Where is the Economy Headed?

Alice’s Adventures in Wonderland has a conversation between Alice and the Cheshire cat. ‘Would you tell me, please, which way I ought to go from here?’ ‘That depends a good deal on where you want to get to,’ said the Cat. ‘I don’t much care where…,’ said Alice. ‘Then it doesn’t matter which way you go,’ said the Cat. ‘…so long as I get somewhere,’ Alice added as an explanation. ‘Oh, you’re sure to do that,’ said the Cat, ‘if you only walk long enough.’ In terms of the economy, are we clear about where we want to go? Or are we just trundling along, as long as we get somewhere? questions Bibek Debroy

01 April, 2012 Opinion, Economy
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Consider the following quote. ‘In the last four or five decades, there has been considerable industrial development in India, accompanied by urbanisation and expansion of commerce. Large towns and cities have grown and transport and communications have developed extensively. The isolation of the village has been broken and the average citizen lives in an environment significantly different from the one in which he lived and worked fifty or sixty years ago. Indian enterprise has made considerable headway…. New economic and social relations have emerged, giving rise in turn to a general desire for more rapid change. But the development that has taken place is partial and limited when judged in terms of the country’s needs and potentialities. Industrialism and the use of modern techniques have affected only limited segments of the economy…. The size of agricultural holdings has progressively diminished; the old cottage and small-scale industries have been decaying, and the rural population…suffers from chronic underemployment and low incomes. Population has increased by more than fifty per cent in the last fifty years, but the growth of alternative occupations either in the rural areas or in the towns has not been on a scale which could absorb this growing population…. The economic development of the last few decades has brought no significant improvement in standards of living and opportunities for employment, and has perhaps accentuated to some extent inequalities of income and wealth.’ The Planning Commission was set up in 1950 and the First Five Year Plan was launched in 1951. The Planning Commission is now drafting the Twelfth Five Year Plan (2012-17) document. This quote isn’t from that document. This quote is from Chapter 1 of the First Five Year Plan document. A sense of déjà vu is unavoidable. The more things change, the more they seem to remain the same.1 We are getting somewhere, but we don’t seem to care where.

We are getting somewhere. The question is: at what speed? When the rupee was devalued in two stages in July 1991, a code was used, and that was ‘hop, skip and jump’. The devaluation was in two stages, so as to test the waters. That is irrelevant now and is only of historical interest. What is relevant is the phrase ‘hop, skip and jump’, better known as the triple jump. In a triple jump, each of the three phases is stronger and longer than the preceding one. In our reforms, we have hopped. On rare occasions, we have skipped. But we have still not jumped. If this sounds like a strong statement, we should go back and read an official government document that everyone has forgotten about now. It was published in July 1993, two years after the reforms.2 If we revisit that paper, we will find that many of the reforms that were talked about in July 1993 have still not been implemented. Earlier, pre-1991, Indian economic policy was supposed to have been influenced by Fabian socialism, though it was actually influenced much more by Soviet socialism. The reference to Fabian socialism is a reference to the Fabian Society, established in London in 1884. That kind of socialism was meant to be incremental and creeping, not revolutionary. Hence, the Society consciously adopted the name of Fabius Maximus, the Roman dictator and general during the Second Punic War (218-202 BCE) against Hannibal of Carthage. Fabius didn’t take decisive action. He used delaying tactics and was thus named ‘Cunctator’, the delayer. The point is that our economic policy-making lacks decisive action and resorts to delaying tactics.

