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Rethink
There have been prolific and hair-splitting analyses of the GDP downturn in India for some time now and more intensely after the negative 24% growth published for Q1-21 and a potential dismal projection for the next few quarters too. GDP growth has been the primary showcase of our performance – more to the world than internally. A vast number of people of India are, in fact, impacted more by factors like - how the growth is driven (policy, approach) and the resultant outcome on them - rather than being seriously concerned about the growth rate per se.
Growth by R K Laxman
Façade of Our Growth Concoction
(September 2020)
It’s a number after all…
GDP growth after all, is just a number – that is flexible and thanks to the advanced algorithms and simulation techniques, can be derived, calculated and possibly adjusted – mostly by but not limited to economists and are often interpreted to advantages or allegiances to oneself, organizations or institutions.
We have witnessed the validity of the statement in India over the years including the recent past. Indian and international agencies have made multiple predictions of revising the GDP growth – uniformly downward though in recent times – they have estimated or forecasted. This makes us belief that the factors or assumptions that such estimates are based at are either not robust or influenced by factors of self-interest, the methodologies used are not uniform or simply, growth is not predictable.
While the current pandemic poses an unprecedented blow to the economy with no clear visibility of the finish-line of control, the agencies have continued with predictions and their regular revisions. For example, over the last few months, CRISIL has projected growth of the economy from 3.5%% to 1.8% to -9% in FY21!
Moreover, the flexibility of growth rate projection is not the only question, a group of economists have expressed concerns around the change of measurement of GDP with the new base of 2011 that makes comparison between the pre and post base year difficult. The initiative of a revised methodology of GDP calculation was taken in UPA2 regime in 2011 and completed in NDA regime in 2014. Arvind Subramanian, the former Chief Advisor to the Government of India estimates that “instead of the reported average growth of 6.9 percent between 2011 and 2016, actual growth was more likely to have been between 3½ and 5½ percent. Cumulatively, over 5 years, the level of GDP might have been overstated by about 9-21 percent” (Subramanian, 2019). This remains as an academic exercise.
If the measurement of growth is questionable, rates are flexible and subject to interpretation, we may avoid discussion on the numbers – but the trend, the approach and the impact remain points of our interest.
Whatever way it is measured, growth (in real terms) represents increase in the production of final goods and services – adjusted for inflation. This may be triggered by, among many other factors, technology innovation, more optimal resource allocation, enhanced government expenditure resulting in increase in labour, capital and/or other resource productivity and income. Increased income pushes additional consumption that may trigger further investment and more production to provide next round of impetus to growth. This potentially increases income more to the sections who directly contribute to the growth process (and control resources that drive the growth) and indirectly to others when the increase in income is percolated or distributed.
The growth may be dampened, if the resources show diminishing returns or reach a limit, the lag between the stages (e.g. increase in income resulting in demand, production response to demand etc.) are long enough to adversely impact growth etc. There is a plethora of literature in economic theory that models the process, describes the factors that may limit or decelerate this growth over time and explains how the growth behaviour is witnessed in developed and developing countries.
Interesting dimensions of India’s growth story
The growth over the last 3 decades of post liberalization in India has shown a positive trend – higher than the pre-liberalization period (annual average of 6.3% during 1991-2019 vis-à-vis 4.2% during 1961-90) but with periodic slowdowns – owing to internal and external factors. However, a few identified trends are worth noting.
First, the movement of growth was less influenced by the growth of agricultural sector while manufacturing sector has a stronger positive correlation with the overall growth (Figure 1). That is, the fluctuations in agricultural growth have not made much influence in the overall growth – thanks to the reducing size of the sector in overall GDP (30% in 1990 to 16% in 2019). The higher productivity of the more capital-intensive manufacturing sector has pulled the overall growth rate, but it has directly benefitted a relatively smaller section of the population vis-à-vis agriculture sector.
However, the growth in manufacturing is likely to push growth of other sectors owing to the inter-sectoral linkages and reaches the other poorer sections through percolation and distribution. There is also absorption of people from rural areas in growing manufacturing sector (refer to my earlier article on migration in August 2020) but the dependency on agriculture remains high. The gains accrued to the richer sections from this growth, if progressively taxed, can be distributed to the poor section – for the overall welfare of the country.
Interestingly, direct tax rates for India have remained stable or decreased over time. For example, taxes were lowered at all the levels of personal incomes in 1974-75, including cutting the maximum marginal rate from the highest ever 97.75% to 75%. The maximum level was further reduced to 50% in 1985-86 and gradually down to 30% since 1997-98. Moreover, deliberation on the wealth tax reintroduction is still in progress in policy circles. Thus, the resources to undertake such steps remain limited even if the intent is not in question.
