Category: Macroeconomics

Urbanization in India: What does it mean’

 

In the recent past, there have been a lot of discussions and commentaries on the merits of urbanization in India. In addition to this, we also hear about the poor, rather pathetic, living conditions of migrants who work in urban spaces, there are pressing environmental concerns especially regarding air and water pollution, public transport is in a disarray, etc. The latter concern has led to the rise of ‘new’ areas of learning and research such as urban studies, urban economics, urban ecology, urban sociology and urban planning. These are extremely important areas of learning considering the fact that urban centers attract both labour and capital. This blog post tries to understand some economic issues relating to the process of urbanization that is taking place in India. In particular, we seek to understand the limits of urbanization and in the process we try to know what it means to achieve economic growth.

According to the World Bank, ‘Urbanization is not a side effect of economic growth; it is an integral part of the process.’ ‘McKinsey states that ‘Urbanization is critical to India’s development.’ Further, Ministry of Urban Development, Government of India notes that ‘It is important to note that the contribution of urban sector to GDP is currently expected to be in the range of 50-60 percent. In this context, enhancing the productivity of urban areas is now central to the policy pronouncements of the Ministry of Urban Development. Cities hold tremendous potential as engines of economic and social development, creating jobs and generating wealth through economies of scale. They need to be sustained and augmented through the high urban productivity for country’s economic growth. National economic growth and poverty reduction efforts will be increasingly determined by the productivity of these cities and towns.’

From the above excerpts, some important assumptions (or rationales) for promoting urbanization can be understood.

(1)”’ Economic growth is synonymous with urbanization.

(2)”’ India has to urbanize in order to attain economic growth and development.

(3)”’ Urban spaces need to be promoted because they generate about 50% of the Indian GDP.

(4)”’ Cities are potential engines of economic and social development.

‘Economic growth

In a macro sense, economic growth refers to the sustained growth in national output ‘ GDP. However, for policy purposes it is important to look at per capita GDP. This is a proxy for looking at how much on income an average person possesses. The objective of economic growth (and economics) is to ensure that all individuals are employed (who seek work), have adequate food, have access to drinking water, transport, etc. In no way should we consider the objective of increasing GDP to be our aim. It is a necessary means to an end- better life.

Urbanization is understood as an increase in the population of urban spaces. This also means that there is a growth in employment, capital inflow, infrastructure, etc. In turn, such large increases in population will result in an increased pressure on resources ‘ water, space, housing, transportation, office space, air, etc. Communication seems to be the only one which has relatively negligible supply problems.

Given this, how can the Central Government or Planning Commission argue that urbanization is the way to go forward’ This means ‘ fatten urban spaces and neglect rural areas! Both, as we know, are not desirable. Fattened urban spaces will present a whole new set of issues to tackle with; neglecting rural areas will mean that agriculture and those dependent on agriculture (around 60% of India) will not be encouraged. Clearly, this does not increase the well being of majority of Indians. More importantly, it is illogical and unwise to argue that urbanization is (or leads to) economic growth. Yes, it leads to economic growth, but only in a very superficial manner and not in any substantive way.

India: Rural and Urban

As per Census 2011, 69 % of Indians live in rural areas and only 31 % in urban spaces. It seems to be the case that the policy makers are interested in improving the ‘urban spaces’. This does not necessarily include improving the living conditions of the majority of Indians. It is strange how language plays a dividing role too: urban habitats versus rural areas! It is true that the urban sector contributes roughly around 50% of India’s Net Domestic’ Product (NDP). The remaining comes from rural India which comprises majority of the populace. As for agriculture, rural areas contribute 94% (for the year 2004-05) of total agricultural output. So, if urban areas are targeted at the cost of rural areas, those employed in agriculture, which is a very difficult occupation, are going bear the brunt.

