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.

Alexander Vasilevich Chayanov, the Russian agricultural economist published the essay ‘On the Theory of Non-Capitalist Economic Systems’ in 1924 and Peasant Farm Organization in 1925, both in Russian. This blog post presents a selective summary of the English translations of these two works, one of the aims being to comment on Chayanov’s method of doing economics. He wrote around 60 books and essays during his lifetime. This blog post, it must be noted, is not an exhaustive survey of the essay and the book.

I

Chayanov’s essay on non-capitalist economic systems questioned the dominant approach of economic theorising which is conducted in the framework of capitalism. One of the characteristic features of the capitalist system is the presence of wage labour. So, how does such a theoretical framework understand peasant economies, where wage labour is non-existent? This is Chayanov’s question. Since labour is entirely provided by the peasant family, there exists no labour market and therefore no concept of wage labour. Moreover, the peasant family undertakes agricultural production (and engages in simple manufacturing) with the family labour and the surplus (or net product) arising from production cannot be resolved into wages and profits. The notions of profitability present in a family run enterprise, according to Chayanov, is very different from a capitalist enterprise. Chayanov terms the returns from the enterprise as the net product.

The required consumption of each family member is set by custom and habit. Chayanov computes an ‘internal equilibrium for the well-being of the family’ which is given by the intersection of their well-being and drudgery functions (p. 5). The gross product can be increased if more land is cultivated and/or an increase in labour intensity; remember, that the number of workers are given for any peasant farm organization. (This can change, perhaps in the very long-run, if the birth rate of the family is greater than its death rate.) The net product is arrived at by deducting the necessary consumption of the family and necessary consumption of the capital equipment from the gross product. The increase in labour intensity has definite physical limits; according to Chayanov, the family as a farm unit will increase labour intensity (drudgery) until the point when the net product is sufficient to meet the consumption needs of the workers and their dependants (children, parents and grandparents). The family’s access to land will depend on the land price and their ability to buy/lease more land will be constrained by their net product.

After laying out the basic relationships prevalent in a peasant farm, Chayanov concludes the essay by listing the various economic systems (p. 25). The extreme forms are capitalism and communism. In between, he introduces the family economy, slave economy and the feudal system (comprising landlord economy and peasant economy). Chayanow wishes for multiple economic theories catering to the needs of different economic-systems, as his last sentence in the essay shows:

…we have no doubt that the future of economic theory lies not in constructing a single universal theory of economic life but in conceiving a number of theoretical systems that would be adequate to the range of present or past economic orders and would disclose the forms of their coexistence and evolution. (p. 28)

 II

In Chayanov’s 1925 work entitled Peasant Farm Organization, his team carries out a detailed analysis of the agricultural situation in various districts of Russia based on zemstvo statistics, state statistics, independent research and budget studies (p. 38). At the outset, Chayanov points out the ‘coexistence and evolution’ of the capitalist and non-capitalist forms. When the peasant as worker-entrepreneur is unable to make sufficient earnings (owing to a bad harvest, increased input cost or some other factor), he temporarily abandons his undertaking and becomes a wage-labour in order to avoid being unemployed (p. 40). A peasant farm, to reiterate, does not make use of hired labourers.

The peasant farm is an organization that makes use of family labour and receives a single labour income. And, the trade-off between physical effort and material results (already noted in the previous section) is re-emphasised (p. 41). Responding against criticisms against their employing the method of marginalist economics, Chayanov maintains that the trade-off between family member as consumer and as labourer (labour-consumer balance) determines the volume of family economic activity but he does ‘not at all consider it possible to deduce from this a whole system of the national economy’ (p. 46). His objective is not, in modern terms, macroeconomics. The concept of a family has its basis in ‘the purely biological concept of the married couple, living together with their descendants and the aged representatives of the older generation’ (p. 54). Moreover, the gross product of the labour farm includes income from ‘agriculture’ as well as ‘crafts and trades’ (p. 70).

Given the trade-off between manual work and well-being, ‘the annual intensity of labor declines under the influence of better pay, because to remain the same it is absolutely essential that the productivity of the year’s labor (and equally the standard of well-being) should grow in proportion to the increase in the pay of a unit of labour’ (p. 80). In conclusion, as Chayanov states:

Thus, any labor farm has a natural limit to its output, determined by the proportions between intensity of annual family labor and degree of satisfaction of its demands. (p. 82)

One of the problems of such a principle is the exclusion of the relationship between labour intensity and consumption needs of the labourers. For instance, when income increases, there might arise a heightened demand to consume more of luxury products. The consumption needs certainly have a lower limit or a floor, but it is not bounded from above. In other words, labour intensity and consumption needs are interrelated factors.

One final observation before we move to conclusions. Chayanov, with a view to aiding practical policy, was interested in finding the ‘optimal farm size’ because ‘the optimal combination gives the highest income, and any deviation from it gives the proprietor a reduced profit rate’ (p. 91). In part, and by large, the combination is based on the technical relations between inputs and outputs. Therefore, ‘[a]ny excess of production means available to labor or of land above the technically optimal level will be an excessive burden on the undertaking’ (p. 92). It is also on account of the technological relationship that  the ‘volume of agricultural activity is not a simple arithmetic derivative of the size of area used’ (p. 94). Some of these technological relationships can be better grasped by taking recourse to ‘the basic laws of contemporary agricultural science’ (see especially pp. 138-47 for a rich account of crop rotation, manuring, etc).