Whatever be the baseline trend of GDP growth, adequate infrastructure services will provide an increment of 1.5 per cent to GDP, of which, 1 per cent is on account of the power sector alone. Legal reform can add another increment of 1 per cent. Improved morbidity, mortality, skills and higher work participation rates can add another 1.5 per cent. Satisfactory delivery of public services can add another increment of 1 per cent

Complacency has set in. This is fuelled by external reports that are bullish about India. The first BRIC (Brazil, Russia, India, China) paper by Goldman Sachs was partly responsible for popularising the idea of India’s explosive income and consumption growth potential.3 But there have been several others since then.4 And more importantly, there has been turbulence in the rest of the world, for example, in Europe. What do these reports generally argue? First, the savings rate, as a share of GDP, has increased and will increase further. Second, the investment rate has also increased. Third, the efficiency in the use of capital, measured, say, by the incremental capital/output ratio (ICOR), has improved because of competition. Fourth, the share of agriculture and allied activities in GDP is declining, while that of services is increasing. What is pertinent is that the services sector tends to have a lower ICOR, though not invariably. That apart, if agriculture is growing relatively slowly and services is growing relatively fast, the sectoral shift from agriculture to services itself jacks up GDP growth as a statistical inevitability. Fifth, there is the effect of export growth on GDP, though that it is contingent on a global recovery. Sixth, there is the demographic dividend and increase in labour input. Seventh, there is total factor productivity (TFP) growth, after netting out increases in labour and capital inputs. Not every report or study tries to quantify and estimate this, but nevertheless, this is a factor. Eighth, the young population does things to entrepreneurship that is difficult to pin down and make tangible. Ninth, and finally, projections are typically in US dollars and if the rupee appreciates against the dollar, there is the impact of exchange rate appreciation.

These reasons are all true. However, we seem to have settled down to a 7 per cent growth trajectory rather than a 9 per cent-plus or double-digit one. Here is a quote from the Planning Commission on the Twelfth Five Year Plan and the issues the country faces.5 ‘GDP growth for the 11th Plan is likely to be 8.2 per cent, which is less than the target of 9 per cent….The target of 10 per cent is being mentioned, but our internal assessment is that even 9 per cent will be difficult given the constraints we face.’ Even 9 per cent will be difficult for the Twelfth Plan. This is a departure from the days when the government glibly talked about double-digit growth in a couple of years. And for the next couple of years or so, we seem to be settling down on a growth trajectory of between 6 and 6.5 per cent. The period since 2003-04 is important, since before that, a growth rate of 9 per cent and more wasn’t regarded as feasible. Real rates of GDP growth were 8.5 per cent in 2003-04, 7.5 per cent in 2004-05, 9.5 per cent in 2005-06, 9.5 per cent in 2006-07, 9.8 per cent in 2007-08, 6.7 per cent in 2008-09, 7.4 per cent in 2009-10 and 8.5 per cent in 2010-11. However, it dropped to 6.9 per cent in 2011-12 and as one looks forward to 2012-13, the question is: what kind of real GDP growth is one likely to get? The Prime Minister’s Economic Advisory Council submitted a report in February 2012. This suggests GDP growth in 2012-13 will be between 7.5 and 8 per cent. In its third quarter review, the Reserve Bank of India (RBI) suggests 7.3 per cent for 2012-13, based on predictions by professional forecasters. We got 6.9 per cent in 2011-12. The difference between 7 and 8 per cent may seem to be marginal, but there is an issue. Are we stuck on a growth trajectory of around 7 per cent, or are we going to break out of it? The coming year, 2012-13, being marginally better than 2011-12 (at 7.3 per cent rather than 6.9 per cent), is neither here nor there. If 2012-13 gets us 8 per cent, we can aspire towards double-digit growth in the foreseeable future.

Bibek Debroy, Honorary Fellow, Skoch Development Foundation

It is an unfortunate human tendency not to look inwards. Hence, instead of identifying the problems within, we blame the global financial crisis and what is happening in Europe. It is not that the external world had no impact. It certainly did. But had reforms been introduced, this impact could have been neutralised and we would still have been on a growth trajectory of 9.5 per cent and more. In other words, the ‘constraints’ the Planning Commission mentions are internal, not external. The reason we are stuck on a 6-6.5 per cent trajectory is because the government is unable and unwilling to introduce reforms. What kind of reforms? These are instances of both government inaction and action. That pending reform agenda need not be recapitulated. It has been listed several times. However, a few back-of-the-envelope kind of numbers should be flagged. Whatever be the baseline trend of GDP growth, adequate infrastructure services will provide an increment of 1.5 per cent to GDP, of which, 1 per cent is on account of the power sector alone. Legal reform can add another increment of 1 per cent. Improved morbidity, mortality, skills and higher work participation rates can add another 1.5 per cent. Satisfactory delivery of public services can add an increment of 1 per cent. This is in the realm of the potential.

