Category: Economics

The Real Economy of India

Economy: Main Constituents

Agriculture sector or otherwise known as the ‘primary sector’ comprises agriculture and allied activities like crop production, horticulture, plantation crops, farm mechanization, land development and reclamation, digging of wells, tube wells and irrigation projects, forestry, construction of cold storages and warehouses, processing of agri-products, finance to agri-input dealers, allied activities like dairy, fisheries, poultry, sheep-goat, piggery and rearing of silk worms.

Industrial sector or the Secondary sector consists mainly of mining and quarrying; manufacturing and electricity; gas and supply.

The services sector or the tertiary sector includes trade, hotels, restaurants, transport storage and communication; financing, insurance, real estate and business services; community, social and personal services and construction.

Gross Domestic Product(GDP)

According to the Central Statistical Organisation (CSO), the Indian economy recorded a real GDP growth of 8.0 per cent in the second quarter of 2005-06.

When an economy grows at, say 5 %, it implies that the average growth of the 3 sectors within the economy, namely agriculture, industrial and services are growing at an average rate of 5%.

The data by CSO says that, the agricultural growth in real terms during the second quarter (July-September) of 2005-06, is 2.0; industrial sector 7.6 and tertiary sector 9.8.

The slow growth of the primary sector has been mainly attributed to the weak monsoons.

Business Expectation: A digression

Business expectation surveys suggest that the current phase of industrial activity is likely to continue in the near future. According to the Reserve Bank’s latest Industrial Outlook Survey, the Business Expectations Index for January-March 2006 quarter increased by 2.4 per cent over the previous quarter. Survey results indicate that employment, selling prices, imports and profit margins are expected to improve during the quarter January-March 2006 vis-‘-vis October-December 2005.

What the ‘growth’ comprises

The area under kharif crops was 1.2 per cent higher than a year ago, led by increased area under rice, maize, pulses and sugarcane. As regards rabi crops, the area coverage as on January 2, 2006 was 1.5 per cent higher than a year ago on account of increased coverage in respect of major crops such as wheat and rapeseed.

The mining and electricity sectors, on the other hand, recorded a deceleration. The sharp slowdown in the mining sector may be attributable in part to a decline in production of crude oil caused by the break-out of fire in the Mumbai-High oil field in July 2005 and the adverse impact of heavy rainfall on coal mining activities. Lower growth in the electricity sector is attributable to shortage of coal and gas.

Robust growth in the cellular subscriber base broadband connections supported the strong growth in the communication sector.

Sustained growth in bank deposits and non-food credit as well as increased exports of information technology enabled services boosted the sub-sector ‘financing, insurance, real estate and business services’.

These are some of the reasons mentioned by the RBI for the growth in real GDP.

Growth projections

Agencies like ADB, CII, CRISIL, NCAER, IMF and RBI have projected the Real Gross Domestic Product for India during 2005-06 to be over and around 7.0. This reflects a bright prospect for the people of India. Is it so’

Current Scene


Link: The Hindu

Conclusions

The current GDP rate is exuberating and so are the projections. All the hype is on the growth rate. The politicians’ rhetoric is that India is growing as its GDP is rising. The agricultural sector is weak, structurally. More reason to be worried is because of the fact that more than 50% of the Indian populace are dependent on agriculture for their livelihood. The number of farmer suicides in Vidarbha and even in highly literate states like Kerala, speaks of discontentment. Relying only on the GDP and expecting the ‘trickle down effects’ to comply is nonsensical. Even if the high rates of GDP brought forth positive externalities, the time lag required for ‘these benefits’ to reach the masses would be large.

It is a commendable and laudable fact that India is improving it’s IT related exports. IT sector definitely seems resplendent.

Even if ‘trickle down effects’ ensued, all the benefits have gone to the middle class sector. More people are becoming better off with this sector.

The main concern is that of sustaining the realised growth of services and improving upon the primary and secondary sectors. The issue of ‘sustainable development’ should be our main concern. Lop sided development cannot be sustainable in the long run. Therefore, resting on a weak agricultural base is dangerous.

