Category: Development Economics

Understanding India’s Economic Growth and Development

This post is a review of the recent book by Jean Dr’ze and Amartya Sen titled An Uncertain Glory: India and Its Contradictions. An earlier post in this blog has dealt with the vexed relation between economic growth and development and elsewhere, I have discussed the need to focus on the structure of economic growth. Dr’ze and Sen’s book contains 10 chapters including the introduction (‘A New India”) and the conclusion (‘The Need for Impatience’); the main text spreads across 287 pages. Their argument is buttressed with comparative exercises between Indian states, international comparisons, historical facts, surveys, published data sources and contemporary events apart from ample secondary literature. However, this review does not engage with their empirical findings.

For Dr’ze and Sen, the aim of any society should be the expansion of human capabilities. And, institutions such as markets and democracy are a means to that end. Similarly, economic growth ‘generates resources’ which can be used to improve human capabilities. As they write in the preface, ‘the achievement of high growth must ultimately be judged in terms of the impact of that economic growth on the lives and freedoms of the people’ (p. viii). Human capabilities, as is to be expected, refer to a spectrum of endowments and the ability to access all of them. For instance, it includes, in no particular order, nutrition (pp. 157-162), education (see ch. 5), health (see ch. 6), clean environment (pp. 41-44), access to energy (pp. 84-87), transportation, communication and banking infrastructure. The ability to access them, however, is severely constrained by caste (pp. 218-223). And some of them are also constrained by gender (pp. 224-239) besides other power relations.

Given India’s high growth rate, the authors pose one major question: why has the ‘pace of change ‘ been excruciatingly slow’ for majority of the Indian populace (p. 29)’ According to Dr’ze and Sen, the major cause for this is the abysmal situation of public education and health in India. (There are some Indian states which have done relatively better.) This is because of issues relating to accountability and also due to insufficient public spending. Moreover, the authors harshly criticize the Indian media for their ‘excessive focus on a relatively small part of the population whose lives and problems are much discussed’ (p. 261; see also pp. 262-267). This wide gap in public discourse provides their motivation in writing the book. Hence, they point out the ‘importance of enlightened public reasoning’ as ‘a central part of the general thesis of this book’ (p. 239). Furthermore, they state that ‘this book is aimed much more as an attempted contribution to public reasoning, including discussion in the media, than at giving professional advice to the government in office’ (p. 253).

Is their account of economic growth and development entirely satisfactory’ Their second chapter is about ‘Integrating Growth with Development’. First, what determines economic growth’ According to mainstream (neoclassical) economics, a growth in physical capital, human capital (educated and healthy workforce) and technological progress causes economic growth. This is known as the supply-side view of economic growth. If we accept this growth account, then clearly an improvement in the quality of life directly contributes to faster economic growth. Dr’ze and Sen do not have theoretical dissatisfactions with mainstream economics, as is made very clear in the following passage written in the context of a discussion on markets.

Relying solely on the market has become a strongly advocated theme in India on the basis on highly exaggerated expectations, often based on a misreading of the conclusions of mainstream economics, which includes much scepticism of the performance of markets in the presence of externalities, public goods, asymmetric information and distributional disparities. We do not have to look for any ‘alternative economic paradigm’ to see what the market cannot do, in addition to what it can do ‘ and do very well. (p. 184; emphasis added)

They also approvingly cite Joel Mokyr and Elhanan Helpman who emphasize the importance of ‘accumulation of knowledge’ and ‘total-factor productivity’ through education in economic growth respectively (p. 35). This is the supply-side production function approach in understanding the growth determinants. No one denies their significance. However, if one is convinced by such a theory/view of economic growth, the popular version of it being the Cobb-Douglas production function in various clothes, then, theoretically, physical capital can be substituted with human capital. And, this would entail a very different method of attaining economic development from that mentioned in the book. Moreover, aggregate demand does not play a role in this growth account; as the authors write in the preface, the ‘expansion of human capability, in turn, allows a faster expansion of resources and production, on which economic growth ultimately depends’ (p. x). That is, economic growth is entirely determined by the growth of aggregate supply, without considering the problems which can arise from aggregate demand deficiency (such as a fall in wage income or decrease in government spending). Without getting into the details of the argument, it appears that their conception of economic growth and development sits more comfortably with the economics of the classical economists (such as Adam Smith, David Ricardo and Karl Marx) combined with the effective demand theories of Michal Kalecki and John Maynard Keynes.

The surplus generated from economic growth can be utilized for societal needs which is further determined through socio-political movements and economic considerations of the entrepreneurs as well as the state. To put it differently, ‘the fruits of growth’ need to be allocated intelligently ‘ based on our physical, economic, environmental, social and cultural needs (p. 9; cf. p. 14, p. 18, p. 38). There are two very different kinds of distribution that takes place ‘ income distribution between wage-earners and profit-earners and the expenditure of the government from the revenue they collect as taxes and duties. They also observe,

The impact of economic growth on the lives of the people is partly a matter of income distribution, but it also depends greatly on the use that is made of the public revenue generated by economic expansion. (p. 37)

They mention the importance of collective bargaining (p. 141) and point out that the NREGA ‘strengthened the bargaining power of rural workers’ (p. 201). But their focus in the book is how to utilize public revenue in improving the quality of life (p. 269). Since this public revenue can be utilized in a variety of ways, Dr’ze and Sen assert ‘the constructive role of the state for growth and development’ (p. 39; italics in original). Hence, the organs of the state need to be made more accountable (ch. 4).

