Dilli Durbar: The Physics of an Economic Crisis

Reserve Bank of India governor Dr D Subbarao brought all his academic skills to the table for the M Chidambaram Chettyar Memorial Lecture at the Indian Institute of Science, Bengaluru, on 27th August to explain why the economic crisis hit the world. Dealing with the subject “Economic Crisis and Crisis in Economics: Some Reflections”, Dr Subbarao, an IIT physics graduate (Kharagpur) and a doctorate in economics from Andhra University, compared and contrasted the sciences of physics and economics to explain why economics went awry two years ago. “The years before the crisis saw economics as a subject gain impressively in clout and popularity. The price stability and macroeconomic stability gave economists an enviable halo; the increasing sophistication of financial markets where risk could seemingly be measured with precision of up to five decimal points gave economics the clout of prophesy; and the way economists were able to raise obscure questions such as why drug dealers continue to live with their mothers, what school teachers and sumo wrestlers have in common, and answered those questions with impressive insights, awed common folk.” Till the financial crisis came and crashed all this. “It now seems that by far the most egregious fault of economics, one that led it astray, has been to project it like an exact science.” The charge is that economists suffered from ‘physics envy’ which led them to formulate elegant theories and models deluding themselves that their models have more exactitude than they actually did. This “physics envy,” he said, led to “the obsession of economists with models; so much so that they convinced themselves that if something cannot be modelled, it is not fit enough for academic pursuit. Indeed, with the benefit of hindsight, it is now possible to see that one of the basic causes of the crisis was that the models used by central banks remained confined to the real sectors of the economy and did not capture the complexities of the financial markets. It is not surprising that economists missed seeing the crisis brewing in the underbelly of the financial sector.” Soon, he said, instead of fitting the models to the real world, economists were trying to fit the real world to the models. “The fundamental difference between physics and economics is that physics deals with the physical universe which is governed by immutable laws, beyond the pale of human behaviour. Economics, in contrast, is a social science whose laws are influenced by human behaviour. Simply put, I cannot change the mass of an electron no matter how I behave but I can change the price of a derivative by my behaviour… Physics, an exact science, explores known unknowns. Economics, a social science, deals with unknown unknowns. All through his life, Einstein remained sceptical about quantum mechanics.
 
In particular, he could not reconcile to the probabilistic nature of the physical world implied by quantum physics and famously said that ‘God does not play dice’. Less well known perhaps is the retort of Neils Bohr who told Einstein, ‘Albert, stop telling God what he can or cannot do’. Economists have a much humbler remit. They cannot even tell man, let alone God, what he can or cannot do.” So will economics stop behaving like physics? And will economists stop playing God? (See full text of the lecture on rbi.org.in).

The Vedanta Philosophy

The high point of the past couple of weeks has to be the rather dramatic rejection of the bauxite mining lease of Vedanta in the Niyamgiri hills of Orissa. The fact that the chief minister of a state personally represented to the prime minister of the country that the mining be allowed but was overruled by an environment minister, within two days of the appeal, clearly suggests that there are forces higher and mightier than the prime minister taking decisions. If Jairam Ramesh, as we have been pointing out in these pages regularly, is looking like he is no push-over, it is only because he has been told not to be a push-over by the Gandhi benefactors, especially Rahul. Denying permission for Vedanta had multiple benefits for the Congress Party. Firstly, it put Orissa chief minister Naveen Patnaik in a very tight political corner by showing him up as a friend of big business against the powerless tribals. Secondly, in the obsession with ‘growth economics’ of the past three decades, the tribal constituency so carefully cultivated by Indira Gandhi and lying vacant since the garibi hatao heyday, has been returned to The Family in one stroke. At another time, at another place, Vedanta might have gotten away with the alleged illegalities because the philosophy of realpolitik tells us that there are those illegalities that must not be tolerated and there are those illegalities that must be furthered…

…Such as the Airport at Panvel

That brings us to the clamour for the second Mumbai airport at Panvel. Jairam Ramesh has upset civil aviation minister Praful Patel, Maharashtra chief minister Ashok Chavan and a host of other corporate biggies and media houses no end, with his adamant refusal to fast-track the environment clearance. Mumbai is saturated and needs a second airport. But the question is where should it be? To Mr Patel and his band of influential backers it can be only at Panvel where, even by their own admission, about 200 hectares of mangroves (that protect the shore) will have to be sacrificed. When Mr Patel recently announced that Mumbai airport cannot handle any more private jets, he was seeking to scare corporate India and to put pressure on a central government that is ever eager to please businesses to achieve double-digit growth. So, no wonder, within days of rejecting the Vedanta proposal, Jairam met Praful to discuss the Panvel problem and both made friendly noises. On the same day, the Observer Research Foundation released a study which said Panvel is a bad idea even for purely business reasons. Firstly, the swampy nature of the land might make building an airport extremely expensive; secondly, the land available will allow only an airport of a capacity that will be saturated within two decades requiring a third airport soon enough. But you know what; my hunch is that the second airport will come up at Panvel. Ramesh will be made to see reason. In the light of the Vedanta refusal, corporate India, and the world, will need to be sent a message that India has not suddenly turned anti-big business. It is enough if Vedanta pays for now.

Not All Politics, Of Course

But if you think I am suggesting that Vedanta is a victim of just politics, of course, I’m not. It cannot be a mere coincidence that the refusal of permission happened just days after Vedanta announced acquisition of Cairn India. The same day, we were interviewing IOC chairman BM Bansal (for another magazine). We asked him why the biggest Indian energy company was sitting by idly when a private firm was making new forays. Mr Bansal told us IOC would look at acquisitions in the $1-billion or $2-billion range. Meaning, it had no cash to think of making a bid for Cairn and the idea didn’t even occur. But a few days later, reports started appearing of a combined PSU bid to thwart Vedanta. It’s clear that people other than just politicians are out to prevent Vedanta from becoming the biggest Indian conglomerate outstripping Reliance Industries.

BV Rao has wide experience across print, TV and digital media. He was group editor at ZEE News and senior editor with DNA and Indian Express.

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