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Keynesian Solution to Current Economic Condition

October 22, 2020

Current economic conditions, due to pandemic, is compared to Global Recession 1929, especially in terms of its impact of Gross Domestic Product (GDP), and Unemployment. GDP of most of the countries in the world shows declining trend because of Covid – 19 and lockdown implemented world over. Along with declining production, unemployment is also increasing, many companies world over have started downsizing, salaries of employees are reduced by nearly 40 – 50 percent. Government across countries, including India, are taking various measures to stabilize the economic conditions. Most governments are worried about declining GDP rates and increasing unemployment rates. Economic conditions are quite similar to the conditions prevailing during great depression 1929. During great depression, unemployment rate increased to around 25 percent. During the period 1929 – 1932 World GDP declined by about 15 percent. During the tough time John Maynard Keynes (J. M. Keynes) made and attempt to understand the economics behind great depression and suggested the solution in this book “The General Theory of Employment, Interest and Money” released in 1936. The solution came in the form of simple equation;

Y = C + I + G + (X – M) where,
Y = National Income
C = Consumption
I = Investment
G = Government Expenditure
X = Exports
M = Imports

This equation tells us that National Income depend on aggregate demand which in turn depend on consumption demand, investment demand, government expenditure, and next exports. Increase in aggregate demand will increase aggregate supply i.e. production and employment. Keynes has advocated increase in government expenditure and reduced tax rates to stimulate demand. In his book, Keynes has categorically presented a view the reducing wages is not the solution to the problem. The basic idea propounded by Keynes was simple; keep people fully employed, government is required to run fiscal deficit when economy is slowing down, because private sector would not invest enough to maintain production at its normal level, and bring the economy back to track. Working on Keynesian principles, many countries have survived the recession.

The theory propounded by Keynes is quite relevant in present context, even though situation today is not of recession but depression. Following the recommendation form the theory government should;

  1. Reduced the taxes, which will increase disposable income and thus leads to increase in consumption expenditure (increasing ‘C’).
  2. Private sector should be provided with incentives to invest. These incentives may come in the form of reduced indirect taxes, low interest loan, government purchase from private sector, concession in electricity charges etc. Concession to privet sector should be direct and something which can easily be understood by all. These concession will boost private sector investment (‘I’). But considering the present conditions any amount of concessions/benefits to private sector will not be enough, as private sector will not increase investment as long is demand in the market is low. Increased investment by private sector, on one side will increase production, and on the other side, it will create employment opportunities.
  3. Government should not reduce the salaries and wages of people working with government and also public sector employees. Such action will have adverse impact. Reduced wage/salaries means low income and low demand. Rather it is time for the government to increase its expenditure, spending on various government schemes which create direct employment. Government should spend money by way of direct benefit transfer. Such money, especially spend for welfare schemes, will increase demand. Such actions will increases fiscal deficit, but government should allow fiscal deficit to increase, deficit financing should be followed rather than public borrowings. The increased government expenditure (‘G”) will boost aggregate demand in the market, which in turn will increase production, and employment.
  4. Among the four measured as suggested i.e. C, I, G, (X-M), the last one is bit difficult due the pandemic situation. This measured talks about reducing imports and increasing exports, increasing net exports (X – M). Still government can take measured in order to increase exports. Companies engaged in exports should be given special incentives. On the other side import substitution policy can be employed to reduce imports.

Government of India has taken some measured to support Indian economy from recession, but the results do not support the efforts. Last quarter GDP data released shows economic growth has declined by nearly 24 percent. This is high time for the government to take quick actions to support economy, moving from recession to depression.

Dr. Kishor Bhanushali, Director – Academic Administration, Unitedworld School of Business (UWSB)

Disclaimer: The opinions / views expressed in this article are solely of the author in his / her individual capacity. They do not purport to reflect the opinions and/or views of the College and/or University or its members.

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