The Economic Survey (ES hereafter) is a document which presents the macroeconomic situation of India during a given period. It is drafted by the Ministry of Finance (MoF), Government of India with the Chief Economic Advisor (CEA) playing a chief role. The current CEA is Raghuram Rajan. At the MoF website, detailed profiles of the people who drafted the Economic Survey 2012-13 are available.

This blog has analysed the previous three economic surveys (2009-10; 2010-11; 2011-12) undertaken under the guidance of Kaushik Basu, the predecessor to Rajan. The current analysis is broadly divided into two parts. The first part deals with the ES’s view of economic growth and employment and its theoretical underpinnings. Here, we discuss the gloomy industrial performance, issues surrounding productivity of labour and the role of government expenditure. The second part focuses on select policy proposals and examines it in brief; the debates surrounding oil subsidies, high current account deficit and attracting foreign capital fall under this section.

I

The underlying theory of growth outlined in the ES is what economists’ term supply-side growth theory. Growth in output per worker is determined by growth in the supply of factors – labour and capital (more precisely, produced means of production). Whatever be the growth in their supply, the demand will automatically adjust. In other words, aggregate demand adapts to aggregate supply and investment adjusts to saving. Thus, in equilibrium, there can be no unemployment of factors, including that of labour. It will presently be seen that it is such a framework which enables the ES to recommend a reduction of government expenditure which will apparently promote growth.

Rajan deserves praise for underscoring the importance of quality employment right in the beginning of the ES. In Chapter 2 entitled ‘Seizing the Demographic Dividend’, a case is made for improving labour productivity and for increasing both the quantity and quality of employment.

Policymakers are usually focused on short-run economic management issues. But the short run has to be a bridge to the long run. The central long-run question facing India is where will good jobs come from? Productive jobs are vital for growth. And a good job is the best form of inclusion. (p. 26)

‘Productive jobs’ refers to jobs where the productivity levels are high. Growth in per capita income is primarily determined by labour productivity, growth in the working population and growth in the working population who find jobs – the employment rate (p. 30). Labour productivity rises with greater investment in physical and human capital. The reason for low agricultural productivity is identified to be low investment and therefore the solution proposed is an increase in capital per worker (p. 32). Yes, technological advances are necessary but so are transformations in agrarian relations pertaining to caste and gender. Moreover, the presence of inter-linked markets makes agricultural markets very coercive, and less competitive.

Furthermore, low labour productivity is linked to rigid labour laws and excessive government regulations. It is of course necessary that the current labour laws be examined and improved upon whereby workers are provided decent wages, adequate sick and maternity leaves, indexation with inflation, etc. As the chapter rightly concludes, ‘We need to examine carefully whether regulations constrain businesses excessively and, if so, strip away the excess regulation while ensuring adequate protection and minimum safety nets for workers’ (p. 54).

But, the question remains: what is the mechanism by which employment rises? The answer provided is that saving generates investment and investment generates employment. ES points out that investment can be increased by increasing saving.

If India were to follow a similar path [like that of China], it would need to increase savings and investment, both of which will follow from the demographic transformation. But it will also have to increase the intrinsic productivity of jobs…. (p. 31)

But, why will aggregate investment increase without a corresponding rise in aggregate demand? And, where will this increase come from if all the individuals save more, based on the recommendation by the ES? (One only needs to recollect the ‘paradox of thrift’.) Investment is undertaken so that the commodities and services that are being produced can be sold. Only if they are sold can profits be realised.

The adherence to a supply side theory of growth is clearly visible in the chapter dealing with industrial performance (Chapter 9). Owing to this belief, the analysis carried out in that chapter mistakes correlation for causation and also gets the causal chain wrong.

The moderation in industrial growth, particularly in the manufacturing sector, is largely attributed to sluggish growth of investment, squeezed margins of the corporate sector, deceleration in the rate of growth of credit flows and the fragile global economic recovery.

