Saturday, June 20, 2009

The Indian economic debate

Three approaches to economic development
in India

After liberalization of the economy in 1991 India has grown at a rate that is roughly twice the world average in the same period. The growth rate was around 6% initially and touched 9% in recent years before dropping to 6.7% this year due to the global recession. This is a big improvement over the 3% growth rate that India had before economic reforms were introduced in the 80s and 90s. The high growth is usually attributed to the end of the era of excessive bureaucratic regulations that were required to set up and run businesses in India (the License Raj) and the opening up of the economy to foreign investment.

These reforms have visibly transformed the lives of many middle and upper class families in urban India. This has led to a growing sense of optimism among those of us who have benefited most from these economic reforms. In a country where nothing worked our generation has seen pockets of efficiency emerge. The mainstream media tells us how more and more Indians are overcoming their instinctive fatalism and are becoming more "aspirational". There are frequent reports that tell us how India will soon surpass major economic powers to become one of the three largest economies in the world. Those of us who are concerned about the large number of poor in our country are assured by the media that prosperity of the rapidly growing Indian middle class will slowly but surely trickle down to the poor people.

The intellectual underpinning of this model of economic development is provided by supply side economics. Supply side economists believe that the most effective way to grow the economy is by providing incentives to industries to produce (supply) more by removing unnecessary regulations, reducing corporate taxes etc. They argue that prices of goods come down because of greater supply and as industries grow they employ more and more people so that wealth eventually trickles down (where I use the term in a purely descriptive and not pejorative way). In India proponents of this view support measures that encourage industries to grow like privatization, deregulation, allowing more foreign investment etc. They are skeptical of government spending on subsidies and social programs and say that most of this money is wasted as it never reaches the poor because of poor implementation and corruption. Thus, they say, the only effect these social programs have is that they increase the budget deficit which in turn stifles growth. They point out that in India even a perfectly equal distribution of the net income would mean that every person would earn only about Rs 3000 per month so that rapid economic growth is a necessary condition for poverty alleviation. The fact that we have almost tripled our pre-reform growth rate of 3% (the so called Hindu growth rate) is therefore a big achievement. Thus they believe high growth itself is the best strategy for poverty eradication pointing out that while there was virtually no change in the percentage of people below the poverty line in the 'socialist' phase till 1980, with the introduction of reforms this fraction has steadily dropped ever since (from 51% in 1978 to 28% in 2005 according to official figures).

The Indian Left is, however, highly skeptical about what these figures mean and doubt that there has been any real change in the lives of the poor. For instance if poverty is measured according to number of calories consumed one finds that 75 % of the Indian population was getting less than 2400 calories in 1999-2000 compared to only 56% in 1973-74 (see this article for an explanation of these figures by a pro-reforms economist). In fact India has a very poor record in reducing hunger and according to a World Bank report houses "about 49 per cent of the world's underweight children, 34 per cent of the world's stunted children and 46 per cent of the world's wasted children". The report goes on to note that much higher economic growth in India compared to Sub-Saharan Africa has not translated to a better "nutritional status of the Indian child". Leftist commentators think that the reason for all this is that India has experienced a highly lopsided growth which has benefited mainly the top 20% of the population. The growth has been led by the services sector which employs only about a quarter of the population (most of whom live in the cities) while agriculture which employs 60% of the population has grown at a much slower rate of about 3%. They point out that the great performance of the Indian industries has not been through employment expansion but due to a manifold increase in the output per worker (without a corresponding increase in their wages). Compared to a growth rate of 1.2 % in the period 1983-94 the fraction of people employed by the organized sector has actually shrunk at a rate of 0.3% per annum in the period 1994-2005 ! But the organized sector only employs about a tenth of the Indian workforce. What about the unorganized sector? Noted leftist economist Amit Bhaduri believes that only the big industries can produce goods and services, such as ACs or spas, that meet the growing demand of the rich. Thus the poor people, most of whom are in the unorganized sector, cannot participate in this economic growth either as produces or consumers. The Left is also infuriated by incidents like Nandigram and Singur, where farmers were forced to give up their land for the sake of industrialization, and stories of small scale producers who are unable to compete with big global corporations. Bhaduri asks "Why should the very poor who are least able, bear the burden of ‘economic progress’ of the rich ?"

