An important theme of this year’s Economic Survey is about how to make policies and decisions under circumstances of radical uncertainty.
Given the impact of the Covid-19 pandemic on both health and economic trajectories across the world, this issue is obviously topical. The Survey, therefore, explains India’s ‘barbell’ strategy that combined hedging against worst-case outcomes, on the one hand, with step-by-step responses driven by a Bayesian updating of information on the other. It shows how policies were targeted and sequenced in ways that would maximise bang for the buck.
The Survey then explores how the same intellectual framework can be also used to improve routine administrative processes. Almost a century ago, economist Frank Knight provided a distinction between Risk and Uncertainty. Risk relates to outcomes where we have a sense of possible future outcomes and their probabilities. Uncertainty relates to a world of ‘unknown unknowns’.
Although most mainstream economists focus on issues related to Risk, the real world is a complex, evolving place of butterfly-effects, unintended consequences and random shocks. This is even more true when one is faced by a once-in-a-century shock like the Covid-19 pandemic. It was the recognition of radical uncertainty that was central to India’s response.
As readers will recall, many global experts were of the opinion last year that India’s initial lockdown was unnecessary, and that it should resort to a front-loaded reflation of domestic demand using a grand one-time stimulus package. Some economists, like Nobel Prize-winner Joseph Stiglitz, specifically named India as a country that had mismanaged its response and called for large-scale money transfers funded by unrestrained monetisation and extortionate taxes on business.
As argued in my ET column at that time (‘A Very Asymmetric Opinion’, October 9, 2020, bit.ly/36nebrS), Indian policymakers consciously decided against this advice, even though several developed countries opted for it. Instead, the Indian government prioritised saving lives while providing a cushion for the most vulnerable sections of society and the business sector.
Given the uncertainty, the lockdown plus-cushion approach was aimed at avoiding the worst possible outcomes rather than revival. This is the context in which the government rolled out the world’s largest food programme, temporarily suspended the insolvency process, provided 100% guarantees to loans to small business, and so on.
Discretion vs Valour The lockdown provided time to create testing and quarantine facilities, and learn the best way to minimise fatalities. As time passed, policymakers were able to do a Bayesian updating of their responses based on new information.
As the lockdown was steadily unwound, economic activity revived. With infections peaking in September, GoI ramped up capital expenditure on an unprecedented scale: up 129% y-o-y in October, 249% in November and then 62% in December. This coincided with a decompression in pent-up consumption. The result is a sharp revival in economic activity.
By avoiding spending precious fiscal resources on a rushed headline grabbing stimulus, Indian policymakers were able to conserve resources for a series of targeted and calibrated packages. Similarly, by recognising that the pandemic was both a demand and a supply shock, it deliberately timed the expenditure push for when the supply-side could respond. There would have been no point in pressing the accelerator with the other foot on the brake. As the ancient sage Thiruvalluvar put it, ‘Doing the right thing at the right time is the rope that binds unlimited wealth.’
The above intellectual framework based on Uncertainty has applications even in routine administrative processes. This year’s Survey devotes a full chapter to the need for simple and transparent regulations. It argues that Indian regulatory processes are plagued by a misplaced belief in the human ability to precisely work out future outcomes. Notice that this is exactly the same intellectual fallacy that led certain experts to confidently espouse a grand one-time response to Covid-19.
Both economic theory and evidence unequivocally show that it is not possible to write complete ex-ante regulations for all possible situations. Attempts to write complete regulations lead inevitably to excessively complex processes. This is why it takes 1,570 days in India to do a routine activity like voluntarily close down a company, even when there is no dispute or litigation. This is an order of magnitude longer than in other countries.
The Economic Survey argues that the inevitability of incomplete regulations makes it impossible to remove discretion from decision-making. Attempts to reduce discretion with more prescriptive rules leads, ironically, to more discretion to choose between rules and renders the processes opaque.
Timing is of the Essence The only solution, ultimately, is to keep rules simple and allow for discretion, while investing in greater transparency. The recently launched Government e-Marketplace (GeM) portal for routine government procurements is an example of how simplicity and transparency can be combined. The prices are openly visible and can be monitored by any concerned citizen.
Meanwhile, the honest official can make purchases without worry. The Covid-19 pandemic should have left no one with a doubt about the importance of accounting for radical uncertainty. This year’s Survey lays out how this informed India’s response to the pandemic. Over the next year, readers will have an opportunity to judge who had the better advice — Stiglitz or Thiruvalluvar.
The writer is principal economic adviser, GoI. Views are personal