowed to function freely. But there are externalities and problems of asymmetric information which vitiate market functioning and this means that governments must intervene to tackle these. In spite of these, some may say because of them, undesirable outcomes persist.

There are other more basic problems. One should realise that any economic activity, be it sale and purchase of daily necessities such as vegetables or negotiating loans from banks to foster industrial growth, involves a contract between two parties. Often, one of the parties could be the government. But someone has to oversee the maintenance of these contracts. Otherwise, what can one do, if one party fails to keep to the terms of the contract?

Dragging the offending party to court for a quick and fair decision is the only legitimate answer. This would make the breaking of contracts unattractive. Clearly, we do not have such an opportunity in India today and we are forced to enter into lengthy, costly exchanges with lawyers and courts to the detriment of the affected.

Thus, trade or transactions which could have taken place may not; funds, which could have come, are diverted elsewhere. Trade that did occur is twisted into yielding outcomes which illegally benefit one party and scams and market failures occur. And what should be worrying is that such occurrences are going to keep surfacing periodically.

This depressing conclusion is because we have not yet realised the centrality of the above argument. We often read about steps being advocated by various scholars from home and abroad. Yet, how many times have you seen the reforms of courts and the judicial system being mentioned as top priority? Quick identification of violators of contracts and awarding deterring and just punishment should be the number one priority. Breaking contracts may often be hugely rewarding, if one can get away with it.

In such situations, the perpetrator continues to do exactly as he wishes, and scams and unwelcome outcomes continue and flourish. As someone said with respect to the handling of the situation at Yes Bank, while profits were privatised, losses will now be nationalised and incentive for wrongdoing strengthened.

Finally, both Adam Smith and Chanakya realised that freely functioning markets can lead to prosperity only on the basis of good moral behaviour. Mistakenly, people have attributed greed to be the enabling characteristic. Greed together with a belief of being able to get away scot-free has got us the various scams and failures that we have alluded to. It is this aspect that we no longer emphasise while framing policies. To counter this, the need for timely, just policing and a fair and efficient legal system becomes paramount.

—The writer is Professor Emeritus, Centre for Economic Studies and Planning, JNU. This note appeared in the 10th Edition of Vitta, the FIC, Sri Ram College of Commerce Journal. It appears here with the kind permission of their editorial board

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