It is strange that the Government and policy makers (including private think tanks) argue that cities are potential engines of economic growth, when 60% of Indians depend on agriculture for their livelihood which is mainly located in rural areas. This tendency of policy making to favour any method which just boosts the numerical value of GDP without any qualitative change must be stalled. By qualitative change, I refer to improvements in quality of life ‘ food, shelter, education, water, health and so on.

According to a recent paper (July-August 2011) by Gilles Pison in Population & Societies, India is expected to become the most populous country by 2050 and will overtake China. Yes, we have heard that India has been blessed with the demographic dividend; but we must remember that it is no dividend unless there are employment opportunities, and they should not just be in urban spaces. This paper also notes that India records the highest number of deaths under age one ‘ 13,96,000.

Hence, the Planning Commission has considered it imperative that the next 5 Year plan will include urbanization as a key challenge. This, however, is a myopic strategy and especially because of the neglect of agriculture. In addition, employment generation should be the key challenge. Jayati Ghosh also argues in a similar fashion in a recent article of hers. She points out that ‘The number of urban settlements has increased from 5161 in 2001 to 7935 in 2011, an increase of 54% that dwarfs the 32% growth in urban population.’ This means that urban statistics have swelled up because of a reclassification and not mainly because of rural-urban migration. This key information poses further problems for policy makers; actually, it poses problems only for the ‘concerned’ policy makers!

Conclusion

To sum up, it would be disastrous to formulate policies which targeted the urban spaces at the cost of rural areas. The objective of economic policies must be to improve the well-being of the people and not to increase the percentage of GDP by a few points! In fact, even in France and Europe, when the process of urbanization began in the early 18th century, agriculture was neglected. However, a group of economists known as Physiocrats argued that agriculture cannot and should not be neglected as it will lead to a downfall of the economy (see more). It is time that we realized the interdependence present in the economy between rural and urban areas and also high time we acknowledged the significance of creating employment opportunities to the majority of the population.

(Mis)understanding Inflation

 

The recurrent hikes in fuel prices over the last one year are a cause of concern. For, fuel is a basic commodity and it enters as an input directly or indirectly into the production of all commodities ‘ agriculture, manufacturing and services. About a year back, an ‘expert’ committee headed by Kirit S Parikh recommended a partial deregulation/liberalization of fuel prices. This has eased the financial burden of the government. In addition, economists have posited that deregulation will enable markets to become efficient (subsidies and taxes distort efficiency). In any case, the role of the government has been changing rapidly too ‘ from that of a provider to that of an enabler (to quote our Chief Economic Advisor, Kaushik Basu).

A couple of days back, our esteemed Deputy Chairman of the Planning Commission Montek Singh Ahluwalia told the media that the recent hikes in fuel prices was a strategic move. According to him, the hike in prices of petroleum products would help ease inflation in the long run as it would suck money from the system. This post examines this statement by trying to understand the mechanism of inflation.

INFLATION

Inflation, as we know, refers to a continuous increase in the price level over a period. To make sense of this seemingly simple statement, we must have a clear understanding of the two concepts based on which we understand inflation. It is on the basis of this understanding that policy decisions are made both by the RBI as well as the Central Government to control inflation. The two concepts are:

(1)” Time: the price rise has to be continuous over a certain period.

(2)” Index number: inflation is studied by making use of these special averages

Time

How much time must elapse before we can characterise the price increase in an economy as inflationary’ In theory, economists solve this problem of having to fix the time period by introducing the distinction between short-run and long-run. However, this distinction does not solve the problem, but only adds to the complexity. What do we understand by short-run’ Does it refer to one week, one month, 6 months or one year’ Interestingly, there is no fixed answer to this. The distinction between short-run and long-run shows how creative economists are, although its utility is questionable. Short-run refers to the time during which the variables under consideration do not have adequate time to adjust or settle (at their equilibrium positions). Whereas, long-run refers to a period (point’) when all the adjustments are over and all the variables have settled. How convenient! The long-run will remain a mirage.

