"Public investment: for a new normal", 'The Hindu', January 25, 2016


Public investment for a new normal

Barring the IMF, most observers of India’s economy appear to think that it is not exactly “in a bright spot”. Of course, one can see where the Fund is coming from. Multilaleral agencies, though armed with a cookie- cutter approach, do take a global view and it is true that India is today the world’s fastest growing economy. Cheer on this fact must however be mediated by awareness of a far lower per capita income in India compared to the other countries of the BRICs grouping. Moreover, early indications are that India’s growth rate is slowing this financial year. All this is far from what some had expected when Narendra Modi was elected in May 2014. Expectations of a new dynamism in the economy were rife then, at least among corporates and the middle class. Mr. Modi was seen as decisive and growth-oriented, his credentials burnished by his record as the chief minister of Gujarat. The enthusiasm has dissipated by now, and he is under pressure to show results on the economy when, in fact, on the core issues of the economy he has not been able to even show much initiative. Some part of this situation may be out of his control as the bureaucracy matters when it comes to crucial decisions. But even in terms of the politics, as far as the core of economic policy is concerned, not much has changed since UPA II. I elaborate on both these points. The bureaucracy and the technocrats in government may have since 1991 locked economic policy into some tenets of the so-called Washington Consensus leaving it with less than the desired degree of flexibility. And, independently of this, there is a consensus within the  political class that militates against change. Both have a bearing on the current situation. But, first, how is the current situation to be understood?

           The recent stagnation, if not further decline, in the rate of growth is a continuation of the decline since 2008. We are possibly facing a ten-year cycle here. Some part of this has to do with the global slowing but some part of it has also to do with internal factors. Agricultural performance has been poor since the phase 2003-08 when India had boomed and the pace of infrastructural growth driven by public investment has slowed. It bears mentioning that in this period, when India had come close to achieving double-digit growth rates, private investment in infrastructure was been very high but yet eclipsed by the growth of public investment. This should make us accept the idea that publicly-created infrastructure will be part of any high-growth process for the foreseeable future. Secondly, in purely macroeconomic terms, there are moments when public investment serves as the deus ex machina. This is when the private investor is skittish on spending. We are very likely facing such a situation presently.

           It is devilishly difficult to separate out the demand from the supply-side causes of an economic change, in this case, the slowing of growth, but much points to the growth of demand slowing of late. The growth slowdown, has taken place when the supply side governed by policy has not seen any great worsening for firms in the non-agricultural sector. Private investment has been very high in the past even as the supply side has not been discernibly more favourable than  right now. But private investment is depressed today, leaving the economy almost entirely dependent upon public investment. The excellent, for both incisiveness and style, ‘Mid-year review of the economy’ issued by the Finance Ministry states that there are only two sources of demand growth in India today, namely private consumption, and public investment. But, actually, with private consumption largely tied to income, public investment is the only exogenous source of demand growth now, exports having stagnated for close to one year. It may be too hasty to term this situation ‘the new normal’ but it certainly is a noteworthy aspect of what we are up against.

            Even if global demand has not caused the slowing to start with it, is clear that we must now rely on our own devices to grow, in the sense of finding the source of demand. Enter, with enervating effect, an element of the Washington Consensus that stands in the way of such a project!  This is the axiom, so to speak, that expanding government is not good for the economy. It is no more than an ideological construct and no better than the axiom that privatization is to be avoided under any circumstance. In a situation when private investment is reluctant, public investment has a role in not only as a source of aggregate demand but also as catalyst. This it does by anchoring profit expectations. Private investment is based on expectations of profit. In the technical language of finance, expectations are contained in the ‘internal rate of return’ of a project. In the slightly more academic language of behavioural economics expectations of profit are captured by the ‘marginal efficiency of capital’. Far from being known with certainty, profit expectations are highly subjective. They are based on anticipations of the future state of the economy of which little is known. However, private investors need to know it as the demand for their product depends upon aggregate demand in the future and this depends upon investment, both public and private. In the absence of public investment each private investor must guess what others are going to do. To use the pithy phrase of Maynard Keynes, investors now end up “chasing each other’s tails”. In a situation of contagious pessimism no increase in private investment will take place. The Government of India would have a unique role to play now. For, substitute ‘state governments’ for ‘private investors’ and we have a replay of the investment game where everyone is waiting for someone else to make the first move. Public investment provides forward guidance to the economy.

            Even when the Finance Minister is convinced of the necessity of public investment he is berated by admirers of the Washington Consensus who argue against an expansionary budget on grounds that fiscal consolidation will be damaged. India’s fiscal consolidation programme is based on norms drawn from the European Union. There is no basis in economic theory for a pre-specified fiscal deficit target. And in any case, the European economy is in such a mess that no self-respecting economist would adopt its macroeconomic architecture uncritically. Fiscal policy is to be used imaginatively, according to the needs of the economy as they arise. Instead we run the danger of tying it to unjustified targets. If an increase in the fiscal deficit were to be used to expand public infrastructure it would have served a useful purpose, both in the current context and with regard to the longer-term trajectory of the economy.

            We may conclude with two observations. First, is it absolutely essential that the fiscal deficit must expand substantially to enable a programme of increased public spending on infrastructure? Not necessarily. Here, a sort of New Delhi Consensus, shared by all political parties, stands in the way of the expansion of public infrastructure. There is a reluctance to raise public revenues even in the face of inflation. At the Finance Minister’s annual meeting with economists in 2015 one the gathering had pointed out that the real value of railway fares had been eroded upto forty percent by inflation. If public bodies are starved of funds they cannot expand. This acts as an in-built depressor. Even Mr. Modi is quick to expound that he intends not to cut subsidies, only to target them better. Is it possible that at least some of the subsidies of the Government of India may be bad for growth, and therefore employment, in the sense that they constrain expanding public investment? Possibly. Political parties are reluctant to review the subsidy regime. They are also reluctant to divest. This stance is a mirror image of the position that any expansion of government is bad. It is considered form to even suggest sale of public assets. But why should we not consider sale of assets in areas where a public presence is no longer considered essential as it was some decades ago? There can be no intrinsic argument against the government selling some assets only to acquire others. Barring consideration of the prices at which these transactions would occur, there is no case for ruling out of court such asset swaps. It can be beneficial for growth and employment, and therefore for welfare. It is a no-brainer to have to choose between a publicly-owned airline that charges more than the private sector or with roads, bridges and irrigation channels. The forward guidance for our FM is that he should not take his foot off the accelerator of public capital formation. A rationalisation of subsidies and some asset swapping would ensure that he can do this without much more borrowing.