Growth Theories and Development Strategies: Lessons from Indian Experience
Author(s): Pronab Sen
Source: Economic and Political Weekly , July 27, 1991, Vol. 26, No. 30 (July 27, 1991),
pp. PE62-PE72
Published by: Economic and Political Weekly
Stable URL: https://www.jstor.org/stable/41498498
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Growth Theories and Development Strategies
Lessons from Indian Experience
Pronab Sen
The objective of this study is two-fold: (a) to re-establish the macro-economic foundations of developme
strategy; and (b) to reiterate and re-emphasise a conventional, and now largely ignored, wisdom- that policy for-
mulation in developing countries, even for meeting short-run shocks, must be based on an awareness of lon
run consequences .
Outlining the broad contours of the evolution of the Indian economy based on existing literature, the author
indicates the organic linkage between the development process, conduct of policies and the nature of the binding
constraints on growth . It is from this that an argument for a complete re-evaluation of Indian development policies
is developed and an alternative strategy for development proposed .
I
macro-economic conditions and not the
development economics and growth theory
was most significant in that it led to a moreother way around.
or less constant awareness of medium and
The biggest casualty of this era of intellec-
Introduction
>
long run issues in the formulation of
THE history of economic thought and practice relating to the less developed countries
of the world during this latter half of the
tual retreat on the macro-economic front
development policies. There were no doubt was policy- formulation in developing counany number of aberrations arising out of tries. The new challeges thrown uç by the
social, political and administrative conmpul- turbulence of the period could not be met
sions, but conceptual myopia was seldom the by the application of new theories and
20th century can be classified into two
distinct and equal segments or, in the words
of А К Dasgupta, epochs.
cause.
The 1950s and 1960s were the era of
The idealism and the concern about
perspectives.2 As a result these countries
were forced to employ orthodox (i e, DMEC-
based)
global growth that had characterised
the short-run macroeconomic managedecolonisation; and the process of transition
1950s and 1960s all but vanished in the
ment policies with very little idea of the
of the newly-emergent nations from passive
consequences.3 In this vacuum,
economically more turbulent 1970s longer-run
and
victims of external exploitation to active
1980s. The oil price shocks of 1973-74the
andrather doctrinaire policy recommendaarbiters of their own destiny was fertile
1979-80, the global recession of the early
tions of the multilateral aid agencies led by
ground for the emergence of development
the IMF held sway.
economics as a field of enquiry in its 1980s
own and the 'debt crisis' of the mid- to
right. Development economics branched
late-1980s
off
shifted the attention of policy- What is perhaps worse, the dominant
. in two distinct directions. On one hand there
growth and development prescription
makers from long-run strategic issues to very
were the microeconomic issues which arose
available today - the World Bank's structural
short-run fire-fighting. In the developed
from the institutional differences between
'north', global idealism was seen to be an
adjustment' package- -seems to be based
developing and industrial economies. On the unaffordable luxury and battle-front terms
more on ideology than on any clear and
other hand were the more macroeconomic
such as 'economic triage' came into currency.
rigorous analysis of developmental proproblems of generating rapid and sustained Academic economics kept pace with this
cesses. The emphasis, or rather almost total
reliance, on market forces which characgrowth in economies which had only the
attitudinal shift," with 'growth and developrudiments of an industrial sector.
ment' giving way to 'stabilisation and adjustterises this approach appears to ignore much
Issues of growth and development strategyment' as the catch-words for the profesof history and all the various distortions prewere central to many of the great debates ofsion.1 The shift away from macrosent in developing countries which call for
to least judicious government interventions.
this era. The economic histories of already-dynamics to macro-statics led inevitably at
industrialised countries were disinterred and a certain pauperisation of development This is perhaps an inevitable consequence
re-examined with much greater analytical theory. For the most part, the structure of the emerging dominance of microrigour than ever before in order to identifyand the analytical techniques used in macroeconomic development theory and dethe sources of growth. The 'stages of growth',statics were well known, and little new was
emphasis of macro-economic issues. Since
Чаке-off into self-sustained growth', theadded. The most significant development most
arguments for government intervention
in
Kuznetsian 'U-curve', 'balanced and un-
the field was in the area of 'Computable
arise out of macro conditions, almost any
balanced growth', the 'dual' economy, 'heavy General Equilibrium* (CGE) models, which
overtly micro-economic approach will
vs light industrialisation- all were products more or less displaced planning and opinvariably require the minimisation of the
of this incredibly fertile epoch of economictimisation models from the forefront of
government's role and expansion of untramacademic and policy discourses.
