The Macroeconomics Underlying the Economic Survey of India 2013-14

This blog post critically evaluates the first two chapters of the Economic Survey of India 2013-14 in order to get a sense of the macroeconomic theory underlying it. [This blog has assessed previous ones for the years:2012-13,2009-10;2010-11;2011-12.] What conceptual framework does the Economic Survey adhere to, implicitly and/or explicitly? This is of significance not just for those interested in theory but also for those who want to understand how economic policies are formulated. Attention will be mainly divided among the following macroeconomic themes: (1) role of investment in economic growth, (2) labour market flexibility and economic growth, (3) policies emanating from (1) and (2), and (4) the overarching aim of economic policy.

I

It is well-known and widely accepted that investment, be it private or public, is necessary for economic growth. By investment, we primarily refer to additions to fixed capital – machinery, tools, storage facilities, transport equipment, etc. Investment in education, health and environment should also be included, for they expand the productive capacity of the economy in the long term. Two questions may be posed now. First, what is the source of investment? Second, what ensures that the growth in productive capacity will be matched by an equivalent growth in demand?

Prior to the path-breaking work of Keynes, it was widely believed that investment is savings constrained and that saving and investment are equilibrated through variations in a sufficiently sensitive interest rate. Keynes convincingly argued that investment is not savings constrained, rather, it is finance constrained. Moreover, he demonstrated that it is activity levels (output and employment) which equilibrate saving and investment, and the causation runs from investment to saving. This is the principle of effective demand, also to be found in the work of the Polish economist Kalecki. The Economic Survey adopts the pre-Keynesian view, which, not surprisingly is still around, embedded in the neoclassical school of economics – the dominant school in economics teaching and publishing. This marginalist idea of saving-investment equilibrium is mirrored by the market equilibrium for ‘capital’ – the demand for and supply of capital is brought into equilibrium by variations in the interest rate; this is nothing but the marginal productivity theory of distribution.

Implicit in the Economic Survey is the pre-Keynesian view, an essential part of neoclassical economics. ‘…higher investment required for raising growth had to come from higher domestic savings…’ (p. 9). However on p. 11, the slowdown in investment growth is attributed to policy uncertainty, sluggish demand and high interest costs. Despite the reference to demand deficiency on the same page (on p. 13, it is acknowledged that an increase in aggregate demand has a positive impact on economic growth), the conclusion on the same page supports ‘structural reforms’ and the elimination of ‘supply-side bottlenecks’. Also, Keynes’s finance-constrained investment view is expressed when the ‘bank credit flow to industry’ is briefly discussed (p. 25); due to sluggish demand, the demand for credit was lower. [See an earlier post on the determinants of investment.]

Income earners make saving decisions (commonly referred to as households or wage earners) whereas it is the firms and entrepreneurs who make investment decisions in a decentralized economy as India. Firms also make use of their retained earnings for purposes of investment (p. 14). The intermediation of saving and investment is carried out via the banking and financial system – the suppliers of credit, so to speak. The point I wish to highlight is this: abundant savings or a low rate of interest is not sufficient for (physical) investment. There should be demand for the commodities and services produced. Also, there are no mechanisms which ensure that supply will create its own demand, famously known as the Say’s Law. At various points, it appears that the architects of the Economic Survey believe in the Say’s Law. In other words, they do believe that a growth in productive capacity will engender an equivalent growth in demand.

Policy uncertainty & investment

Policy uncertainty emanates from ‘difficulties in land acquisition, delayed environmental clearances, infrastructure bottlenecks, problems in coal linkages, ban on mining in selected areas, etc.’ (p. 11; also see p. 33). This particular statement is reflective of a view which does not take common property resources, ecosystems and environmental sustainability seriously and with caution. The uncertainty in policy vanishes when the government is clear, transparent and committed to socio-economic and environmental justice. Policy uncertainty arises from vague, untimely and arbitrary policy decisions. In fact, this approach to securing higher economic growth is inconsistent with the position adopted in the Economic Survey on sustainable development and climate change which, on paper, appears committed to environmental justice and inter-generational equity. And it is such inconsistencies which cause confusion and policy uncertainties for firms wishing to invest in India.

II

The marginalist growth theory (Solow’s growth model being the exemplar) makes use of the marginal productivity theory of distribution. Put simply, a growth in the factors of production (or factor endowments) is sufficient for economic growth. And, supply creates its own demand. According to this view, widely taught in macroeconomics courses, growth is supply-side. The impediments to growth then become imperfections in the factor markets, particular labour markets. Consequently, policy is supposed to make labour markets flexible/free/perfect so that the economy can gravitate towards the full-employment position. But, this theoretical view has been shown to be unsatisfactory given the logical problems associated with the marginal productivity theory of distribution. In addition, the creation of a just society must necessarily ensure a minimum wage for all workers sufficient for a decent living, the scope of which ought to widen as societies progress.

According to the Economic Survey, ‘[t]he inflexibility of labour markets have prevented high job creation’ (p. 30). For those brought up in the marginalist tradition, the usual culprit is the labour market. Of course, labour laws, like any other law, should be just and provide opportunities for workers to support each other given that the employers are more powerful than the workers. Also, working conditions, social security, equal opportunity across gender, caste and class and so on must be provided to the workers. This is the responsibility of institution builders – the government together with the civil society. Yes, labour market reforms are necessary: ‘changes in the legal and regulatory environment for factor markets’ (p. 31).

Reforms, unfortunately, have come to possess a single meaning in economics and politics. Reforms have come to refer to policies which make markets more free. There is no reason why reforms need to be thought of in this manner. Politics is about possibilities, and economics suggests some ways of engineering these possibilities in order to provide a decent life to all. There is nothing intrinsically good in any economic or political sense about reforms. The efficacy and goodness of reforms lies in its details.

‘Factor markets such as those for labour, land, and capital, however, remained largely unreformed. This has proved to be a constraint for growth and employment generation’ (p. 48). This statement also is very marginalist or neoclassical in nature. Moreover, one has to be cautious for the three factors of production are very different from one another. Capital refers to produced means of production – commodities and services. Barriers to entry and exit need to be reduced and firms need to operate in a competitive environment. Land is a resource which needs to be treated very carefully and on a case-by-case basis; it has immediate impacts on livelihood as well as on the natural environment. Labour market constitutes people, and there should be strong social security for workers and good working conditions.

III

Policy prescriptions include primarily supply-side measures. This is not surprising owing to the Economic Survey being fundamentally neoclassical. Investment, a component of aggregate demand, is rightly considered crucial. But, public investment is not much favoured. Investment, as noted in section I, will be revived if supply bottlenecks are removed – that is, projects get easily cleared. Policies are targeted at boosting productivity. Provision of physical and social infrastructure is of utmost importance. A market for food (reducing distortionary interventions in agriculture) needs to be created. Manufacturing must be improved.

IV

What is the central aim of these economic policies? Repeatedly, in these two chapters, the objective is to create a ‘well-functioning market economy’ (p. 29; also 26, 46). This is much needed, but the ‘reforms’ need to be socially and environmentally sensitive. Also, just as with reforms, many different configurations of a market economy are possible. This must not be forgotten, and nor should social, economic and environmental justice be overlooked. To conclude, I would add a few words to the first sentence in chapter 2: ‘The defining challenge in India today is that of generating employment and growth’ (p. 29) which is economically, socially and environmentally inclusive. These additional words make all the difference, both in terms of economics and politics.