Category: Economic history

V K R V Rao: The Entrepreneur Economist

The contents of the following post was written over a year ago for an in-house publication. Hence, the tone of the post is different from that of the rest. And since we are more enamoured by American economists these days, this is a timely post, which talks of one of the many great economists India has seen.

V K R V Rao founded Delhi School of Economics (DSE), Institute of Economic Growth (IEG) and Institute for Social and Economic Change (ISEC). These institutions were established so as to impart economics education in India, which would compete with world-famous institutes like LSE, Cambridge, etc. He was also instrumental in establishing the Indian Council of Social Science Research (ICSSR). Apart from establishing these institutes, Rao also served in various administrative positions – Planning Commission Member, Union Cabinet Minister first for Shipping and Transport and then Education and Youth Services. For the services rendered, he was awarded Padma Vibhushan in 1974.

Rao completed his Master’s in economics from Bombay University, where he worked on the taxation of income in India for his Master’s thesis. He then moved on to Cambridge to pursue his PhD, where he became a student of Keynes. For Rao, economics was a social science that would aid in improving the human condition. In Cambridge, he discovered that the tools of government intervention could aid in fulfilling the objective of economic as well as social betterment. And it was Colin Clark who stimulated his interest in statistical demography and national income accounting. However, as Shigeto Tsuru points out in his review of Reflections on Economic Development and Social Change: Essays in Honour of Professor V K R V Rao by C H Hanumantha Rao and P C Joshi published in 1979, Rao had insisted that ‘the blind application of Keynesian formulae to the problems of economic development has inflicted considerable injury on the economies of underdeveloped countries.’ For Rao, economic theory was only a servant of economic policy.

There are three published works by V K R V Rao on national income – An Essay on India’s National Income 1925-29 (1936); The National Income of British India (1940) and India’s National Income 1950-80 (1983). Though V K R V Rao has published on various aspects of economics, his work on India’s National Income is of special interest. This is because of a variety of reasons. Austin Robinson provides one such reason: ‘I myself remember Rao as the brilliant Cambridge undergraduate and research student of almost fifty years ago, who single-handed tackled the almost impossible task of estimating the Indian national income at a time when hardly a single ingredient was known and even guesses involved heroic despatch of countless questionnaires to every corner of India to establish, for example, the milk-yields of she-buffaloes or the average earnings of village barbers.’ An analysis of economic growth and change is possible by studying the National Accounts Statistics (NAS), as Rao has demonstrated in his 1983 book.

Despite the limitations of NAS in India, Rao is able to meaningfully explain the changing structure of the economy through the relative shares of agriculture, industry and services in the gross domestic product (GDP). In addition, he calculates the implicit price deflator so as to understand how much of GDP increase is on account of price rise. Also, implicit price deflators are constructed for the three major sectors to find out how each sector has performed vis-a-vis the others. Savings, capital formation and consumption are also dealt with in detail. V M Dandekar has hailed his 1983 book as ‘a model of scholarship and objectivity particularly coming from one who, during the period, was in the thick of making and implementing policies and programmes for economic development of the country.’

Thus, V K R V Rao was a model economist ‘ a practical man who was well aware of various theories and their limitations in applicability to India. And because he wanted to use economics for policy purposes, he was committed to extensive data collection and data analysis. Also, he was clear that, in practice, economics must interact with other social sciences, especially sociology and anthropology. This is evident from the name of the institute he founded in Bengalooru ‘ Institute for Social and Economic Change.

Labour, Scarcity and Techniques of Production

Value ‘ is of utmost importance to all paradigms in Economics (Neo-classical, Classical Political Economy, Austrian Economics, Marxian Economics, etc) because the theory of value is the fundamental proposition or the foundation on which subsequent theories are built. Therefore, it is crucial to understand the various theories of value.

The problem of value has different features. The aim could be to find the source of value, a standard of value for inter-temporal comparisons between and across countries and determination of exchange values in theoretical problems.

