UPSC IAS exam preparation - Fundamentals of the Indian Economy - Lecture 2

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Economic planning in India

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1.0 Introduction

Today, India is one of the fastest growing economies in the world. In recent times, the country has witnessed spells of good rise in its growth rate. The history of the Indian economy can be broadly classified into four parts listed below:

1. Indian economy before the Colonial Period (Till 1770)
2. Indian economy during the Colonial Period (Till 1947)
3. Indian economy before Liberalization (Till 1991)   
4. Indian economy after Liberalization

1.1 Malthusian theory of population

Thomas Robert Malthus was the first to propose a systematic theory of population in his book titled "Essay on the principle of population". In this book, he proposed the principle that human populations grow exponentially (i.e., doubling with each cycle) while food production grows at an arithmetic rate (i.e. by the repeated addition of a uniform increment in each uniform interval of time). 

This scenario predicted a catastrophic future where humans will have nothing to survive on. He predicted that by the 21st century population would increase to 256 billion whereas the available food supply would sufficient for only 9 billion people. 

The chief preventive measure suggested by Malthus was moral restraint but was strongly opposed to birth control within marriage and did not suggest that parents should try to restrict the number of children born to them after their marriage.

Some of the conclusions that can be drawn from Malthus's ideas thus have obvious political connotations and this partly accounts for the interest in his writings and possibly also the misrepresentation of some of his ideas by authors such as Cobbett, the famous early English radical.

Some later writers modified his ideas, suggesting, for example, strong government action to ensure later marriages. Others did not accept the view that birth control should be forbidden after marriage, and one group in particular, called the Malthusian League, strongly argued the case for birth control, though this was contrary to the principles of conduct which Malthus himself advocated.

1.2 Indian economy before the Colonial Period

The earliest known evident civilization which flourished on the Indian soil was the Indus Valley Civilization. Historians believe that this civilization would have flourished between the time frame of 2800 BC and 1800 BC. It is evident from the excavated cities and structures that the inhabitants of the Indus Valley practiced agriculture, domesticated animals and had developed trade relationships between different cities. They are also known to have developed a uniform system of weights and measures. Also, the inhabitants of Indus Valley were one amongst the very first of people to have developed a network of well-planned cities with their application of urban planning. These planned cities were equipped with the world's first urban sanitation systems. Quite an achievement!

India had been successful in developing international trade as early as the first century BC. Historical evidences suggest that the Coromandel, the Malabar, the Saurashtra and the Bengal coasts were excessively used for the transportation of goods via sea routes from, and towards, India. In ancient times, India conducted international trade mainly with parts of Middle East, Southeast Asia, Europe and Africa. Overland international trade, conducted via Khyber Pass, was also prevalent in ancient India.

Later, in medieval times, the Mughal Empire created a centrally administered uniform revenue policy, and this brought some political stability to India which in turn led to the further development of trade and unified the ‘nation’. During this era, India was primarily an agrarian self-sufficient economy which depended on the primitive methods of agriculture. After the downfall of the Mughal Empire, the economy of India was primarily governed by the Maratha Empire which then ruled over most parts of India. Later, the Maratha defeat in the third battle of Panipat disintegrated India into several Maratha confederate states which raised a widespread political turmoil in the country. The economy of India turned highly turbulent in most parts of the country during this phase, but some areas gained in local prosperity too. Later, by the end of eighteenth century, the British East India Company was successful in capturing a part of the Indian political machinery, following which there was a drastic change in the country's economic activities and the trade conducted from the Indian soil.

1.3 Indian economy during the Colonial Period

During the reign of the British East India Company, there was a big shift in the economic activities conducted across the country. More stress was laid on commercialization of agriculture. This led to a change in the agricultural pattern across the nation. During this phase of the Indian economy, there was a constant decline in the production of food grains in the country which resulted to the mass impoverishment and destitution of farmers. Also, in a short span after this shift of pattern, there were numerous famines raised in the country.

Though, after and during this phase, there was a sharp decline in the economic structure of the country, but this was also the phase during which some major and economically important developments took place. These developments include the establishment of railways, telegraphs, common law and adversarial legal system. Also, it was during this era that a civil service which essentially aimed to be free from the political interference was established.

