It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness ...”

– A Tale of Two Cities by Charles Dickens

The present period of global turbulence and uncertainty leads to several challenges which confront public policy. So let us explore the conundrums that confront us at this juncture.

First, what should be the role of markets, to what extent should such a role be unfettered, and what should be the limits of the state?

The Western orthodoxy of open markets, financial sector liberalisation and privatisation of all state-owned enterprises is in question now as the “invisible hand” of the markets has not been self-equilibrating. The free play of markets left us awash in liquidity and in its wake, swept away our financial systems and the world as we knew it. Clearly, market liberalisation did not enable the financial system to perform its main function of allocating scarce capital more efficiently to benefit the rest of the economy.

STATE AND MARKET

Should we then take comfort in according overarching power to the state? Would it not be best to tread the much maligned middle path, allow the free movement of markets within the bounds of reason and possibility, and allow the state to create the necessary financial regulatory framework?

Markets by themselves are not evil. But artificial ones – whether of tulips, commodities such as iron, steel and gold, Corot paintings, mortgages, derivatives or market making instruments which impart depth and liquidity where none exist – are always evil. The role of the state is to ensure the protection of its citizens from such dubious instruments.

This brings us to the second issue: wWhich should dominate, the financial or the real sector?

The financial sector came into being to serve the needs of the real sector, i.e. the productive and employment-generating sectors of agriculture and industry, and not the other way round.

In recent times, however, the financial sector has, of its own accord, assumed overweening importance. This has resulted in chronic ‘financialisation’, a situation where all value that is exchanged, whether tangible, intangible, present or future promises, is reduced to a financial instrument or a derivative of a financial instrument with hectic trading allowed.

At some point of inflection in this process, financial leverage overtook equity and the real economy became the handmaiden of the financial sector. This excessive financialisation is an evil we would do well to eschew.

GROWTH WITH EQUITY

Third, we must ask whether partnerships between the public and private sectors are at all feasible. Which is better – a large inefficient public sector or an efficient private sector that is all steel and chrome. Here again, public-private partnerships can work and work very well provided the roles are clearly defined.

Ideally, the private sector provides a public service or project and assumes financial, technical and operational risk. However there are limits to private sector activism.

Electricity, roads, water supply, education, and healthare are core responsibilities of the state. The sustainability of development processes must be ensured, along with the sanctity of the natural environment.

In India today, villagers are rapidly abandoning agriculture to throng at city gates, while cities themselves are stretched at their seams. Issues such as these must engage the attention of public policy makers. Above all this remains the primary need for good governance, which embeds concern for growth with equity.

(The author is Executive Director, Reserve Bank of India. Views are personal.)

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