thought.
melled market forces, no matter how inapOn the other hand, the new-found em-propriate it may be given the imperatives of
Hand in hand with the conceptual and
empirical evolution of development
social and political factors.
phasis on 'efficiency' gave an added fillip to
economics, there were tremendous advances
the micro-economics stream of development The objective of this study then is twoeconomics, which had been relatively low
fold: (a) to re-establish the macro-economic
made in growth theory. The rather primitive,
profile during the earlier era. This field grew
though most insightful, growth models of
foundations of development strategy; and
to such good effect that today development
Harrod and Domar were supplemented by
(b) to reiterate and re-emphasise a convenis seen more as a process of getting each seca whole host of new models and concepts.
tional, and now largely ignored, wisdom The Solow-Swan, Kaldor-Pasinetti and the toral parameter and institution right ratherpolicy-formulation in developing countries,
two-sector models, the 'turnpike' 'and op-than how they fit into the overall scheme of
even for meeting short-run shocks, must be
timal control are only a few of the instances.
•
things.
There is no doubt that this burst of
based on an awareness of Jonger-run conresearch on micro-economic issues was
These models to a large extent drew their
necessary, and it has contributed coninspiration from the burning issues of
development economics and, in turn, pro-siderably to the understanding of the
sequences. This has become even more imperative now than earlier, since the complex-
ity of growth processes has increased
differences between the development
substantially, at least in their theoretical
vided the theoretical foundations for much
of the development strategy literature. experiences of different countries. But sec- recognition.4 Much of what is presented in
This symbiotic relationship between.toral optima should be contingent upon this paper is-well known, but little has been
PE-62 Economic and Political Weekly July 27, 1991
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done to integrate these commonly available
insights into a development policy perspective. The primary objectives of this study will
be to try and fill this lacuna in its small way.
II
rate of GDP growth which may be very difThe first major complication was introduced by Chenery in his Two-Gap*ferent from the savings- or the" foreign
exchange-constrained rates. The simplest
model, which explicitly recognised the role
version of this relationship is as follows:11
of imports in the creation and effective
utilisation of productive capacity. The 'Sav- g(y) = n + [g(a) - n]/E . . .(3)
ings constraint* of the earlier models was where: g(a) = exogenously given growth
therefore supplemented by a 'Foreign
rate of agriculture
Exchange constraint*. As it happened, the n = growth rate of population
Development Policy
full significance of the Two-Gap* model was E = income elasticity of demand
not realised until much later. In the early verGrowth Constraints: An
for agricultural output.
sions, the classical assumption of a savings- Simple ttfough the above expression may
Introduction
constrained investment function continued
be, this theory is of a considerably higher
Like most of economics, growth
theory
to be
made. This hàd a serendipitous effect
degree of sophistication than its precursors.
is concerned with maximising anonobjective
the relationship between the two con- In the first instance, it recognises that growth
function (the rate of growth of straints.
GDP [g(y)]
The inflow of foreign exchange in and development are not synonymous terms
in this instance) subject to the the
limitations
form of foreign savings (either aid or and that development policies have objecplaced by certain exogenous constraints.
debt) wouldInaugment the availability of tives (in this case, inflation) beyond the
its simplest and most commonly both
usedforeign
form,exchange and investible
maximisation of the GDP growth rate.
the growth rate is specified as a function
of
resources. Likewise,
efforts at relaxing the Second, it emphasises the importance of the
the rate of capital accumulation of
domestic savings constraint would also tend sectoral break-up of developing countries in
investments:
to relax the foreign exchange constraint. terms of the relative efficiencies of investThus there was apparently no real conflict ment and their amenability tò policy ing(y) = i/v ... (1)
Constraints to Growth and
between the two.
fluences. Third, and perhaps most imporwhere: i = the investment
rate (investment/
The most valuable contribution of the
tantly, it brings out starkly the interaction
GDP)
Two-Gap* model was in opening up the
between the growth constraints, and the need
v = incremental capital-output ratio
closed-economy structure of the earlier
to be aware not only of the immediately bin(ICOR).