The phase till 1947 falls under this description. However, as India gained independence and set upon deciding its own economic destiny, many new experiments were tried, the most prominent of them being central planning and the 5 year plans. The period 1947 - till date can broadly be divided into ‘Before Liberalisation - Till 1991’, and ‘After Liberalisation - From 1995 onwards till date.’ 

1.4 Objectives of economic planning in India

Planning without an objective is perhaps like sailing without a chart, or driving without any destination. There are generally two sets of objectives for planning, namely the short-term objectives and the long-term objectives. While the short-term objectives vary from plan to plan, depending on the immediate problems faced by the economy, the process of planning is inspired by certain long term objectives. In case of our Five Year plans, the long-term objectives are:

1. A high rate of growth with a view to improvement in standard of living,
2. Economic self-reliance,
3. Social justice,
4. Modernization of the economy, and 
5. Economic stability.

High rate of growth: All the Indian Five Year Plans have given primary importance to higher growth of real national income. During the British rule, Indian economy was stagnant and the people were living in a state of abject poverty. The Britishers exploited the economy both through foreign trade and colonial administration. While the European industries flourished, the Indian economy was caught in a vicious circle of poverty. The pervasive poverty and misery were the most important problems that had to be tackled through the Five Year Plans.

During the first three decades of planning, the rate of economic growth was not so encouraging in our economy. Till 1980, the average annual growth rate of Gross Domestic Product was 3.73 percent against the average annual growth rate of population at 2.5 percent. Hence the per-capita income grew only around 1 percent. But from the sixth plan onwards, there has been a considerable change in the Indian economy. In the Sixth, Seventh and Eight plans the growth rates were 5.4 percent, 5.8 percent and 6.8 percent respectively. The Ninth Plan, started in 1997 targeted a growth rate of 6.5 percent per annum and the actual growth rate was 6.8 percent in 1998-99 and 6.4 percent in 1999-2000. This high rate of growth is considered a significant achievement of the Indian planning against the concept of a Hindu rate of growth.

Economic self-reliance: In the Indian context, self-reliance implies that dependence on foreign aid should be minimum. At the beginning of planning, we had to import food grains from USA to meet our domestic demand. Similarly, for accelerating the process of industrialization, we had to import capital goods in the form of heavy machinery and technical know-how. For improving infrastructure facilities like roads, railways, power, we had to depend on foreign aid to raise the rate of our investment. As excessive dependence on foreign sector may lead to economic colonialism, the planners rightly mentioned the objective of self-reliance from the Third Plan onwards. In the Fourth Plan much emphasis was given to self-reliance, more specially in the production of food grains. In the Fifth Plan, our objective was to earn sufficient foreign exchange through export promotion and import substitution.

By the end of the Fifth Plan, India became self-sufficient in food-grain production. In 1999-2000, our food grain production reached a record of 205.91 million tons. Further, in the field of industrialization, now we have strong capital industries based on infrastructure. In case of science and technology, our achievements are no less remarkable. The proportion of foreign aid in our plan outlays have declined from 28.1 percent in the Second Plan to 5.5 percent in the Eighth Plan. However, in spite of all these achievements, we have to remember that hike in price of petroleum products in the international market has made self-reliance a distant possibility in the near future.

During the eleventh five year plan (2007-12) India recorded an average annual growth rate of 8% against the target of 9%. During the 12th plan period, the National Development Council fixed a target of 8% growth rate. 

Social justice: Social justice means to equitably distribute the wealth and income of the country among different sections of the society. In India, we find that a large number of people are poor, while few lead an ultra-luxurious life. Therefore, another objective of development is to ensure social justice and to take care of the poor and weaker sections of the society. The Five-Year Plans have highlighted four aspects of social justice. They are:

1. Application of democratic principles in the political structure of the country,
2. Establishment of social and economic equity and removal of regional disparity,
3. Putting an end to the process of centralization of economic power, and
4. Efforts to raise the condition of backward and depressed classes.