Low investment is considered to be the primary cause of poor industrial performance with a slight mention of decline in foreign demand. Further, the authors’ of the ES maintain that a low investment has resulted in excess capacity (obviously!) and also a decline in capacity utilization. Yet, they fail to point out that it is a fall in demand for industrial products which has caused the fall in capacity utilization and to a reduction in investment! Although, unconnected to their narrative of industrial decline, they note a reduction in the rate of growth of sales of listed manufacturing companies. The rate of growth ‘declined from an average of 28.8 per cent in Q1 of 2010-11 to 11.4 per cent in Q2 of 2012-13, the latest quarter for which comparable set of data are available.’ Hence, in order to increase investment, the authors’ want to attract foreign direct investment (FDI). But, the problem is not a lack of investment but a deficiency of demand.

In a similar line of supply-side thinking, the ES argues that fiscal consolidation or a lowering of government expenditure will result in a ‘higher growth in real GDP.’ As the ES clearly states,

Staying on the indicated fiscal consolidation path is critical to sustaining the desirable macroeconomic outcomes not only in terms of higher growth in real GDP and lower inflation, but also in easing the financing of the widening current account deficit (CAD), for which India’s sovereign credit rating is important. (p. 56)

While it is unfortunately true that credit rating agencies and foreign capital considers government spending to be a threat, the claim that fiscal consolidation enables faster growth seems to lack any solid proof. Unless, we treat inflows of foreign capital to be a source of sustainable and high economic growth!

In sum, the theoretical framework underlying the current Economic Survey is problematic because of its inability to explain labour unemployment (or excess capacity) as a permanent feature of capitalist economies. This unemployment is primarily owing to a deficiency of aggregate demand. Furthermore, owing to the supply-side underpinnings, the recommendations are to increase savings. This is clearly stated as objectives in the ‘Press Statement on Release of Economic Survey: 2012-13’. (1) ‘Increase government savings, especially by reducing distortionary subsidies’ and (2) ‘increase opportunities for savers to get strong real returns on financial investment.’ Therefore, a deficiency in saving is identified as the main hurdle for the Indian economy.

II

In this part we briefly examine the reasons why fuel subsidies are harmful to India in the long run and the problems surrounding India’s current account deficit. Fuel is a basic commodity in the sense that it enters as an input into the production of all commodities. And, petroleum is an exhaustible resource. The price in the international market does reflect its scarcity. A high price indicates that demand is over stripping supply. Fuel subsidies are a short term solution which takes the burden of innovation from Indian oil companies and the responsibility of proper use from Indian consumers onto the shoulders of the Government. Yes, workers need to be insulated from high oil prices. One way to do this is by indexing wages to inflation. A high fuel price also quickens the search for alternative sources of energy and better agricultural and manufacturing machinery which uses less fuel. One final point. The argument that fuel subsidies need to be reduced so as to reduce budget deficit so that there is economic growth is, as pointed out earlier, based on the flawed economics of supply-side growth theory.

India’s current account deficit has reached worrisome levels. The value of imports has been rising mainly on account of higher international oil price. Exports have fallen due to a slowdown in foreign demand. India’s main imports are (1) petroleum, (2) pearls (for re-export) and (3) gold. Owing to the surplus in invisibles (services such as transport and software; and private investment income transfers) some of the deficit in the merchandise trade balance is absorbed. Apart from the surplus in invisible trade, the other avenue for meeting the merchandise trade deficit comes from the capital account. The major source of (net) capital inflow is foreign investment, which comprises foreign direct investment and portfolio investment. The other source of foreign exchange is loans. Given this situation, the Economic Survey proposes measures which attract foreign investors and by imposing duties which make gold imports costlier. Both these are extremely short-sighted measures and the latter one makes economic growth to hinge crucially on foreign capital which is not advisable. The long term solution, as suggested in the case of oil subsidies, ought to be technological innovations in the export industries so that they are internationally competitive. Also, the propensity to imports should be reduced by promoting industries which can produce similar commodities. Moreover, there is a huge potential in the Indian tourism industry. And, as the ES also recognises, ‘the best way to reduce gold imports in a sustainable way will be to offer the public financial investment opportunities that generate attractive returns.’

