President-elect Barrack Obama might stop just short of taking Keynes’ advice literally, to create jobs
—Richard Nixon, former US president
“The bailout package?” I asked, as we stopped and sat on a bench.
“Yes that’s what the press is calling it. But officially it’s TARP.”
“It’s a bailout either way. Of the $700 billion allocated, $300 billion has already been spent. Of this around $250 billion has been infused into various banks including the Citigroup and $40 billion has been infused into insurance major American International Group (AIG),” I explained.
“All that I know. What I wanted to know was what are the banks doing with that money?”
“Interesting question. The idea behind bailing out these banks was to get these troubled banks and financial institutions to get lending again. But from what one has been reading in the international media, banks haven’t stepped up efforts to give out more car loans, student loans or even loans to businesses. Estimates suggest that banks are using a good portion of the bailout money to shore up their share prices. I was reading this blog by Robert Reich (A Bottom-Up Bailout Rather Than Trickle-Down, www.robertreich.blogspot.com), former US labor secretary and currently a professor of Public Policy. He says that about one-third of the money has “gone into dividends the banks are paying their shareholders; some of the rest into executive salaries and bonuses; another portion toward acquisitions designed to raise share values; another chunk for bailing out giant insurer AIG.”
“So what is the problem with that?” she interuppted.
“The idea behind the bailout was to get banks to start lending again, which they had stopped doing for some time. But that clearly is not happening because the bailout money did not come with enough conditions to get them to start lending again.”
“Hmmm... But why is it important for banks to start lending again?”
“Let us try and understand some economic theory here. The aggregate demand of any particular country is made of four distinct elements and can be represented in equation form as Y = C + I + G + NX; where C stands for private consumption or money you and I spend on buying things and availing services; I stands for investment made by private sector in setting up factories or any other thing that helps in producing stuff that can be consumed in the future; G stands for government spending; NX is essentially the difference between exports and imports. The rationale is that the money the country earns through exports comes back into the country and the money the country spends on imports leaves the country.”
“And how does it connect to the US?”
“The American economy is heavily dependent on consumers. Nearly 70% of the aggregate demand comes through private consumption. Today, spending by American citizens is falling. One reason, of course, is that a lot of the spending was done with borrowed money and with banks not willing to lend that is not happening now. Also, job cuts and fear of job cuts have led to people to save up for a bad day. As a result, retail sales in October fell by 2.8% in comparison with September and by 4.1% in comparison with October last year. Automobile sales also fell by 32% in comparison with October 2007. With private consumption taking a beating and banks not willing to lend, it is highly unlikely that investment spending made by the private sector will go up. If people don’t buy stuff, why produce more?” I explained.
“How about net exports?” she asked.
“The US imports more than it exports. For net exports to add to aggregate demand, American exports need to go up considerably. With most of the developed world entering into a recession, the chances of American exports going up are highly unlikely. The US dollar has been appreciating against most currencies and this makes it expensive for other countries to import stuff from the US. (The Mini Depression and the Maximum-Strength Remedy, www.robertreich.blogspot.com). I don’t see net exports going up”
“Are saying that only a rise in government spending can raise aggregate demand? And how would it help?”
“Oh, simple. Whenever we spend money, it ends up as income in the hands of someone else. Then that individual goes out and spends a certain proportion of the income and so the chain works. Economists call this the multiplier effect. And this works because individuals, firms and the government spend money. Right now, as we have seen, the consumers and companies are not spending, and exports are unlikely to rise. Only the government is in a position to spend money.”
“And this brings us back to John Maynard Keynes, the famous British economist, who suggested that in a recession the government should pay people to dig holes in the ground and then fill them up, or build roads or schools. He said it doesn’t matter what they do as long as the government is creating jobs,” she said, repeating what I had told her in our last meeting.
“Well, US president-elect Barack Obama is taking the idea seriously. He has gone on radio saying the US economy has a big problem and “We must do more to put people back to work and get our economy moving again. We have now lost 1.2 million jobs, and if we don’t act swiftly and boldly, most experts now believe that we could lose millions of jobs next year.””
“So what does he plan to do? Get people to dig holes?”
“Well, sort of. He has directed his economic team to come up with a recovery plan that would create around 25 lakh new jobs by January 2011.”
“And how?”
“Well as he said in his speech “We’ll put people back to work rebuilding our crumbling roads and bridges, modernising schools that are failing our children, and building wind farms and solar panels; fuel-efficient cars and the alternative energy technologies that can free us from our dependence on foreign oil and keep our economy competitive in the years ahead.” Experts feel this would involve spending of around $700 billion dollars, an amount similar to the bailout package,” I explained.
(The example is hypothetical)
k_vivek@dnaindia.net
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