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Approach Paper to the Eleventh Five-Year Plan

The growth forecast for 2007-12 in the draft approach paper to the Eleventh Plan is based on unrealistic levels of private investment and productivity growth. The Planning Commission also seems unaware that the current growth strategy's resemblance to the Japanese consumption boom of 1986-92 is more than superficial. Thus, there are strong instability risks attached to the strategy currently pursued, with a very real threat of a prolonged asset deflation.

Commentary

Approach Paper to the Eleventh Five-Year Plan

A Sceptical Note

The growth forecast for 2007-12 in the draft approach paper to the Eleventh Plan is based on unrealistic levels of private investment and productivity growth. The Planning Commission also seems unaware that the current growth strategy’s resemblance to the Japanese consumption boom of 1986-92 is more than superficial. Thus, there are strong instability risks attached to the strategy currently pursued, with a very real threat of a prolonged asset deflation.

D M NACHANE

W
hen the Planning Commission was reconstituted after the change of government in 2004, cheerleaders of the reforms process were seized with apprehension. Will a high profile commission revive their bete noire of centralised planning and act as an impediment to the liberalisation programme? The composition of the body – an uneasy amalgam of known votaries of liberalisation and those whose concerns with “the human face of reforms” were equally public knowledge – lent an edge of suspense and uncertainty to this apprehension. The title of the draft approach paper to the Eleventh Five-Year Plan, ‘Towards Faster and More Inclusive Growth’, is suggestive of elements of a compromise; a detailed examination of the contents of the paper, however, sets all doubts at rest. The cheerleaders’ fears have proved unfounded, with reforms very much on the commission’s mind.

Let me begin by focusing on the growth side of the story. The previous few years’ economic performance has led many of us to expect high growth rates almost as routine, and in keeping with this sanguinary attitude several commentators have berated the Plan paper for being overmodest, in setting the economy a target of 8 to 9 per cent growth. A growth rate of 8 per cent has been predicated (in the approach paper) upon an average investment rate of 32 per cent of GDP – domestic savings contributing 29.6 per cent and foreign resources 2.4 per cent. (The figures for the 9 per cent growth scenario are correspondingly higher.)

The Eleventh Plan carries to a logical conclusion a process begun in the Ninth Plan, viz, of placing the major burden for the success of the growth projects on the fulfilment of private investment targets. Of the projected investment rate of 32 per cent of the GDP, a large slice (22.2 per cent) is expected to be forthcoming from the private sector, with public investment accounting for only 9.8 per cent (of GDP). A role for private investment of this magnitude introduces a large element of unpredictability in any growth target, given the large element of uncertainty and volatility surrounding it. The same logic applies with even greater force, to the reliance on foreign direct investment (FDI). The growth targets in the approach paper are then better treated as simply forecasts, rather than as firm statements of intent.

In this context, I was surprised to see the explicit reference in the approach paper (p 4) to the “…important potential strength arising from our demographic trends”. I have, of course, heard some strong votaries of liberalisation waxing enthusiastic on the “demographic dividends” theory, but this is the first time one finds an official endorsement of this pernicious doctrine. Advocacy of such a theory is even more dangerous than the “development is the best contraceptive” philosophy much touted in the 1950s, which lay at the basis of the absence of a firm and sensible population policy in the Indian plans at a time when it would have made a difference. If the demographic dividends doctrine signals a back-pedalling on the population policy front, then it is a cause for serious alarm. Future employment growth is going to rely increasingly on skilled labour (under the current liberalisation policies), and the human resource requirements of imparting such skills are formidable. With the trend towards exploitation of scale economies and increased capital intensity in manufacturing, and the move to get India Inc on a big scale into traditional sections of the unorganised service sector, it may prove difficult even to preserve the existing levels of employment, so the question of absorbing huge unchecked additions to the potential labour force simply does not arise. Perhaps, at the risk of sounding a bit cynical one might conjecture that the demographic dividendoccurs only to those who benefit from keeping unskilled wages at artificially low levels, by the perpetuation of a permanent labour surplus.

Questionable Assumptions

Even the growth story so far is not the glittering success, that it is often portrayed to be in sections of the Indian ( and sometimes foreign) media. The macroeconomics underlying the story is far from clear. Undeniably part of the growth stimulus derives from a genuine rise in productivity, though the approach paper itself is fairly vague about this “…acceleration of the baseline 7 per cent growth to say 9 per cent will require an increase in the total investment rate from 29.1 per cent to 35.1 per cent…This is much lower than the rates reported in China implying that we are in a position to achieve comparable rates of growth with a lower ICOR” (p 10). An idea of the task ahead might be gauged from the following explicit calculations of Y K Alagh “…a one per cent increase in real inputs led to a 3.8 per cent increase in output in the 80s and a slightly lower increase in the 90s. This has now to go up to 5 per cent so that the dream of 8 per cent growth is achieved” (The Financial Express, July 3, 2006). But if productivity rises are only a part of the explanation of

