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BW Businessworld

Understanding The Economy

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The prime minister broke his rule of silence and gave a press conference — just the third in his decade-long reign. True, he often takes some journalists on his trips abroad, and answers their questions for an hour or two on his way back. But they are a selected, captive audience; he generally avoids fielding surprise questions from potentially hostile journalists. He met reporters this time to announce that he will step down as prime minister after the general elections this summer.

He also felt that his contemporaries, especially the media, were unfair to him, and that future generations would judge him more kindly.

One thing that he took credit for was the high growth under his leadership. It is not surprising that he did; but any economist would know that growth does not depend on the government alone, or even principally, and that its influence on growth is not coterminous with its tenure. Investment creates productive capacity, but it would be reflected in growth only after the capacity becomes operational.
Demand can push output up or down, but its impact on growth can be delayed by changes in inventories. Government budgets affect private incentives; but their effect will be seen only after investors or consumers react to the incentives. Thus, it can be years before a new government impacts growth. And growth depends on many factors; there is no close connection between change in government and the pace of growth. The high growth came too early in the UPA tenure to be due to change of government. The slide in growth in the past five years followed UPA’s coming to power by three years and may have something to do with it; but the mechanism of influence has to be specified. 

I lived through the period and watched it closely enough to write about it. My impression is that a powerful industrial investment boom started in the last years of NDA rule, and continued into the first years of UPA rule. The boom followed abolition of import licensing in 2001 and tariff reduction under the NDA. This by itself would be surprising. But I think that industrialists anticipated the liberalisation, and invested heavily to increase efficiency. The investment increased industrial capacity, intensified competition, and eliminated high-cost producers. It was a boom of the type historically associated with trade cycles; such booms generally end when the capacity created by high investment outruns demand. That is what happened from 2008 onwards. The PM blamed the collapse on international factors. They were present; but the basic cause of the collapse was domestic, namely emergence of excess capacity in manufacturing.
The severity of the downturn is remarkable: the growth rate has halved in five years. If the government had understood the cause of the boom, it could have taken steps to ameliorate the downturn: it could have devalued the rupee, and shifted government expenditure to investment and thus offset the collapse of demand for capital goods. Its failure to do so and the prime minister’s explanation of the downturn show that the government misread the cyclical situation. This may sound an extreme statement about a government which employs such eminent economists; but that is my reading of what happened. 
It is sad for two reasons: first, the government economists’ faith in their own judgment is so strong that they are unlikely to consider a different view; and second, even if they did, the downturn is too advanced and has no easy remedy. The only silver lining is that this government will probably be swept away in the election. But the country may get as finance minister Baba Ram Dev, who thinks all taxes can be replaced by a Tobin tax on cheque clearances. Little does he realise that the tax would have to be 25 per cent. If he imposes such a tax, everybody, including his acolytes, would take their money out of banks and settle all transactions in cash. But the economy would collapse much before that. After that, history would certainly look back nostalgically on Manmohan Singh.

The author is Consultant Editor of Businessworld.

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(This story was published in BW | Businessworld Issue Dated 10-02-2014)

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