Through an example pertaining to ‘value’, this post tries to bring out the distinction between the Neo-classical and Classical paradigm in terms of the source of value. As students of economics, all of us have come across the Diamond-Water paradox. This paradox is a commonplace in economic literature, even before Adam Smith. This is how Smith refers to the paradox:

‘The things which have the greatest value in use have frequently little or no value in exchange; and, on the contrary, those which have the greatest value in exchange have frequently little or no value in use. Nothing is more useful than water: but it will purchase scarce anything; scarce anything can be held in exchange for it. A diamond, on the contrary, has scarce any value in use; but a very great quantity of other goods may frequently be had in exchange for it.‘

For the classical economists, value of a commodity means the value in exchange. And prices of commodities are believed to reflect its ‘value’. Value in exchange is determined by the conditions of reproduction of the economic system. The economic system is one where a number of firms using labour, land and capital (machinery, tools, etc), produce commodities (goods produced with the intention of selling them) by using commodities produced by the economic system (the firms within it). The conditions of reproduction would include the technology available (which would tells us in what proportions the labour and capital need to be mixed; in neo classical terminology, it would give a fixed proportions production function) Moreover, the classical economists did not consider value in use as a measurable quantity.

Before the ‘marginalist revolution’, utility had an objective sense as the capacity of a good to satisfy some need, and not as the subjective evaluation on the part of one or more individuals. It is worth noting that, in a capitalist economy a good or service is produced only because it can be sold. According to Marx, it is commodity production which forms the fundamental tenet of Capitalism. So, any commodity in a capitalistic economy does have utility. To clarify my argument, let me modify the definition of a commodity. A commodity is a good or service which is produced or offered only because it has a use value. Rather, it can be put for sale only if it has utility for someone or the other. The market does not produce commodities which has no demand or that which has no use/utility for any one.

Thus, it is clear that in a capitalistic economy (all economics theories, namely neoclassical, classical and Marxian tried to understand the working of a capitalist mode of production) the proposition that a commodity has a use value is a truism. So, because all commodities had a use value which they believed could not be measured, the value of a commodity was seen as the exchange value of it.

Since, labour was considered to occupy a central position in the economy, Adam Smith put forth the view that ‘labour commanded’ could be used as a standard to measure exchange value. In Marx, it takes the form of ‘labour embodied’ which then gives rise to the labour theory of value. For Marx, it is labour which provides value to the commodity by engaging in the production of that particular commodity.

Thus when the paradox is viewed through the classical and Marxian lens, it seems as if the paradox is only an illusion. The production of diamond is a costly affair and thereby requires a lot of labour (in today’s world, a lot of capital as well) due to which the value (exchange value) of diamond is high and thereby it commands a high price. More the labour needed for producing a commodity, more will be its value. So, because of the higher production costs, diamond is priced high.

For the neoclassical economists, the price of a commodity is determined by its marginal utility. Marginal utility is based on a subjective theory of value. Let me put forth two snippets from neoclassical economics as to how the paradox is resolved.

‘The more there is of a commodity, the less the relative desirability of its last little unit becomes, even though its total usefulness grows as we get more of the commodity. So, it is obvious why a large amount of water has a low price.‘ ‘ Paul Samuleson, the first American to receive a Nobel Prize in Economics.

In the blogosphere, I came across this piece from Michael Stastny, who blogs at Mahalnobis.

‘A better answer to the paradox why diamonds are more expensive than water would be that since water is so plentyful, the marginal utility (= the derivative of U(x) with respect to x, i.e. (approx.) the extra satisfaction of wants and needs obtained from consuming one additional unit of good) of water is is relatively low. An extra liter of water provides very little additional satisfaction. To the contrast, diamonds are very scarce and the marginal utility is therefor relatively high.‘

The study of economics is aimed at discovering the laws prevailing in the economic sphere. This helps in understanding the inter relationships within an economy. This further helps in policy purposes, by trying to increase investment rates, saving rates, GDP, etc.

The reasons provided for the paradox above assume that prices of commodities arise from their scarcity. Capitalism ensures a constant supply of the commodities which have utility (objective or subjective). It is to understand how prices come about, that economists theorize on values. For neoclassical economics, prices are indices of scarcity.