III

First, Chayanov is dissatisfied with economic theory studying capitalist systems alone. But, (neoclassical) microeconomics can perhaps explain certain features of the peasant farm, especially the trade-off between drudgery and well-being (the backward bending labour supply curve is a good example). Also, the search for the optimal farm size can also be conducted by certain microeconomic procedures. One does not need to accept the marginal productivity theory of distribution which is a central feature of microeconomics. To put it differently, the ‘science of choice’ can explain the trade-offs which Chayanov is talking about by making appropriate changes in the parameters.

Secondly, treating the farm output as being ‘determined by the proportions between intensity of annual family labor and degree of satisfaction of its demands,’ as noted earlier, assumes them to be independent of each other which need not be the case. But in his credit, Chayanov undertakes a very detailed analysis of the farm households which provides content to the maximization problem. Also, the tabular and visual representation of the data is remarkable.

Finally, the co-existence of different economic organizations like capitalist and peasant farms is characteristic of economies like India. Often, they are called a dual economy. Self-employment, as opposed to wage employment is a significant feature of the Indian labour force; so is informal versus formal employment. Understanding their innate dynamics as well as their interrelationships is of much use. They require a combination of good theory, data collection methods, statistical analysis and an understanding of the socio-economic history of the particular locality.

Over the years, much has been written about the methods employed in economic theory. The recent financial crisis and the ongoing economic crisis in Europe have resulted in a marked increase in criticisms directed at mainstream economic theory – neoclassical economics (more precisely, marginalist economics). Internal critics of neoclassical economics have been modifying certain assumptions of marginalist economics and have ‘developed’ new forms of economic knowledge such as law and economics, welfare economics, neuroeconomics, new institutional economics and so on. Critics external to marginalist economics, often known as heterodox economics (examples include Classical/Sraffian economics, Post-Keynesian economics and Marxian economics), have provided compelling logical critiques of the theory. Additionally, they also supplement their analysis with empirical and historical details (which is not uncommon in neoclassical economic either). This post is reflective in nature and tries to comprehend the character of economic theory along with a commentary on its contemporary function in the form of questions, thereby reinforcing the reflective nature of this blog post.

First, the definition adopted has a critical influence on the aims and scope of economic theory. For instance, the definition of economics as a study of reproduction and accumulation of wealth/income (characteristic of the heterodox economic theories mentioned above) is qualitatively different from a definition which views economics as a study of allocating scarce resources among competing ends (characteristic of neoclassical economics). The former definition is more modest in scope and seeks to provide answers to a limited number of questions vis-à-vis the latter one which encompasses any and every issue where human decisions are involved. Examining the causes of accumulation and growth warrant the following theories: a theory of value and distribution; a theory of activity-levels (at times, this is absent); and a theory of economic growth. While examining the causal connections within these theories, some features of human behaviour are taken as given. The most important, perhaps, is the human propensity for self-betterment in material terms. Such a limited domain enables these economic theories to be more specific and definite thereby improving their explanatory power in the analysis of economic growth, unemployment, technical progress, wage dynamics and so on. An extremely wide scope is entailed by the definition of economics present in neoclassical economics; consequently, we see the emergence of sub-fields such as: cognitive economics, neuroeconomics, economics of philosophy, experimental economics, evolutionary economics, cliometrics, etc. The questions addressed in many of these sub-fields often have nothing to do with the generation of income or its distribution. The questions being asked are different, and quite relevant in understanding various aspects of human behaviour and institutions. However, if the aim of economic policy and economists is to improve material well-being, neoclassical economics and its sub-fields are not entirely satisfactory, primarily for logical reasons. The two most dangerous tenets of marginalist economics are the marginal productivity theory and the tendency to full employment.

Second, economic theory, I think, has two broad functions. One is to explain the logically necessary connections which exist between various economic variables, and the direction of causation. Usage of terms such as exogenous, endogenous, dependent and independent variables convey the direction of causation. For example, classical/Keynesian theory argues that activity levels and economic growth is demand-led whereas marginalist economics posits that activity levels and economic growth is supply-driven. This is a theoretical debate, which cannot be resolved by recourse to empirical data given the high degree of correlation present among (macro)economic variables such as income, investment, saving, etc. Another reason for the debate being unresolved in the incommensurability of the two kinds of economic theory involved – classical/Keynesian vs. marginalism. The other broad function of an economic theory is to provide an explanation for the manner in which these (marco)economic variables grow over time; strictly speaking, the dominant economics influences the way in which data is collected and presented and the explanation for the data is also provided by the dominant economics. (A chief, although not very reliable, exception to this is the econometric technique known as VAR which attempts to undertake ‘measurement without theory’.) Much of these numbers will need to be supplemented with contextual and historical details. Also, in economics, one needs to be careful about assigning too much ‘reliability’ to data so much so that they are considered ‘adequate’ to overturn a particular economic theory. This is not to say that data does not matter, but that it should be treated with significant caution.

Third and finally, it is of great practical importance to know what economic policies can be advanced based on economic theory, supplemented by data or not. In other words, what conditions must a particular theory fulfil in order for it to be reliable? Is an empirical assessment necessary or is it sufficient? How sound must the logic be? To what extent must the assumptions be scrutinised? Can econometric analysis provide conclusive evidence?

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!