Tuesday, December 6, 2011

The Erroneous Views of the Chief Economic Advisor of Indian Finance Ministry, Prof. Kasushik Basu

Prof. Kaushik Basu - who apart from being a professor of economics at the Cornell University, USA, is currently the chief economic adviser of the Ministry of Finance, Government of India - recently published a paper titled "Understanding Inflation and Controlling It" in the journal Economic and Political Weekly (EPW), which is a well known journal in India published from Mumbai.

Since inflation is the grave problem being faced by any economy and because Prof. Basu is the chief economic adviser of the Indian government, I decided to read the article to know his economic views, especially re inflation. It is important to know what the chief economist of Indian government has to say about Inflation. Knowing his views is important because billions of common man's lives depend on this one person's economic views. If his economic views are erroneous then our lives are in a big danger. If his understanding of inflation is faulty then we all are doomed.

And as it turned out his economic views are indeed erroneous. Particularly, his understanding of 'inflation' is very poor. After reading his paper I am more worried about the future of the Indian economy because if the top economic adviser of Indian government is having a wrong understanding of economics then the chances of elimination of inflation from the Indian economy are zero!

After reading his erroneous views, I wrote a short article criticizing his views and submitted it to EPW for publication in their 'discussion section'. Being an Austrian Economist myself I thought to discuss the various issues with Prof. Basu in academic arena in front of the mainstream economic profession. Since the advancement of scientific knowledge can only take place through such critical dialogues, I thought to engage the chief economist of Indian government in a dialogue in the public sphere. But as I expected, EPW refused to publish my article. Now why they didn't consider my article for publication is only they know, but for me the message is clear that they are not interested in furthering the intellectual discussion of this extremely important issue. Never mind. In this age of internet I have other sources of taking the issue in front of the concerned public. In this blog I am reproducing the article which I submitted to EPW for publication. I have also emailed a copy to Prof. Basu so at least the chief economist of Indian government can consider the alternative Austrian economics explanation of inflation, which then can aid him in combating and eliminating inflation. So without any further delay here is my article criticizing the erroneous economic views of India's chief Economist, Prof. Kaushik Basu.

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Critical Investigation of Professor Kaushik Basu’s Economic Views

By
Madhusudan Raj


EPW vol. XLVI, No. 41 (October 8th issue) carried an article, entitled Understanding Inflation and Controlling It, of the chief economic adviser to the Ministry of Finance, Government of India, Professor Kaushik Basu. This short discussion is a critical investigation of Prof. Basu’s economic views presented in that paper.

To begin with, the title of Prof. Basu’s article itself is highly problematic in that it talks about controlling inflation. The problem lies in his intentions of controlling it instead of eliminating it altogether out of Indian economy[1]. His use of word “controlling” gives an impression that he has no discomfort with a moderate level [sic] of inflation, as is the case with the finance and prime minister. I myself being an Austrian economist and above all a common man find such economic and policy views of this top policy maker absolutely outrageous. How can someone, after naming inflation as an “Emperor of Maladies”, be okay with it is beyond my imagination. If I adopt his style of using false biological analogies to define economic phenomena then it is like saying that, cancer is the king of maladies, but I am comfortable with 10% of it in my body, and further, I only want to control and manage it! I am sure Prof. Basu, as an economic doctor [sic], will surely want to eliminate inflation cancer from his patient Indian economy’s body, and not just control or manage it!

Prof. Basu starts by asserting that, “inflation is one of the most dreaded and most misunderstood of economic phenomena (p.50)”. This is mostly true for the 21st century mainstream economists who mistake the effects of inflation with its true cause, but it is simply wrong to say such similar thing for the Austrian School of Economics who is crystal clear in its understanding of inflation since the time of 14th century proto Austrian scholars like Jean Buridan and Nicholas Oresme (1956). 15th century’s great thinker Pole Nicholas Copernicus was the first person to set forth clearly the “quantity theory of money”. As discussed by Rothbard (2006: 165), for Copernicus,

The causal chain began with debasement, which raise the quantity of money supply, which in turn raised prices. The supply of money, he pointed out, is the major determinant of prices. ‘We in our sluggishness’, he maintained, ‘do not realise that the dearness of everything is the cheapness of money. For prices increase and decrease according to the condition of money’. ‘An excessive quantity of money’, he opined, ‘should be avoided’.

 30 years after Copernicus, the Spanish scholastic of the famous school of Salamanca Martin de Azpilcueta Navarrus, in his important work Comentario resolutoio de usuras (1556), again unambiguously set forth the “quantity theory of money”. When the supply of gold and silver from the New World flooded the Spanish markets, it experienced inflation. Azpilcueta deciphered this new phenomenon and wrote:

...other things being equal, in countries where there is a great scarcity of money all other saleable goods, and even the hands and labour of men, are given for less money than where it is abundant. Thus we see by experience that in France, where money is scarce than in Spain, bread, wine, cloth and labour are worth much less. And even in Spain, in times when money was scarcer, saleable goods and labour where given for very much less than after the discovery of the Indies, which flooded the country with gold and silver. The reason for this is that money is worth more where and when it is scarce than where and when it is abundant[2].

 This great tradition was continued and fully developed in the 20th century by one of the most brilliant but heavily ignored Austrian economist Ludwig von Mises (1953; 1998). Murray Rothbard (2004) and Huerta de Soto (2006) further elaborated Mises’s brilliant work. The reason why mainstream economics is not in a position to fully understand inflation is due to their age old disappointing avoidance and stubborn reluctance to take these very important Austrian contributions seriously.