Conclusion

The move to reduce government spending and measures which attract foreign capital are therefore based on the flawed supply-side theory of economic growth; we require an increase in employment and incomes and in aggregate demand. Moreover, the proposed measures to deal with structural problems of the Indian economy are not just short-term but short-sighted and unsustainable in the long-run. These measures also discourage technological innovations especially in the area of alternative energy sources.  Oligopolistic markets should be replaced with competitive markets with good labour laws which ensure that part of the productivity gains go to the workers.

Wages is the payment made to a labourer for the number of hours worked – sowing seeds, rolling tobacco, developing computer software or providing medical care in a hospital. How are these wages determined? Are they determined in a similar manner as that of commodities? That is, are they determined based on some sort of demand and supply mechanism? Or, are they predominantly set by non-economic forces which are not easily quantifiable? This blog post looks at the dominant neoclassical or marginalist viewpoint and contrasts it with the theoretical approach of classical economics. In this light, the post examines certain characteristics of the Indian economy relating to labour and employment.

The basic principles of neoclassical economics tell us that the price and quantity demanded and supplied of a commodity are determined by the intersection of its demand and supply curves. This is the demand and supply approach to economics. When extended to labour, the intersection of the demand and supply curves of labour is supposed to determine the wages per hour (the price of labour) and the number of hours worked (the quantity of labour). Therefore, an increase in the demand for labour relative to its supply is expected to raise the wage rate and a relative increase in supply of labour (say, from an increase in the working population commonly termed the demographic dividend) leads to a fall in the wage rate.

Classical economics, a distinct theoretical framework in economics, has a very different view of wages. It largely considers wages as an exogenous variable; that is, wages are not determined by market forces – demand and supply of commodities or of labour. Of course, temporary changes can be brought about by market forces. In the theoretical world of classical economics, wages are determined primarily by socio-cultural factors such as trade union strength, the collective notion of minimum wages for different occupations and the society’s views on trust, risk, etc. In this theoretical world, which to me, seems closer to the reality, an improvement in social institutions lead to an increase in subsistence wages. Wages, in this framework, has a subsistence (relatively fixed) component and a surplus (relatively flexible) component. Hence, classical economics allows for an increase in wages, in its surplus component, when GDP is rising on account of higher labour productivity.

A conflict is present in the distribution of GDP between workers and capitalists. Neoclassical economics eliminates this conflict by recourse to marginal productivity theory. By employing logically fallacious concepts (especially of capital), a theory of distribution has been erected where both labour and ‘capital’ are ‘justly’ remunerated. In this framework, trade unions distort the market and causes injustice! According to classical economics, the presence of strong trade unions and fair labour laws ensure that workers get a fair share of productivity gains, which will otherwise entirely go as profits of the capitalists. The Global Wage Report 2012/13 published by the International Labour Organisation (ILO) notes that in several countries wage rises have not matched the increase in employment and productivity (see especially p. 28).

There are enormous disparities in wage rates across the states in India, with Kerala paying relatively high wages. One reason for the high wages is the presence of strong trade unions. As per the Labour Bureau (as part of the Rural Labour Enquiry) report on ‘Wage Rates in Rural India’ for September 2012, the average daily wage rates for men for engaging in sowing in Gujarat is 132 rupees; in Kerala, it is 500 rupees; and in Tamil Nadu, it is 222.02 rupees. A carpenter in Gujarat is paid 233.33 rupees daily; in Kerala, he is paid 514.05 rupees and in Tamil Nadu, he is paid 388.6 rupees. The differences are starker with respect to unskilled labour: a male unskilled worker in Gujarat gets paid 109 rupees; in Kerala, he earns 411.32 rupees; and in Tamil Nadu, he earns 223.54 rupees. The corresponding wages for a female worker are: 101.71 rupees in Gujarat, 266 rupees in Kerala and 159. 76 rupees in Tamil Nadu. Note the gender-wage inequality in Kerala. Also, the economic condition in rural Kerala is significantly better than rural Tamil Nadu; therefore, the statistics will have to be interpreted with some restraint.