In spite of various efforts undertaken by the authorities, the problem of inequality remains as great as ever. Census 2011 data shows that only 4.6% of India’s population has ownership all four assets i.e. television, computer, vehicle and mobile phone. According to an OECD report on social indicators published in 2014, low social spending by the Indian government and skewed ownership of assets are major reasons for high income and social inequalities. Thus the progress in the filed of attaining social justice has been slow and not satisfactory.

Thus the Five Year Plans have targeted to uplift the economic condition of socio-economically weaker sections like scheduled castes and tribes through a number of target oriented programmes. In order to reduce the inequality in the distribution of landed assets, land reforms have been adopted. Further, to reduce regional inequality, specific programmes have been adopted for the backward areas of the country.

Modernization of the economy: Before independence, our economy was backward and feudal in character. After attainment of independence, the planners and policy makers tried to modernize the economy by changing the structural and institutional set up of the country. Modernization aims at improving the standard of living of the people by adopting a better scientific technique of production, by replacing the traditional backward ideas by logical reasoning and bringing about changes in the rural structure and institutions.

These changes aim at increasing the share of industrial output in the national income, upgrading the quality of products and diversifying the Indian industries. Further, modernisation also includes expansion of banking and non-banking financial institutions to agriculture and industry. It envisages modernization of agriculture including land reforms.

Economic stability: Economic stability means to control inflation and unemployment. After the Second Plan, the price level started increasing for a long period of time. Therefore, the planners have tried to stabilize the economy by properly controlling the rising trend of the price level. However, the progress in this direction has been far from satisfactory.

Thus the broad objective of Indian plans has been a non-inflationary self-reliant growth with social justice.

1.5 Problems in the Indian job market

The employment trends for the year 2016 in India seem to be very positive according to a few experts. However, most of the optimism is centered around the organized sector which is only about 7% of the overall job market. According to India's Labor and Employment Ministry, India's total workforce comprises 485 million people. 93% of these workers are in what is known as the "informal sector".

Every year, between 10 and 12 million more Indians enter the workforce. This number will keep increasing given the fact that the average Indian is a very young 27-years-old. According to India's National Skill Development Mission, only 4.69% of India's workforce has undergone any formal skill training. In the U.S. (52%), the UK (68%), Germany (75%), Japan (80%) or South Korea (95%) these percentages are much higher.

Therefore, one can safely say that the quantum of the challenge is very high. Skills development is one of the major hurdles in India truly realizing its demographic dividend. The National Skill Development Corporation India (NSDC) was setup as a one of its kind, Public Private Partnership Company with the primary mandate of catalysing the skills landscape in India. 

Skilling is perceived in India as the last resort only for people who have not had access to a formal education system. This mental block has only increased the gap between what the industry requires and what is currently available. There are more than 10,000  ITIs in the country, employing large numbers of trainers but their knowledge and skills do not match industry requirements of today. The education system has also not been able to produce effective skills.

In India there has been a difference in job creation and job demand since many decades. Hence, the new job opportunities have to be provided not only to the people entering the system in the current year but also to the vast numbers that are already unemployed (and not possessing the required skills). 

Another persistent problem in the Indian job market is India's apparent belief that keeping wages low is the way to be competitive in the international market. Yet China, whose wages are two and a half times those in India, is more competitive than India in the international market. The wage cost is a small share of the total cost of production, and this proportion has fallen steadily since 1981. It's time for India to face up to the fact that saving on labor costs and producing impoverished workers is not the key to becoming competitive on the world market.

Eighty per cent of Indian manufacturing output comes from enterprises in the formal sector while a similar proportion of manufacturing employment is generated by enterprises in the informal sector. This is a fundamental disconnect: one set of enterprises accounts for most of the output while another set of enterprises accounts for most of the employment. The government has to create conditions that encourage large enterprises to take on more workers while making it easier for informal enterprises to grow in scale.

The archaic labour laws is another problem that maybe stifling investment and consequently job creation in India. Though the current Government is trying its best to reform the laws and make them more flexible, it is proving to be very difficult to create a political consensus on the same. 

