None of the experts saw India's debt bubble coming. Sound familiar?

India's economic problems reflect a global boom-to-bust pattern. Why do policymakers act surprised?

• 
• • Jayati Ghosh
  • The Guardian, Monday 26 August 2013 20.00 BST

'The Indian economy has been in trouble for quite a while already, and only wilful blindness could have led to ignorance on this.' Illustration: Daniel Pudles

So now India is the latest casualty among emerging economies. Over the past 10 days, the rupee has slid to its lowest-ever rate, and the Indian economy may well be on the verge of a full-blown currency crisis. In this febrile situation, it is open season for rumours and pessimistic predictions, which then become self-fulfilling.

This means that even if there is a slight market rally, investors quickly work themselves into even more gloom. Each hurriedly announced policy measure (raising duties on gold imports, some controls on capital outflows, liberalising rules for capital inflows and so on) has had the opposite of the desired effect. Everything the government does seems to be too little, too late – or even counterproductive.

These are all classic features of the panic phase of a financial market cycle. This doesn't mean that a crash is inevitable, but clearly it is possible. The real surprise in all this is that investors and Indian policymakers are surprised. For some reason, they apparently did not foresee this turn of events, even though the story of every financial crisis of the past, and many in the very recent past, should have caused some nostrils to twitch at least a year or two ago.

The Indian economy has been in trouble for quite a while already, and only wilful blindness could have led to ignorance on this. Output growth has been decelerating for several years, and private investment has fallen for 10 consecutive quarters. Industrial production has declined over the past year. But consumer price inflation is still in double digits, providing all the essential elements of stagflation (rising prices with slowing income growth).

At the moment the external sector is the weakest link. Exports are limping along but imports have ballooned (including all kinds of non-essential imports like gold), so both trade and current account deficits are at historically high levels. They are largely financed by volatile short-term capital. This has already started leaving the country: since June more than $12bn has been withdrawn by portfolio investors alone.

This situation is the result of internal and external imbalances that have been building up for years. The Indian economic boom was based on a debt-driven consumption and investment spree that mainly relied on short-term capital inflows. This generated asset booms in areas such as construction and real estate, rather than in traded goods. And it created a sense of financial euphoria that led to massive over-extension of credit to both companies and households, to compound the problem.

Sadly, this boom was also "wasted" in that it did not lead to significant improvements in the lives of the majority, as public expenditure on basic infrastructure, as well as nutrition, health, sanitation and education did not rise adequately.

We should know by now that such a debt-driven bubble is an unsustainable process that must end in tears, but those who pointed this out were derided as killjoys with no understanding of India's potential. Something similar is occurring in a number of other Asian economies that are also feeling the pain at present, such as Indonesia – while the Brazilian economy shows some similar features. The current Indian problems may be extreme, but they reflect what should now be a familiar process in all major regions of the world.

The typical story, which was elaborated half a century ago by Charles Kindleberger, goes something like this: a country is "discovered" by international investors and therefore receives substantial capital inflows. These contribute to a domestic boom, and also push up the real exchange rate. This reduces the incentives for exporters and producers of import substitutes, so investors look for avenues in the non-tradable sectors, such as construction and real estate. So the boom is marked by rising asset values, of real estate and of stocks. The counterpart of all this is a rising current account deficit, which no one pays much attention to as long as the money keeps flowing in and the economy keeps growing.

But all bubbles must eventually burst. All it takes is some change in perception for the entire process to unravel, and then it can unravel very quickly. The trigger can be a change in global conditions, or a sharp slowdown in domestic income growth, or political instability, or even economic problems in a neighbouring country. In India Ben Bernanke of the US Federal Reserve is being blamed for bringing this on, but it could easily have been some other factor. Once the "revulsion" in markets sets in, the very features that were celebrated during the boom are excoriated – by both investors and the public – as examples of crony capitalism, inefficiency and such like. The resulting financial crisis hits those who did not really benefit so much from the boom, by affecting employment and the incomes of workers.

This is what has just started to happen in India, and is also likely to happen in several other emerging markets. But essentially the same process has already unfolded many times before in different parts of the world: Latin America in the 1980s, Mexico in 1994-95, south-east Asia in 1997-98, Russia in 1999-2000, Argentina in 2001-02, the US in 2008, Ireland and Greece in 2009, and so on.

Why are we so startled each time? And why do we never, ever, see it coming?

Ten years on, the case for invading Iraq is still valid

A decade after Saddam was overthrown, why are some progressives still loath to celebrate his demise?

