The new government that will take over in a month has to
tackle some serious challenges on the economy, many of which require
long-term solutions. These include environmental degradation and the
woeful state of public services.
The people realise
that these are unlikely to be sorted out soon. But they are no longer as
patient as they used to be. Especially the younger generation, which
expects a newly-elected government to attend to these issues with
alacrity and resourcefulness.
The most urgent
matters are growth and inflation. In the past decade, high growth with
low inflation has been replaced by low growth with high inflation. This
has to be reversed, and quickly.
With productivity
languishing, increasing the investment rate is absolutely essential if
India is to return to the high growth rates of five years ago.
Investment in the right quarters is essential to maintain stable prices.
Thus observers are right to emphasise that the investment climate is
crucial, and that the government has to be conscious of incentives to
the private investor.
Investment climate
The
question, though, is how to alter the investment climate favourably. In
fact, this is the challenge for the government. A ready answer to the
question is “more reforms”, but this solution often stays on paper.
Beyond
the proposal for a Goods and Services Tax, there is no major pending
macroeconomic policy reform with the potential to reverse the growth
slide. For instance, the tariff rate and corporate tax rate are by now
quite low by international comparison, and a round of private issue of
bank licences has only just been completed.
Sector-specific
liberalisation that increases profits and, maybe, even the
profitability of private players will help, particularly in the
financial sector, though these, in themselves, may not lead to a higher
private investment rate.
In the virtual stagnation
of economy-wide investment over the past five years, fixed capital
formation in the public sector actually fell since 2008. Household
investment, however, grew faster than before. Private investment may
have dipped a couple of years since but has, on average, grown.
Public
investment, on the other hand, actually collapsed, recording in 2012-13
a level less than half of what it was in 2007-08. It is this that led
to the growth slowdown in India, just as its steady rise had fuelled
rapid growth in the five years from 2003-04. Once it is recognised that
the public sector invests more in infrastructure than the private, it is
easy to see why public investment is so important to the country’s
growth dynamic today.
The investment climate for the
private sector is defined by the expectation of profits to be realised
entirely in the future. A firm’s forecast revenues are related to the
demand for its product which, in turn, depends on the expected state of
the economy.
This itself, as we can see from the
experience of the past decade, is at least partly dependent on public
capital formation. Public capital formation both enhances aggregate
demand and transforms the supply side. Private investment too adds to
aggregate demand but is relatively less transformational. This is
because public investment, at least in principle, creates, public goods
that are open to other producers — think “bridges and roads” or even
just pavements, which are in such short supply in our cities that they
hold back economic activity. Therefore, the investment climate for the
private sector is, in some part, determined by public capital formation.
So, from a macroeconomic point of view, the first task for the new
government would be to step up public investment substantially.
Also,
as the fiscal deficit is quite large, space will have to be made by
cutting subsidies to the same extent. This will not really impact
growth, as growth has been hit even amid burgeoning subsidies. On the
other hand, increasing subsidies may well have crowded out investment by
the government in the past. And so, any proposed increase in investment
may be expected to speed up growth.
A plan for
enhancing public investment does not in any way mean restraining the
private sector. Actually, public investment enables the private in two
ways: It generates demand for the latter’s products and enables the
expansion of private production by providing the necessary physical
infrastructure.
Much of this infrastructure is in
the nature of public goods and the private sector has no incentive to
produce them, as it cannot ration their use by the public.
Empowering the poor
The
political left, heavily invested in the language of rights and the
practice of distributivism, does not adequately recognise the importance
of public infrastructure for any meaningful empowerment of the poor,
leave alone the ultimate elimination of poverty. In fact, the poor are
left seriously disempowered by the absence of access to infrastructure
that is vital to their survival. After all, they are empowered less by
airports than by producer services such as rural roads and urban water
supply.
What has been set out here is a programme of
fiscal action that makes up for the deflationary stance of monetary
policy in the recent past. The RBI claims that it is engaged in
‘anchoring inflationary expectations’. This it has done by raising
interest rates. The result has been declining manufacturing output with
inflation having yielded little. Private investors cannot but remain
pessimistic of the future in such a situation.
Unless the government steps in to invest, by its inaction it would have ended up ‘anchoring stagflationary expectations’.
The writer is a professor, Centre for Development Studies, Thiruvananthapuram
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