The Hindu Business Line : Will the revival package work?

The assumption behind the recent measures is the belief that additional expenditure can increase aggregate demand and economic activity, thereby forestalling recession. But how much of the money pumped into the system will translate into real output and how much into higher prices remains to be seen, says A. SESHAN.

Will the measures help increase output and employment?

The authorities have released massive amounts of money through monetary and fiscal measures to give the economy a fillip. There are many predictions on Gross Domestic Product growth this year ranging from 6 to 8 per cent. One does not know how these rates are worked out — whether on the basis of robust econometric models or simply based on the hunches of pseudo-economists and politicians.

It is quite possible that the predictions of leading institutions engaged in economic research are estimates derived from macro-econometric models. The experience of this writer, who was associated with the formulation of a macro model by P. K. Pani in the Reserve Bank of India (RBI) many decades ago, was that it was satisfactory in analysing the behaviour of the economy — sectoral and aggregate — from 1975-76 to 1981-82, based on an evaluation of errors of prediction and turning points (Reserve Bank of India Occasional Papers, December 1984).

The RBI might have done some further work on this model taking into account the fundamental and widespread changes in the structure of both the real and financial sectors in the last quarter century. The economists who trot out estimates of GDP growth would be rendering a service if they display their models in the public domain, transparently.

The assumption behind all the recent measures, whether in India or abroad, is the belief that additional expenditure can raise the level of aggregate demand and economic activity and forestall recession. It is a truism in a nominal sense.

After all, one of the procedures for computing national income is through the expenditure route. One man’s expenditure is another man’s income. For example, the increases in salaries effected this year, thanks to the recommendation of the Sixth Pay Commission, will certainly contribute to a growth in GDP! However, the fundamental question raised in monetary economics is how much of the additional money pumped into the system translates into real output and how much into prices.

Prisoners of ideas

From Knight to Keynes to Friedman, and further on, economists have come out with varying answers, not all of which have stood the test of time. A recent fashion in the thinking of some economists in the country, following their peers in the US, is to say that fiscal measures need to be undertaken to deal with the falling rate of growth of output. Their patron saint is John Maynard Keynes, who himself cautioned his contemporaries on the dangers of becoming prisoners of past ideas.

Our economists know the circumstances under which Keynes formulated his theory and how it worked satisfactorily until about the 1970s when the phenomenon of stagflation appeared. Basically, the Keynesian postulate is that a deficiency of demand leads to a decline in the economy and, if government fills up the gap, it could raise employment to its full level utilising the idle productive capacity in the system.

It means that there is plant capacity available to raise production and there are unemployed personnel available to assist in the process.

The missing link is purchasing power to raise aggregate demand to make production worthwhile. It can be provided by government. This premise may still be true in the Western context. It holds true only partially in India. The demand-constraining problem facing the average consumer today is not just inflation but also the level of prices.

When a banana is priced at Rs 3 against Rs 2 a few weeks ago, or a cup of coffee costs Rs 15 in contrast to Rs 12 earlier in a Grade III restaurant in Mumbai, it makes no difference to the common man whether the price rise is 5 per cent or 10 per cent. It was just not affordable, even at the pre-existing level. Think of the experts claiming that inflation is no longer a problem when it is still in double digits for primary goods!

The reduction in effective demand is partly domestic and partly external. On the external side, the demand for exports depends, inter alia, on prices, world incomes and currency values of competing countries. There is nothing India can do to raise the levels of incomes abroad. But it can try to capture a larger share of the existing export market, even if there is no growth there.

Farm potential

Although the share of agriculture and allied activities is less than one-fifth of GDP the proportion of population dependent on that sector is around 70 per cent despite all the changes in the structure of the economy over the years. What is the unutilised capacity in agriculture? Practically all the land available for cultivation is brought under the plough. And despite considerable improvement in irrigation facilities, agriculture is still a gamble in monsoons.

The only unutilised capacity lies in double-cropping, or even triple-cropping. The area sown more than once rose from 13.15 million hectares in 1950-51 to 45.27 million hectares in 1995-96. Since then, progress has been tardy. It was 50.90 million hectares in 2005-06, the latest year for which data are available. All the money that is channelled to agriculture now will only keep up production on the existing net area sown, not increase the gross cropped area. It remains to be seen whether the money now released will lead to additional production, incomes and purchasing power in the farm sector, given the above constraints. “Disguised unemployment” is the problem in the agricultural sector.

Industrial output

As evident from current trends, there is unutilised capacity in the industrial sector, which accounts for about 20 per cent of GDP. There is scope for raising production and employment through both fiscal and monetary measures. One way of solving the problem of deficiency in demand is to reduce prices so that more products can be sold.

Recent reductions in taxes have resulted in benefits for the citizens buying consumer durables. However, it is an irony that while prices are falling in respect of automobiles, two-wheelers, telephone handsets, etc., there is no such discernible trend in the case of necessities like textiles and other fast-moving consumer goods.

Technological revolution should result in a reduction in costs and prices. It has happened in luxury and comfort goods but not in respect of necessities.

The unprecedented spurt in the demand for mobile phones brings out the importance of declining and affordable prices. It is, however, possible that the fiscal measures would revive demand for some consumer durables and have a favourable impact.

Services account for around two-thirds of GDP. How much can the reliefs help this sector? This is a hybrid group consisting of several sub-sectors including construction.

The attempt to revive this sub-sector, accounting for about 7 per cent of GDP, is well conceived, given its wide impact on the economy, as seen by the inter-industry or input-output tables of the Leontief type. Here, again, the basic question is how much will be translated into output gain and prices.

(The author is a former Officer-in-Charge of the Department of Economic Analysis and Policy of the Reserve Bank of India. blfeedback@thehindu.co.in)

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