Given these unsettled issues, how does our Deputy Chairman of the Planning Commissions confidently maintain that fuel price hikes will ease inflationary pressures’ This statement is meaningless because the long-run is a fictitious concept. Such statements indicate the misplaced confidence economists possess as well as the poverty of economic theory.

Index numbers

Price level is what we examine in theory when trying to understand inflation. In applied work, we trace changes in indices such as WPI and CPI (which is a proxy for the general price level in an economy) in computing inflation. The construction of a good index number is a difficult task. Selection of relevant variables, choice of base year, the kind of index number to use ‘ Paasche, Laspeyre or Fisher ‘ are some of the issues which have to be tackled. A detailed discussion of index number will feature as a blog post in the future.

Ahluwalia, one of our economic planners, maintains that fuel price hikes will ease inflation in the long run. The explanation he provides for this occurring is both logically and factually incorrect. He said that fuel price hikes ‘suck excess money out of the system.’ Firstly, this statement is based on a particular view or understanding of inflation, namely the neoclassical one. Inflation is seen by this group as a result of excess money in the economy. In the words of economics textbooks, which do an excellent job at indoctrination, inflation occurs when too much money chases too few goods. It is this factually incorrect view which dominates academia as well as the policy arena. In fact, it is this view which is widely communicated in the media as well. Several economists have questioned this notion but with limited success. For, if inflation is not a monetary phenomenon, how will the central banks survive’ In any case, this view is not a correct representation of reality because manufactured products and services are not priced on the basis of demand (unlike agricultural prices which are largely demand-determined). [See Who prices the Products’ and On Prices/Values] If the prices increase from non-monetary factors, such as production conditions, expensive labour, from a higher profit margin, corruption or rise in fuel prices, how will removal of money reduce inflation’ In fact, how does one arrive at a benchmark for computing ‘excess’ money’ Fuel price hikes, on the other hand, will threaten the livelihood of both the poor consumers and poor producers.

What does our planner mean when he talks of the ‘system” A closed economy’ An open one’ Will the money not still be circulating in the economy even after the fuel price rise’ Without clarifying the above mentioned issues, the statement made by the Deputy Chairman of the Planning Commission holds no ground, however scientific it might sound! Such statements only reinforce the arrogance of economists and the poverty of economics!

 

 

Employment: The Neglected Variable

Today, the issue of employment receives attention in public discussion mainly because of NREGA. It is economic growth or GDP growth which is given prominence in most policy documents. In economics, employment generation and related aspects form a part of macroeconomics alone. Financial economics, international trade, monetary economics, etc hardly comment on the issue of employment. Increasingly, the question of employment is getting less attention in most academic and policy oriented discussions. This post attempts to revive certain issues pertaining to employment. For this purpose, we revisit the 1943 paper of a neglected macroeconomist ‘ Michal Kalecki. His paper straddles the fields of industrial economics, financial economics, public economics and macroeconomics, and provides insights regarding employment generation.

The generation of more employment, rather full employment, according to Kalecki, is beneficial to both government and capitalists. In addition, it also benefits the class of workers. Employment can be generated by capitalists or by the government. However, the government is restricted from generating employment because apparently government investment crowds out private or capitalist investment. In Kalecki’s words:

‘The economic principles of Government intervention require that public investment should be confined to objects which do not compete with the equipment of private business, e.g. hospitals, schools, highways, etc. Otherwise the profitability of private investment might be impaired and the positive effect of public investment upon employment offset by the negative effect of the decline in private investment.”

It is for this purpose that we have Acts such as the FRBM Act to ensure sound finance. This Act regulates and limits the employment generation capacity of the government. As for the corporate sector, they never support public investment. Hence, the employment generating capacity gets solely determined by the corporate sector/capitalists.