Subsistence wage, as a concept, has enormous theoretical and practical significance. In fact, the legislations pertaining to minimum wages in India ought to look at socio-cultural factors too, such as gender, caste, geographic location, kind of labour (formal vs. informal, rural vs. urban) and so on. The enforcement of minimum wages has been beset with difficulties as evident from a recent study (published in 2011) by Patrick Belser and Uma Rani; the proportion of salaried workers and the proportion of casual workers below the minimum wage at the national level is 25.3 and 50.6 per cent respectively. Discussions on and about subsistence wages, and by extension, on minimum wage legislations are much needed. Moreover, discussions surrounding subsistence wages can also result in more dignified definitions of poverty and minimum wages.

Published in 1936, The General Theory of Employment Interest and Money remains a valuable book for both economists and policy makers. The recent financial crisis and the ongoing economic crisis have revived popular interest in this 1936 classic. The year 2009 saw the publication of two concise books on Keynes by two eminent scholars, Skidelsky and Clarke; an earlier blog post reviewed both their works. Not much will be said about the author – John Maynard Keynes, in the following paragraphs. The main objective of this blog post, as the title suggests, is to provide a foreword to The General Theory. By foreword, we mean the following: ‘The introduction to a literary work, usually stating its subject, purpose, scope, method, etc.’ (Oxford English Dictionary).

The rapidly expanding market for economics textbooks has, to a significant extent, substituted the reading of original works. In this environment, where our understanding of Keynes is based upon what Blanchard, Branson, Mankiw or Romer write, the following blog post strives to remain faithful to Keynes unlike the IS-LM version of Keynes proposed by Hicks and popularised by these textbooks. Keynes labelled Ricardo, Marshall and Pigou as Classical economists; this definition is not adhered to in the present blog post for Classical economics is a system of economic theory (to which Ricardo belongs) which is distinct from and a rival to Marginalist economics of which Marshall and Pigou are important members (see Thomas 2011 for more).

For Marshall, Pigou and marginalist economists of today, unemployment is a transitory phenomenon caused by ‘imperfections’ in the operation of the market forces. In their theoretical world characterised by competition, full employment is the ‘general’ case. However, Keynes demonstrated that this notion was based on assumptions contrary to the real world such as flexibility of money wages, absence of store of value function of money and rate of interest as a real phenomenon capable of equilibrating savings and investment and hence can only be considered a ‘special’ case. As he writes, ‘there has been a fundamental misunderstanding of how in this respect the economy in which we live actually works’ (p. 13). Opposed to this state of affairs, Keynes argued that the ‘general’ situation in an economy with competitive markets is the prevalence on unemployment. In other words, the central purpose of Keynes’s work is to demonstrate that unemployment is the usual situation in a competitive economy.

The main subject matter of The General Theory is the determination of aggregate employment and income or ‘the theory of output as a whole’ (Preface, p. vi). This needs to be seen against the then prevalent mode of economic analysis which was largely Marshallian in nature. Marginal productivity theory along with the principle of substitution was employed to understand the allocation of a given level of output; under conditions of competition, in equilibrium, full employment was (and still is) expected to prevail. And questions concerning the determination of the level of output were carried out within a theory whose primary subject matter was allocation, and not determination, of output levels. (On this, see especially Keynes’s preface to the German edition of his 1936 book.)

Marginalist economics, in the 1900s, looked up to the works of Marshall, and Pigou.  Keynes was brought up on a large dose of their works. Theories of production concentrated on determining the output levels in individual markets, and more often on allocation of output. Similarly, theories of distribution examined the allocation of income to workers and capitalists. Policy recommendations were made on the basis of such theories. The remedy to unemployment, according to Pigou and other orthodox economists, consisted in lowering workers’ wages. Economics certainly did not have an apparatus or a framework to study the ‘level of output as a whole’, or macroeconomics as it is called today. Besides output levels, Keynes also stressed the role played by money in ‘real’ analysis – the examination of income, employment, investment, consumption and saving. Rate of interest, according to Keynes, is a monetary phenomenon which depends on liquid preference. In short, the scope of his work remained the same as that of earlier economists – the study of wealth. Today, economics has broadened its scope to include any subject which can be examined by employing some form of the cost-benefit analysis. (See Malthus: The Scope of Political Economy)