The reason mainstream economics and Prof. Basu fails to understand inflation is because their concept of inflation itself is wrong. On page 56 of his article, Prof. Basu defines inflation as, “an overall increase in prices and not the relative increase in the prices of some goods. Clearly, Prof. Basu is committing the logical fallacy of putting the cart before the horse by defining inflation in this way. He, and with him the mainstream economics too, mistakes effect for cause. As already pointed out by the above cited scholars, the root cause of inflation is the increase in the quantity of money and credit. In his brilliant one page explanation Henry Hazlitt (2004) defined inflation clearly. He wrote, “Inflation is an increase in the quantity of money and credit. Its chief consequence is soaring prices. Therefore inflation—if we misuse the term to mean the rising prices themselves—is caused solely by printing more money. For this the government’s monetary policies are entirely responsible.  

The reason Prof. Basu fails to understand inflation is because his understanding of “money” itself is extremely poor. For him money is, “nothing but a generic promise from society – the government being the most important representative of that – that you will be able to change these useless bits of paper for actual goods and services in the future (p. 57).Nothing could be farther from the truth. Prof. Basu is forgetting to take into account last 6000 years history of money. As originally discussed by Aristotle and later on elaborated by Rothbard (M. Rothbard 2008a: 6-8), proper qualities of money are, 1) already heavy demand in the market, 2) high divisibility, 3) easy portability and for that money commodity must have high value per unit weight, and for that it must be scarce[3], 4) should be highly durable so that it can serve as a store of value for a long time[4].  The founder of the Austrian School of Economics, Carl Menger, in his very important work The Origins of Money (Menger 2009), very clearly defined what money is and how it evolves in the market through thousands of years of cultural evolution. As explained by Menger, some commodities (gold and silver) which had proper qualities of money slowly evolved as a common medium of exchange in the market. Later on in 1912 Ludwig von Mises through his “money regression theorem” conclusively demonstrated that, money does not and cannot originate by the order of the State or some sort of social contract agreed upon by all citizens; it must always originate in the processes of the free market[5]. This exposes the error of Prof. Basu’s definition of money. During last 6 millennia’s evolution, gold and silver has clearly defeated all other competing monies in the market (Maloney 2008). The pure paper promise money to which Prof. Basu is alluding is actually a currency, and only 40 years old phenomenon started by American President Nixon in 1971 when he closed the gold window. Just before 100 years ago most countries were on the classical gold standard[6]. Even 150 years or so ago India was on the silver standard. The frantic rate at which Indian, Chinese and people around the world as well as most major central bankers are presently buying gold (and silver) amidst high government inflation should give Prof. Basu some reason to pause and doubt his definition of money!

I have run out of space here and so can’t discuss Prof. Basu’s other erroneous views regarding demand management, interest rate manipulations, use of price index for measuring inflation, currency competition, interventionism etc. Although I appreciate him for his realisation that human societies and economies are very complex in nature, but lament that despite this realisation he still wants to micro-manage everything, instead of leaving it all alone. 

I will end with a humble request to Prof. Basu, that in the true spirit of Science – which he hails very much in his article - he seriously consider the contributions of the Austrian school to aid him in understanding and combating the “emperor of maladies”, inflation.  

References


Hazlitt, Henry (1960), What you should know about inflation (Princeton, N.J.,: Van Nostrand) 152 p.
--- (1983), The inflation crisis, and how to resolve it (2nd edn.; Lanham, MD: University Press of America) 192 p.
--- (2004), 'Inflation in One Page', The Freeman, 54 (9).
Maloney, Michael (2008), Guide to investing in gold and silver : everything you need to know to profit from precious metals now (Rich dad's advisors; New York: Business Plus).
Menger, Carl (2009), The Origins of Money (Auburn, Alabama: Ludwig von Mises Institute).
Mises, Ludwig von (1998), Human Action: A Treatise on Economics (The Schoalr's Edition edn.; Auburn, Alabama: Ludwig von Mises Institute).
Mises, Ludwig von and Batson, Harold E. (1953), The theory of money and credit (new edition, enlarged with an essay on monetary reconstruction / translated from the German by H. E. Batson. edn.; London: Jonathan Cape) [iii],493 p.
Oresme, Nicholas (1956), The De Moneta of Nicholas Oresme and English Mint Documents (London: Thomas Nelson and Sons Ltd).
Rothbard, Murray (2006), An Austrian Perspective on the History of Economic Thought - Economic Thought Before Adam Smith, II vols. (I; Auburn, AL: Ludwig von Mises Institute).
--- (2008a), The Mystery of Banking (2nd edn.; Auburn: Ludwig von Mises Institute).
--- (2008b), What has government done to our money? (Auburn: Ludwig von Mises Institute).
Rothbard, Murray Newton (2004), Man, economy, and state with Power and market (Scholars edition) (2nd edn.; Auburn, Ala.: Ludwig von Mises Institute) xcix, 1441 p.
Sennholz, Hans F. (1979), Age of Inflation (Libertarian Press).
Soto, Jesus Huerto De (2006), Money, Bank Credit, and Economic Cycles (Auburn, Alabama: Ludwig von Mises Institute).





End Notes

[1] Eliminating inflation is very much possible. Those who want to know more can read these important works, (Hazlitt 1960, 1983, 2004; Sennholz 1979)

[2] As quoted in, (M. Rothbard 2006: 106)

[3] Government paper tickets are not scarce; they can be printed endlessly with computer digits. And this is the reason why it is causing such a high level of inflation.

[4] It is clear that government’s useless bits of paper have no such qualities. A piece of paper can’t become money even if it is forced on populace by government through fiat and other legal tender laws. Government pure paper monetary standard is dying all over the world. 

[5] See, (M. Rothbard 2008a: 3)

[6] I don’t have sufficient space here to go deeper in my discussion of these points. Interested readers are advised to read, (M. Rothbard 2008b).