2.0 STRUCTURE OF STATISTICS MEASUREMENT IN INDIA

The British administration laid down the foundation of the statistical system in India. The Provincial Governments were required to publish the relevant statistics in their annual administration reports who, in turn, depended upon the district offices. The first significant development in the pre-independence era was the constitution of a Statistical Committee (1862) for the preparation of forms to collect statistical information on different subject areas. This led to the publication entitled Statistical Abstract of British India in 1868. This publication was based on the returns of the local administrations and contained useful statistical information for all the British Provinces, and became an annual feature till 1923.

Following the recommendations of the Indian Famine Commission, Agriculture Departments were opened in 1881 in various provinces inter alia for collection of Agricultural Statistics, while the work of coordination in the collection of Agricultural Statistics by the Provinces was vested in the Department of Agriculture. The first publication on the subject, Agricultural Statistics of British India, was brought out in 1886.

A Statistical Branch was established in 1862 in the then Finance Department of the Government of India. In 1895, the Statistical Branch was converted into a full-fledged Statistical Bureau embracing subsequently, within its function the task of dissemination of commercial intelligence in 1905. Functions and activities of the Bureau were carried out through two well-defined wings namely, Commercial Intelligence and Statistics putting both under an organisation entitled Department of Commercial Intelligence and Statistics headed by the Director General. 

The Director General of Commercial Intelligence and Statistics until 1914 was responsible for the compilation and publication of almost all the principal statistical information on demography, crop production and prices, rainfall, industrial production, education, health and hygiene, mining, roads and communications, and other subject matters. In April 1914, a separate Directorate of Statistics came into being. Subsequently, the Directorate of Statistics and the Commercial Intelligence Department were merged into a single organisation, which was renamed as the Directorate of Commercial Intelligence and Statistics in January 1925.

After the outbreak of the War in 1939 a need for more accurate and comprehensive statistics was felt by the Government. In 1945, the Government of India set up an Inter-Departmental Committee with the Economic Adviser to the Government of India as Chairman to consider the statistical material available and to make recommendations for filling up of the gaps, and for improvement in the existing organisations. One of the recommendations was creation of a Central Statistical Office.

With Independence and the advent of the concept of a planned economy gave a major thrust to the field of statistics in India. Important phases in this development are:

1. A nucleus statistical unit was set up at the Centre in the Cabinet Secretariat in 1949. This unit was developed later on in 1951 into the Central Statistical Organisation (CSO).
2. A National Income Committee was appointed in 1949 to work out a system for reliable estimation of national income.
3. The National Sample Survey (NSS) came into being in 1950 to collect information through sample surveys on a variety of socio-economic aspects.
4. In 1954, the National Income Unit was transferred from the Ministry of Finance to the CSO and a new Unit for Planning Statistics was set up.
5. In 1957, the subject of Industrial Statistics was transferred from the Ministry of Commerce and Industry to the CSO.
6. In April 1961, the Department of Statistics was set up in the Cabinet Secretariat and the CSO became a part of it.
7. In 1972, a Computer Centre in the then Department of Statistics was set up.
8. In 1973, the Department of Statistics became a part of the Ministry of Planning.
9. In February 1999, the Department of Statistics and the Department of Programme Implementation were merged and named as the Department of Statistics and Programme Implementation under Ministry of Planning and Programme Implementation.
10. In October 1999, the Department of Statistics and Programme Implementation was declared as the Ministry of Statistics and Programme Implementation (MoS&PI).

The federal structure of the Indian polity has influenced the organisation of the statistical system. The collection of statistics on any subject generally vests in the authority (Central Ministry or Department or State Government Department) that is responsible for that subject according to its status in the Union, State or Concurrent Lists. By and large, the flow of statistical information emanates from the States to the Centre except in cases where the State-level operations are an integral part of Centrally- sponsored schemes or data are collected through national sample surveys.

The Statistical System in the States is similar to that at the Centre. It is generally decentralised laterally over the Departments of the State Government, with major Departments, such as, agriculture or health, having large statistical divisions for the work of departmental statistics. At the apex level is the Directorate (formerly Bureau) of Economics and Statistics (DES), which is formally responsible for the coordination of statistical activities in the State.

