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Prices, Competition and Markets

Posted by Alex M Thomas on 31st March 2014

It has become commonplace in India to point fingers at the central government when prices of essential commodities such as onion or fuel rise. The underlying arguments behind this accusation could be that: (1) the government is expected to maintain price stability and/or (2) the government should socially engineer agricultural markets in a ‘fair’ manner. But, is the pursuit of price stability not the job of the Reserve Bank of India (RBI)? It is true that the RBI cannot do anything to combat inflation when it is caused by a supply-and-demand mismatch in the domestic vegetable market or the international oil market. What the RBI can do is manage inflation expectations, and that is for another post. The present post is motivated by the insightful analyses of Kannan Kasturi on the Indian vegetable market, published in the Economic & Political Weekly and other places. That is, this post takes up the second of the reasons mentioned earlier.

The price mechanism – adjustments made by producers to the selling prices and consumers to the purchasing prices – is expected to allocate the commodities brought to the market amongst the consumers, in accordance with their needs, reflected in their willingness to pay. The prices therefore act as signals for the producers especially. Sellers can adjust quantity in order to affect prices; hoarding commodities is one such strategy. At equilibrium, producers earn a normal rate of profit, which contains a pure rate of return on capital advanced and a return for risk and entrepreneurship. If producers do not make normal profits in time t, they will cut down production in time t+1. During the equilibration process, producers who are unable to earn a normal rate of profit will exit the market. If entry costs are low, new producers will enter the market. Producers who have large financial resources (or access to easy credit) at their disposal are insulated from temporary alterations in demand. Producers who have enough accumulated earnings can shield themselves from such market volatility. In short, a competitive market is one where prices are not distorted (by the producers or by external intervention), no (especially, cultural and social) barriers to enter the market exist and workers are mobile within and across markets.

Of course, the agricultural markets in India are far from competitive. Since more than 50% of Indians derive their income from agriculture, and particularly because of the poverty of the farmers, these markets require government intervention. This is not to say that any form of government intervention will better the situation. Kasturi quite convincingly shows that the fault lies with the supply-side – the agricultural supply chain. This post will not discuss minimum support prices or other input subsidies, such as for electricity, irrigation and fertilizers. Also to be noted is the specific manner in which the agricultural input markets are inter-linked in India, which has been of an exploitative nature. Finally, social and cultural factors (pertaining to caste and gender) are seen to hinder competitiveness in Indian markets, not just in agriculture.

What are the problems with the agricultural supply chain? Kasturi points out the following: (1) Small farmers lack storage facilities in order to gain from the high market prices. (2) The middlemen (those who intermediate between farmers and final consumers), i.e. the wholesale traders and commission agents have the ability to hoard vegetables and consequently they reap the benefits of the high prices they themselves engineer; the Agricultural Produce Marketing Act governs the agricultural markets (mandis) and it is here where all the proceeds from higher prices are absorbed with nothing reaching the farmers. These traders and commission agents are ‘well entrenched in the mandis, having been in the business on average for 20 years’ (3) Agricultural pricing is not at all transparent and the mandi records are of no assistance in this regard.

To sum up, the nature of government intervention has to change, in such a way that is beneficial to farmers. Proper laws are of utmost importance, not just in protecting the interests of the small farmers, but also that of the consumers.  Moreover, intermediaries in any market perform useful functions but laws should be in place which ensures that they do not become monopolistic and exploitative. Agricultural infrastructure such as storage facilities is paramount in this context. A very detailed study of how these supply-chains operate will be of much help in our attempts to combat inflation.

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Posted in Agricultural sector, Development Economics, Economics, Government, India, Inflation, Markets, Prices | No Comments »

Misunderstanding Economic Growth and Development

Posted by Alex M Thomas on 25th August 2013

If two previous posts dealt with trying to understand how economic growth may or may not translate into development, this post goes a step behind and discusses what economic growth means. More importantly, this post examines what economic growth does not mean. The motivation for this blog post comes from Jagdish Bhagwati and Arvind Panagariya’s 2013 book titled Why Growth Matters: How Economic Growth in India Reduced Poverty and the Lessons for Other Developing Countries. Note that the following paragraphs are not intended to be a detailed review of the book; only their central premise – ‘the centrality of growth in reducing poverty’ (p. 4) – will be engaged with. The blog post, however, ends with a critical commentary on the authors’ methodology (focusing on authors’ engagement with opposing views, presentation of authors’ own arguments and referencing), as contained in the Preface, Introduction and the first three chapters. Also, no comments are offered on the data analysis present in their book.

