The ‘Micro-Foundations’ of Economic Survey 2009-10

The Economic Survey 2009-10 is different from its predecessors. Of them, it is chapter two of the publication which deserves special attention. The chapter is titled ‘Micro-Foundations of Inclusive Growth.’ This is no new phrase for economists who have witnessed the recent ‘we want microfoundations’ movement in economics. Traditionally, economic survey analysed trends in income, food production, prices, net exports, and so on without telling the readers about their ‘foundations’. For the first time, microfoundations of macroeconomics (a progeny of the failed neoclassical microeconomics enterprise) makes a loud entry into the analysis of the Indian economy.

One of the first signs of this shift is to be seen on the book cover itself. This has been reproduced below, as it is a matter of great concern.

In 2007-08, the cover page indicated various aspects on the Indian Economy. Coupons equilibrium, something which very few people understand gains entry on the cover page. Why’ Is it to show that economics is scientific and can only be understood by a few’ Or does it mean that economic survey is only for those who know such concepts’ Or does it convey that the economy is in safe hands now, run by competent economists’ One can only wonder. The rest of the post will hover around theoretical explanations and policy suggestions provided in chapter 2. Very often, the proposal outlined below are seen as emnating from the ‘political economy school’. It will be argued that this school is only a variant of neoclassical economics, albeit a superior one.

The chapter starts by emphasising the need to look at the foundations of macroeconomic policies, which have been neglected. The author(s) point out that an ‘enabling state’ is what India needs; a state which provides incentives through proper institutions for the individuals. That is, for policy to be effective, we ‘need to take people to be the way they are and then craft incentive-compatible interventions.’ Under the sub heading of ‘development and distribution’, some space is devoted to the question of futures trade. It is of national concern because very often futures trade tends to make the underlying spot prices volatile. However, it is argued that ‘An enabling Government takes view that if we cannot establish a connection between the existence of futures trading and inflation in spot prices, we should allow futures trade.’ The literature contains mixed views on this issue. Perhaps, it is being suggested that since it cannot be proved conclusively, we must go for futures trade. The rationale provided to pursue futures trade is a dangerous trend. For, economics is unlike sciences where laboratory experiments can be carried out. In any case, what is the percentage of people who invest in futures trade’ And what is the percentage of Indian farmers’

Trickle down effect is said to have taken place in India through injection of demand to the poor through increases in budgetary allocations for anti-poverty programmes. The firming up or increase in prices of food items is presented as evidence for income increases of the poor. This piece of evidence is wrought with methodological as well as conceptual difficulties. Hence, it cannot be argued with such certainty that incomes of the poor have risen. For, if the prices of food items have gone up, their real wage or purchasing power must necessarily be reduced. In effect, there might not have been any notable improvement.

Subsidies are considered essential for India. However, price controls are seen as distortionary and also they result in high levels of corruption. Therefore, it is pointed out that subsidies should take the form of ‘coupons’. This achieves two objectives. (1) Prices are left to the market and (2) Individuals have more choice. Both are hallmarks of neoclassical as well as neoliberal thinking. Hence, the need for Unique Identification (UID) system for improving information. It is argued that the state should not tamper with the ‘preferences’ of the subsidy reciever. Because ‘modern behavioural economics reminds us that there are situations where individuals act against their own interests because of lack of self-control or inconsistencies in their inter-temporal preferences, and so some pateranlistic interventions can be good for them.’ This result cannot be directly imported to a macroeconomic setting, owing to differences in objectives and also, the sum of parts may be more or less than the whole (fallacy of composition).

Apart from such proposals, foreign direct investment (FDI) in the textile and clothing sector is favoured as they ‘can help modernize this industry and aid its integration to the global textile market.’ The introduction of powerlooms have rendered many weavers jobless and most of them have become migrant construction workers. When any sector gains more importance than those employed in that sector, it is a sign that the objective of policy makers is plain ‘numerical growth’ and not employment!

