Are Crises Good for the Economy?


Could Japan’s latest crisis help it economically?

Those who believe in Keynesian economics might answer yes. For them, destruction is creation because it “creates jobs” and otherwise “stimulates the economy.” Taking an opposite, more rational, view economists of the Austrian school would either laugh Keynesian theory off, or if they were more considerate, expound Bastiat’s broken window fallacy: there must be something wrong with the idea that if we all go around breaking windows, somehow we’ll be better off, because the windows will have to be repaired. The problem with notions like this is that we see the creation of a new window; we see money going into the workmen’s hands; but we do not see all the beneficial projects that cannot go forward because the money for them has been spent on mere repairs.

The broken window fallacy notwithstanding, there seems to be something that enables crises to revitalise an economy. While crises destroy wealth, sustained crises also weaken government, a hostile, anti-development institution. It is the latter event that eventually can have a huge favorable affect on society.

This is what India has experienced.

I lived in Bhopal in 1984 when the Union Carbide gas leakage swept the city, killing thousands and thousands of people within the hour. Hundreds of thousands were seriously sick. The same year, Indira Gandhi, the Prime Minister, was killed by her bodyguards, producing a very weak government. Massive Hindu-Sikh riots occurred all over the country. Sikh terrorism in support of the separation of Punjab and troubles in Kashmir kept us on edge for the rest of the decade. Then, in 1991, Rajiv Gandhi, who had just completed his term as Prime Minister, was killed, presumably by the same ammunition that he had supplied to the Tamil Tigers, a Sri Lanka-based terrorist organization. Around the same time, help from the USSR to India ceased, as the USSR ceased to exist. Nineteen ninety-two was a year of major Hindi-Muslim riots all over India. Massacres took place that competed with what Rwanda had experienced in terms of brutality. The economy was in a terrible shape, and India came very close to a default on its international commitments. In short, India was crumbling in 1992 and the government was extremely weak.

Let’s look at what was behind some of these events.

Punjab was not only the breadbasket of India, but huge fund transfers were happening from Punjab to the rest of the country. Supposedly bad elements in the Punjabi society, who had earlier been encouraged by Indira Gandhi, took leadership in the quest for a separate state, and the Indian government’s response was pathetic. Indira Gandhi sent army commandoes to attack and occupy the holy place of the Sikhs, the Golden Temple. A sane approach would have been for the Indian government to cut off the water and food supply to the temple. In that event, the terrorists (if that is what they actually were) would eventually have walked out without a shot being fired. But Gandhi wanted to humiliate the Sikhs. So her humiliated Sikh bodyguards killed her. Thereafter leaders in the Congress Party orchestrated anti-Sikh riots. India was in flames.

When a crisis hits, the first thing that fails and escapes is the government.

(One of the biggest regrets that I live with is the fact that in a fit of nationalistic fervor, I sent all my savings, which for a teenager in a poor country were a mere couple of dollars, to help the families of the dead army commandoes.)

The Bhopal gas tragedy happened in the place where I lived. I was awakened very early in the morning by the sounds of sirens and a smell in the air. Until then, ambulances and fire brigades, if they existed, usually did not use sirens, because they were usually not in working order. The working sirens were on the cars of all the petty politicians and bureaucrats. Reaching the rooftop of my house to see what was happening, I saw a stream of cars with sirens and emergency lights leaving the city — they were all running away. The people of Bhopal were soon to learn that when a crisis hits, the first thing that fails and escapes is the government. Not only were the government and the army (which has a huge existence just outside Bhopal) no longer in sight for a very long time, but given that most of the services — medical, water and electricity, sanitation, banks, intercity transportation and railway — were in the monopolistic hands of the government, it became extremely difficult for the city to get back on its feet. Comfortably sitting hundred of kilometers away from Bhopal, the head of the city was issuing statements that nothing was wrong, while carcasses rotted on the streets. He was making absurd decisions, such as banning the sale of gasoline to stop people from leaving the city.

