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The classic economic conundrum: Slipping as you rise

'Consumers were slightly more positive about current business and labour market conditions, suggesting the economy will continue to expand at a moderate pace.' Photograph: (Getty)

WION New Delhi, India Aug 12, 2016, 12.40 PM (IST) Vrinda Aggarwal
It was the year 2005 and I was in the 9th grade. My whole family was talking about a distant relative who got admission in London School of Economics (LSE) for her masters. And just a year later, everyone was again talking about her as she’d got a job with some big company in London with a monstrous pay package. In such talks, no one ever knows the exact name of the company or the exact figure of the money. When news travels through multiple sources, such details are often lost in transit.
 
At an impressionable age of 15, such talks leave a significant impact. One doesn’t even realise when they become part of the sub-conscious and influence one’s future decisions in one way or the other. Fast forwarding to 2011, I completed my undergraduate studies in Economics from Delhi University and was holding an offer letter from LSE for Masters. It was just 4 years after the financial crisis had rocked the world and the effects of this meltdown had not significantly subsided. Moreover, in the same year, the UK government had stopped giving 2-year work permits along with the student’s visas. They were protecting jobs for their own citizens.
 
A year later, I graduated but with a job in a niche think tank in Delhi. Many of us still reminisce the pre-2008 period. At that time, every student was holding almost two to three jobs with decent salaries much before his/her final exam. Job seekers held the bargaining power. People were taking loans to buy houses and expensive cars as paying the instalments was not a big deal. We indulged, our governments indulged and sometimes over-indulged. There was an element of irrational exuberance.
 
There are four stages in a business cycle: boom, recession, depression and recovery, with the names themselves indicative of their meanings. Most of us think that recession and depression are the worst phases of a business cycle but are they really? Instead, it is during boom when we take the most stupid decisions, plummeting ourselves into a recession.  
 
Every time there is a boom, we make mistakes and, often, those turn out to be big mistakes. In a paper on the 1997 Asian crisis, Paul Krugman writes: “as long as the real estate prices and stock markets were booming, even the questionable investments tended to look good. As the air began to go out of the bubble, losses began to mount, further reducing the confidence and causing the supply of fresh loans to shrink even more.”
 
Before the 2008 crisis, more importance was given to international finance than to international trade. We started moving from real to nominal - an important factor for not being able to contain the crisis in just one part of the world. Most of the European economies were over-leveraged before 2008, thus falling into an abyss of debt crisis after the shocking financial year.
 
Similarly, in Venezuela, they focused so much on oil during the boom years and lavishly spent their windfall. When the oil prices fell recently, they were unable to bear the losses. Oil was their only source of income. They made the age-old mistake of putting all their eggs in the same basket.
 
Also, many of the South American economies like Brazil, Colombia, etc. gorged on debt during the so-called happy times with the entire debt being denominated in US Dollars. When the Dollar appreciated significantly and the exports of commodities fell sharply, these countries were unable to service their debt and, as a result, their GDPs contracted and the standards of living worsened. Instead of maintaining the same level, the South American people have actually become poorer.   
 
When there is boom, every institution in every country demands lowering of rules and regulations. Everyone wants to ride the wave, be it the government, banks, financial institutions, citizens or international bodies. People behave irrationally, completely disregarding the consequences of their actions.
 
We may need a regulator monitoring the activities of the various institutions during such periods of the business cycle so that it stops anyone from making those mistakes which have severe consequences in the long term. But here too, the regulator is caught up in a catch - 22 situation. If the regulator stops irrational behaviour in the beginning and things are upward looking for a while, then people think that the regulating body was panicking for no reason as everything is going great. Nobody understands that this is because the bad elements were weeded out at the right time.
 
As a world, we need to arrive at a solution to clip this irrational exuberance when we are healthy. Maybe we need to devise a mechanism where someone reminds us of our past mistakes so that we don’t repeat them in future. 

Vrinda Aggarwal

Vrinda is a senior researcher with Zee Media. She has majored in Finance and Economics from London School of Economics.

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