Human beings take a sanguine view of the long-term future, believing that life will take care of itself. It is the immediate future that bothers us more. In his famous book, Thinking Fast and Slow, Daniel Kahneman documents the human tendency to emphasize the ‘peak-end’ experience rather than the average experience over its duration”. 

According to Kahneman, human beings are inclined towards what they refer to as “the instant high”. Consequently, we prefer decisions that improve the short-term prospects, even at the cost of creating fundamental, structural long-term problems.

The financial crisis of 2008 was rooted in overleveraging and excessive risk taking. Despite clear evidence having emerged of high, unsustainable levels of debt, the financial markets kept encouraging more and more risky debt.

Post crisis, when reduction of interest rates has not succeeded, central banks have introduced negative interest rates. When QE1 (Quantitative Easing1) did not have the desired effect, we had the QE2 and QE3. When the first Greece bail-out did not succeed due to lack of fiscal discipline, providing a financial relief package was considered more critical than getting that country to avoid financial profligacy. It was only German insistence on financial discipline that prevented European Central Bank (ECB) insanity. Such examples can be easily multiplied manifold.

Ideas to resolve a specific problem often get abused through inappropriate application to different scenarios, purely based on convenience. The most abused proposition has, of course, been that of providing fiscal stimulus as a onetime palliative to overcome the recession in the 1930s.

Keynes had proposed fiscal stimulus as a onetime solution to a specific problem that confronted the global economy, but never as a generic antidote to underutilization of economic capacity. The proposition has, however, been used to justify persistent fiscal deficits the world over to such an extent that such pump priming has become almost a moral duty of governments. This, of course, is music to the ears of the politicians who can merrily engage in indiscriminate spending, without any qualms. Why worry about the long term implications such a policy may have? We can always take recourse, again inappropriately, to another contextually specific statement from the great man (Keynes, of course) that in the long run we are all dead!

There is a case here for a concept, which economists have termed as ‘moral hazard’. Moral hazard refers to any situation where one person takes decisions about how much risk to take and someone else bears the cost if things go wrong. Insurance is an area where moral hazard is a common phenomenon. We are likely to take better care of an asset that is not insured, compared to an asset, which we have insured. Similarly, insurance of deposits encourages banks to take greater risks in investment. They enjoy higher returns on investments; whereas being insured, the tab for any losses is picked up by the insurance companies.

As often happens in governance, the impact of a policy, good or bad, manifests itself only after a lag, by which time the government may have changed and the costs are borne by the new occupant. Alan Greenspan was not around to pick up the tab for his eventually rather disastrous policies that were responsible for the financial crisis. Nor was the cost of the financial crisis paid by the bankers and the shareholders of banks, but by the public at large in the form of government bailout, which in itself has created significant moral hazard.

Choices we make now come back to haunt us later. Support for dictatorships at various times has reduced the credibility of the US. Going to war against Saddam Hussain, without sufficient proof of possession of chemical weapons, has turned a large part of the Muslim community against the US and the western countries. The current terrorist activities are, in some sense, an outcome of such policies. Lower savings may increase demand temporarily but the long-term impact will be reduced investments and inflation. Ignoring climatic concerns today jeopardises the future of the planet and our children. Pump priming by the government may help generate demand in the current recessionary conditions but comes back to bite later with higher inflation and unsustainable debt. One of the major reasons the world has not been able to recover completely, even eight years after the financial crisis, is the inability to deleverage and relying on politically palatable, loose monetary policy rather than tougher structural changes. 

Ultimately, the future of mankind will be determined by the choices we make. Do we continue to succumb to the easier and expedient policies or does humanity have the courage to abide by basic principles and values that may be a little inconvenient but have stood the test of time.

(This is the concluding part of a 2-part series by the author.)

Here is the first part that you may also want to read: 

Dilution of values: Has the wisdom lost its sanctity in economics?