References

1) RBI: Third Quarter Review 2005-06, The Real Economy .

Supply side Economics

Supply side economics revolves around the central concept that changes in economic growth can be brought about more rapidly by making changes in the ‘aggregate supply’ rather than changes in the ‘aggregate demand’.

Supply side economists prefer policies such as cuts in tax rate (Which increase the supply of workers and thereby increase employment, as a result increased incentive to work) to various other demand side policies such as changes caused about by monetary policies, such as an increase in the money supply or fiscal policies, such as a progressive tax.

Conservative economists are of the view that tax cuts need to be concomitant with cuts in government expenditure or purchases, so that the effect on the budget is neutral.

History of Supply-side Economics

Robert Mundell is the person who furnished the theoretical genius behind ‘supply-side economics.’ The ideas and premises of supply-side economics are described most lucidly in the writings of a political science and journalism graduate of UCLA, Jude Wanniski. Those writings, in turn, reveal that three individuals were primarily responsible for advancing the ideas of supply-side economics: Robert Mundell as the economic theoretician; Arthur Laffer as the pragmatic economist with a flair for public relations; and Jude Wanniski as the journalistic link between the two economists, the public, and the worlds of Wall Street finance and Washington politics. [Jett 2003]

America and Supply-side Economics

The US of A experimented with supply side policies in 1980. Ronald Reagan was the man behind it and his opponent, George H. W. Bush called it ‘Voodoo Economics’. Reagan cut the marginal tax rate on the highest income earners from 75% to 38%. His rhetoric was that if taxes were lowered, these rich would earn more and thus increase the gross taxes collected.

In a nutshell, here is Krugman’s account of the ascent and record of supply-side economics. Except for a few renegade professors like Arthur Laffer, supply-siders come from outside the economics profession. They come from journalism (Wall St. Journal columnists, Jude Wanniski, George Gilder), political staffs and think tanks. They convinced key Republicans that the cause for slowing U.S. economic growth was high taxation and excessive regulation. Supply-siders asserted big government was the problem. The cure required tax cuts, which would 1) bring back growth, 2) raise investment, and 3) enable deficit reduction. Disregarding sophisticated conservative economists like Martin Feldstein, politicians seized on the cruder, easy to peddle supply-side message that the economy would benefit from tax cuts – without concern for offsetting spending cuts.

The track record of early 1980’s tax changes can now be gauged from economic history regarding the three supposed benefits. Krugman presents and discusses the evidence summarized below.
1) The U.S. long-term rate of economic growth was not changed by supply-side tax cuts or by anything else since 1973. Productivity growth in the 80’s was 0.8% on an annual basis, compared to 2.8% in the prosperous period after World War II until 1973.
2) “By any measure, over any time period, investment fell” in the U.S. during the 1980’s, a result contrary to supply-side claims. As one example, net national savings was only 3.4% of GDP in the 1980’s, compared with 8% in the 1970’s.
3) In the absence of high economic growth or deep spending cuts, the deficit ballooned – to 4.9% of GDP in 1992 compared with 2.7% in 1981 when Ronald Reagan became President. The resulting debt will burden taxpayers for decades to come. [Neubauer 1996]

Conclusions

Pindyick and Rubinfeld say that some supply policies can shift actual output, but not all supply side policies can. Assistance of demand side policies is required.

If an economy is growing close to full employment level, i.e. with the presence of only natural unemployment(Frictional unemployment) then such ‘tax cuts’ will be beneficial. But, if such policies are implemented in developing countries, with the presence of large degrees of unemployment, all it will do is widen the inequalities of income between rich and poor.

Trade Cycles

Trade Cycle is defined as the existence of fluctuations in National Income over a variable time span. It was first observed by the English economist Sir William Petty.