The end of the chapter contains a discussion on ‘social norms, culture and development’ which points out that standard economics has not paid much attention to social and cultural factors. And that game theory and behavioural economics ‘is begining to give us some insights into the formation of customs and behaviour.’ It is argued that though such ‘phychological and sociological determinants’ may not effect short-term economic outcomes, they do affect medium-term and long-term outcomes.

In the following manner, this ‘political economy school’ explains economic issues through concepts such as ineffeciency, information asymmetry, bureacracy and corruption, inventives, incomplete contracts, etc. This school of thought should not be confused with Marxian or Sraffian political economy. This chapter is testimony to the fact that economists believe that economics is a science which has testable propositions and that they result in conclusive results. For the authors hail behavioural economics as though it is a new branch of economics which is the ‘saviour’ of economics. More dangerous is some of the causal connections made in the chapter, as they are not based on any logically consistent theory nor are they borne out of experience. The ‘micro-foundations’ of the economic survey definitely needs a rethinking!

Model Building and Planning in India

Ever since the First Five Year Plan, we have utilised models in order to channel resources for achieving objectives of higher growth, establishing strong capital base, strengthening import substitution, reducing poverty, increasing foreign exchange resources and so on. The early plans made use of Harrod-Domar model and the Feldman-Mahalanobis models. The models used for planning purposes were largely taken from economic theory, which were then adapted (hopefully) by the Planning Commission. Owing to changes in the structure of the Indian economy, the nature of modelling has also undergone various alterations. This post highlights certain issues in the macro-modelling that was done for the 11th Five Year Plan, chiefly based on the publication by the Planning Commission Macro-Modelling for the Eleventh Five Year Plan of India edited by Kirit S Parikh.

It is incorrect to argue that planning in India has become redundant after the 1991 reforms. These reforms provided freedom to the firms with respect to what to produce and how to produce them. As the recent global financial crisis has shown, unregulated finance can lead to unfavourable outcomes for the financial as well as the real sectors of the economy. Also, significant divergences in income and wealth are being reported. This is the case, especially in India which is home to some of the richest and poorest people in the world. As Parikh writes, ‘As long as disparities in income, endowments and wealth persist, access to public goods and services is uneven and infrastructure paucity is there, we need active government policy. We need planning.’ [Planning Commission 2009, 16]

The 11th Five Year Plan’s goal is to have ‘Faster and More Inclusive Growth’. The basis of this goal is that the growth of GDP is treated as a necessary and almost sufficient condition for improving livelihoods. We know that markets exclude those without adequate purchasing power. And growth in GDP mainly results in an increase in the extent/size of the market. Unless appropriate systems are in place, ‘trickle down’ does not take place. Hence, an outline of how ‘inclusive growth’ can take place needs much greater attention. And it is disappointing to see that employment generation is not considered as a central objective. For the first time, the inputs of the 11th Five Year Plan have been provided by a ‘modelling forum’. The forum consists of researchers from NCAER, IGIDR, IEG and ISI Bangalore apart from the in-house team of the Planning Commission.

A formal model is constructed for the purposes of planning because it makes the assumptions transparent, ensures consistency and provides insights into the inter-relationship between various actors and sectors in the economy. These models in turn borrow concepts, categories, functional relationships and links from the paradigms in economics. The paradigms that have influenced modellers, according to Parikh are Input-Output, Walrasian, Neoclassical, Keynesian, Structuralist, Vector Auto Regression/Error Correction, New Neoclassical and Dynamic Stochastic General Equilibrium. The most obvious drawback of this classification is the mix-up of paradigms with tools of economics. For instance, IO framework, VAR models and DSGE models are only tools. For our later exposition, it would be helpful to point out the important characteristics of each of these paradigms/tools.

