Macroeconomics

What should we do about the Indian economy? A wide-angled perspective - IV

  • Blog Post Date 29 September, 2019
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Ashok Kotwal

Editor-in-Chief, Ideas for India; University of British Columbia

ashok.kotwal@ubc.ca

In the previous part of this series, Ashok Kotwal and Pronab Sen traced the genesis of the present economic slowdown. In this part, they discuss the way forward to arrest the slowdown. They suggest a rural-led growth strategy, which would deliver slower overall growth but will have a bigger positive impact under the present circumstances. They argue that a rural-led strategy may also circumvent some of the obstacles that are presently preventing India from implementing the template followed by successful Asian countries.

This piece was written for The India Forum by I4I Editors Ashok Kotwal and Pronab Sen: https://www.theindiaforum.in/article/what-should-we-do-about-indian-economy

The way forward?

It is clear that fast, sustained, and transformative growth that will create good jobs, relieve rural distress, and take India to the ranks of a developed country is not possible unless some structural problems are solved. These include vastly improving the public education and public health system to improve India’s human capital, reforming labour and land laws, improving the financial system, and changing the suspicious and punitive attitude toward business.

Market forces operate through the animal spirits of entrepreneurs, and there is little scope for these to manifest themselves unless the structural bottlenecks are cleared. Governments of different parties have come and gone and these structural problems have remained unresolved.

Yet, it is not clear that even if the domestic obstacles are overcome, India will succeed in charting the East Asian course of development (through labour-intensive exports of manufactures) to the extent that China and other Asian countries did. As mentioned earlier, the times are different now. Developed country markets are less receptive to imports from low wage countries. Automation has eroded the comparative advantage of cheaper Indian labour. What then is the way forward?

Rural-led strategy

An approach worth trying is a rural-led growth. The idea of a rural-led strategy is predicated on the notion that at this juncture in time it might be easier to revive demand in rural India than in urban India. Growth driven by productivity growth in agriculture and the informal sector would be slower than industry-led growth. But it would make more sense given the state of affairs today.

Urban demand growth has slowed down due to the myriad reasons recounted earlier. The skewed pattern of growth in India over the last several decades implies that income growth has been concentrated in the same upper crust of the population that benefitted from skill-biased technology. Their demand for consumer durables may have now reached a saturation point. If a person who already owns a house gets richer, he is not likely to buy another house. If on the other hand, a person marginally below the income that makes house ownership affordable experiences an income increase, he or she may be inclined to buy a house. Here we are taking the ‘house’ just as an example of an urban product. But the principle is valid for any consumer durable. In general, the marginal propensity to consume will be higher for lower income consumers.

Rural consumers, on an average, are poorer than urban consumers. A transfer of income from the urban to the rural areas would therefore tend to increase overall consumption demand. Some of this will be for goods produced in the urban sector such as two-wheelers and other consumer durables. Farmers in the upper strata may also be induced to buy expensive items like cars, pick-up trucks and tractors if they experience an income boost.

It is also true that after repeated drought years, demonetisation, and GST, the rural population has been in distress for several years. They are likely to have a great deal of pent-up demand. Any transfers to them are likely to spill onto a demand for durables as well as non-durables. All this suggests is that transfers to rural areas through different government schemes such as the MNREGS, the Public Distribution System (PDS), the Pradhan Mantri Awas Yojana (PMAY), and pensions, should be regarded not just as poverty alleviation schemes but also as antidotes to the present slowdown.

Most forms of urban to rural sector transfers would require the government to tax urban residents and subsidise rural residents. However, the claims on the existing revenues are many and the government’s capacity to garner more revenues is limited. Under the circumstances, one way for the government to arrange for an urban to rural transfer is by increasing the terms of trade for agriculture through an increase in MSPs. Of course, this would also mean an increase in food subsidy through PDS to prevent an increase in the issue price. However, such an increase in government expenditure would be a more effective stimulant since the entire burden of increasing demand would not fall on the treasury. Demand for food of the urban consumers is inelastic. An increase in the MSP would result in a direct transfer of ready cash income from urban to rural sector. It would no doubt increase the hardship of the urban poor who are not protected by access to PDS. However, it would help the urban residents by alleviating the demand slowdown in their economy. The government did increase the MSPs for several crops in July 2019 but they could be raised higher.