Secondly, Indian growth since liberalization has emphasized on private investment that increased 3X to 22% of GDP between 1971 and 2018. On the other hand, public investment increased from 5.8% of GDP in FY-71 to 12.3% in FY-87 (pre-liberalization) before declining to 7.9% of GDP in FY-13.
The growth in the last couple of years however, has witnessed slack in demand (and sentiments thereof) in the economy and slowdown of private investment. Public investment provided the demand thrust to support the growth. In more recent pandemic period – there has been a genuine need for public expenditure to boost health and economic support. Leaving aside the current exceptional situation, this mode of growth impetus has created additional fiscal pressure, as evidenced in the rise of fiscal deficit (3.99% of GDP in FY15, 4.59% in FY20 and likely to be 7% in FY21).
The fiscal deficit is primarily financed through RBI/ public borrowing. It is argued that in both cases, this is supported by the saving of the higher income bracket people (who has higher propensity to save whereas the poor hardly has saving) who continue to earn higher interest returns with virtually zero risk on sovereign saving instruments – instead of investing the same in business in the situation of slack demand. This, in turn, potentially pushes inequality further.
Thirdly, the increasing growth trend is also followed with an increased inequality within the country. What it means, the income owned by the top 1% and top 10% of the population have grown along with the growth of GDP – and have not responded to short term downturns of the economy. Figure 2 shows the index inequality (index of ratio of % share of national income by top 1% to bottom 50% of population) and index of GDP growth during the last 3 decades. The pattern is the same when we look at the inequality in terms of wealth too.
Source: Data source World Bank and World Inequality Index
In fact, “IMF, so long as the bastion of growth-first orthodoxy, now recognises that sacrificing the poor to promote the growth was bad policy. It now requires its country teams to include inequality in factors to take into consideration when providing policy guidance to countries and outlining conditions under which they can receive IMF assistance” (Banerjee & Duflo, 2019, P-204).
A directional change – Hard policy call
The overemphasis of achieving higher growth in India over the last couple of decades – has witnessed concentration of income and wealth in a limited section of the population.
On the other hand, India’s tax revenue growth has plateaued in recent years. Leaving aside the corruption in tax payment and collection, a little over 1% of total population (1.46 Cr) pays income tax today demonstrating a narrow base of eligible tax-paying population. Moreover, the stable tax rates and broadening of the slab for exemption of taxes – together have contributed to inadequate direct tax revenue.
The result is striking: the direct tax to GDP ratio fell to its lowest in 14 years, at 5.1%. In fact, the overall tax to GDP ratio for centre and states combined was 17.1% in 2018-19 - much lower than OECD countries (34%) and even the average of emerging markets (21%). The Government thus has enough room to tax higher income group for revenue generation and also to bring better parity in income across sections. On top of this, sub-optimal subsidy policy has contributed more to exchequer and inequality.
India’s fiscal deficit is funded primarily through tapping of saving from the private sector at a higher interest (23.7% of government revenue). While this may potentially cause a crowding effect of private investment in short or medium run, the current situation provides an added source of income for the richer sections (those having higher propensity to save). As the recent period of demand slackness does not incentivise more private investment, the higher-yield government bonds provide opportunities to utilise the savings of the richer sections. In reality, the current government financing adds to inequality further.
The increasing inequality may result in social unrest – more likely when pandemic impact has been taking further toll on the economy – in production, employment and demand. Some sporadic incidences have already appeared.
It’s time to consider significant increase in tax – on income and wealth at higher income bracket as the policy for generating additional revenue and to devise a mechanism of distributing the same to the poorer section to enhance demand in the economy.
The Government has taken tough calls like demonetisation, introduction of GST. It is time to take a hard stance on direct tax and reorganising subsidy for direct disbursement to the poor. The Government has established an extensive framework for direct money transfer (to provide subsidy in specific areas or forms) – it’s now time to leverage this for direct money transfer on a periodic basis. Let the people decide how to spend their money. This would not only generate the needed demand but also would support the bigger cause of reduction of inequality. Even with a little less aggressive growth, we may be able to ensure better living of the citizens – a better welfare state for the country. What more the government is meant for!
References
Banerjee, Abhijit and Duflo, Esther (2019): Good economics for Hard Times, Juggernaut Press
Banerjee, Gopinath, Rajan et. al. (2019): What the Economy Needs Now, Juggernaut Press
Bhatia, S (2020): India’s fiscal performance, in nine charts, The Mint, 17 Feb 2020
Mallick, Jagannath (2009): Trends and Patterns of Private Investment in India, Working Paper 226, The Institute for Social and Economic Change
Subramanian, Arvind (2019): India’s GDP Mis-estimation: Likelihood, Magnitudes, Mechanisms, and Implications, Faculty Working Paper No. 354, Center for International Development at Harvard University, June 2019
(The views are personal)