Political Economy

What the Centre Really Needs to Do if it Wants to Tackle the Economic Slowdown

Both the Modi government and former Prime Minister Manmohan Singh are ignoring one crucial aspect of reviving the economy: raising effective demand.

Only a few weeks ago, the central government was talking grandly about India reaching a $5-trillion economy and refusing to recognise the severe slowdown India is going through. (This is not such a grand ambition when compared with China, which is often portrayed as India’s competitor, because by 2025, China’s economy is expected to achieve a GDP of $29 trillion).

Then reality, at last, struck the proud citadels of the Prime Minister’s Office and North Block, at which point finance minister Nirmala Sitharaman announced a slew of measures. These included retracting the only progressive feature of her budget: the additional surcharge on incomes of the super-rich, reducing the interest on housing loans for government employees, a Rs 20,000 crore stress fund for real estate and sops for exporters.

Recently, these sops have been increased further. Rs 50,000 crore has been allocated for exemptions and support for insurance of exporters. Interest rates for all housing loans have been brought down. At the same time, the government capped foreign investment in digital media at 26% and allowed 100% foreign investment for coal mining, associated infrastructure and sales of fuel.

However, so far, foreign investment has flowed into non-manufacturing sectors such as PayTM, into shopping malls, food and beverages, and so on. So it does not help the government’s ‘Make in India’ project. In fact, in the recent slowdown, the decline in manufacturing  has been a leading factor. Moreover, foreign investment flows tend to hold up the exchange rate of the rupee. As ex-Prime Minister Manmohan Singh pointed out, India should allow the rupee to be devalued.

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Two of the leading sectors that have been particularly hurt are the automobile sector and the fast-moving consumer goods sector. Parle, one of the leading biscuit manufacturers has laid off thousands of workers. Sales of basic goods such as atta, hair oil, soap  and toothpaste have badly fallen, especially in rural areas of north Indian states such as Uttar Pradesh, Bihar, Rajasthan, Madhya Pradesh and Chhattisgarh.

Auto industry sales have reached a 19-year low. Maruti Suzuki has slashed its production continuously for the last seven or eight months. It has not responded to prodding by Central government ministers. Ashok Leyland has closed five of its factories. Tata Motors and Mahindra have also drastically slashed their sales. All this has led to the unemployment not only of direct factory workers, but also of contract workers who come from surrounding areas.

India’s employment shrank by seven million between 2013 and 2018. Open unemployment of the youth (forget about disguised unemployment) has reached 16%. As Singh also pointed out, agricultural income has fallen to a 14-year low.

GDP growth comes the back of investment. The India’s rate of investment as a percentage of GDP has declined from 34 in 2010 to 29 in 2017, recovering to a little over 31 in 2018-19. As John Maynard Keynes had pointed out a long time ago, investment is basically driven by effective demand and the rate of interest only plays a minor part.

But most of the measures adopted by the current government, as well as those suggested by Manmohan Singh, focus on cheaper loans. The only part of the latter’s recommendation that is aimed at increasing effective demand is to raise rural incomes by reviving agriculture. Apart from the fact that this will require a large increase in public investment in agriculture, which had come down as a proportion of GDP under the Congress regime also, we have to remember that the major part of India’s national income is constituted by urban incomes.

Watch: Centre Must Focus on Rural Employment and Growth to Revive Economy

What we should talk about is not just the slowdown in economic growth, but the miserable state of our human development. To take just two of the indicators of human development, India is home to the largest mass of illiterate people in the world, and in terms of the hunger index, India ranks even below some of the poorest Sub-Saharan countries. This is because India is one of the worst performers globally in terms of expenditure on both health and education.

Let us now look at the percentages of GDP spent by India and other countries. India spends 3.8% of its GDP on education, compared with – taking some countries at random – 3.9% by Afghanistan, 4% by Albania, 5.3% by Australia, 5.5% by Austria, 4.2% by Burkina Faso, 12.8% by Cuba, 7.6% by Denmark and 5.5% by France. Most of India’s expenditure on education is incurred by private persons; government spending on education is just about 1.3% of GDP.