Note that an increase in MSP is only the second best option of bringing about an urban to rural transfer when fiscal constraints make other avenues of transfers infeasible. It may distort the crop choice toward crops whose MSPs are raised. It may create storage problems and frictions with WTO. Worse still, it will create inflationary pressures making the measure politically difficult. Yet, we are suggesting it as an effective way to bring about transfers to the rural economy if all other avenues are blocked. We find support for our idea in the events following 2008 when MSP increases prevented a growth collapse, despite the crippling effect of a slowdown in demand for software exports after the GFC.

Is this just short-term thinking? Do we not think of industrialisation as synonymous with development? We would like to suggest that under the present circumstances when the prospects for exporting to developed countries are weak, structural reforms in land and labour laws are not easy to implement, and reforming public health and education is taking a very long period, it would make sense to explore the avenue of a rural-led strategy.

Urban manufacturing requires a larger scale, and this is what is running smack into India’s hard-to-reform land and labour laws. Large manufacturing units also need environmental clearances, delays in which are partly the reason for many projects being stalled. Rural growth may steer clear of these obstacles.

Why is the rural economy poor and stagnant? If they just produce to satisfy their own demand, there is no point in raising productivity. If they increase the output of food, prices will fall as their own demand for food will not be elastic enough. They would ideally like to export to the urban economy and perhaps also to the rest of the world. To accomplish this they must diversify into fruits, vegetables, flowers, dairy, poultry etc., for which urban consumers will have a relatively elastic demand. They need infrastructural facilities like refrigerated storage, suitable transport, even agro-processing industry.

A rural-led strategy should prioritise this type of investment. A rural-led strategy would imply diverting some of the public investment from urban to rural areas. Even though in principle there is greater potential for productivity growth in urban industry, the systemic obstacles to industrial development makes a rural-led strategy relatively more fruitful. The additional advantage this sort of strategy would generate is that it would create a lot more jobs for unskilled and semi-skilled labour. Consequently, growth would be much more equitable and the trend towards widening inequality would be thwarted.

It is worth noting that though now China has become the manufacturing hub for the whole world, the first steps it took after it started liberalising from 1979 to 1986 focused on increasing agricultural productivity. The intermediate stage of Township and Village Enterprises (TVE) was an attempt to utilise the resources available in its rural areas and for providing employment there. Even other successful countries like Taiwan, Indonesia, Malaysia, and Thailand paid a great deal of attention to the development issues in their countryside. Indian policymakers should take notice.

We believe that it does not make sense to set economic goals in terms of GDP (a US$5 trillion economy) for a country like India. Growth is just the means to the end of poverty reduction. A high growth rate is desirable because it may lead to a faster poverty decline. But how much impact an increase in the growth rate would make on poverty would depend on the pattern of growth. Himanshu reports on the basis of the 2017-18 Periodic Labour Force Survey that despite the fact that the growth has exceeded 6% from 2015 to 2018, consumption expenditure per capita has declined at the rate of 4.4% per annum in rural areas and by 4.8% in urban areas. This is much more alarming news than the growth slowdown.

A rural-led strategy will deliver slower overall growth but it will have a bigger impact on poverty under the present circumstances that keep the East Asian strategy out of India’s reach for now.

The analysis and arguments in this series have benefited from discussions in recent times that both authors have had with a large number of individuals, far more than can be named here. Our thanks to all of them.

Ashok Kotwal would like to thank Parikshit Ghosh, Ashwini Kulkarni, Milind Murugkar, and Bharat Ramaswami for many useful conversations.

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