Being brought up in the marginalist Marshallian tradition, Keynes attempted to completely break away from their method. In the preface to the German edition, he makes his desire explicit: ‘It was in this [Marshallian] atmosphere that I was brought up. I taught these doctrines myself and it is only within the last decade that I have been conscious of their insufficiency. In my own thought and development, therefore, this book represents a reaction, a transition away from the English classical (or orthodox) tradition.’ However, his attempt was not entirely successful. This is especially visible in his analysis of investment, where he develops the ‘marginal efficiency of capital’; much has been written on this in the context of the capital theory debates. The role he assigned to ‘expectations’ and the links to investment levels have been considered an improvement of the economists’ toolkit and consequently seen as an improvement in the capacity of economic theory to understand reality.

The aim of this blog post has been mainly to put The General Theory in the 1936 context, where Marshallian economics reigned supreme. Today, central governments, central banks and policy makers employ macroeconomic theory to understand the real world and to frame policies which increase output levels, stabilise prices and ensure financial stability. However, majority of these theories remain rooted in the orthodox tradition (variants of Marshall, Walras, Pigou and others resurface in the form of DSGE, New Classical macroeconomics or New Keynesian macroeconomics) which Keynes broke away from. Truly, The General Theory published in 1936 remains an economics classic, which is of enduring value to those who find terrible problems with the current orthodoxy!

Although J.-C.-L. Simonde de Sismondi (1773-1842) lived in Geneva and wrote on economics, history and public policy, his concerns about the role of political economy is valid even today, especially for India. Marx considered Sismondi to be the last classical economist. Sismondi engages with the economics of Adam Smith, David Ricardo and J B Say in his 1819 work New Principles of Political Economy: Of Wealth In Its Relation to Population. This work has been translated into English by Richard Hyse in 1991 (available at Google Books). According to Sismondi, the objective of Political Economy is to ensure that majority of the population live a happy life.

Indian realities

Sainath informs us that India has seen over a quarter of a million farmers’ suicides between 1995 and 2010. The total figure according to National Crime Records Bureau (NCRB) is 256,913. And, since 1998, at least 15,000 farmers have committed suicide very year. More unsettling is that fact that the total number of farmers have been declining significantly. In Andhra Pradesh, it is alleged that 90 farmers committed suicide, that too, in rain-fed areas, in the last few weeks.

The inflation of food articles has reached double digits. Food inflation doubly affects the actual cultivators. Since, the prices are fixed by the Government (minimum support prices), the price rise does not benefit the actual cultivators. Secondly, their ability to purchase their usual consumption basket also falls when price rise. It is in this context that M S Swaminathan’s reminders need to be understood. He rightly asserted: “If agriculture goes wrong, nothing else can go right for this country.”

Very recently, Dreze and Sen pointed out the nature of the asymmetrical growth that is driving India with a majority of the population living without access to basic amenities. They concluded their article in the Outlook by stating that one of the ways forward is to have a “radical broadening of public discussion in India to development-related matters—rather than keeping it confined to simple comparisons of the growth of the gnp, and naive admiration (implicit or explicit) of the high living standards of a relatively small part of the population. An exaggerated concentration on the lives of the minority of the better-off, fed strongly by media interest, gives an unreal picture of the rosiness of what is happening to Indians in general, and stifles public dialogue of other issues.” In other words, how much has the socio-economic condition of majority of the Indian populace (who happen to be farmers and weavers) improved?

Sismondi

In the hurry to build sophisticated DSGE models and while working out monetary and/or fiscal solutions to inflation and economic growth, it is often forgotten that actual human livelihood is at stake. How can Indian agriculture not be a necessary component of the curriculum in economics? Within economics, steep walls which cannot be crossed exist between agricultural economics, macroeconomics, monetary economics, labour economics, development economics, etc. The so-called specialization in these fields (to be understood as literature which is not easily accessible or comprehensible to an economist from another field) has reached alarming levels. Sismondi says the following on the nature of economic inquiry:

However, I believe I should protest against the manner, so often superficial, so often false, in which a work on the social sciences is judged in the world. The problem which they offer to resolve is tangled in quite another way than those that arise from the natural sciences; at the same time it appeals to the heart as well as to reason. The observer is called upon to recognize unjust sufferings that come from man, and of which man is the victim. We cannot consider them coldly and pass them over, without seeking some remedy (Sismondi 1819: 13).