Let me illustrate the ignorance of neoclassical economics with an example. In a functioning economy, suppose an inventor discovers/invents a new product/commodity ‘ say a vehicle that runs on air. So, at this point of time, there is only one firm supplying this commodity. It is extremely scarce and according to neoclassical theory, it is rational for the producer to sell the first vehicle at any price because it has the highest value by being the sole product in the market.

So, when the first vehicle is on sale, the demand outstrips the supply. According to the neoclassical theories, the capitalist can ask for a higher price in such circumstances. I conclude by asking: is that how commodities are priced’ Are such prices ethical’ Isn’t it the techniques of production along with the wage rate and profit rate that governs the prices of commodities’

References

1) The Wealth of Ideas: A History of Economic Thought, Alessandro Roncaglia, 2005.

2) Das Kapital, Volume 1, Karl Marx.

3) Economics, 11th edition, Paul A Samuelson, 1980.

On Malthusian Theory of Population

This post revisits ‘An Essay on the Principle of Population’ written by Thomas Malthus in 1798. In my last post I briefly touched upon his population theory. Unfortunately, mainstream economics textbooks mention Malthus only for his ‘bad’ population theory. His other significant contributions like Differential Theory of Rent, his theory of money, his questions about the validity of Say’s law, etc are conveniently suppressed.

First, I would like to discuss why his theory is ‘good’ and then I would like to show how Malthus is viewed, interpreted and treated by various economists and students of economics.

Economics as viewed earlier and as viewed now (by a few) was a discipline which tried to understand the society (now known an economy) and also to come up with solutions for the problems that persist. His Essay ‘was the first serious economic study of the welfare of the lower classes‘ during his times. He was also a clergyman who wanted to make the society perfect.

His two postulates were that ‘food is necessary to man’ and that ‘the passion between the sexes is necessary and will remain nearly in its present state’. [Malthus 1798] Now we know that the first is a true premise and the second one is believed to be a law of nature. So, there are no issues with both his postulates. He also refers to these postulates as ‘laws of nature’.

Ceteris paribus, population growth will outstrip food growth. He also gives additional insights as to how population growth will necessarily be checked. His thought experiment based on the ‘true’ premises is therefore valid. At this juncture, one needs to understand the underlying assumption of diminishing returns to agriculture. Once this is understood, there is no reason to call his theory ‘bad’.

How can such a theory be useful to the society’ It brings to the fore the need for improvements in agriculture through technological advances, so that food production can be increased. (Assuming increased food production implies lesser hunger, but Amartya Sen proved otherwise. But it is necessary to have sufficient ‘food’ to feed society) Family planning is undertaken so that no child goes hungry apart from other reasons. Such checks are welcomed by all. Also, they indirectly draw from Malthus- the need for all people to consume food. However, checks like the Chinese one child policy create social problems on a massive scale.

It is amazing that even when his theory is viewed in isolation (from his other works), it still holds good! With progress in education (school children get introduced to a lot of theories and facts at an early age) theories like Malthus’ seem obvious and hence pointless. This also reflects the way theories are taught in schools and colleges. Very often, the context of the theory is left out. Corn Laws, the then predominant Ricardian theories, etc are very often not mentioned or discussed.

Now, I shall put forth two different views on Malthus, the economist.

1)

In this famous work, Malthus posited his hypothesis that (unchecked) population growth always exceeds the growth of means of subsistence. Actual (checked) population growth is kept in line with food supply growth by “positive checks” (starvation, disease and the like, elevating the death rate) and “preventive checks” (i.e. postponement of marriage, etc. that keep down the birth rate), both of which are characterized by “misery and vice”. [Source] (Note the mention of (unchecked))

2)

Malthus believed that population would increase at a geometric rate and the food supply at an arithmetic rate.

Malthusian population theory was eventually dismissed for its pessimism and failure to take into account technological advances in agriculture and food production. [Source]

Conclusion

How should theories be taught’ By this post, I only intend to question the current teaching and understanding of Malthus’ theories. Also, I wish to stress the importance of understanding and studying the ‘context’ (historical, political, social, cultural,etc) of a theory.

