GDP – Page 2 – Undergraduate Economist

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 20^th 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.

The 2012-13 Economic Survey of India (with Raghuram Rajan)

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.

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.

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 former 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.

Urbanization in India: What does it mean’

In the recent past, there have been a lot of discussions and commentaries on the merits of urbanization in India. In addition to this, we also hear about the poor, rather pathetic, living conditions of migrants who work in urban spaces, there are pressing environmental concerns especially regarding air and water pollution, public transport is in a disarray, etc. The latter concern has led to the rise of ‘new’ areas of learning and research such as urban studies, urban economics, urban ecology, urban sociology and urban planning. These are extremely important areas of learning considering the fact that urban centers attract both labour and capital. This blog post tries to understand some economic issues relating to the process of urbanization that is taking place in India. In particular, we seek to understand the limits of urbanization and in the process we try to know what it means to achieve economic growth.

According to the World Bank, ‘Urbanization is not a side effect of economic growth; it is an integral part of the process.’ ‘McKinsey states that ‘Urbanization is critical to India’s development.’ Further, Ministry of Urban Development, Government of India notes that ‘It is important to note that the contribution of urban sector to GDP is currently expected to be in the range of 50-60 percent. In this context, enhancing the productivity of urban areas is now central to the policy pronouncements of the Ministry of Urban Development. Cities hold tremendous potential as engines of economic and social development, creating jobs and generating wealth through economies of scale. They need to be sustained and augmented through the high urban productivity for country’s economic growth. National economic growth and poverty reduction efforts will be increasingly determined by the productivity of these cities and towns.’

From the above excerpts, some important assumptions (or rationales) for promoting urbanization can be understood.

(1)”’ Economic growth is synonymous with urbanization.

(2)”’ India has to urbanize in order to attain economic growth and development.

(3)”’ Urban spaces need to be promoted because they generate about 50% of the Indian GDP.

(4)”’ Cities are potential engines of economic and social development.

‘Economic growth

In a macro sense, economic growth refers to the sustained growth in national output ‘ GDP. However, for policy purposes it is important to look at per capita GDP. This is a proxy for looking at how much on income an average person possesses. The objective of economic growth (and economics) is to ensure that all individuals are employed (who seek work), have adequate food, have access to drinking water, transport, etc. In no way should we consider the objective of increasing GDP to be our aim. It is a necessary means to an end- better life.

Urbanization is understood as an increase in the population of urban spaces. This also means that there is a growth in employment, capital inflow, infrastructure, etc. In turn, such large increases in population will result in an increased pressure on resources ‘ water, space, housing, transportation, office space, air, etc. Communication seems to be the only one which has relatively negligible supply problems.

Given this, how can the Central Government or Planning Commission argue that urbanization is the way to go forward’ This means ‘ fatten urban spaces and neglect rural areas! Both, as we know, are not desirable. Fattened urban spaces will present a whole new set of issues to tackle with; neglecting rural areas will mean that agriculture and those dependent on agriculture (around 60% of India) will not be encouraged. Clearly, this does not increase the well being of majority of Indians. More importantly, it is illogical and unwise to argue that urbanization is (or leads to) economic growth. Yes, it leads to economic growth, but only in a very superficial manner and not in any substantive way.

India: Rural and Urban

As per Census 2011, 69 % of Indians live in rural areas and only 31 % in urban spaces. It seems to be the case that the policy makers are interested in improving the ‘urban spaces’. This does not necessarily include improving the living conditions of the majority of Indians. It is strange how language plays a dividing role too: urban habitats versus rural areas! It is true that the urban sector contributes roughly around 50% of India’s Net Domestic’ Product (NDP). The remaining comes from rural India which comprises majority of the populace. As for agriculture, rural areas contribute 94% (for the year 2004-05) of total agricultural output. So, if urban areas are targeted at the cost of rural areas, those employed in agriculture, which is a very difficult occupation, are going bear the brunt.

It is strange that the Government and policy makers (including private think tanks) argue that cities are potential engines of economic growth, when 60% of Indians depend on agriculture for their livelihood which is mainly located in rural areas. This tendency of policy making to favour any method which just boosts the numerical value of GDP without any qualitative change must be stalled. By qualitative change, I refer to improvements in quality of life ‘ food, shelter, education, water, health and so on.

According to a recent paper (July-August 2011) by Gilles Pison in Population & Societies, India is expected to become the most populous country by 2050 and will overtake China. Yes, we have heard that India has been blessed with the demographic dividend; but we must remember that it is no dividend unless there are employment opportunities, and they should not just be in urban spaces. This paper also notes that India records the highest number of deaths under age one ‘ 13,96,000.

Hence, the Planning Commission has considered it imperative that the next 5 Year plan will include urbanization as a key challenge. This, however, is a myopic strategy and especially because of the neglect of agriculture. In addition, employment generation should be the key challenge. Jayati Ghosh also argues in a similar fashion in a recent article of hers. She points out that ‘The number of urban settlements has increased from 5161 in 2001 to 7935 in 2011, an increase of 54% that dwarfs the 32% growth in urban population.’ This means that urban statistics have swelled up because of a reclassification and not mainly because of rural-urban migration. This key information poses further problems for policy makers; actually, it poses problems only for the ‘concerned’ policy makers!

Conclusion

To sum up, it would be disastrous to formulate policies which targeted the urban spaces at the cost of rural areas. The objective of economic policies must be to improve the well-being of the people and not to increase the percentage of GDP by a few points! In fact, even in France and Europe, when the process of urbanization began in the early 18^th century, agriculture was neglected. However, a group of economists known as Physiocrats argued that agriculture cannot and should not be neglected as it will lead to a downfall of the economy (see more). It is time that we realized the interdependence present in the economy between rural and urban areas and also high time we acknowledged the significance of creating employment opportunities to the majority of the population.