A premise is ‘a statement or proposition from which another is inferred or follows as a conclusion.’ Bhagwati and Panagariya start with the premise that economic growth entails increase in employment opportunities and an improvement in income per person. This is also their conclusion, and forms the title of their book. They write:

Bhagwati argued nearly a quarter century ago that growth would create more jobs and opportunities for gainful improvement in income, directly pulling more of the poor above the poverty line and additionally would allow the government to pull in more revenues, which would enable the government to spend more on health-care, education, and other programs to further help the poor. Growth therefore would be a double-barrelled assault on poverty. (p. xix)

Further, they write: ‘growth helps by drawing the poor into gainful employment’ (p. 23). A simple question is sufficient to negate this view. Does the market create jobs after taking into account the abilities and skills of the poor? Of course not! If so, there would not be any unemployment or underemployment. A well-educated (and healthy) workforce is necessary so as to actually ‘gain’ from the newly created employment opportunities. [Not to forget the hardships involved in deskilling and reskilling.] And, it is not logically necessary for employment opportunities to increase when the economy grows. Jobless growth is a possibility where the surplus is not used to create further jobs; more often, it is a question of whether jobs are being created at the same pace as at which the economy grows.

By definition, economic growth entails a rise in income. But whose income? Economic growth can co-exist with the rich getting richer. Or, economic growth can give rise to stagnant wage shares amidst productivity rises. Growth can be export-led. It can be service-led. It might favour capital-intensive over that of labour-intensive technology. A rise in real GDP can happen because of a variety of reasons. It is these ‘reasons’ that one must investigate. For, it is here that we will find answers as to who the beneficiaries of economic growth are. It is to the mechanisms or processes which generate economic growth that we must attend to in order to comprehend which sector/classes/groups are losing out. For example, the nature and consequences of service-led growth will be very different from that of growth that is manufacturing-led. Bhagwati and Panagariya repeat the same fallacy, pointed out in the previous paragraph, in the following passage.

Conceptually, in an economy with widespread poverty, labor is cheap. Therefore, it has a comparative advantage in producing labor-intensive goods. Under pro-growth policies that include openness to trade (usually in tandem with other pro-growth policies), a growing economy will specialize in producing and exporting these goods and should create employment opportunities and (as growing demand for labor begins to cut into “surplus” or “underemployed” labor) higher wages for the masses, with a concomitant decline in poverty. (p. 23; see p. 43 as well)

Conceptually, in an economy with excess labour supply, labour is cheap. Bhagwati and Panagariya argue that a growing economy with cheap labour will adopt labour-intensive techniques. This reasoning assumes that an unemployed farmer or school teacher can easily and naturally be employed in a firm which exports computer parts. The authors’ views seem to indicate a gross misunderstanding of the actual economic dynamics of any society (see below as well). Moreover, one is not just concerned with mere employment, but with employment that provides good working conditions – including sick leave, maternity leave, overtime wages, etc.

‘The pie has to grow; growth is a necessity’ (p. xx). Yes, a larger surplus makes it feasible for each claimant to get a greater share, including the government. The contention is with respect to the feasibility and who these claimants are. According to Bhagwati and Panagariya, growth automatically and naturally generates higher incomes per person thereby ‘directly pulling more of the poor above the poverty line.’ Growth is not manna from heaven which everyone gets in equal amounts. It is based on definite political, economic and social institutions/processes – wage bargaining, possibilities of reskilling, mobility of labour, gender, caste, family structure, social security nets (family based or from the government) and so on. In this context, the authors rightly note the negative effects excessive licensing, government monopolies and protectionism can have on the growth of an economy (p. xii).

Given the authors’ belief in a strict one-way causation running from economic growth to development, they argue for carrying out growth-enhancing reforms first, which they refer to as Track I reforms. Subsequently, the surplus can be redistributed by the government to achieve development; this can be through transfer payments of various kinds. These are known as Track II reforms. They argue:

Track II reforms can only stand on the shoulders of Track I reforms; without the latter, the former cannot be financed. (p. xxi)

Of course, they can be financed through government borrowing and there is ample literature on the issues surrounding debt-sustainability in relation to achieving full employment. One wishes to see a more nuanced understanding of such matters.

This separation of growth from development is not just illogical and untrue, but also dangerous to public policy. Often, for purposes of economic theorising, in order to carefully study the causal relations between variables, some boundaries are drawn and certain assumptions are made. But, an import of this technique into the domain of public policy is methodologically flawed, where the abilities of individuals to seek jobs and actually work and earn (higher) incomes crucially depend on their social, cultural and economic backgrounds. In other words, while the distinction between economic growth and development might be reasonable for some purposes, in practical politics, they go together. Moreover, if the policy objective is to ensure good quality of life for all, then it must be the case that, to use the authors’ terminology, both Track I and II should be undertaken at the same time, with perhaps a greater emphasis on Track II reforms.