3.0 GDP MEASUREMENT : SOME CONCEPTS

3.1 Purchasing Power Parity (PPP)

Because of integration of world economies it is essential to devise a common basis for measurement of GDP. Hence the Purchasing Power Parity method has been devised to measure economies on a common scale and compares the income levels in different countries. 

The concept of purchasing power parity allows one to estimate what the exchange rate between two currencies would have to be in order for the exchange to be at par with the purchasing power of the two countries' currencies. For example if a commodity costs Rs 2800 in India, then, assuming that the exchange rate is $1 = Rs.70, it should cost $40 in America. Conversely, it can also be said that if the same commodity costs US$ 40 in America, the exchange rate according to PPP is $1 = Rs.70.

As far as comparison over different economies are concerned, there would be much variance due to factors such as inflation, different costs of living, population etc. To overcome the first problem, instead of nominal GDP economists tend to compare real GDP.  

However, not much can be gained by comparing the nominal GDP of China to the nominal GDP of Ireland. For starters, China has approximately 300 times the population of Ireland. Hence economists tend to compare the GDP per capita. Now suppose China has a GDP per capita of $1,500, while Ireland has a GDP per capita of $15,000. This doesn't necessarily mean that the average Irish person is 10 times better off than the average Chinese person.

GDP per capita doesn't account for how expensive it is to live in a country. PPP attempts to solve this by comparing how much one U.S. dollar could buy of a common basket of goods.

3.2 The three approaches

The production estimate is based on the value of final output in the economy less the inputs used up in the production process. Final outputs include products such as cars, while intermediate goods are inputs used in the production of another good or service, such as car tyres, electricity and advertising. As the value of the final good (the car's price) reflects both the value of its inputs (the tyres) and the engineering expertise of the manufacturer, adding the final output of the tyre manufacturer to final output of the car manufacturer together would overestimate GDP. To avoid this double counting, the value-added at each stage of production is calculated and aggregated. This is known as gross value added (GVA), which is further adjusted for taxes and subsidies on products to create a GDP estimate. 

The expenditure estimate is based on the value of total expenditure on goods and services, excluding intermediate goods and services, produced in the domestic economy during a given period. Whereas the production approach captures the value of production, the expenditure approach reflects the value of spending by corporations, consumers, overseas purchasers and government on goods and services. The primary data for this measure come from expenditure surveys of households and businesses, as well as from data on government expenditure. Specifically, information from the Living Costs and Food Survey, the International Trade in Services survey and the Retail Sales Inquiry are used, along with data on producer and consumer prices.

The income estimate measures the incomes earned by individuals (for example, wages) and corporations (for example, profits) directly from the production of outputs (goods and services). The main data for this approach to measuring GDP come from the Quarterly Operating Profits, Average Weekly Earnings and employer surveys, along with administrative data from HM Revenue & Customs.

Using the three different methods avoids sole reliance on one source and allows greater confidence in the overall estimation process. GDP is estimated on a quarterly basis and if perfect data were available, the three approaches would generate equal estimates. However, as the data collected and processed by CSO are based on a variety of statistical surveys and administrative datasets, the three estimates can be different. In order to obtain the best estimate of GDP, the estimates from all three approaches are reconciled.

 

3.3 GDP Deflator

The GDP deflator (implicit price deflator) is a measure of the level of prices of all new, domestically produced, final goods and services in an economy. Like the Consumer Price Index (CPI) and the Wholesale Price Index (WPI), the GDP deflator is a measure of price inflation/deflation with respect to a specific base year; the GDP deflator of the base year itself is equal to 100. Unlike the CPI, the GDP deflator is not based on a fixed basket of goods and services; the "basket" for the GDP deflator is allowed to change from year to year with people's consumption and investment patterns. Hence, the GDP deflators bears a direct relationship to the inflation rate prevailing in an economy. If the rate of inflation reduces, the GDP deflator would also decrease. In India the GDP Deflator is reported by the Ministry of Statistics and Programme Implementation (India).