Input-Output: Usage of inputs in fixed proportion

Walrasian: Optimising behaviour of economic agents

Neoclassical: Pricing through supply and demand mechanism and full employment at prevailing wage rate

Keynesian: Underemployment equilibrium

Structuralist: Imperfect markets and incomplete monetization of the economy

Vector Auto Regression: All variables depend on lagged values of all variables and data speak for themselves

New Neoclassical: Microeconomic foundation of macroeconomics- importance of information, expectations and contracts

DSGE: Forward looking and optimising economic agents

In the modelling for the 11th Five Year Plan, six different models with different analytical approaches have been used. The models are a) Perspective Planning Division’s In-house Model, b) A VAR/VEC Model from ISI, Bangalore, c) A General Equilibrium Model from IGIDR, d) An Econometric Model from IEG and e) Macro-Econometric Model of NCAER. The various model scenarios show that the direction of policy shocks are similar ‘though the structure and philosophy of the models are different’. However, this is not such a shocking or an interesting revelation. For everybody knows that oil price shocks have a negative impact on the GDP growth rate and that the global slowdown affects the GDP adversely. The only result of interest is that of an increase in NREGs by 1% of GDP. This will result in an increase of around 0.35 to 0.5 GDP percentage points. However, it must be noted that this is based on ‘a general equilibrium model in which it is assumed that the adjustments to the new equilibrium are completed in one year. Thus, the impacts may be overstated as in reality this may not be the case’.

Overall, it seems that the assumptions of the various models are far from our Indian reality. There is no attempt at including the unorganised sector. And it is very clear, from the recent evidences from neuroeconomics, experimental economics and game theory that individuals are not rational optimizing machines. Instead, we are more moved by social concerns and we exhibit a pro-social behaviour which is norm-based. There is no explicit move to analyse employment generation. Nor is there the necessary focus on agriculture. It is stated that agriculture needs to grow by 2.4 % to 4 % so as to achieve 9% GDP growth rate. One cannot help but wonder whether the objective of economic planning in India is only about the GDP growth rate! And as to the use of VAR models, the generators of the model argue that since there is ‘no real basis to say which variable is endogenous and which is exogenous’, they adopt a ‘general equilibrium approach, where everything (except rainfall, of course) depends on everything else.’ [Planning Commission 2009, 88] An easy route indeed!

This publication by the Planning Commission is a must read for all those who are interested in understanding the Indian policy making. Also, it provides the crucial link between policy and theory. Hence, making the study of economic theory very significant, especially for policy makers. It will also be of interest to students and practitioners of time series methods using the VAR framework.


Planning Commission (2009), Macro-Modelling for the Eleventh Five Year Plan of India, edited by Kirit S Parikh, Academic Foundation: New Delhi.

What are the Contents of India's Economic Growth’

The above question was discussed by Bhabatosh Datta in 1977 in his book The Contents of Economic Growth and Other Essays. This blog post briefly revisits Datta’s article to see whether the current growth of India is on the right track. A few details about Datta is in order. For most of his life, he taught at Presidency College, Calcutta. He is an economist who has written on diverse aspects of the Indian economy – industrialisation, planning, regional rural banks, economic growth, monetary reforms, commercial banks, financial system and on Indian economic thought. And for this reason, his work is of utmost relevance to us- who want to understand the Indian economy.

On 29th December 2009, the Deputy Governor of RBI spoke about the ‘Current Macroeconomic Developments in India’. I reproduce some of her observations below:

India had a strong recovery in the second quarter of 2009-10 at 7.9 per cent. “The sequential recovery over the first quarter of 2009-10 was driven by notable turnaround in industrial output (9.0 per cent), and services sector (9.0 per cent), while agriculture sector also came to record a positive growth (0.9 per cent), despite drought like conditions and floods in some parts of the country.”

Which India had a strong recovery, when more than 60% of Indian population work in the agricultural sector’ As Datta writes, for India, economic growth takes place when there is “growth in employment and growth in incomes of large numbers.”

“On the whole, agricultural production during 2009-10 hinges critically on the performance of the North East monsoon and rabi production.”

“The recovery in industrial growth has been broad-based with acceleration in growth of all the three sectors, viz., mining, electricity and manufacturing .”

The consumer durables sector shows an impressive growth with 22.2 per cent in the second quarter of 2009-10.