Since democracy offers ‘significant opportunities’ for improving the quality of life as well as its pace, the authors are ‘contingently optimistic’ (p. xii). In fact, the issues addressed by the authors are intended to be a contribution to a wider debate on how to construct a better society. Thus, the book aims to provide ‘reasoned solutions to the problems’ (p. 3). They also write that ‘economic reforms, even when appropriate, require informed public debate’ (p. 28). In sum, there ought to be a ‘greater use of informed reasoning in the practice of democracy’ (p. 181). As they observe, and correctly, I think, that daily troubles are ‘less spectacular and less immediate ‘ [and hence] provide a much harder challenge’ to politicize (p. 14). The book is primarily about these issues and since they cover a vast terrain, there have been some omissions. Two very varied issues come to my mind: the influence of public debt on economic growth is only addressed briefly (p. 18) and the gap between English and non-English speakers get barely one paragraph (pp. 215-6). In addition, there is no mention of freedoms relating to sexuality. To conclude, the book is an excellent contribution in so far as it provides an accessible introduction to several social concerns such as armed conflicts, child mortality, corporate power, corruption, land ownership, minimum wages, nutrition, open defecation, pollution and sanitation.

On Economic Growth and Development

There exist disagreements about the role economic growth plays in socio-economic development. Among economists, a divide exists between those who consider economic growth to be a necessary condition for economic development and those who do not. This blog post tackles this issue from the perspective of the ‘surplus approach’, an approach embedded in the works of economists such as Adam Smith, David Ricardo and Karl Marx, and revived and improved in the 20th century notably by Piero Sraffa and Pierangelo Garegnani. For our purposes, it is enough to focus on the concept of the social surplus.

Deducting necessary expenses (subsistence wages, raw material costs and depreciation) from the annual gross product of an economy leaves us with the surplus. In the work of classical economists, this surplus consisted of profits and rents. Wages could also contain a ‘surplus’ element when the economy is growing or when collective bargaining favours the working class. Most importantly, the surplus could be utilised freely (or for any purpose) without it affecting the ability of the economy to reproduce itself. Of course, for the economy to grow, some of that surplus will have to be reinvested. This reinvestment of a part of the surplus results in an expansion of productive capacity. When this expansion in productive capacity is matched by an equivalent aggregate demand, there will be economic growth.

In physical terms, the volume of the surplus depends on the methods of production in use and the magnitude of subsistence wages. The methods of production specify how much of output can be produced with a certain combination of inputs (given by the technical know-how and blue prints available with the firms). (To use marginalist terminology, the production function in classical economics is of fixed-coefficients; that is, labour and ‘capital’ cannot be substituted for each other such that the same commodity is produced.)

Leaving rent aside, the distribution of the surplus between capitalists and workers will depend on the strength of the labour unions and other labour market conditions. For instance, in India, it will also depend on the gender and caste determinants. Also, the distribution will vary depending on whether the firm is formal or informal. There exist sectors where productivity gains entirely accrue to the capitalists. Whereas, the distribution of the surplus between private individuals (both workers and capitalists) and the government depends on the prevailing income and corporate tax structure.

The surplus, as mentioned previously, can be used for reinvestment (to produce capital goods) or for luxury consumption (in the production of non-capital goods). Also, the surplus can accrue as taxes to the government. And we have seen that if the surplus is reinvested, there will be economic growth as long as there is adequate aggregate demand. How much of economic growth is good’ Are all kinds of economic growth desirable’ Are all kinds of economic growth sustainable’ By ‘kinds of economic growth’, we refer to several combinations ‘ driven by agriculture; service-led; consumption-driven; debt-induced; foreign trade-driven; or productivity-driven. These issues will not be addressed in this blog post. More precisely, we do not examine the difficulties associated with any of these drivers of growth.

So far, we have not discussed development. Let us define economic development to be the rise in the standard of living of the people in an economy/nation state. An overall increase in real incomes is necessary for an overall improvement in the standard of living. If all workers and capitalists have sufficient (real) incomes to access their as well as their dependents’ educational needs, health needs besides the basic needs of ‘decent’ food, shelter and clothing, we can safely say that the economy is ‘developed’. In an economy where workers do not have sufficient (real) incomes and/or there are socio-cultural impediments to access/consume any of their needs, development needs to take place.

What is the source of (economic) development’ There has to be monetary resources available to build the lacking infrastructure or to directly import them where possible. One of the means of generating such resources is through economic growth. But, generating a surplus is clearly not sufficient. The manner in which the surplus is distributed among workers and capitalists as well as redistributed by the government is extremely crucial. There is no predefined way of going about this. It is determined by wider social, cultural and political factors. For example, if trees are felled during the creation of infrastructure, some of the surplus can go towards planting new trees. Or, some of the surplus accruing to the capitalists can be reinvested for improving the working conditions. The important point to note is that there are no automatic mechanisms which ensure such allocations. The market has no such interests or objectives. In short, the decision of ‘development’ is primarily undertaken in the socio-political arena. And, as long as we aspire for better standards of living, economic growth is necessary so that it generates adequate monetary resources in order that our aspirations may be met. But, yes, economic growth by itself cannot guarantee or ensure development.

Reflections on Chayanov’s The Theory of Peasant Economy

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.

Wages in Economic Theory and Reality: Some Issues

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.