Saturday, July 27, 2013

Why an exclusive focus on economic growth is misplaced?

The biggest criticism of the current government in New Delhi has been that its excessive focus on redistribution programs has skewed governance priorities. It is argued that these programs have taken away from other more important growth creating and growth sustaining interventions like structural reforms (the second generation of reforms) and investments in infrastructure. Further, the large fiscal burden imposed by these subsidies has distorted incentives and engendered macroeconomic problems which have been a drag on the country's economic growth.

If we follow the mainstream critiques of the government, one cannot but not get the impression that it has taken the form of an aversion to all forms of growth redistribution. Accordingly, in this narrative a "subsidy" to a poor person is virtually a four letter word. An important argument of people like Jagdish Bhagwati is that India should initially focus just on raising growth, through structural reforms and liberalization, and then use the increased revenues to both expand its welfare state and re-distribute. If this ideology were to assume power, we would experience a drift to the other extreme with excessive focus on growth creation and a marginalization of growth redistribution policies. I believe that this would be as detrimental to long-term growth as the current skewed focus on growth redistribution.    

It is perplexing as to why this should be so difficult to understand. It has been widely accepted, and has also been borne out by India's experience over the last 15 years, that economic growth does not automatically create the conditions, capacity, and resources for sustained poverty reduction as well as further growth. This is because economic growth happens when markets expand - more people demanding goods and services attracts investments, raises production, creates jobs, increases purchasing power, creates demand for more and newer goods and services, and so on. 

The critical factor is "more people demanding goods". In other words, the base of the "demand pyramid" has to become as broad as possible, eventually encompassing all the citizens of the country. But more people can enter the market only if they are equipped with the human capital resources to access the opportunities that arise once economic growth picks up. In case of all successful growth stories, including East Asia, governments have laid this platform by making large and effective investments in human capital formation. They have generally been in the form of investments in education, health care, nutrition, and skill development.  

It is of course possible that in a continental economy like India, high growth rates can be sustained for some time by a much narrower pyramid, in relation to its potential size. Further, an initial spurt of pent-up demand, locked-up entrepreneurial energies, and readily available capital will help generate high growth rates and achieve some poverty reduction for some time. Furthermore, this initial phase of growth can be used to build up the capacity to provide a massive thrust on human capital formation. 

But neither does the access to opportunities for human capital formation nor the capacity of the state to provide the required thrust for improvements in human capital formation automatically follow from economic growth. It is here that Jagdish Bhagwati and Arvind Panagariya's argument about sequencing priorities fail. This assumes even greater significance in case of India since we carry a legacy of extremely poor performance on the human capital formation side. A weak state, misplaced policy priorities, and historical legacies, have come in the way of development of our human capital base. Despite the latest exultation on poverty reduction, an overwhelming majority of our citizens are even today not equipped with the basic skills and resources to access the opportunities in a competitive market place. 

In fact, it is possible that the dynamics of initial growth spurt created conditions that worked against the desired trends that economists like Bhagwati have taken for granted. There is growing evidence to argue that except for the small knowledge-based services sector, India's spectacular economic growth spurt of the past 15 years has been exclusionary and also been underpinned by a crony capitalism that may have even weakened the state's already feeble capacity to create the conditions for sustained economic growth. In any case, its sustainability is already in question.  

So the obvious answer is to acknowledge the importance of addressing the challenge of human capital improvements, without seeing it as a trade-off with economic growth. Economic growth is built on the size and quality of human capital. This does not of course mean that we should go the other way, as Amartya Sen and Co appear to suggest, and should spend time improving human capital before we focus on economic growth creating policies. But it should undoubtedly be a matter of great concern that this issue does not get anything remotely close to the attention that growth creation policies get in mainstream discussions in India. 

There is another argument for being cautious against an exclusively growth creating focus. In a large country like India structural transformations are most certain to be long-drawn, destabilizing, and politically difficult. A generous social safety, which seeks to provide a basic dignified human existence, is desirable not only on moral considerations, but even more importantly on economic and political grounds. Economically, it would be the necessary first step to equip these people with the requisite human capital to compete in the market place. It would provide the political space to push through the difficult structural reforms. 

We need to seriously debate this social safety net. Who should be its beneficiaries? What should be its components? What should be the design of each component, so that incentives are aligned towards minimizing distortions and achieving the objective? What should be the exit protocol from this safety net? What should be the most effective channel for its delivery? How much resources are we able to spend on it? What should be the role of the private sector in this endeavor? 

One gets the impression that critics of the government suffer from representativeness bias. They appear to conflate the idea of a growth model that simultaneously focuses on human capital formation, establishment of a social safety net, and growth creating policies with those being pursued by the present government. This narrative sub-ordinates everything to economic growth and policies that are perceived as directly contributing to economic growth. Its occasional concern with distributional issues and sustainability of growth is confined to simplistic advocacy like replacing the PDS with cash transfers and increasing private participation in the delivery of health and education services.

The clearest proof of this comes from their diagnosis of the current weakness with the Indian economy. They blame the weakness on inadequate liberalization of foreign investment norms, lack of labor market reforms, still-born financial market liberalization, insufficient domestic tax reforms, deficient investments in physical infrastructure, and pervasive corruption. Investments in human capital formation and building state capacity to improve it are rarely discussed with anything like the passion associated with the former. Policies to establish a comprehensive social safety net has received even less attention.

In other words, a development model that focuses exclusively on economic growth creating policies, without much concern for enabling the availability of conditions for a broad-based and therefore sustainable economic growth, has come to dominate the mainstream media. If Amartya Sen's provocative push in the other direction, irrespective of its extremism, contributes towards re-balancing the agenda, he would have done more, albeit unwittingly, to the long-term future of Indian economy than any other intellectual.

Update 1 (27.07.2013)

This is a classic example of what I mean by mainstream discussion. One gets the impression that liberalization of FDI norms, infrastructure investments, and policies to make India more externally competitive are enough to overcome the "looming crisis". 

1 comment:

Anonymous said...

I used to wonder why our country was so fucked up. After seeing that the most influential policy makers like you are drunk on socialism and are supporting it even after most countries have realized their mistake, I know now.