With the increasing neglect of public educational institutions, there has been a mushrooming of private institutions, increasing the burden on poorer people. The Tapas Majumdar Committee’s recommendation for spending 6% of GDP on education has never been realised.

According to World Health Organisation figures, in 2016 India spent 3.66% of its GDP on health as against 5.27% by South Africa and 8.11% by Russian Federation (two other members of BRICS). Taking other countries at random, expenditure on health as percentage of GDP was 10.2% by Afghanistan, 6.7% by Albania, 7.55%  by Argentina, 9.25% by Australia, 10.44% by Austria, 11.77% by Brazil, 6.75% by Burkina Faso, 8.53% by Chile, 10.35% by Denmark, 11.54% by France and 11.14% by Germany.

It is no wonder that the life expectancy is lower in India than in practically all East and Southeast Asian countries, and lower than even that of Bangladesh, a much poorer countries. Most of the expenditure on health comes out of private pockets, the percentage rising to 90% in some northern states. In states such as Kerala and Tamil Nadu, where the public health sector is more active, the longevity is much higher than the all-India average.

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Let us now turn to the area of environmental protection, including minimising the ravages of climate change. Before the advent of British rule, India had extensive forest cover except some desert in Rajasthan and Sind. Even there, the kings and nawabs had created special forest reserves for hunting. The British began the commercial exploitation of forests, throwing large numbers of forest-dwellers out of their habitat, and increasing the soil erosion without forest cover and leading to silting of rivers. Unfortunately, the same policies were continued by successive Indian governments, giving only nominal protection to Scheduled Tribes, the main victims of the government’s forest and mining policies.

In order to advance human development, India will have to double public expenditure on education, healthcare, special educational and health schemes for Adivasis and Dalits, ICDS and other schemes like girls’ hostels, not only under the Central government  but also under states, which are responsible for most of the expenditure on social sector heads.

First, the public distribution system should be made universal as in Kerala. In education, the public sector contribution should be raised to 3% of GDP, which will take the total to about 5%. In healthcare, the public expenditure should be raised to 3% of GDP, which will take the total again to somewhere around 5% of GDP (rough calculations). In every case, the part specifically meant for women, Adivasis and Dalits should be tripled. The money meant for environmental protection should be quadrupled and the policy of attaining low carbon emissions should be monitored, wherever possible.

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Where will the money come from for all these ambitious schemes? Thomas Piketty, the author of Capital in the Twentieth Century, has recommended that it come from 80% of the income of the top 1% of earners, which he thinks will not infringe on incentive for work or investment. In India, the highest marginal income tax rate is 30% for everybody from Mukesh Ambani, Uday Kotak, Gautam Adani and K.P. Singh to a mere college professor.

I would increase the marginal income tax rate in two steps – 35% for incomes up to Rs 20 lakh and 45% for all incomes above Rs 50 lakh. That is the top marginal tax rate in the UK and Germany. In countries like Denmark, Sweden and France, the highest marginal tax rates are much higher, ranging from 60% to 75%. I would also abolish the special treatment for Hindu Undivided Families, which is invidious because families following the Dayabhaga law or families practicing other religions cannot take advantage of it, and because a major portion of high incomes escape taxation using that route.

I would raise the tax rate for domestic companies with a turnover up to Rs 250 crore from the current rate of 25% to 30%, for domestic companies with a turnover above Rs 250 crore from 30% to 35%, and for foreign companies from 40% to 45%. These changes in tax rates should be enough to finance the increased public expenditure suggested above.

What will be the implications of all these changes? The increases in public expenditure suggested will at once lead to enormous increases in employment (India has been witnessing jobless growth) in educational institutions, public hospitals and health centres, etc. Special schemes will have to be devised for aiding farmers and workers in medium and small enterprises in trade and manufacturing, which are the primary sources of employment in the non-farm sector.

Amiya Kumar Bagchi is a distinguished economist whose books include The Political Economy of Underdevelopment, Private Investment in India 1900-1939 and Colonialism and the Indian Economy.