With the election season in full swing, I am reminded of the famous phrase “There ain’t no such thing as a free lunch”. As clear as this phrase is to Economists, politicians tend to disregard this important lesson while they formulate populist economic policies that tend to garner more support than sound economic policies. Socialists just want to spend, spend and spend as if it’s a free buffet, little do they realise that at the end of the day, there’s someone’s labour that is responsible for paying for the buffet. A good example of how such policies can be detrimental has been the recent inflation that has been experienced in Venezuela.
Venezuela’s economy has largely been driven by Oil Exports as it has the largest proven reserves of Oil. The domestic economy of Venezuela didn’t produce many goods except for petroleum products and it was dependent upon imports for most of their needs. Thus, when the prices of international crude oil reduced, the economy started to face the heat as the value of its exports started to fall while its imports continued. The government started to fuel economic growth by expansionary fiscal policy and as a consequence over a period of time, inflation rates accelerated. One of the reasons behind the high inflation rate is the fact that there is too much of demand for goods while the supply for them is limited and this has to do with the fact that most of the goods in Venezuela were imported from other nations. Thus, the twin deficits could be held majorly responsible for the current high levels of inflations.
The case of hyperinflation (or exceedingly high inflation) is not just limited to Venezuela as it has been historically observed at different points in time in Germany, Zimbabwe and other nations. The reason why I am highlighting this issue today is to reiterate the point that in Economics, there are no free lunches. This is a case in point as India too witnessed a brief phase of high inflation between 2011-2014 and this coincided with a phase of high current account deficit and a high fiscal deficit.
Thus, it is important to be aware of the fact that India too maintains a current account deficit as we import more than we export. As a result of this, we need to be careful with the way we maintain our fiscal and monetary policy to ensure that strong fundamentals can subdue any downside risks to our growth in the short or medium run. The first instance of fiscal recklessness came in the budget of 2008, which was a pre-election budget. Over the course of the financial year 2008-09, populist measures led to a widening of the fiscal deficit and the North Atlantic Financial Crisis in September 2008 led to a global recession which slowed our growth. The period coincided with high inflation and the “taper tantrum” episode whereby external market interventions by the Reserve Bank of India didn’t have a significant impact on rupee stabilisation.
Given that there are no free lunches, it is amusing to see that socialist policies continue to resonate the discourse every now and then. The recent increase in international crude oil prices and the subsequent politicisation of the same by the UPA demonstrate that clearly, they haven’t learnt their lessons. The problem with such populist policies is that their economic costs are huge and have to be borne by subsequent governments while the benefits are immediate. A good example of this can be the fiscal expansion by the UPA government in 2008 which led to high growth for financial years 2009-10 and 2010-11 post which, growth started to collapse.
The current government has taken an entirely different approach towards economic policymaking as it has relied upon strong structural reforms to revive growth while ensuring fiscal prudence. The commitment by the government towards fiscal consolidation, especially in an election year is worth appreciation as it shows to some extent there is decoupling of economic policymaking from short-term political considerations. This, I believe is an important reason why our current account deficit and fiscal deficit has been lower than what it was between 2007-2013.
The fact that socialists continue to scream for federal spending illustrates that they don’t regard the fundamental principle of economics that merely increasing the liquidity will not automatically translate into real growth in the economy. This disregard towards the inflationary impact of such policies is the reason behind Venezuela’s current crisis and this disregard is also responsible for the double-digit inflation that India experienced during the period of 2011-14. It would be wise if socialists take out a page from the book of economics and remind themselves of the popular phrase that there are no free lunches. The Socialists, who speak of labour, must be reminded, that if a lunch is free, then they stole from the wage of the worker, who prepared the meal in the first place!
Karan Bhasin is an economist by academic training. His research interests are diverse in the field of economics. He tweets at @karanbhasin95.