Kalecki questions this stance of the capitalists. For, full employment, as noted above, clearly benefits the capitalists by providing them greater profits. He argues that it is the ‘political realities’ associated with the maintenance of full employment which prevents the government and big business or capitalists from doing so. Given that the Government has to adhere to sound finance, largely, the capitalists determine the volume of employment in an economy. The capitalists tend to increase employment and output if they expect a good economic and political environment to be forthcoming. This environment is a dynamic and complex function of government policies, international events, political outcomes, etc. In economics, we call it state of confidence. Today, one factor which reflects this state of confidence is the bullish trend seen the stock markets. It is for this reason that, in India, SENSEX occupies such an important place in everyday news. Hence, the state of confidence assumes such an important role only in an economy where the government is supposed to maintain sound finance. As Kalecki points out:

‘The social function of the doctrine of ‘sound finance’ is to make the level of employment dependent on the ‘state of confidence’.’

Similarly, on the politics involved in capitalists pressing for sound finance, Kalecki powerfully notes that:

‘Under a laisser-faire system the level of employment depends to a great extent on the so-called level of confidence. If this deteriorates, private investment declines, which results in a fall of output and employment (both directly and through the secondary effect of the fall in incomes upon consumption and investment). This gives to the capitalists a powerful indirect control over Government policy: everything which may shake the state of confidence must be carefully avoided because it would cause an economic crisis.’

Thus, regardless of whether we agree with Kalecki or not, he provides an interesting way to examine the issue of employment creation; especially for the Indian economy where FRBM Act is taken seriously and because of the growing significance of SENSEX. Such an analysis also calls for greater interdependence between macroeconomics, public economics, industrial economics and financial economics on one hand and between economics, political science, sociology and culture studies on the other. The latter sort of interdisciplinary inquiry will provide descriptions of actual processes by which such ‘politics’ take place. This analysis by Kalecki also revives the classical notion of ‘political economy’ which understands that economics cannot be divorced from politics. For practical purposes, it is of utmost importance that we pay more attention to the variable ‘ employment, in our economics curricula and debates, especially in a country like India.

References

Kalecki, Michal (1971), ‘Political Aspects of Full Employment’, in Selected Essays on the Dynamics of the Capitalist Economy 1933-1970, Cambridge: Cambridge University Press. (full text available at Monthly Review)

Further reading

Bhaduri, Amit (2006), ‘The Politics of Sound Finance’, Economic and Political Weekly, 4 November.

 

Economic Survey of India 2010-11: A Critical Look

The Union Budget is presented based on the Economic Survey conclusions and recommendations. Therefore, the Economic Survey becomes a crucial document to examine and interpret. This time as well, the hands of its architect remain quite visible. Like the previous attempt, there is an increased use of economic theory ‘ game theory, mechanism design, rational choice theories, etc ‘ which provide support to various policy recommendations. According to this economic architect, all solutions are to be found in incentives. If the right incentives are provided, then economic and political governance will be smooth like that of the most competitive market. Agreed! What commonsense and insights from various social processes tell us is that individuals have heterogeneous preferences and what is an incentive for one might be poison for another. This blog post will examine some of these suggestions in detail (from Chapters 1 and 2 of Economic Survey 2010-11). In particular, the suggestions examined below will be those which have been favoured or disregarded based on arguments drawn from (neoclassical) economic theory.

Fiscal policy

Economic Survey 2010-11 assures the reader that India has recovered from the global financial crisis because of the high growth rates. For all practical purposes, this information indicates that we can now call for fiscal consolidation or lowering of the fiscal deficit. The usefulness of the government is over; let market forces function peacefully now without any government intervention!

‘With clear evidence of economic recovery in 2009-10 as indicated by the Advance Estimates of the GDP, the Budget for 2010-11 resumed the path of fiscal consolidation with a partial exit from the stimulus measures.’