Economic and Political Weekly July 22, 2006 the high growth witnessed in the last few years, then all the evidence is really a pointer to a consumption boom riding on the back of the newly acquired prosperity of a metropolitan upper middle class. A taxation curve with zero progressivity at the top income scales, a spurt in bank financing of durable consumption goods, a capital inflow surge and abundant liquidity at historically low interest rates have fuelled this boom, which has now spilled into an asset prices boom (especially in the stock market and real estate). The resemblance to the Japanese consumption boom of 1986-92 is certainly more than superficial. Thus there are strong instability risks attached to the high growth strategy currently pursued, with a very real threat of a prolonged asset deflation (as in the Japanese aftermath which extended over 1992-2003).

In the early years of the liberalisation wave, much reliance had been placed on the efficacy of the “trickle down” effect. However, the actual impact on poverty (as shown by several studies) has belied these early tall claims, and one heartening feature of the approach paper has been a tacit recognition about the urgency of tackling unemployment and poverty. Chapter 5 of the paper (rather poetically titled ‘Bridging Divides: Including the Excluded’) offers several palliative measures of which two seem most appealing, viz, paying special attention to labour-intensive manufacturing sectors and the National Rural Employment Guarantee Programme (NREGP). However, it is in evaluating these solutions that the sectoral composition of growth assumes importance. One needs to distinguish between sectors like construction and tourism, which have considerable employment and income generating potential, but which do not produce basic consumption goods, and sectors like food processing and textiles which partake of both features. But for a pro-poor growth strategy, merely placing additional incomes in the hands of the poor is not enough, the production of basic goods needs to be strengthened too. A strategy of income generation for the poor decoupled from increased basic goods production could most likely lead to inflation and/or trade deficits. If one looks at the very recent period (2003-05) the fastest growing sectors have been construction, hotels and restaurants, communication, finance, insurance, real estate and business services, none of which would figure prominently in the poor man’s consumption basket. The phenomenal growth in the “FIRE” (finance, insurance, real estate) sectors has usually been justified by the argument that financial deepening promotes real growth. Without denying the validity of this supposition in the early phases of financial liberalisation, diminishing returns to this phenomenon can be very much in evidence beyond a certain stage. One does wonder whether in India a stage has now been reached when we need to ask ourselves whether the excessive absorption of resources in asset (and derivatives) trading is really yielding any worthwhile gains in terms of real sector productivity or is it turning out to be a waste of social resources.

The approach paper accords key roles to civil society organisations (CSOs) and panchayati raj institutions (PRIs) in rural development and poverty alleviation. There is no denying that in principle the idea is indeed appealing. Equally undeniable is the fact that several CSOs have had an excellent track record. Yet, given the wide differences in the scope of activities, levels of commitment, ideological affiliations, etc, of the CSOs, without an effective regulatory and coordinating mechanism (and perhaps also a rating mechanism) how the system will work in practice is anybody’s guess.

Neglect of Inequality

Inequality is possibly one of the most neglected dimensions of the liberalisation programme. The approach paper duly recognises the seriousness of regional inequality in India but locates the answer to this problem in the increased overall provision of infrastructure services, with a large part of the responsibility in this task being put on the states themselves. But this can only furnish a partial solution at best. The paper maintains a diplomatic silence on the key issue of migration from the badly governed and/or backward states to the advanced states, which is putting the urban systems in the latter states to severe strain. Decentralisation of industrial activity, setting up of special economic zones (SEZs), etc, are essentially long-term solutions. What is needed over the medium term is a national commitment to huge resource transfers to these advanced states earmarked to salvage their urban systems. There are limits to how long these states can continue to pay the penalty for faulty policies followed elsewhere. The emergence of aggressive sectarian political groups will continue unabated unless this issue is addressed on a war footing.

If regional inequality gets short shrift in the paper, interpersonal inequality does not even get a mention. The central features from major studies such as Mundle and Tulasidhar (1998), Ravallion and Datt (1999) and Jha (2000) are that in the 1990s, India has witnessed a moderate rise in both rural and urban inequality (in contrast to the two previous decades when inequality remained constant), accompanied by a decline in urban poverty, but the widening of the ruralurban income gap has implied a significant increase in overall inequality. There is now a small body of theoretical literature concerning the disequalising impact of liberalisation and globalisation. This has been examined critically elsewhere by the author [Nachane 2006]. But two points need to be recorded here. So far as trade liberalisation is concerned, the Wood (1997) thesis (based on standard factor price equalisation assumptions) leads us to expect a narrowing of wage differentials in emerging market economies (EMEs), a conclusion hardly borne out by the empirical data available. One plausible explanation of this counterintuitive result revolves around the inappropriate choice of technologies in EMEs. The import of first world technologies here often leads to a scarcity rent for skilled labour, aggravating wage inequality [see Lindert and Williamson 2001]. Rodrik (1997) stresses an alternative line of explanation in terms of the political economy of distribution in a world of mobile capital and immigration inflexibilities. The second aspect refers to the domestic policy changes (including labour market reforms, tax reforms and privatisation) which have to be initiated to render the country an appealing destination for foreign investment. Labour market reforms in the manufacturing sector typically involve relaxation of safety norms, reducing job security, and weakening of collective bargaining mechanisms. In the services sector, employee rights hardly exist in India (and many other EMEs) and attempts by unions to enter this sector have been frustrated by vested interests and an unsympathetic government. The exact quantitative impacts of these trends on wage dispersion in the organised and unorganised sectors and on income inequality in India are, however, difficult to assess, given a consistent dearth of relevant statistics.

