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The ‘Micro-Foundations’ of Economic Survey 2009-10

Posted by Alex M Thomas on May 11th, 2010

The Economic Survey 2009-10 is different from its predecessors. Of them, it is chapter two of the publication which deserves special attention. The chapter is titled ‘Micro-Foundations of Inclusive Growth.’ This is no new phrase for economists who have witnessed the recent ‘we want microfoundations’ movement in economics. Traditionally, economic survey analysed trends in income, food production, prices, net exports, and so on without telling the readers about their ‘foundations’. For the first time, microfoundations of macroeconomics (a progeny of the failed neoclassical microeconomics enterprise) makes a loud entry into the analysis of the Indian economy.

One of the first signs of this shift is to be seen on the book cover itself. This has been reproduced below, as it is a matter of great concern.

In 2007-08, the cover page indicated various aspects on the Indian Economy. Coupons equilibrium, something which very few people understand gains entry on the cover page. Why? Is it to show that economics is scientific and can only be understood by a few? Or does it mean that economic survey is only for those who know such concepts? Or does it convey that the economy is in safe hands now, run by competent economists? One can only wonder. The rest of the post will hover around theoretical explanations and policy suggestions provided in chapter 2. Very often, the proposal outlined below are seen as emnating from the ‘political economy school’. It will be argued that this school is only a variant of neoclassical economics, albeit a superior one.

The chapter starts by emphasising the need to look at the foundations of macroeconomic policies, which have been neglected. The author(s) point out that an ‘enabling state’ is what India needs; a state which provides incentives through proper institutions for the individuals. That is, for policy to be effective, we “need to take people to be the way they are and then craft incentive-compatible interventions.” Under the sub heading of ‘development and distribution’, some space is devoted to the question of futures trade. It is of national concern because very often futures trade tends to make the underlying spot prices volatile. However, it is argued that “An enabling Government takes view that if we cannot establish a connection between the existence of futures trading and inflation in spot prices, we should allow futures trade.” The literature contains mixed views on this issue. Perhaps, it is being suggested that since it cannot be proved conclusively, we must go for futures trade. The rationale provided to pursue futures trade is a dangerous trend. For, economics is unlike sciences where laboratory experiments can be carried out. In any case, what is the percentage of people who invest in futures trade? And what is the percentage of Indian farmers?

Trickle down effect is said to have taken place in India through injection of demand to the poor through increases in budgetary allocations for anti-poverty programmes. The firming up or increase in prices of food items is presented as evidence for income increases of the poor. This piece of evidence is wrought with methodological as well as conceptual difficulties. Hence, it cannot be argued with such certainty that incomes of the poor have risen. For, if the prices of food items have gone up, their real wage or purchasing power must necessarily be reduced. In effect, there might not have been any notable improvement.

Subsidies are considered essential for India. However, price controls are seen as distortionary and also they result in high levels of corruption. Therefore, it is pointed out that subsidies should take the form of ‘coupons’. This achieves two objectives. (1) Prices are left to the market and (2) Individuals have more choice. Both are hallmarks of neoclassical as well as neoliberal thinking. Hence, the need for Unique Identification (UID) system for improving information. It is argued that the state should not tamper with the ‘preferences’ of the subsidy reciever. Because “modern behavioural economics reminds us that there are situations where individuals act against their own interests because of lack of self-control or inconsistencies in their inter-temporal preferences, and so some pateranlistic interventions can be good for them.” This result cannot be directly imported to a macroeconomic setting, owing to differences in objectives and also, the sum of parts may be more or less than the whole (fallacy of composition).

Apart from such proposals, foreign direct investment (FDI) in the textile and clothing sector is favoured as they “can help modernize this industry and aid its integration to the global textile market.” The introduction of powerlooms have rendered many weavers jobless and most of them have become migrant construction workers. When any sector gains more importance than those employed in that sector, it is a sign that the objective of policy makers is plain ‘numerical growth’ and not employment!

The end of the chapter contains a discussion on ‘social norms, culture and development’ which points out that standard economics has not paid much attention to social and cultural factors. And that game theory and behavioural economics “is begining to give us some insights into the formation of customs and behaviour.” It is argued that though such “phychological and sociological determinants” may not effect short-term economic outcomes, they do affect medium-term and long-term outcomes.

In the following manner, this ‘political economy school’ explains economic issues through concepts such as ineffeciency, information asymmetry, bureacracy and corruption, inventives, incomplete contracts, etc. This school of thought should not be confused with Marxian or Sraffian political economy. This chapter is testimony to the fact that economists believe that economics is a science which has testable propositions and that they result in conclusive results. For the authors hail behavioural economics as though it is a new branch of economics which is the ‘saviour’ of economics. More dangerous is some of the causal connections made in the chapter, as they are not based on any logically consistent theory nor are they borne out of experience. The ‘micro-foundations’ of the economic survey definitely needs a rethinking!

5 Responses to “The ‘Micro-Foundations’ of Economic Survey 2009-10”

  1. Tweets that mention Undergraduate Economist » Blog Archive » The ‘Micro-Foundations’ of Economic Survey 2009-10 -- Topsy.com Says:

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  2. Sumirti Singaravel Says:

    Hello Sir,

    I am a student of Chartered Accountancy who is interested in Economics. To your knowledge, am no way connected with economics academically. Yet I would like to get through all the basic concepts of Economics in a most lucid way. The only book which I took for guidance is ‘The Fundamentals of Economics’, by Paul.A.Samuelson published by Mcgraw – Hill (this s also a much older edition. I don’t even know whether there is a recent publication of the book). Kindly suggest me some books that explains economics and its basics in a much lucid way (although it does not require that it has to be as lucid as being explained to a layman).

    Hope you extend your kind help.
    I enjoy every bit of your blog and keep posting.

    Sumirti Singaravel

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