Consumer durable showing strong growth, a recovery of industrial growth alongside a critical agricultural sector seems to suggest that Indian policy makers and economists seem pre-occupied with non-problems. As Datta lucidly points out: “it is possible that over a particular year there has been only a very small increase in agricultural and essential industrial production, while there has been a substantial rise in the output of luxury goods, high-income varieties of consumer goods and outdated capital goods.”

It is easy to forget that 8% or 9% rate of growth does not have a unique meaning. For, it might express many alternative states of affairs. I often wonder, what our objective should be as an economist in India! As I had argued elsewhere, it is time that we looked at the structure or the contents of economic growth carefully.

On Disguised Unemployment: Some Issues

This post discusses some of the broad theoretical issues underlying the category of ‘disguised unemployment’. The discussion is made clear by closely examining the hypothesis that Indian agriculture is plagued by the presence of high disguised unemployment.

Let us take a glimpse at the Economics textbook for class XI published by the NCERT. (NCERT 2006, p 131, Indian Economic Development)

‘Economists call unemployment prevailing in Indian farms as disguised unemployment. What is disguised unemployment’ Suppose a farmer has four acres of land and he actually needs only two workers and himself to carry out various operations on his farm in a year, but if he employs five workers and his family members such as his wife and children, this situation is known as disguised unemployment. One study conducted in the late 1950s showed about one-third of agricultural workers in India as disguisedly unemployed.’ (italics mine)

Is disguised unemployment unemployment’

A thought experiment. Suppose A and B are two similar countries ‘ both are equally populated. Now, a study has estimated disguised unemployment in country A to be 30% and in country B to be 10%. This implies that employment in country A is more than that of country B. Should this be of concern’ Must we try and reduce disguised unemployment in country A’

If so, what is the basis of ‘disguised unemployment” Do we see the principle of allocative efficiency present in disguise’ Disguised unemployment means that ‘labour’ is ‘inefficiently’ utilised. Attestation of this claim is done by showing the high share of workers employed in agriculture alongside the low contribution of agriculture to GDP.

The first draft of National Employment Policy (2008) reads thus: ‘Over half the workforce continues to depend on the agriculture even though it accounts for less than a fifth of the total GDP. This implies a vast gap in incomes and productivity between agriculture and non-agriculture sectors. This is mainly due to inadequate growth of productive employment opportunities outside agriculture.’ Is employment the need of the hour or is it contribution to GDP’ Which variable (employment or GDP) should be the criterion’ Why not improve the quality of employment in agriculture’ To attain quality, provision of infrastructural support is absolutely essential- credit facilities, good roads and increased railroad connectivity, storage houses, institutions so as to enable the farmers get a ‘decent’ price for their produce, etc.

In 1960-61, the share of agriculture, forestry and fishing in total GDP was 53% (at 1993-94 prices). This came down by around 30 percentage points to 22% in 2002-03. On the other hand, the share of agriculture, forestry and fishing in total employment was 75.9% in 1961; by 1999-2000, it had come down to 59.9%. [The Oxford Companion to Economics in India, ed Kaushik Basu, OUP: New Delhi, 2007, p. 11]

The above discussion attains significance when we view agricultural workers as those who are trying to make a livelihood out of various jobs ‘ farm and non-farm employment and self-employed and casual labour. ‘Employment’ mainly refers to wage employment. In India, out of total employment, the share of self-employment is the highest. As Amit Bhaduri writes, the economic activities predominant in the agricultural sector (or rural or informal) can be called as ‘survival strategies’. [Bhaduri 2006, Employment and Livelihood, in Employment and Development: Essays from an Orthodox Perspective] He cautions the policy makers on the use of dual-sector models in framing development policies for India owing to the heterogeneity prevalent in rural India and also because of the specificities present in the unorganised agricultural sector. Hence, the notion of ‘surplus labour’ loses much of its weight. In turn, we need to carefully look at ‘disguised unemployment’ for it disguises a lot of specificities of rural India.