In practice, the difference between the deflator and a price index like the Consumer price index (CPI) is often relatively small. Since the deflator covers the entire range of goods and services produced in the economy - as against the limited commodity baskets for the wholesale or consumer price indices - it is seen as a more comprehensive measure of inflation. 

Recently in 2016, there has been a controversy over the method of computation of the GVA deflator. In the computation of the deflator, WPI is used whereas roughly 60% of the services considered under GVA are not included in the deflator. That is why, although the GDP/GVA deflator is supposed to be the widest measure of inflation in the economy, in India it is not so because of the way it is constructed. In other words, the sharp decline in the GDP/GVA deflator is due to WPI having a larger weight in it. In the services sector, inflation according to the GVA deflator was -0.6% in the first quarter of FY 2016. Taking estimates of production at current prices and then using the deflator to compute the constant price estimate will give you a misleading result.

4.0 The P.C. Mahalanobis Model

The second five year plan functioned on the basis of Mahalanobis model. The Mahalanobis model was propounded by the famous economist Prasanta Chandra Mahalanobis in the year 1953. His model addressed different issues pertaining to economic development.

Assumptions made by the Mahalanobis model

• According to this model, it is assumed that the economy is closed and has two segments:

1. Segment of consumption goods
2. Segment of capital goods.

• Capital goods cannot be moved or are "non shiftable"
• Production is at its peak
• Depending on the availability of capital goods, investments are decided upon  
• Capital is the scarce factor
• Capital goods production is not influenced by consumer goods production

By following the Mahalanobis model, the-then government wanted that there should be optimum assignment of the funds among the various productive segments. This was aimed with a view to achieve maximum returns on a long-term basis. 

5.0 NITI AAYOG

On 1st January 2015, the Prime Minister Narendra Modi announced the formation of the National Institute For Transforming India (NITI) Aayog and the 5 decade old Planning Commission was abolished. The Prime Minister will be the Chairman of NITI Aayog. One of the important mandates of NITI Aayog is to bring cooperative competitive federalism. To achieve this objective three sub-groups of chief ministers have been appointed. They will make recommendations in three important areas (centrally sponsored schemes, skill development and Swachh Bharat). NITI Aayog will provide opportunities, that the previous Planning Commission structure lacked, to represent the economic interests of the State Governments and Union Territories of India.

The NITI Aayog will comprise the following:

1.  Prime Minister of India as the Chairperson.
2. Governing Council comprising the Chief Ministers of all the States and Lt. Governors of Union Territories.
3. Regional Councils will be formed to address specific issues and contingencies impacting more than one state or a region. These will be formed for a specified tenure. The Regional Councils will be convened by the Prime Minister and will comprise of the Chief Ministers of States and Lt. Governors of Union Territories in the region. These will be chaired by the Chairperson of the NITI Aayog or his nominee.
4. Experts, specialists and practitioners with relevant domain knowledge as special invitees nominated by the Prime Minister.
5. The full-time organizational framework will comprise of, in addition to the Prime Minister as the Chairperson:

• Vice-Chairperson: To be appointed by the Prime Minister
• Members: Full-time  
• Part-time members: Maximum of 2 from leading universities research organizations and other relevant institutions in an ex-officio capacity. Part time members will be on a rotational basis.
• Ex Officio members: Maximum of 4 members of the Union Council of Ministers to be nominated by the Prime Minister.  
• Chief Executive Officer: To be appointed by the Prime Minister for a fixed tenure, in the rank of Secretary to the Government of India.
• Secretariat as deemed necessary.

Currently, it is essentially a think-tank that can make recommendations and has no power to allocate funds. The funding part has been vested with the finance ministry.

Recently the Aayog's task force on the farm sector submitted a report which suggested scrapping the procurement of crops at the minimum support price (MSP) and replacing the system with a 'price deficiency payment' mechanism. This involves fixing the price of crops based on their average market prices in previous three years and compensating farmers for any shortfalls in realising these rates. Some of the other recommendations of the Aayog included direct transfer of urea subsidy to the farmers' accounts and liberalising the land-leasing market to allow landholders to exit farming. It also suggested use of genetic modification technology in pulses and oil seeds and better use of Essential Commodities Act to encourage private investment in storage.

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