Environment – Undergraduate Economist

The Macroeconomics Underlying the Economic Survey of India 2013-14

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

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

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

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

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

Policy uncertainty & investment

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

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

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

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

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

III

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

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

Kunkel on David Harvey and Robert Brenner: Demand, Profits and Employment

The link between demand and profits, and consequently employment, is visible in the works of the classical economists and Marx. In this blog post, we set out the link between these variables by way of assessing the contributions of David Harvey and Robert Brenner, as narrated and presented by Benjamin Kunkel in his 2014 collection of essays, all previously published ‘ Utopia or Bust: A Guide to the Recent Crisis (and not on the basis of Harvey’s and Brenner’s original texts).

Karl Marx has already presented us with the possible reasons for the occurrence of crises in capitalist economies. Kunkel treats these crises as profitability crises (pp. 34-6); they can occur because of (1) profit squeeze, (2) a rising organic composition of capital, and (3) underconsumption. A capitalist crisis causes activity levels to drop and results in wide-spread unemployment. The three factors mentioned above reduce the profits of capitalists, consequently affecting their decision to produce and therefore adversely affecting their decisions to employ workers and purchase capital goods. The first ‘ a profit squeeze, is self-explanatory, but its causes need not be. A rise in real wages, ceteris paribus, leads to a decline in the rate of profit. The organic composition of capital, according to Marx, refers to the ratio between constant capital and variable capital. Constant capital refers to the investment expenditure on plant, machinery, tools and other constant/fixed capital. Variable capital refers to the investment expenditure relating to the workers ‘ wage costs, training costs and the like. When the ratio of constant to variable capital rises, or equivalently, when the organic composition of capital rises, the rate of profit (the ratio between profits and capital advanced) falls. The third cause is underconsumption, by workers. This occurs, by definition, since the value of the real wage is less than the value they add to the commodity. In Marxian terms, this difference measures the surplus-value that the capitalists extract from the workers.

Strong bargaining power on the side of the workers can generate a rise in the real wages; although, note that the terms of agreement are usually set in money wages. The rising organic composition of capital is not a law, but a contingent proposition. As for underconsumption, if workers’ wages are just sufficient for their survival, it can result in goods lying unsold and therefore affect capitalist profits. To put it differently, there arises a gap between aggregate supply and aggregate demand. This, according to Harvey, places a ‘limit to capital’.

What can possibly eliminate underconsumption, a facet of capitalism, a consequence of positive capitalist profits and a cause of economic crisis’ Harvey points out that it is credit which eliminates this cause, at least, temporarily.

‘Any increase in the flow of credit to housing construction, for example, is of little avail today without a parallel increase in the flow of mortgage finance to facilitate housing purchases. Credit can be used to accelerate production and consumption simultaneously.’

(Harvey; as quoted on p. 32)

But, Kunkel cautions us that even if credit can fund the required aggregate demand, changes in income distribution brought about by the struggle between workers and capitalists will affect the aggregate equilibrium, and will render it unstable.

‘If there exists a theoretical possibility of attaining an ideal proportion, from the standpoint of balanced growth, between the amount of total social income to be reinvested in production and the amount to be spent on consumption, and if at the same time the credit system could serve to maintain this ratio of profits to wages in perpetuity, the antagonistic nature of class society nevertheless prevents such a balance from being struck except occasionally and by accident, to be immediately upset by any advantage gained by labor or, more likely, by capital.’ (p. 37)

It is not entirely clear what mechanisms and processes Kunkel is referring to when he makes the above claim about income distribution rendering the equilibrium unstable. Indeed, if the available credit is not sufficient to counter the depressed wages and high profits, the aggregate equilibrium will be unstable.

Another route through which capitalist crisis can be postponed is via long-term infrastructural projects. ‘Overaccumulated capital, whether originating as income from production or as the bank overdrafts that unleash fictitious values, can put off any immediate crisis of profitability by being drawn off into long-term infrastructural projects, in an operation Harvey calls a ‘spatio-temporal fix” (p. 39). Here again, it is contingent on the extent to which the workers gain from the surplus generated by these projects, both in the short and long-term. For example, the employment guarantee programme in India creates infrastructure as well as provides employment and wage income.

‘So what then are the ‘limits to capital” (p. 41)’ ‘Keynesians complain of an insufficiency of aggregate demand, restraining investment. The Marxist will simply add that this bespeaks inadequate wages, in the index of a class struggle going the way of owners rather than workers’ (p. 43). Inadequate wages, as previously indicated, does generate demand deficiency. To that extent, Marx’s and Keynes’s account of capitalist crises are very similar.

Kunkel points out the role of environmental degradation, a consequence of capitalist drive for profits, in capitalist crises. ‘Already three-concentrations of carbon in the atmosphere, loss of nitrogen from the soil, and the overall extinction rate for nonhuman species-have been exceeded. There are impediments to endless capital accumulation that future crisis theories will have to reckon with.’ This can be easily integrated into the theories of output and of growth, as Ricardo’s diminishing returns to land, has been. Environmental depletion poses constraints on the supply side primarily and for economic growth, positive capital accumulation is necessary. Therefore, environmental degradation poses a strong constraint on the supply side of the economy.

Robert Brenner made a ‘frontal attack on the idea of wage-induced profit squeeze’ (p. 87). As Kunkel puts it, ‘increased competition exerted relentless downward pressure on profits, resulting in diminished business investment, reduced payrolls, and-with lower R&D expenditure-declining productivity gains from technological advance. The textbook result of this industrial tournament would have been the elimination of less competitive firms. But the picture drawn by The Economics of Global Turbulence is one of ‘excessive entry and insufficient exit’ in manufacturing’ (p. 87). In other words, the profit squeeze was not wage-induced.

Marx’s realization crisis finds a mention in Kunkel’s essay on Brenner too. ‘If would-be purchasers are held back by low wages, then the total mass of commodities cannot be unloaded at the desired price. Capital fails to realize its customary profits, and accumulation towards stagnation’ (p. 91). This is the crucial point. Capital has to realize its customary profits, a magnitude which includes a return on risk and undertaking (a return on enterprise, if you like) and the rate of interest. Capital that is invested in a riskier enterprise is expected to provide higher returns. The search for demand (or markets) is not new. Mercantilism was precisely that. More recently, ‘[i]n Germany and Japan, and then in China, catering to external markets won out over nurturing internal demand’ (p. 94) However, currently, there are signs of a reversal as external demand is falling, and net-exporting countries are reorienting towards domestic demand (p. 95).

But, what is to be done’ According to Kunkel, ‘[g]lobal prosperity will come about not through further concessions from labor, or the elimination of industrial overcapacity by widespread bankruptcy, but through the development of societies in which people can afford to consume more of what they produce, and produce more with the entire labor force at work’ (p. 98). Kunkel rightly advocates better wages and the full-employment of labour. For, it is only such a society which can afford its citizens with a dignified and economically comfortable life. As a matter of fact, ‘[m]ore leisure or free time, not less, would be one natural-and desirable-consequence of having more jobs’ (p. 103). A similar call is visible in Robert & Edward Skidelsky’s How Much is Enough’ Money and the Good Life published in 2012. We urgently need an economic architecture where goods can flow easily across regions, workers earn good wages, capital earns its customary profits, labour is fully employed and the environment is respected. In working towards this goal, it is necessary to possess an accurate understanding of the link between demand, profits and employment.