Now, economists (positive economics) are busy using scientific methods so as to universalise theories rather than provide solutions to hunger, poverty, unemployment and other socio-economic problems.

To sum up, Malthus stressed on the need to keep population and food production in such a way that everyone would be fed. I believe that this still holds true across the globe as one of the main concerns of economics.

Further Reading

1) 1) 1) Darwin and Malthus

2) 2) 2) Is India falling into the Malthusian trap’, C. J. Punnathara, The Hindu Business Line, April 9, 2008.

3) 3) 3) Malthus, the false prophet, May 15th 2008, The Economist.

4) 4) 4) The International Society of Malthus (further links from the society)

5) On GM Food and GM Mosquitoes

Economics Education: The Indian Context

Economics is viewed in most schools, colleges (Management institutes as well) and universities as a monolithic enterprise. It comprises mainly Microeconomics and Macroeconomics and uses Econometrics and Mathematical Economics as tools to understand the economy. Interestingly, tools like philosophy, history, sociology, anthropology lie forgotten. Or probably they are not viewed as tools anymore. Or they are not scientific enough!

This post deals with the dominant perception of Economics within India and how these perceptions adversely affect the spirit of economics in particular and of scientific inquiry in general.

Courses like History of Economic Thought are extended to include Classical Political Economy, Marxian Economics, etc. They are taught as outdated ideas and not as relevant approaches in understanding the economy. This is visible from the responses of students when works of Adam Smith, David Ricardo, Karl Marx etc are mentioned. I shall discuss Malthus in this post and in the next post, I shall discuss some of the theories of Marx.

Unfortunately, Malthus is known only for his ‘bad’ population theory. Interestingly enough, all that Malthus [1798] said was ‘that population, when unchecked, increased in a geometrical ratio, and subsistence for man in an arithmetical ratio.

Let us examine whether this position be just. I think it will be allowed, that no state has hitherto existed (at least that we have any account of) where the manners were so pure and simple, and the means of subsistence so abundant, that no check whatever has existed to early marriages, among the lower classes, from a fear of not providing well for their families, or among the higher classes, from a fear of lowering their condition in life. Consequently in no state that we have yet known has the power of population been left to exert itself with perfect freedom.‘ (Italics added)

Such an argument is what philosophers of science classify as a ‘thought experiment’. But mainstream economists classify this as a theory which has provided wrong predictions.

Thought experiments are devices of the imagination used to investigate the nature of things. And in our own time, the creation of quantum mechanics and relativity are almost unthinkable without the crucial role played by thought experiments. [Brown 2007] If one were to discredit and disregard Malthus’ theory, then there is no reason why the theory of perfect competition should be considered in Economics at all. The issue is that, there is hardly any work being done in methodological issues pertaining to economics and on the structure of a good economic theory, therefore one definitely needs to consider each and every theory in its own context. By context I refer to the historical background and the general argument that is being put forth.

Philosophical debates within Economics are very essential for the growth of both the disciplines, but more significant for economics. Methodological and epistemological issues are not commonly discussed in economics. This is very necessary because economics, economists and economies are ever growing in importance. Their policies have far reaching effects. And if they are not constructed in the right spirit, the objectives of the policy might not be fulfilled at all. The Indian budget 2008-09 is one such example. None of the Indian universities have a course pertaining to the Philosophy of Economics in its Masters’ courses. This shows the importance it has received vis-a-vis econometrics and game theory.

Also, economics claims to be a science and Professor Peter Englund, Secretary of the Economics (Nobel) Prize Committee thinks so as well when he says ‘In all relevant respects the committee understands and treats economics as a field of science.’ I see it as a shirking away of economics from questioning itself- its methodology and its knowledge.

It is primarily this attainment of a scientific nature by mainstream neoclassical economics that is bringing doom to the people constituting the economy. The present analysis in mainstream economics is not only ahistorical but also asocial. Economics needs to understand its origins and its epistemology. It ought to be a pluralistic enterprise. And let theoretical anarchism prevail because ‘it is more humanitarian and more likely to encourage progress.’ [Feyerabend 1975]