Methodological Problems

My final comment is purely methodological. Depending on the underlying economic set-up, a planning experiment

Economic and Political Weekly July 22, 2006

can assume either of two polar extremes. In a dirigiste system, a long-term plan is supposed to play three important coordinating roles – the ensuring of dynamic inter-sectoral consistency, resolution of conflicting inter-ministerial demands for investment resources and the resolution of similar conflicts at the state levels. In a market-oriented system, the prime determinant of long-term growth is private investment.

Private investment is driven by cyclical factors, the relative state of domestic versus foreign demand growth, financial accelerators and myriad other factors. At best the Planning Commission can make a forecast of private investment intentions and perhaps exert some persuasion to the private sector to pre-commit itself to its announced intentions. (This, of course, is the well known indicative planning exercise practised to varying degrees in eastern Europe and France in the 1960s.) Given its aggregative nature, it is difficult to comment on the basis of the approach paper, to which of these two alternatives the Plan model is veering. One will have to await the release of the detailed plan document, alongside the technical note. But even within the limited information presented within the approach paper, certain inconsistencies come to the fore, casting doubts about the feasibility of attaining the ambitious growth targets. There is no hint in the approach paper that the planning methodology followed is going to be any different from the earlier plans, nor any realisation that a role for private investment of the magnitude envisaged in the Eleventh Plan sits uneasily with the existing structure of planning in India.

The old methodology of ensuring intersectoral (and inter-regional ) balances by input-output tables and other general equilibrium techniques proves irrelevant in this context, for it is based on the presupposition that the quantum and pattern of allocation of investment is effectively a “policy control variable”. With a major role for private investment, this assumption becomes anachronistic. To rely on the “crowding in” effects of public investment to get private investment in place, smacks of a naïve optimism. Merely getting the financial balances right is no guarantee of the overall consistency of the sectoral growth targets and other macroeconomic parameters in a plan designed for a marketoriented environment.

Overall, one fails to be enthused by the cheerful spirit pervading the approach paper.

EPW

Email: nachane@igidr.ac.in

[This is a revised version of my comments made at the Planning Commission regional consultation meeting held in Mumbai (June 28, 2006). I am grateful to the participants at that meeting, and in particular the Planning Commission members, Kirit Parikh, B L Mungekar, Abhijit Sen and B N Yugandhar, as well as S L Shetty for their incisive reactions. The views expressed here are the author’s personal views and do not reflect those of the institution he represents.]

References

Alagh, Y K (2006): ‘Plan Panel Realistic, But Should Assume Shiva’s Role’, The Financial Express, July 3.

Jha, R (2000): ‘Reducing Poverty and Inequality in India: Has Liberalisation Helped?’ UNU/ WIDER WP No 204, Helsinki, Finland.

Lindert, P and J Williamson (2001): ‘Does Globalisation Make the World More Unequal?’ paper presented at an NBER Conference ‘On Globalisation in Historical Perspective’, Santa Barbara, California.

Mundle, S and V Tulasidhar (1998): ‘Adjustment and Distribution: The Indian Experience’, Occasional Paper No 17, Asian Development Bank, the Philippines.

Nachane, D M (2006): ‘Financial Liberalisation: Implications for Sustainable and Equitable Growth’, paper read at the Centre for Economic and Social Studies, Silver Jubilee Seminar on ‘Perspectives on Equitable Development: International Experience and What India Can Learn’.

Ravallion, M and G Datt (1999): ‘When Is Growth Pro-Poor? Evidence from the Diverse Experience of Indian States’, World Bank, Washington DC (mimeo).

Rodrick, D (1997): Has Globalisation Gone Too Far? Institute for International Economics, Washington DC.

Wood, A (1997): ‘Openness and Wage Inequality in Developing Countries: The Latin American Challenge to East Asian Conventional Wisdom’, World Bank Economic Review, Vol 11 (1), pp 33-57.

Economic and Political Weekly July 22, 2006

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