Maybe, the idea of modern science does not allow investigators to be moved by the ‘object’ under study. Nevertheless, as Sismondi reminds us, economic problems and their solutions affect people (who are not ‘objects’) in a significant manner. The state of Indian farmers and weavers is certainly to be given attention, especially in terms of livelihood building, through providing employment and incomes in a dignified manner.

The following lines from Sismondi echoes what Dreze and Sen recently pointed out as regards Indian growth:

If they find a tremendous accumulation of riches, an improved agriculture, a prosperous business community, manufactures which multiply without end all products of human industry, and a government that disposes of almost inexhaustible coffers, as in England, they call the nation opulent that has all these things, without stopping to inquire whether all those who work with their hands, all those who create this wealth, are not reduced to mere subsistence; whether every tenth member among them must not apply each year to the public welfare; and whether three-fifths of all individuals, in a nation that is called rich, are not exposed to more privation than an equal proportion of individuals in a nation called poor (Sismondi 1819: 22).

In India, the wealth creators, the farmers, are forced to live below even ‘subsistence levels’ as Sainath’s commentary on farmer suicides indicate. Even though we have 53 agricultural universities in India, their contribution to the farming population is circumspect. Three to four decades before, working on agricultural economics and debating issues related to agriculture was fashionable and ‘important’. Today, it is even more important but, perhaps, not very attractive. In fact, the Government admits that the farm sector has been neglected.

Admitting that the government is neglecting research in the farm sector, the agriculture ministry has sought more funds in the next Five Year Plan (2012-2017) for significant jump in food grain production.

But, focussing on aggregate food grain production is clearly insufficient. One needs to look at the ‘production conditions in Indian agriculture’. As Sismondi points out very clearly

Commercial wealth is augmented and distributed by exchange; and even the produce of the ground, so soon as it is gathered in, belongs likewise to commerce. Territorial wealth, on the other hand, is created by means of permanent contracts. With regard to it, the economist’s attention should first be directed to the progress of cultivation; next to the mode in which the produce of the harvest is distributed among those who contribute to its growth; and lastly, to the nature of those rights which belong to the proprietors of land, and to the effects resulting from an alienation of their property (Sismondi 1819: 133).

In 1974, Krishna Bharadwaj published a book Production Conditions in Indian Agriculture. In the same period, economists such as Amit Bhaduri, Ashok Rudra, Amartya Sen, K N Raj, C H Hanumantha Rao, Pranab Bardhan, etc wrote extensively on various aspects of Indian agriculture. The issues Sismondi pointed out were discussed and debated. Bharadwaj points out the significance of examining property relations, technology, local patterns of power, etc. Moreover, she notes that non-economic variables such as tradition, customs, caste and religion determine the economic position of a farmer and thereby determines their income and asset levels. The rise in food inflation has prompted many commentators to hold employment guarantee schemes (NREGA) responsible. If agriculture generated adequate incomes (to maintain a decent and dignified life) employment guarantee would not be necessary. In other words, employment on and off farm cannot be treated as independent of each other. Further, in India, markets are interlocked through both price and non-price links (with the Government playing an ambiguous role). These interlocked markets are exploitative as it denies the following freedoms to the agricultural farmer, who is very much an entrepreneur.

(1)   What to produce?

(2)   How much to produce?

(3)   For whom to produce?

(4)   When to sell the produce?

Conclusion

As Sismondi reminds us, we cannot ignore the majority of the Indian population who do not have access to the basic necessaries of life. Agriculture provides livelihood to more than half the Indian workforce. A farmer is an entrepreneur who produces food, the most basic of all commodities. Although, it might not be academically fashionably and profitable to study Indian agriculture but as Sismondi notes: “We cannot consider them coldly and pass them over, without seeking some remedy.”