Growth of 9.5 per cent and more is not an end in itself. It is a means to an end. It provides additional resources for public expenditure, be it for items that are public or collective private goods, or through direct anti-poverty programmes. If a government doesn’t have the resources, how will it spend on such agenda items? Further, it is correlated with improvements in human development outcomes. As examples, as per capita income increases, so do life expectancy and literacy and assorted other indicators. Infant mortality, gender disparities in access and many other indicators show improvements. There is no need to debate the causation right now. It is sufficient to know that there is correlation. The 9th Report of the Second Administrative Reforms Commission included a quote, approvingly, though it didn’t include the last part.6 ‘Government control gives rise to fraud, suppression of truth, intensification of the black market and artificial scarcity. Above all, it unmans the people and deprives them of initiative, it undoes the teaching of self-help.’7 This was written by Mahatma Gandhi.

In any table of poverty, there will be categories of SCs, STs, OBCs and Muslims. But are they deprived because they belong to these collective categories? Or are they deprived because they lack access to the public or collective private goods we have mentioned?

Let us now turn to the issue of poverty and inequality. Since 2004, there has been complete confusion about inequality and poverty and what should be done about either. If there is lack of conceptual clarity, is it at all surprising that there should be confusion about policies to address either? Let us take poverty first, but without getting into the vexed issue of numbers. Instead, let us stick to core principles. First, are people willingly poor? Do they not wish to better their lives and improve their standards of living? Assuming otherwise is tantamount to a very patronising attitude towards poor people. At best, there can be a qualification for the old and the disabled and households where the head of the household happens to be a woman. These apart, people in working-age groups do not wish to be poor. Income growth and liberalisation will ensure that such people are no longer poor. As a minor statistical point, income and expenditure distributions aren’t symmetric. They are log normal, with a thick part towards the left. As soon as this thick part of the distribution passes above the poverty line, however that happens to be defined, there will be sharp drops in poverty. This has already begun to happen for India and will continue, assuming we can ensure that growth continues. In states that have grown, there have been such sharp drops in poverty – Punjab, Haryana, Kerala, Tamil Nadu, Gujarat, Andhra Pradesh and Assam. Second, even if people do not wish to be poor, they may be stuck because they do not have access to education and skills, health services, market information, technology, financial products, roads, electricity, water, sewage and sanitation. Then, the answer is to efficiently provide these public goods or collective private goods.

‘People can be trapped in poverty, when poverty itself becomes a constraint to growth. This occurs in regions that display characteristics of high conflict, low savings or investment rates, dismal education or health outcomes, poor access to credit or property rights, and incomplete insurance markets which increase the risks of crop failures, floods, and droughts.’8 Hence, poverty results from lack of integration. Third, we should therefore ask an important question. Are there sections in the Indian constitution that prevent such integration? For instance, Articles 370 and 371 of the constitution ensure that certain parts of India will never be integrated and mainstreamed. Fourth, this kind of mindset also ensures that we look at the problem of poverty with a distorted lens. In any table of poverty, there will be categories of SCs, STs, OBCs and Muslims. But are they deprived because they belong to these collective categories? Or are they deprived because they lack access to the public or collective private goods we have mentioned? ‘What the numbers do seem to imply are: first, there is a good deal of truth in the old-fashioned story that economic and educational opportunities, more than caste identities, are determinants of access to various goods of poverty.’9 Poverty is an individual household characteristic. By equating it with a collective category like SC, ST or Muslim, we commit a double kind of mistake. We assume that everyone inside this collective category is poor, by virtue of being a member of a collective category. And we also assume that everyone outside this collective category is rich, by virtue of not being a member of this collective category. Neither of these propositions is true.