So while the Left acknowledges the importance of high economic growth they are not happy with the nature and composition of the present growth. So what does the Left propose? Contrary to their usual media portrayal some in the Left do have a positive agenda. They advocate a Keynesian demand driven approach to economic growth. Keynesian economists believe that in certain situations (such as if there is a recession) it is advisable for the government to spend money (even if it leads to a deficit) to employ more people, increase the aggregate demand and thus stimulate the economy. Such a program for economic growth in India has been described in detail in Bhaduri's articles and his book Development with dignity. He says that the government should guarantee jobs for all. This would increase the purchasing power of the poor which would lead to a growth in the rural demand. The nature of the demand would help small scale producers and industries that cater to the demands of the poor leading to a growth of rural markets. Such an economic growth would be more broad based and inclusive. Where would the money to finance such a massive government program come from? Bhaduri argues that the government should deficit finance the program and that the deficit would not lead to inflation in an economy with unsold foodgrain stocks, unemployed labour and unused foreign exchange which can be used to import necessary goods which are not present in excess like steel (inflation is caused if there are not enough goods to meet the demand). The essential difference between this model of economic development and the earlier supply side approach is that while in the earlier approach economic growth leads to employment generation, in this approach employment generation leads to economic growth.

A third approach to economic development which is neither anti-liberalization nor against social sector spending is gaining a lot of support after the convincing return of UPA in the 2009 polls. It is hard not to interpret the election results as an endorsement of UPA policies by the people of India. As psephologist Yongendra Yadav notes, in a country where incumbent governments have been thrown out 80% of the time "in almost every State, the Congress has finished at the upper end of the band that it could have performed within." Even in non UPA states the ruling party has won if it has governed efficiently as in Bihar and Gujrat .

So what is this third approach? The most illustrious proponent of this approach is probably Amartya Sen. Sen supports globalization but says that it must be complemented by policies that build a safety net to protect local producers who are suddenly thrown into the highly competitive global market. He notes that in the years (2004-2005 to 2006-2007) which saw unprecedented growth rates (7.5 % , 9% and 9.4%) government revenue has expanded at an even faster rate (12.5%, 9.7% and 11.2% after correcting for price change). Sen wants the government to use this money in critical areas like health services, education and physical infrastructure. Thus proponents of this view believe that reforms are not undesirable. In fact they think reforms are necessary if India has to raise the resources needed to overcome its major social challenges. Unlike supporters of the first approach, however, they believe that we should not wait for the market to distirbute the fruits of economic growth to everyone and believe that the government has a major role in this. In the last five years which saw high growth rates the UPA government spent massive amounts in the social sector. They started the National Rural Employment Guarantee (NREG) scheme and waived loans of millions of farmers. While some of these policies might have been the result of the pressure from the Left parties the election results seem to have convinced UPA that this is the right direction to take in the future The UPA government has already made it clear that it will continue to spend massive amounts in social programs including a Rs 50,000 crore food bill and a plan to make India slum-free in five years. At the same time, however, they have clearly indicated that they want to relax foreingn direct investment (FDI) caps in various sectors and disinvest PSUs (public sector units) to raise the money needed for the social sector spending.

This approach is beginning to gather some support from both the economic Left and Right. The Left has seen some of its long-standing demands like the employment guarantee scheme being finally implemented. That the Left would welcome this recent emphasis on social schemes is of course expected. What is more interesting is that a growing number in the industry are also favouring these schemes. In 2008 the industry and the mainstream media was very critical of the "populist" tone in the budget and were especially disappointed by the farm loan waivers. Until very recently the media coverage of the NREG scheme was very negative focusing mainly on poor implementation of the scheme. Attitudes began to change even before the elections after India was hit by the global recession. The ideal time for Keynesian, demand side policies is of course in a recession when there is a drop in demand. The farm loan waivers and NREG incomes effectively acted as a stimulus to the rural economy which hardly felt the effects of the slowdown. In March new cellphone connections hit a record 15.6 million mainly because of rural consumers. Hero Honda motorcycle sales directed at rural buyers are also significantly up. The increased rural buying has helped sustain the aggregate demand thus ameliorating the blow of the global recession on the Indian economy. This explains the sudden change in attitudes of the pro-industry group.

The UPA may find it much harder to please everyone again this time. The global environment, which was probably the most important reason for the high growth rates in their first term, may be far less encouraging this time in the aftermath of the worst global crisis since the Great Depression. The fiscal deficit may cross 11 % this year. What would the UPA government do if the economy does not perform so well in the coming years and the deficit does not decrease ? Would the government cut down on social spending and thus enrage the Left ? Or would the government maintain the social programs even at the cost of high deficits and thus disappoint the Indian industry?

PS: As a friend pointed out, by "the Left" I do not mean the Left parties or what the media usually means when they refer to "the Left". Unfortunately the saner Left viewpoint discussed here does not get much exposure and one has to spend a lot of time on the internet to find these arguments.

1 comment:

  1. If not for the "PS: ..." I would have brought that up. :P

    If you ask me the 3rd alternative has been proven to work. And if nothing else, a better infrastructure can't harm a nation of a billion people in dire need of exactly that. Probably education and health are the most important sectors that needs public spending right now.