• 
• • Nick Cohen
  • The Observer, Sunday 3 March 2013

Saddam Hussein during his trial in 2006. 'I can guarantee that you will not hear much about his atrocities in the coming weeks,' writes Nick Cohen. Photograph: David Furst/AFP/Getty Images

Every few months a member of the audience at a meeting I am addressing asks whether I regret supporting the overthrow of Saddam Hussein. The look in their eyes is both imploring and accusatory – "surely you must agree with me now", it seems to say. I reply that I regret much: the disbanding of the Iraqi army; a de-Ba'athification programme that became a sectarian purge of Iraq's Sunnis; the torture of Abu Ghraib; and a failure to impose security that allowed murderous sectarian gangs to kill tens of thousands.

For all that, I say, I would not restore the Ba'ath if I had the power to rewind history. To do so would be to betray people who wanted something better after 35 years of tyranny. If my interrogators' protesting cries allow it, I then talk about Saddam's terror state and the Ba'ath's slaughter of the "impure" Kurdish minority, accomplished in true Hitlerian fashion with poison gas.

My questioners invariably look bewildered. The notion that, even if they opposed military intervention, they had obligations to support those who suffered under a regime which can be fairly described as national socialist had never occurred to them. No one can say that time's passing has lessened their confusion.

It's 10 years since the overthrow of Saddam and 25 since he ordered the Kurdish genocide. I can guarantee that you will not hear much about Saddam's atrocities in the coming weeks. As Bayan Rahman, the Kurdish ambassador to London, said to me: "Everyone wants to remember Fallujah and no one wants to remember Halabja." Nor, I think, will you hear about the least explored legacy of the war, which continues to exert a malign influence on "liberal" foreign policy.

Iraq shocked liberals into the notion that they should stay out of the affairs of others. Of itself, this need not have been such a momentous step. A little England or isolationist policy can be justified on many occasions. There are strong arguments against spilling blood and spending treasure in other people's conflicts. The best is that you may not understand the country you send troops to – as the Nato governments who sent troops to Iraq did not. But unless you are careful you are going to have difficulties supporting the victims of oppressive regimes if you devote your energies to find reasons to keep their oppressors in power. Go too far in a defence of the status quo and the idea soon occurs to you that an oppressive regime may not be so oppressive after all.

Liberals are always the first to walk into that trap. A conservative nationalist has few problems saying: "My country comes first. If foreigners are in trouble, that's their lookout." Liberals need to dress isolationism in the language of morality. They need to feel righteous, especially when they are being selfish, and nowhere more so than in the Obama administration.

Sharp operator and orator though he is, it is hard to imagine Barack Obama beating Hillary Clinton without the help Iraq gave to his 2008 campaign for the Democratic nomination. Since coming to power, he has proved the truth of Karl Marx's warning in the 18th Brumaire that "the beginner who has learned a new language always translates it back into his mother tongue".

Obama learned that George W Bush's foreign policy was a disaster, and translates each new crisis back into the language of his political childhood. If Bush was against dictatorships, Obama would "reset" relations with Russia and Iran and treat them as partners. The failure of his initiatives never deters him. Despite his efforts, Russia remains a mafia state and Iran remains a foul theocracy determined to acquire the bomb. Their peoples, naturally, are restive. Russians demonstrate against Putin's rigged elections. The Iranian green movement tries to overthrow the mullahs. But Obama and the wider tribe of western liberals have little to say to them. The example of Iraq taught them that it is dangerous to worry too much about oppression, so they treat popular revolts that are liberal in the broad sense with indifference and embarrassment.

Russians and Iranians are not alone in noticing the reactionary strain in western "progressive" thinking. The forlorn figure of John Kerry had to beg Syrian opposition leaders to meet him, only to prove to them that their initial instinct to stay away was well-founded. While Iran, Russia and Hezbollah engage in illiberal intervention on Assad's behalf, Kerry made it clear that the Obama administration is determined that there should be no liberal intervention in the form of arms for the opposition or a no-fly zone. Even David Cameron is keener on taking practical steps to prevent a catastrophe in the Levant than this, and when Syrians can receive a fairer hearing from a shire Tory than an American "progressive" you should have the wit to realise that a sickness has taken hold.

So deep has it penetrated that Arab liberals now want nothing to do with the supposed leader of the world's liberal left. In an open letter to Obama, Bahieddin Hassan of the Cairo Institute for Human Rights Studies explained the hard struggle he and his comrades were fighting against the Muslim Brotherhood. The police murdered demonstrators, he told the president. Theocratic thugs raped women activists – "to break the political will of the victims through profound degradation". Yet, he noted, the Obama administration continued to praise the Muslim Brotherhood and patronise its liberal opponents.

Hassan had met Obama in the White House. But he had no illusions left about winning his support. All he asked was that the president's "liberal" officials bite their tongues and stop providing political cover for reactionaries. If "they cannot speak the truth about what is happening in Egypt," he said, "they should keep silent."