I don’t think interest rate hikes have been as much of a problem as they are made out to be. The problems lie elsewhere – forest and environment clearances, problems with land acquisition, mining, coal and a complete lack of decision-making on the part of bureaucracy

We now turn to the more controversial question of inequality. Poverty is an absolute concept, while inequality is relative. There is an impression that increases in inequality, real or perceived, are bad. In a paper by Suresh Tendulkar, there is an interesting anecdote about a conference in Bangkok when Manmohan Singh was the Deputy Chairman of the Planning Commission. ‘After other delegations presented their experiences in managing a market economy, the Chinese vice minister presented an outline of the Chinese reform program. At the end of the presentation, Manmohan Singh, in his usual gentle but forceful tone, asked, “Would not what you are trying to do result in greater inequality in China?” To that the minister replied, with great conviction, “We would certainly hope so!”10 There is a difference between inequality in access to inputs (physical and social infrastructure, financial products and so on) and inequality in outcomes (income). Everyone would like India to be equitable. But equity should be interpreted in terms of access to inputs and we should be legitimately upset if there is inequity in that. However, why should there be equality in outcomes? Any period of rapid economic growth results in increased income inequalities. Simon Kuznets argued this out a long time ago.11 This should be welcomed, not denigrated, while taking care of inequity in access to inputs.

Bibek Debroy, Honorary Fellow, Skoch Development Foundation

Let us get back to 2012-13 and the Prime Minister’s Economic Advisory Council. ‘Despite efforts taken at making investment easier, especially in the infrastructure space, the combination of worsening international conditions, particularly the crisis in the Eurozone and the difficult domestic political situation seem to have combined to slow the recovery in infrastructure investment.’ I am not sure what the ‘difficult domestic political situation’ means, since it is not explained. Whatever it might mean, what is the case for it to improve in 2012-13? Here is something a bit more specific. Gross fixed capital formation (the investment rate) was 32.9 per cent in 2007-08 and dropped to 29.3 per cent in 2011-12. ‘That is a decline of almost 4 percentage points over the last four years.’ The Council expects this to improve by 1.5 to 2 per cent in 2012-13 and that’s the reason for the optimistic growth scenario. It is not obvious to me why private corporate sector investments will increase, or public savings and private corporate savings increase, or deficits decline and subsidies become less. ‘There is a need to alter the investment–savings dynamic in a manner that can lead to higher rates of fixed investment financed from a reduction in the government’s negative savings, less of surpluses being expended in subsidies in the public sector companies and improvement in the mobilization of household financial savings by organized savings institutions.’ No quarrels here. But why is this going to change in 2012-13?

The crux of the problem is this ‘policy paralysis’ phrase that floats around. There is a long list of pending reforms. Let’s not get into that. If those reforms were introduced, we would have been able to do better than 7 per cent. But forget that. Why has everything worsened since 2009? At a macro level, most people focus on monetary policy hardening. Now that inflation numbers are respectable and now that monetary policy has been loosened, there will be a switch from public consumption expenditure to private consumption and investment expenditure. So runs the argument. I am prepared to buy the argument partly for private consumption expenditure, but not for investments. I don’t think interest rate hikes have been as much of a problem as they are made out to be. The problems lie elsewhere – forest and environment clearances, problems with land acquisition, mining, coal and a complete lack of decision-making on the part of the bureaucracy (incorrectly ascribed to Right To Information). Those are the specifics of the ‘difficult domestic political situation’ which the Council did not define. Whatever be our views on the new land acquisition bill and amendments to the mining bill, the point is that those pieces of legislation haven’t been passed. And until they are passed, no land acquisition is happening, or will happen, since there is legitimate fear that courts will step in. Land acquisition is the primary reason why road construction has flagged. The devil is in the micro, not the macro. While the reforms, and their lack of it, are indeed an issue, these are the micro reasons why UPA-II’s track record has been worse than UPA-I.

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