On Keynesian Trade Cycles

The reason why Keynes referred to it as a ‘cycle’ is mainly due to the way in which Marginal Efficiency of Capital (MEC) fluctuates. [According to Keynes, MEC is equal to that rate of discount which would make the present value of the series of annuities given by the returns expected from the capital-asset during its life just equal to its supply price.] As investment increases, MEC decreases.

MEC, according to Keynes depends on
-Existing stock of Capital
-Current cost of production of Capital
-Currents expectation as in the future yield of Capital


‘

These Trade Cycles are characterised by ‘Booms’ (Peak) and ‘Crisis’ (Trough).
Crisis
The causes of ‘Crisis’ was
-A sudden collapse of MEC and not primarily a rise in rates of interest (roi)
A ‘Crisis’ is analogous to a slump in the share markets.

Boom
It is characterised by ‘optimistic expectations as to the future yield of capital goods sufficiently strong to offset their growing abundance and their rising costs of production and, probably, a rise in the rate of interest also.’

During the boom, ‘disillusion comes because doubts suddenly arise concerning the reliability of the prospective yield.’ And ‘once doubt begins it spreads rapidly.’ This eventually results in a crisis.

On Trade Cycle theories

It is a well observed economic phenomenon and the usual time span is of the order of 5 years. The Government tries to reduce the fluctuations of the trade cycles through various stabilization policies.

Some of the economists who are associated with Trade Cycles are Samuelson, Hicks, Goodwin, Phillips, Kalecki and Friedman.

In 2004, theSveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel was awarded to Finn E. Kydland and Edward C. Prescott “for their contributions to dynamic macroeconomics: the time consistency of economic policy and the driving forces behind business cycles”

References

1) The General Theory of Employment, Interest, and Money By J. M. Keynes
2) Dictionary of Economics, The Economist

The Demographic Dividend

India is growing with 7% GDP, Sensex crossing 10,000 and foreign reserves have crossed the $150 billion mark. Is this growth sustainable’ Yes it is, provided we reap the benefits of what is known as the ‘Demographic dividend’.

Simply stated, the demographic dividend occurs when a falling birth rate changes the age distribution, so that fewer investments are needed to meet the needs of the youngest age groups and resources are released for investment in economic development and family welfare. The falling birth rates reduce the ratio of the dependent population to the working population.

The demographic dividend, however, does not last forever. There is a limited window of opportunity. When the window of opportunity closes, those that do not take advantage of the demographic dividend will face renewed pressures in a position that is weaker than ever.

India’s current scene

India is and will remain for some time as one of the youngest countries in the world. A third of India’s population was below 15 years of age in 2000 and close to 20 per cent were young people in the 15-24 age groups. In 2020, the average Indian will be only 29 years old, compared with 37 in China and the US, 45 in West Europe and 48 in Japan.

But India’s developments in ‘human capital’ are exiguous. The poverty ratio for India is still somewhere around the 50% mark. Only 7% of the population is employed in the formal sector. Farmer suicides are being reported every now and then. The social infrastructure vis-‘-vis the physical infrastructure is disheartening.

The dividends

The generations of children born during periods of high fertility finally leave the dependent years and can become workers.

Working-age adults tend to earn more and can save more money than the very young.

And for given unemployment rates, the higher the ratio of those in the labour force to those outside it, the larger would be the surplus. If this larger surplus is mobilised for investment, growth would accelerate.

However, Fareed Zakaria in his book ‘The Future of Freedom’ depicts this bulge to be bad for the economy. He goes on to state that ‘A bulge of restless men in any country is bad news.’

Conclusion

To sum up, it is evident that India is entering the phase of demographic dividend. In order to realise maximum benefit from this population bulge, it is necessary that programmes aimed at improving health care facilities and education are undertaken. Moreover, farmer suicides are not decreasing; the debts are growing and burdening those employed in the informal sector generally and in agricultural activities particularly. Microfinance can help alleviate the farmers’ distress by granting loans without collaterals.

References

1) John Ross [2004]
1) C. P. Chandrasekhar and Jayati Ghosh [2006]