Why unemployment is a direct result of the banking crisis

With the election season heating up, one issue that is garnering limelight in the electoral fight is unemployment. There is significant rural distress and an obvious lack of jobs and employment creation, especially in rural areas. The government is trying its best to whitewash evidence by suppressing the jobs data reported by NSSO, which portrays a deteriorating situation.

When 108 economists pushed back on the growing data dissonance, a group of CA’s resorted to good old whataboutery to counter facts.

Since Economics is not an exact science, it becomes difficult to pinpoint the reasons that led to the unemployment problem. There are multiple forces at play that makes it even more difficult to isolate the primary cause of the problem. If the right reason is not determined, then the economic policy will most likely be wayward as only the symptoms of the disease would be treated rather than the malaise itself.

In this context, figuring out the essential cause will prove highly beneficial in enacting policy change. Many candidates can stake a claim to being the ‘most important cause’ of unemployment. The chief candidates include the twin disruptions of GST and demonetisation, lower rates of savings and investments, demographic changes and the banking crisis among other structural and cyclical causes.  For the sake of brevity, only one candidate will be discussed in this piece. One which I believe is the most important cause.

It is highly likely that the unemployment problem is a result of the widespread bad loans crisis that is plaguing the banking sector in general and government-owned banks in specific. As PSU banks have taken up the mantle of lending to rural areas, it was the rural populace that suffered the most distress caused by insufficient credit.

Many words have already been dedicated to the reasons for the banking crisis, so there is no point in rehashing history. The initial signs that all is not well with our banking system started showing from 2012-2013 itself. It’s 2019, and we are yet to see a concrete resolution to the longstanding crisis. However, recent NPA data suggests that we may be nearing the end of the crisis as the growth of newer NPA’s is declining

The bad loans crisis shocked the banking system and crippled it into inaction. The rate of lending slowed down to a trickle, and the crisis even reached to a point where the RBI had to intervene and disallow a host of PSU banks from lending through its Prompt Corrective Action (PCA) mechanism.

The links between employment and bank lending are quite evidential. Since there is an increase in lending activity, there is a proportionate increase in economic activity of corporations, small businesses and individuals which in turn lead to an increase in job openings. Bank loans enable businesses to increase the scale and scope of their operations which require more workforce to handle those operations. Unfortunately, instead of handing out the funding needed for legitimate business operations, PSU banks were forced to curtail and even stop lending activities. While the better managed private banks were able to dodge the bad loan bullet to a significant extent, their cousins in the public banking sphere had to face the brunt of the damage. As PSU banks constitute a substantial majority of lending activity, their inability to lend became a major stumbling block to economic activity that subsequently curtailed employment creation. 

A clear link between employment and bank financing is also borne out by research on the subject conducted by economists. Observations by Ordine and Rose suggest that unemployment increases when the banking sector fails to operate efficiently¹. They also concluded that a 10 per cent increase in credit volume in Italy increased employment by five per cent. Lakstutiene et al. concluded that the 1998 financial crisis and the subsequent narrowing in credit volume was behind the high level of unemployment that Russia faced in 2002². Bernanke and Blinder also concluded that narrowing in credit volume increases the unemployment ratio at the same time³. Shabbir analysed the credit volume and employment data for Pakistan and reported that one per cent increase in credit volume reduced unemployment by 2.3 per cent⁴. On the flip side, Ismet Gocer analysed data on 14 European countries and concluded that a 10 per cent increase in credit decreased unemployment ratio by only 0.64 per cent⁵. Overall though, there is clear cut evidence that there is a direct link between credit growth and increase in employment creation. Conversely, a slowdown in lending increases the ratio of unemployment.

Once our banking system is brought to full throttle mode wherein all deserving and eligible candidates for funding are adequately provided for, then we will witness an immediate revitalisation of our economy. Economic growth will pick up and so will employment generation. We also have to be wary of the corollary that if the banking crisis continues to linger on indefinitely, then it will manifest in the form of even deeper unemployment.

It is also vital that we follow a bi-partisan outlook to solving the unemployment problem. There is no point in playing blame games or pointing fingers at both sides of the political spectrum are responsible for the banking crisis. Congress allowed and perhaps even augmented indiscriminate lending from banks with no regard to lending processes which created the NPA problem in the first place.

Once the BJP came to power, they were slow to react to the magnitude of the crisis as if they were hoping that the problem will solve by itself without the government taking any concrete steps. Their insouciant approach is coming back to bite them as they deal with the unpleasant consequences of the crisis. The one person, Raghuram Rajan, who diligently attempted to solve the banking crisis, was unceremoniously packed off after just three years at the helm of RBI. It is akin to a patient dismissing the surgeon in the middle of the surgery just because the patient does not like the fact that the surgeon speaks his mind.

Unless we understand the deep-rooted causes, problem-solving is similar to grappling in the dark. In the case of unemployment too, coming to terms with the primary reason will make the job far easier for policymakers. Whichever party comes to power in the forthcoming elections, they should seek to face the problems that the economy is going through rather than staying in denial mode and prolonging the problem. It is advisable that completely resolving the banking crisis is given full priority so that the country does not have to face further adverse consequences of the crisis.

References:

1. Ordine P. and G. Rose 2008 “Local banks efficiency and employment”
2. Lakstutiene A., R. Krusinkas and J. Platenkoviene 2011 “Economic cycle and credit volume interaction: Case of Lithuania”
3. Bernanke B. and S.A Blinder. 1992 “The federal funds rate and channels of monetary transmission”
4. Shabbir G., S. Anwar, Z. Hussain, and M. Imran 2012 “Contribution of financial sector development in reducing unemployment in Pakistan”
5. Ismet Gocer 2013 “Relation between bank loans and unemployment in the European countries”