A fundamental error underlies the authors’ belief that ‘growth’ is an automatic process which takes place when the government lets the private players have a completely free hand, international trade is free, and capital can freely flow in and out of the country. It is this notion which makes the authors’ note that ‘Track II reforms involve social engineering…’ (p. xxi). That is, in their view, Track I reforms require no ‘social engineering’. Nothing could be farther from the truth! A ‘market’ is an engineered institution. The belief that ‘free markets’ will deliver both economic and social justice is quite easily discernible from their statements. Making commodity markets free (from both government and private monopolies) is certainly beneficial for economic growth as well as for wider socio-economic development. But, given the (historical or otherwise) arbitrariness (as opposed to ‘merit’) involved in the ownership of various forms of assets, and the tendency of markets to favour the powerful, there is always a crucial role for the government and civil society to intervene in order to ensure social justice (especially in the arenas of education and health). After all, is this not what we mean by participatory democracy?

The preceding commentary is based on a partial reading of Bhagwati and Panagariya’s book, as noted in the introductory paragraph. Their conception of growth, at best, seems superficial and at worst, they misunderstand the dynamics of economics growth as well as development. The view of ‘free markets’ generating growth with rising incomes per person is never an automatic process. It requires visible hands and is indeed social engineering. We end with a few observations on their methodology. For them, all that their critics say are myths; Part I of their book is titled ‘Debunking the myths.’ On one occasion, some of the critics, who are hardly ever named (and therefore not cited), are accused of being ‘intellectually lazy’ (p. 25; also see p. 32, p. 34, p. 35 for the unnamed critics). On the other hand, the following phrases are used for arguments in their own support: ‘state-of-the-art techniques’ (p. 31), ‘detailed state- and industry-level data’ (p. 31), ‘compelling nature of evidence on the decline of poverty under reforms and accelerated growth’ (p. 33), ‘irrefutable evidence’ (p. 37), ‘evidence…is unequivocal’ (p. 38) and ‘these authors’ superior methodology’ (p. 43). Out of the total number of references excluding data sources and reports (around 125 in number), about 37% (around 47 in number) are references to the authors’ work, either as a sole author, a co-author or as the editor of the volume. This is very striking. And, out of citations to Panagariya’s work (about 27 in number), 14 of them are newspaper articles published in the Times of India or Economic Times. It is indeed unfortunate to come across so many fundamental errors in a book like this, because growth does matter, although not at all in the way Bhagwati and Panagariya expound in their book!

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Posted in Book reviews, Development Economics, Economic Growth, Economics, Education, Employment, GDP, Government, India, Labour Economics, Macroeconomics, Markets, Neoclassical Economics, Poverty, Unemployment | No Comments »

Understanding India’s Economic Growth and Development

Posted by Alex M Thomas on 28th July 2013

This post is a review of the recent book by Jean Drèze and Amartya Sen titled An Uncertain Glory: India and Its Contradictions. An earlier post in this blog has dealt with the vexed relation between economic growth and development and elsewhere, I have discussed the need to focus on the structure of economic growth. Drèze and Sen’s book contains 10 chapters including the introduction (‘A New India?’) and the conclusion (‘The Need for Impatience’); the main text spreads across 287 pages. Their argument is buttressed with comparative exercises between Indian states, international comparisons, historical facts, surveys, published data sources and contemporary events apart from ample secondary literature. However, this review does not engage with their empirical findings.

For Drèze and Sen, the aim of any society should be the expansion of human capabilities. And, institutions such as markets and democracy are a means to that end. Similarly, economic growth ‘generates resources’ which can be used to improve human capabilities. As they write in the preface, ‘the achievement of high growth must ultimately be judged in terms of the impact of that economic growth on the lives and freedoms of the people’ (p. viii). Human capabilities, as is to be expected, refer to a spectrum of endowments and the ability to access all of them. For instance, it includes, in no particular order, nutrition (pp. 157-162), education (see ch. 5), health (see ch. 6), clean environment (pp. 41-44), access to energy (pp. 84-87), transportation, communication and banking infrastructure. The ability to access them, however, is severely constrained by caste (pp. 218-223). And some of them are also constrained by gender (pp. 224-239) besides other power relations.