It is at the same time interesting and worrying to see this sort of rhetoric. Such rhetoric rests on the following premise: the opportunities for investment are limited (read: scarce) and the entry of the government will crowd out private investment. Surprisingly, this neoclassical idea, which is much promoted in our academic textbooks, fail to point out the fallacy of composition on which this argument is based. This argument does not recognise the interdependence in an economy. Wages generated from government jobs are not only used to purchase goods and services from the government sector. In fact, the wages and salaries generated by the government sector are spent in consuming goods and services produced by the private sector. It is certainly time policy makers understood the benefits of crowding in effects of government intervention. The expenditure, one should look for, is mainly in social services ‘ education, health and employment.

Agriculture

Agriculture has been identified to be critical for macroeconomic stability and growth; although services sector is our potential growth engine. This can be read as: agriculture needs to grow at a level which will enable (the favourite word of the economic architect) the service sector to grow. Agriculture is carried out by majority of our fellow Indians (around 60 %) and it provides us food and raw materials. Our economic architect argues:

‘The rise in prices of agricultural produce would in part help incentivize production; the moot question remains what proportion of the rise accrues to the producer and what proportion gets appropriated by middlemen. The creation of more direct farm-to-fork supply chains in food items across the country would be critical in incentivizing the farmer with higher producer prices and at the same time would lower the prices for end-consumers.’

Why are middlemen always blamed’ Are they not the ones who aid production’ Who exactly are these middlemen’ Be that as it may, what is clear is that the middlemen have often more power (economic and social) than the actual producers. Majority of the farmers are forced to sell their product immediately after harvest owing to debt obligations. In addition, the (small) farmers do not benefit from the price rise because they do not have adequate storage facilities. As a matter of fact, even the Government only stores certain food grains in its godowns. Vegetable and fruits are not procured by the government. The undue emphasis placed on incentives by our economic architect is of concern. For one, production can only be carried out if the farmers have sufficient capital to purchase inputs. In India, the phenomenon of inter-linked markets is common in agriculture. That is, the same person provides credit as well as inputs to the farmers, thereby enjoying a very strong bargaining position over the farmer. Now, when our economic architect recommends FDI in retail food because they incentivise production, he is being blind to the production conditions of Indian agriculture. This can exacerbate the plight of the Indian farmer by making him/her subject to the contracts of the foreign firms. In this scenario as well, the farmer, owing to his/her weak bargaining power will never be able to enjoy higher prices. But yes, this could mean a lowering of prices for our urban consumers!

Inflation & employment

The subject of inflation has been dealt with in great detail in Chapter 2 of the Economic Survey 2010-11. In recent times, inflation has affected both the rural and urban consumers. However, as we know, the effect of inflation on the consumers are not equal in magnitude. Consumers who have very less income will be deeply affected by inflation. For instance, the small and marginal farmers are severely impacted when prices rise. Given this plight, the following statement by our economic architect is indeed baffling:

‘It may be mentioned that food price inflation during the last financial year was mainly driven by high inflation in pulses, cereals, and sugar due to bad monsoon. The rise in the purchasing power owing to the rapid growth of the economy and inclusive programmes like the Mahatma Gandhi National Rural Employment Guarantee Act (MNREGA) partly might have contributed to the upward trend in inflation.’

First of all, the above statement indicates an inadequate understanding of inflation. Secondly, what about the rising purchasing power of the urban consumers or the employees of BPOs. What makes our economic architect point fingers at those who barely manage a living’ If the beneficiaries of NREGA were surviving by barely subsisting before NREGA, their purchasing power would not have risen so much post-NREGA to contrbute, as our economic architect suggests, to inflation. In fact, such statements indicate a gross misunderstanding of inflation, a lack of knowledge of how rural India operates and a insensitivity towards subsistence and livelihood in general.

Conclusion

It is high time that we seriously examined some of the tenets of conventional (neoclassical) economic theory. Today, a lot of students and professors of economics world over are questioning the premises and logic of neoclassical economics. However, we find neoclassical economics still domination in various forms, such as new institutional economics, mechanism design, law and economics, microeconomics etc. Given that some of the foundations of economic theory are in question, it is surprising to see how much our economic architect bases the policy recommendations on such apparent scientific and objective truths!