1. Mr Uhuru Kenyatta, Deputy PM and Minister of Trade, Govt. of Kenya will deliver a Special address after Hon’ble Minister’s Keynote address. Opening ambit as appropriate.
2. Although a lawyer by profession, I have been the Minister of Science and Technology for well neigh five years now – and so have picked up a little of scientific terminology and jargon. To put the present crisis in the context of science, we had at the turn of the twentieth century Newtonian physics and the world then seemed neat, orderly and mechanical. Then came along Quantum physics and revealed that deep down things are much weirder than they outwardly seem. Something similar is now happening with economic order as well.
3. Skip to next paragraphOnce classical economics dominated policy thinking. The classical model presumed a certain sort of orderly human makeup. It assumed that inside each person, reason rides the passions. Although sometimes people may do stupid things, but generally on the whole they make deliberative decisions and the market rewards rational behavior. Markets tend toward efficiency. People respond in pretty straightforward ways to incentives. The invisible hand of market forms a spontaneous dynamic order. This view explained a lot, but not the current financial crisis — how so many people could be so stupid, incompetent and self-destructive all at once. The crisis has delivered a body blow to classical free market economics and taken a body of psychological work that was at the edge of economic policy thought and brought it upfront and at the center stage of economic policy.
4. In hindsight over the last few decades we have seen sweeping changes in socio-economic and political formations worldwide. One of the most widely discussed and debated has been the global shift towards the free market economy. The free market economy, by comparison with other systems of economic organization, has really shown itself to be more resilient and more efficient. The alternative to it at the extreme is central planning, which of course the decline of the Soviet Union has shown that it does not perform better than the free market economies. Even within the Western group of countries, over the last few decades, countries have been moving towards deregulation and the freeing up of their markets. We have several examples of this: exchange rates, which not too long ago used to be fixed and managed by governments are now being determined in open markets; interest rates used to be controlled in many countries or had ceilings and floors have now been made free; competition, which in the financial sector was somewhat limited, has become much freer and pervasive now. So, where countries that already had market systems, markets have been increasingly freed up and in those that had centrally or even semi-planned economies, nearly all of them have moved to some form of free market system.
5. But I often hear the arguments that free markets lead to disparities not only among countries but also within countries. It is true! Income disparities within many countries have gotten larger and the gap between the rich and the poor has widened. But I feel, progressive taxation is certainly a means of balancing that. That’s not, by the way, a denial of the free market model: it’s really adapting the consequences of the free market model to have more benign or more egalitarian social consequences. I think you’d find that in Nordic countries the essence of the economic organization is competition and free markets, but they use the tax system in order to provide a more comprehensive safety net than elsewhere so that the free market economics have to be judiciously blended with other fiscal and taxation policies.
6. Now what are the benefits and drawbacks, and what’s the balance sheet for the free market economics? While I would say that a free market system works better than the alternative, it’s nevertheless the case that there are ways in which a purely free market system can malfunction that needs to be regulated and controlled. It’s always been recognized that monopolies can operate to the detriment of efficient resource allocation and to the detriment of the consumer as well.
7. The present crisis is a case in point. The future of free market policies has undoubtedly been damaged by the global financial crisis, and by the continuing rise in unemployment and slowdown of the global economy. The degree of damage, however, will depend upon the length and severity of this slow down. If the recession does not develop into a deep and prolonged depression, there will not be a sizable retreat from the free market policies that have held sway now in the developing world for around two decades now.
8. The crisis has lead to aggressive monetary and fiscal policy actions - both traditional and non-traditional - undertaken to ensure that the inevitable crisis of 2009 does not persist into 2010 and beyond. But what are the possible solutions? One type is free market oriented – and the other, interventionist. The first type calls for continuing with free markets and a global "laissez faire" environment to solve the present financial crises. The second approach regards the free markets as the SOURCE of the problem, rather than its solution. It calls for domestic and where necessary international intervention and assistance in resolving the global financial crises. And here is where I see the need for partnership – globally, regionally, bilaterally and even locally.
9. As a result of the crisis, we see today that while household consumption and business investments are collapsing globally, governments are becoming the spenders of first and only resort, stimulating demand and thus rescuing banks, firms and households. The long-term consequences of the resulting surge in fiscal deficits are no doubt serious but appear to be the only alternative and are now being taken to be acceptable by International Financial Institutions.
10. We have seen that market failure was a result of inadequate information to market participants, and so we’ve come to the conclusion that transparency must be mandated so that participants in markets have adequate information to make right decisions. Markets can go wrong and probably the most obvious example is in financial markets where we see periodic financial crises. Financial variability is not necessarily a bad thing, but sometimes we see market failures that result in crisis. We must learn lessons from that to make the system more resilient.
11. Undoubtedly, in light of the severity of the financial crisis, greater regulation of financial institutions is merited. Better regulation of the financial sector - not an abandonment of policies that generally have supported the private sector - and competition are the need of the hour.
12. The challenge then is to find regulations that would significantly reduce the probability of future financial crises without discouraging the valuable contributions that commercial banks, investment banks and other financial institutions make to risk management and the financing of ownership of personal assets and business investments.
13. What does a common man want economically? A job that allows him to get up in the morning and go to. A job that allows him to pay his bills, make EMI payments, put some money away for education of his kids and also pay for his eventual retirement. A job that he can go to without fear that he may be pink-slipped at any moment and all his life comes crashing down. Is that too much to ask? Not really, but it does require a certain degree of stability in the economy. Something surely lacking in the deregulated free-market economy. What a common man needs is thus simply a stable regulated economy where he would know where he stands from day to day.
14. In the light of this, I foresee several changes to be in the offing. First, the greater capital reserve requirements for all financial institutions, including investment banks and hedge funds, I feel would help these initiatives to better weather runs on their assets. Second, greater transparency in the information that financial institutions provide about their assets would also be useful, although modern assets are often so complicated that transparency will not always be easy to achieve or even if it is there to appreciate and understand the nuances.
15. However, the consequences of imposing minimum capital requirements in relation to assets of all financial institutions, including hedge funds and private equity companies, depends not only on how such a requirement would affect the operation of the financial system, but also on how it would affect investments, employment, and other aspects of the economy as a whole. To understand these consequences it requires developing a model of the effectiveness of competition in this sector, and an analysis of whether the present financial crisis would have been much milder if capital requirements had already been put in place. The general point I am making is that an economic theory of how markets operate is necessary to evaluate any significant new regulations and other government policies favouring a free market economy.
16. Also, I feel that there is a lack of corporate responsibility in the free market economy by arguing that within a system which limits government involvement and regulation, a country’s future may depend on the good will of financial and corporate organizations. But, every country has got regulators and supervisors to look at the way in which financial services institutions and corporates behave; They set standards both to protect the safety and soundness of financial institutions, and thereby protect the interests of depositors, investors and the users of the services; make sure that market practice standards are observed, and that means being adequately transparent to customers about prices and so on, and not exploiting advantages of inside information and a variety of things like that.
17. To conclude, let me reiterate that free market economics continues to be robust. Free and fair world trade remains the best option for both developed and developing nations to grow together. The global community needs to ensure that the institutional framework for doing so is robust, transparent and effective. The welcome measures announced at the G20 Summit are intended to enhance the functioning of the free market and not to control it. India is ready to partner the efforts for building such a framework and we look forward to working with other nations in this endeavour.
18. Closing ambit as appropriate.