Given India’s high growth rate, the authors pose one major question: why has the ‘pace of change … been excruciatingly slow’ for majority of the Indian populace (p. 29)? According to Drèze and Sen, the major cause for this is the abysmal situation of public education and health in India. (There are some Indian states which have done relatively better.) This is because of issues relating to accountability and also due to insufficient public spending. Moreover, the authors harshly criticize the Indian media for their ‘excessive focus on a relatively small part of the population whose lives and problems are much discussed’ (p. 261; see also pp. 262-267). This wide gap in public discourse provides their motivation in writing the book. Hence, they point out the ‘importance of enlightened public reasoning’ as ‘a central part of the general thesis of this book’ (p. 239). Furthermore, they state that ‘this book is aimed much more as an attempted contribution to public reasoning, including discussion in the media, than at giving professional advice to the government in office’ (p. 253).

Is their account of economic growth and development entirely satisfactory? Their second chapter is about ‘Integrating Growth with Development’. First, what determines economic growth? According to mainstream (neoclassical) economics, a growth in physical capital, human capital (educated and healthy workforce) and technological progress causes economic growth. This is known as the supply-side view of economic growth. If we accept this growth account, then clearly an improvement in the quality of life directly contributes to faster economic growth. Drèze and Sen do not have theoretical dissatisfactions with mainstream economics, as is made very clear in the following passage written in the context of a discussion on markets.

Relying solely on the market has become a strongly advocated theme in India on the basis on highly exaggerated expectations, often based on a misreading of the conclusions of mainstream economics, which includes much scepticism of the performance of markets in the presence of externalities, public goods, asymmetric information and distributional disparities. We do not have to look for any “alternative economic paradigm” to see what the market cannot do, in addition to what it can do – and do very well. (p. 184; emphasis added)

They also approvingly cite Joel Mokyr and Elhanan Helpman who emphasize the importance of ‘accumulation of knowledge’ and ‘total-factor productivity’ through education in economic growth respectively (p. 35). This is the supply-side production function approach in understanding the growth determinants. No one denies their significance. However, if one is convinced by such a theory/view of economic growth, the popular version of it being the Cobb-Douglas production function in various clothes, then, theoretically, physical capital can be substituted with human capital. And, this would entail a very different method of attaining economic development from that mentioned in the book. Moreover, aggregate demand does not play a role in this growth account; as the authors write in the preface, the ‘expansion of human capability, in turn, allows a faster expansion of resources and production, on which economic growth ultimately depends’ (p. x). That is, economic growth is entirely determined by the growth of aggregate supply, without considering the problems which can arise from aggregate demand deficiency (such as a fall in wage income or decrease in government spending). Without getting into the details of the argument, it appears that their conception of economic growth and development sits more comfortably with the economics of the classical economists (such as Adam Smith, David Ricardo and Karl Marx) combined with the effective demand theories of Michal Kalecki and John Maynard Keynes.

The surplus generated from economic growth can be utilized for societal needs which is further determined through socio-political movements and economic considerations of the entrepreneurs as well as the state. To put it differently, ‘the fruits of growth’ need to be allocated intelligently – based on our physical, economic, environmental, social and cultural needs (p. 9; cf. p. 14, p. 18, p. 38). There are two very different kinds of distribution that takes place – income distribution between wage-earners and profit-earners and the expenditure of the government from the revenue they collect as taxes and duties. They also observe,

The impact of economic growth on the lives of the people is partly a matter of income distribution, but it also depends greatly on the use that is made of the public revenue generated by economic expansion. (p. 37)

They mention the importance of collective bargaining (p. 141) and point out that the NREGA ‘strengthened the bargaining power of rural workers’ (p. 201). But their focus in the book is how to utilize public revenue in improving the quality of life (p. 269). Since this public revenue can be utilized in a variety of ways, Drèze and Sen assert ‘the constructive role of the state for growth and development’ (p. 39; italics in original). Hence, the organs of the state need to be made more accountable (ch. 4).

Since democracy offers ‘significant opportunities’ for improving the quality of life as well as its pace, the authors are ‘contingently optimistic’ (p. xii). In fact, the issues addressed by the authors are intended to be a contribution to a wider debate on how to construct a better society. Thus, the book aims to provide ‘reasoned solutions to the problems’ (p. 3). They also write that ‘economic reforms, even when appropriate, require informed public debate’ (p. 28). In sum, there ought to be a ‘greater use of informed reasoning in the practice of democracy’ (p. 181). As they observe, and correctly, I think, that daily troubles are ‘less spectacular and less immediate – [and hence] provide a much harder challenge’ to politicize (p. 14). The book is primarily about these issues and since they cover a vast terrain, there have been some omissions. Two very varied issues come to my mind: the influence of public debt on economic growth is only addressed briefly (p. 18) and the gap between English and non-English speakers get barely one paragraph (pp. 215-6). In addition, there is no mention of freedoms relating to sexuality. To conclude, the book is an excellent contribution in so far as it provides an accessible introduction to several social concerns such as armed conflicts, child mortality, corporate power, corruption, land ownership, minimum wages, nutrition, open defecation, pollution and sanitation.