Shut up and stop pretending to be our friends. What an epitaph that makes for the 21st-century's first generation of "progressives". From the start, I wrote that their parochialism would lead them into double-dealing, but Ian McEwan put it better than I ever could. In his Saturday, set on the day of the great anti-war march of 2003, he has the hero, Henry Perowne, argue with his daughter. Perowne, a surgeon, has treated the victims of Saddam's torture chambers and asks her: "Why is it among those two million idealists today I didn't see one banner, one fist or voice raised against Saddam."

"He's loathsome, it's a given," she replies.

"No, it's not," says Perowne. "It's a forgotten. Why else are you all singing and dancing in the park?"

Who came up with the model for excessive pay? No, it wasn't the bankers – it was academics

All the focus has been on bankers' bonuses, yet no one has looked at the economists who argued for rewarding bosses by giving them a bigger financial stake in their companies



Take a big step back. Ignore those sterile debates about how Dave screwed up over Stephen Hester's pay and where this leaves Ed. Instead, ask this: which profession has done most to justify the millions handed over to the boss of RBS, his colleagues and counterparts? Which group has been most influential in making the argument that top people deserve top pay? Not the executives themselves – at least, not directly. Nor the headhunters. Try the economists.




The ground rules for the system by which City bankers, Westminster MPs and ordinary taxpayers live today were set by two US economists just a couple of decades ago. In 1990, Michael Jensen and Kevin Murphy published one of the most famous papers in economics, which first appeared in the Journal of Political Economy and then in the Harvard Business Review. Its argument is well summed up by the latter's title: "CEO Incentives: It's Not How Much You Pay, But How."



The way to get better performance out of bosses, argued the economists, was by giving them a bigger financial stake in their company's performance. You couldn't have asked for a better codification of bonus culture had you stuck a mortar board on Gordon Gekko's head. So popular, so influential was Jensen and Murphy's work that it opened the door to a new corporate culture: one where executives routinely scooped millions in stock options, apparently justified by top research that they were worth it.



The usual criticism of economists is that they missed the crisis: they preferred their models to reality, and those models took no account of the mischief that could be caused by bankers running wild. Of all explanations, this is the most comforting; all academics need to do next time, presumably, is look a little harder – ideally with a grant from the taxpayer.



But economists didn't just fail to spot the financial crisis – they helped create it. They provided the intellectual framework and drew up the policies that helped caused the boom – and the bust. Yet rather than a full-blown investigation, their active involvement in this crisis and their motivations have barely got a look-in. As Philip Mirowski, one of the world's leading historians of economic thought, puts it: "The bankers have got off the hook, and gone back to business as usual – and so too have the economists." It's the same discipline that spoke all that nonsense about markets always being efficient that is now deciding how to reform the economy.



A few weeks ago, I described the current economic system as a bankocracy run by the banks, for the banks. Mainstream economists play the role of a secularised priesthood, explaining to the laity just how and why the markets' will must be done. Why are they doing this? Luigi Zingales, an economist at Chicago, calls it "economists' capture". Much of the blame for the financial crisis has fallen on regulators for being captured by the bankers, and seeing the world from their point of view. The same thing, he believes, has happened to academics. When Zingales looked at the 150 most downloaded academic papers on executive pay he found that those arguing that bosses should get more (à la Jensen and Murphy) were 55% more likely to get published in the top journals.



Anyone who saw the film Inside Job will recall the scene in which leading economists are shown puffing financial deregulation, or the outlook for Icelandic capital markets, or whatever – and then revealed to have taken hundreds of thousands, sometimes millions, from the very interests they are advocating. But this goes wider than direct payment; many academics also believe those arguments about how markets work best when they are left alone. As the economist Steve Keen puts it: "Most economists are deluded."



Maybe, but it also pays to be deluded. Think about the rewards for toeing the mainstream economic line. Publication in prestigious journals. Early professorships at top universities. The conferences, the consultancies at big banks, the speaking fees. And then: the solicitations of the press, the book contracts. On it goes.



Rob Johnson, director of the Institute of New Economic Thinking, quotes a dictum he was once given by a leading west coast economist. "If you got behind Wall Street," he remembers the professor telling him, "you went to Lake Como every summer. If you left finance alone, you took a nice vacation in California. And if you took on the bankers, you drove a secondhand car."



Were this corruption of analytical philosophy, say, this might not matter so much. But economics shapes our policy and our public debates – and it warps both. Yesterday, I listened to a discussion of Hester's bonus (what else?) on the Today programme. Defending Hester, a journalist quoted some American finding that CEO pay had actually halved since 2001.



Chicago economist Steve Kaplan does indeed argue that "CEO pay in 2006 remained below CEO pay in 2000 and 2001". What's missing there is that 2001 was the height of the US dotcom boom, when bosses were getting crazy money. Kaplan also writes papers about how hard it is to be a chief executive. According to his CV, his consulting clients have included Accenture, Goldman Sachs and a bunch of other Wall Street banks. This is the way such arguments are prosecuted: without full disclosure of either evidence or interests. And in such arguments, it's you that loses.