At the same time, the Indian government was financing and arming Tamil Tigers. Prabhakarn, the Chief of Tamil Tigers, was hosted in Delhi. Starting his pro-Tamil Tigers mission, Rajiv Gandhi sent a naval ship, the Island Pride, a name chosen to humiliate Sri Lanka. It seems, in his naïveté (something that had killed his mother), Rajiv was trying to earn Indian votes. The Tigers, a poisonous snake that Rajiv had encouraged, eventually bit him with his own ammunition.

Given the weakened Congress party, Hindu fanatics were growing in power. They were soon to demolish a mosque in the city of Ayodhya, in 1992. The result was widespread massacres in many parts of the country. Distrust between Hindus and Muslims was at its peak. On top of it the economy was in shambles. It seemed that India would only get worse.

I do not wish to minimize the suffering caused by the events of 1984 to 1992. But in hindsight, it seems that something else was happening. By seriously weakening a cancerous growth, the government, the time of troubles created an opportunity to revitalise the society and the economy. It formed the lurid background of what is now a thriving economy. Indian government, the cancer, never recovered its control over society. The private economy had a breathing space, a space in which it could grow. It was as if a strong chemotherapy had been performed. The government was too confused and lost to control the IT industry, when it began to sprout.

The broken window fallacy is still a fallacy, an irrational approach to understanding economics. Destruction cannot be construction. Massacres are just that. There is no humanity in it. But crises can do one thing very important. While destroying the healthy tissue, they can also weaken the cancer, the government. Crises convey to those who survive the important idea that they must not trust in the government, for government is the first to leave when a crisis hits. Crisis teaches self-reliance.

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Fred the Grumbler

Mr Harrison,

Most economists believe that the emergence of Germany and Japan as economic giants didn't happen because they had to shovel rubble and reconstruct whole cities. It happened in spite of it.

True, being occupied by a pro-market foreign country certainly helped. But work ethics and a sense of duty born of desperate necessity had an enormous influence. You don't find such elements in, say, Iraq or Afghanistan, where reconstruction and US occupation are also happening.

Mr Bhandari,

There is a missing link in your article. It's not clear how the Indian government started warming up to a market economy just because it lost control of the events. Didn't some reforms take place? Weren't some monopolies dismantled? How were the red tape and corruption tamed? What happened exactly? Curious minds want to know and understand the Indian miracle. Who knows where else the recipe will be needed.

Jayant Bhandari

Indian government never warmed up to the free-market economy. They had to dismantle a few of their regulations because they were in a very difficult situation. In essence what you need is not government to warm up to the free-market but to get out of the way, which it did by default as it had become weak.

Over the last two decades, the Indian government has become much more corrupt, as good people now prefer to work for the private sector.

My view is that what happened in India was a combination of weak government and huge economic advantages that internet offered, which government was too incapable of controlling.

As time has passed, people have become more enlightened whereas government continues to exist as a corrupt and extremely bureaucratic institution. And you are aware of the kind of stresses this situation created in Tunisia and Egypt!

Jon Harrison

That's a good point, Grumbler. I only meant that out of destruction came something good. I quite agree that a foundation is required to build upon, and that places like Afghanistan do not (and never will) have one.

Jon Harrison

Is the broken window fallacy always a fallacy? Consider Germany and Japan after World War II. On the other hand, consider Iraq today. Granted, deliberate destruction is not a positive thing; we shouldn't go around breaking things in order to repair them. But good, including economic good, may come in the wake of disaster. In my opinion it's a matter of circumstances; there is no hard and fast rule.

Jayant, did the collapse of socialism in the early 1990s have anything to do with the change in the Indian attitude toward government's role in the economy?

Jayant Bhandari

I don't think collapse of socialism in early-90s changed much in terms of Indian attitude towards socialism. Indians were already craving for the free-market.

It was weak government with added contribution from internet that made it possible for people to start by-passing the government. Moreover, internet completely changed the economic structure, as it did in most of the backward countries.

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