It’s time to focus on microeconomic growth

SA Raghu | Updated on July 20, 2020

For too long, we have fixated on the macro-GDP, overall consumption and investment and increased financialisation of the economy. We now need to address labour reform, manufacturing and debt-financed social spending

Economists always had a vaccine for downturns — injection of cash — even if they did not quite know how to go about delivering it. The recession triggered by the Covid-19 pandemicis a not a demand meltdown in the conventional sense, but one that came about by the freezing of economic activity.

To be sure, it created big supply shocks which nations are grappling with. But supplying liquidity through cheap or forgivable loans has not necessarily worked, even in the US. The Federal Reserve reported a record $2 trillion in deposits flowing into US bank accounts since January, fueled by the government’s pandemic stimulus. Consumer savings in the US hit a historic high of 33 per cent in April, because the stimulus still lay in peoples’ checking accounts.

Economic downturn

India’s experience was not very different — the RBI’s easy lines of credit to banks had few takers, with money actually flowing in reverse from the banks to the RBI. Banks everywhere had more cash than they could use, because firms were unwilling to invest and consumers unwilling to spend. The pandemic switched off the economic machine but the impact felt is more from long-standing unsustainability that characterises the modern world — in supply chains, in trade models, in excessive financialisation, etc.

Short-terms measures called for are cash relief and rehabilitation, especially for the hardest hit, the rural poor and the urban migrants who lost even the little they were making before the lockdown. But the crisis provides an opportunity for fundamental reforms, because it is the structural flaws that have made us vulnerable. While we worry about blips in the growth of our $2.7-trillion economy, we must also remember that our per capita income is one of the lowest in the world, an aberration symptomatic of deep inequalities in income and consumption.

We may be a services-driven economy, but that sector employs the fewest people (about 30 per cent) while those that employ the largest workforce (over 50 per cent) produce too little income (17 per cent). The small economic pie has been the source of many ills — the tax-to-GDP ratio is only about 10 per cent (as against over 30 per cent in most countries), which means the government does not have enough money to spend. It is no surprise that our spending on health and hospital infrastructure is low. A taxpayer base of only 85 million in a workforce of about 450 million has meant an excessive reliance on indirect taxes, hurting the poor even more.

Investment spending, the other growth engine, is now largely construction and real-estate oriented — over 50 per cent of fixed asset formation is buildings, dwellings and structures, and only about 33 per cent plant and machinery, suggesting the bank finance-manufacturing-investment-GDP link may not be as straightforward as assumed. In fact, bank lending has veered towards personal credit, over 50 per cent of which is housing loans.

Labour issues

The ubiquitous role of construction and real estate — 15 per cent of total GVA, over 50 per cent of capital formation and in bank financing — probably meant easier opportunities to absorb rural labour, as much as manufacturing and services failed to do so. This, with the combination of low literacy, skills and weak labour laws, has resulted in an employment structure where over 65 per cent is unorganised and informal. To be sure, construction also helped create the much-needed infrastructure assets such as roads, ports, airports or power transmission; but the problem has been the inability to find models that could provide organised, productive and secure employment. Technically, we transited from an agriculture to a services economy but seem to have left our labour behind.

Development economics has been struggling to understand growth, and there seems no quick fix to escape the cycle of low incomes, low demand, low taxes and low investment. For too long, we have focussed on the macro-GDP, overall consumption and investment and increased financialisation of the economy only served to hide weaknesses, as we celebrated feel-good indicators such as foreign investment inflows and stock market indices. Growth as measured by overall consumption spending (aided by low energy prices) or overall investment (spurred by construction, infrastructure and real estate booms), left several inadequacies — in demand, in infrastructure and in revenues — which the pandemic exposed.

If the rationale of lockdowns was to provide breathing space to health infrastructure, it also presupposes adequacy of infrastructure in the first place. We have to now shift focus to micro needs — labour reform, manufacturing (whether through self-reliance or riding global supply chains) and debt-financed social spending (education, health, sanitation).

The writer is an independent financial consultant

Published on July 20, 2020

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