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Posted in Adam Smith, Book reviews, Classical Economics, Development Economics, Economic Growth, Economics, GDP, India, Macroeconomics, Marginalist economics, Neoclassical Economics, Supply side economics | 1 Comment »

On Economic Growth and Development

Posted by Alex M Thomas on 20th April 2013

There exist disagreements about the role economic growth plays in socio-economic development. Among economists, a divide exists between those who consider economic growth to be a necessary condition for economic development and those who do not. This blog post tackles this issue from the perspective of the ‘surplus approach’, an approach embedded in the works of economists such as Adam Smith, David Ricardo and Karl Marx, and revived and improved in the 20th century notably by Piero Sraffa and Pierangelo Garegnani. For our purposes, it is enough to focus on the concept of the social surplus.

Deducting necessary expenses (subsistence wages, raw material costs and depreciation) from the annual gross product of an economy leaves us with the surplus. In the work of classical economists, this surplus consisted of profits and rents. Wages could also contain a ‘surplus’ element when the economy is growing or when collective bargaining favours the working class. Most importantly, the surplus could be utilised freely (or for any purpose) without it affecting the ability of the economy to reproduce itself. Of course, for the economy to grow, some of that surplus will have to be reinvested. This reinvestment of a part of the surplus results in an expansion of productive capacity. When this expansion in productive capacity is matched by an equivalent aggregate demand, there will be economic growth.

In physical terms, the volume of the surplus depends on the methods of production in use and the magnitude of subsistence wages. The methods of production specify how much of output can be produced with a certain combination of inputs (given by the technical know-how and blue prints available with the firms). (To use marginalist terminology, the production function in classical economics is of fixed-coefficients; that is, labour and ‘capital’ cannot be substituted for each other such that the same commodity is produced.)

Leaving rent aside, the distribution of the surplus between capitalists and workers will depend on the strength of the labour unions and other labour market conditions. For instance, in India, it will also depend on the gender and caste determinants. Also, the distribution will vary depending on whether the firm is formal or informal. There exist sectors where productivity gains entirely accrue to the capitalists. Whereas, the distribution of the surplus between private individuals (both workers and capitalists) and the government depends on the prevailing income and corporate tax structure.

The surplus, as mentioned previously, can be used for reinvestment (to produce capital goods) or for luxury consumption (in the production of non-capital goods). Also, the surplus can accrue as taxes to the government. And we have seen that if the surplus is reinvested, there will be economic growth as long as there is adequate aggregate demand. How much of economic growth is good? Are all kinds of economic growth desirable? Are all kinds of economic growth sustainable? By ‘kinds of economic growth’, we refer to several combinations – driven by agriculture; service-led; consumption-driven; debt-induced; foreign trade-driven; or productivity-driven. These issues will not be addressed in this blog post. More precisely, we do not examine the difficulties associated with any of these drivers of growth.

So far, we have not discussed development. Let us define economic development to be the rise in the standard of living of the people in an economy/nation state. An overall increase in real incomes is necessary for an overall improvement in the standard of living. If all workers and capitalists have sufficient (real) incomes to access their as well as their dependents’ educational needs, health needs besides the basic needs of ‘decent’ food, shelter and clothing, we can safely say that the economy is ‘developed’. In an economy where workers do not have sufficient (real) incomes and/or there are socio-cultural impediments to access/consume any of their needs, development needs to take place.

What is the source of (economic) development? There has to be monetary resources available to build the lacking infrastructure or to directly import them where possible. One of the means of generating such resources is through economic growth. But, generating a surplus is clearly not sufficient. The manner in which the surplus is distributed among workers and capitalists as well as redistributed by the government is extremely crucial. There is no predefined way of going about this. It is determined by wider social, cultural and political factors. For example, if trees are felled during the creation of infrastructure, some of the surplus can go towards planting new trees. Or, some of the surplus accruing to the capitalists can be reinvested for improving the working conditions. The important point to note is that there are no automatic mechanisms which ensure such allocations. The market has no such interests or objectives. In short, the decision of ‘development’ is primarily undertaken in the socio-political arena. And, as long as we aspire for better standards of living, economic growth is necessary so that it generates adequate monetary resources in order that our aspirations may be met. But, yes, economic growth by itself cannot guarantee or ensure development.

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Posted in Classical Economics, Development Economics, Economic Growth, Economics, GDP | 2 Comments »