"The slowing economy", 'Malayala Manorama', September 27

The slowing economy

(Translated from the Malayalam)

Pulapre Balakrishnan

Quite suddenly the focus of public discussion in India has turned from the social and political to the economic. Attention is now on the fact that the economy has contracted for five consecutive quarters, that is from late 2015-16 onwards. By now growth is slower than it was in the quarter in which the Narendra Modi government had taken over. For a government that had promised to turn around the economy through decisive governance this must serve as a wake-up call.

          In 2016-17 there was a revival of exports from India, so it cannot be that the slowing of growth here is related to the slowing of world trade. On the other hand, it is possible to identify two factors that have caused the slowdown, both related to the government’s actions. More recently, the demonetisation caused a cash crunch and loss of output. This may be expected to have at least a temporary impact on private investment. How long it will last we cannot say. However, the government may have contributed directly to the slowing of the economy which commenced even earlier than last November by reversing the rate of growth of expansion of public capital formation from 2015-16.  

          Why should it matter to us if the economy is growing more slowly? Growth matters in India as a large number of persons have to make do with far too little goods and services, which is how we define poverty. Note that these goods also include public goods or goods that are accessed by the entire populace of a country, such as parks, roads and bridges. Since these public goods are provided by government, the government needs tax revenues to supply them and tax collections rely on national income. Then there is employment. A demand for labour exists only when there is a demand for goods. So growth is necessary if employment is to grow. In India we not only have a pool of unemployment persons to absorb but we also need to provide employment to young persons continuously joining the labour force. From this point of view, the slowing of the economy is a source of concern, as an economy that has been slowing for five quarters is unlikely to turnaround quickly. Also it may not be able to do so on its own. So, what can be done right now?

          It is generally the case that investment drives growth in the economy. Investment is an immediate source of demand as firms that invest buy goods and services to do so, but it is also expands the economy’s capacity to produce. There are  two sources of investment, namely private and public. By now the first has been depressed for some years. In a slowing economy private investment is unlikely to revive in the absence of some external force. This is so as investment involves committing one’s funds for a long period and the fruits are uncertain. It is for this reason that economic theory prescribes the stepping-up of public investment when private firms are unwilling to invest. Not only does increased public investment increase demand and quicken growth but it could also encourage private investors to invest as the market for their goods expands.

          Other things being the same, increased public investment leads to a higher deficit which is the gap between the government’s expenditure and its receipts. Among economists themselves there is resistance to governments running a deficit for fear that it may be inflationary. But in an assessment, the increase in inflation must be offset with the increase in growth that would have been achieved due to greater public investment. In India the increase in inflation that could come with higher growth is due to the shortage of agricultural goods. So any plan for increasing the rate of growth, not just at the present moment but in general, must reckon with agricultural shortages. We have not yet fully solved this problem in India whichever the government in New Delhi.

          The Narendra Modi government has been reluctant to increase the deficit. While it is right to be concerned with the consequences, the correct approach would be to aim to balance the budget over the cycle. That is, the deficit may be increased as the economy slows and contracted as the economy quickens. To object to an increase in the deficit irrespective of the state of the economy is not a scientific approach to the issue. Since 2014 the government has focussed excessively on the supply side by making it easier for private firms to produce. But we are now facing a demand shortage in the economy. The immediate thing to do is to expand public investment in infrastructure. To understand what exactly this would mean, consider the following report of a statement made in the Kerala Legislature by the Minister for Public Works: “Replying to the debate on demand on grants for public works in the Assembly, the Minister revealed that only 606 of the 2,300 bridges could be deemed safe. An estimated 365 bridges needed “emergency replacement”.” (‘The Hindu’, Thiruvananthapuram edition, May 31, 2017). Repair and reconstruction of India’s infrastructure, of which bridges are only one instance, is the direction in which public investment must now flow. It is the most direct andimmediate measure that can be undertaken to address the slowdown the economy is experiencing.

          Late into its tenure this government appears to have realised that a large and complex economy such as India’s does not work according to political preferences. Now that slowdown has received wide public attention, it has revived the Prime Minister’s Economic Advisory Council, clearly with the view to seeking wider advice. It is worth recalling that in the early years of the Indian republic the government was far less ideological in its approach. Not one of Jawaharlal Nehru’s five Finance Ministers shared his socialistic vision. In fact one of earliest, John Mathai, was a director of Tata Sons. A government is expected to have a sense of what will work.