models. This added an entirely new dimending constraint, but also the extent of slack
In the earliest growth models, it was
sion to development policy and planning.available
In
in the others.12
believed that the primary constraint on acparticular, it laid emphasis on the trade-off
The 'dual economy* models of Lewis,
cumulation was the availability of savings,
between current production and capacity
Jorgensen, etc, capture only a part of the
• which was determined by the savings
creation, and its sensitivity to the allocation
implications of the agricultural constraint
behaviour of the economy. This gave the
of imports between capital goods and intermodel, and are really the building blocks for
famous Harrod-Domar Warranted* growth
mediates. Perhaps equally importantly, it imit. In order to do full justice to poor,
path:
plicitly raised the likelihood of capacity
dominantly agricultural economies, the
g(y) = s/v ... (2)
under-utilisation - which was assumed away
'wage goods* constraint has to be married
where: s = marginal
propensity
to terms,
save
in earlier
models. In practical
it also
to the macro-economic issues of income
Initially both 's* and
V
were
treated
as
provided the most compelling justification
distribution, inflation, balance of payments,
parameters, so that for
the
maximal
development
aid and attainable
the continuing
etc, which this theory seeks to do.
growth rate was seen
to
be
outside
the
conexpansion of the multilateral aid agencies.
The latest addition to the family of growth
trol of the policy-makers. The policy proThis model has been the most durable in
constraints is the 'Fiscal constraint*, which
blem then was to attain and maintain the
so far as its influence on policy recommen-has originated in the Latin American Neowarranted growth rate, which was comdations are concerned. This is not the least
Structuralist school.13 This constraint is
plicated by the 'saddle-point* nature of the
because it provides the intellectual raisonbased on the insight that productive utilisagrowth path whereby even minor deviations
for the multilateral aid agencies, whotion of production capacities requires a corfrom the path would lead to instability.5d'etre
It
are now the dominant purveyors of develop- responding input of certain key infrastrucwas, however, quickly realised by development advice in the world.8 But this is of tural facilities. In most developing countries,
ment theorists and planners that neither of
the arguments could be treated as para-course not all. This model is, if properlyinfrastructural investments are and can be
utilised, a very powerful one and sheds lightcarried out almost entirely by the governmeters. Three main lines of generalisation
on a number of important policy decisionsment or the parastatals. If in such a situaemerged- (a) effect of income distribution
on V (Pasinetti): (b) technological changesuch as whether to follow an export-led tion the government is unable to raise the
strategy or an import-substtituting one,necessary resources in a non-inflationary
(Kaldor); and (c) effect of the economic
structure on V and V (Mahalanobis-
when and how much to borrow on the inter-
manner, either capacity utilisation will fall
national money markets, whether and on or fresh private investments will not be
what terms to allow foreign direct inmade.14 In either case, the growth rate of
Although these developments led to a convestments, etc. Its place in the tool-kit of the GDP will be adversely affected and may well
siderable increase in the sophistication of
development theorists is unquestionable.
fall short of the rates permitted by the
growth models, the essential problem remained simple- a single constraint. The real The next important conceptual develop- savings or the foreign exchange constraints.
Feldman).
ment in this field was the introduction of
Like the agricultural constraint, this one
importance of these researches lay elsewhere.
It was in the recognition that policies could
the 'Agricultural constraint' to growth. This too recognises the peculiarities and the
be directed not only towards attaining the
was uniquely an Indian contribution andimperatives that guide policy-making in
maximal growth rate for a parametrically
arose out of the development experiences of
developing countries. It also brings to the
given constraint, but they could also bethe country.9 But its application range isforefront the need for having an active public
directed toward relaxing the constraintvery much wider. Unfortunately it came atsector. Market forces clearly cannot be relied
itself.6 There were also the first stirrings of
a time when development and growth theoryupon to provide all the necessary inputs for
were already in retreat and, as a result, hadgrowth and development. It also explicitlydissatisfaction with the single constraint
model. This was most often articulated by
much less impact than it deserves.10 The
highlights capacity utilisation as an imporapplied economists and planners in terms basic
of
argument of this theory is that in a tant adjustment variable, which had only
the 'absorptive capacity* of an economy, or
poor and primarily agricultural country,been implicit in the earlier models.15 This
the ability of an economic system to utilise
slow growth of the agricultural sector placesmodel has an important dimension which
is missing in all the others - it draws a wellproductively the possible investments. a limit on the maximum non-inflationary
Economic and Political Weekly July 27, 1991 PE-63
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defined distinction between the real and the
financial sectors. All the earlier models were
in essence real in nature, and discussions of
monetary and financial issues were more in
the nature of qualifications. It is this dimen-
sion that highlights the importance of the
type and the recipients of foreign capital
inflows - a feature which should have been
central to the two-gap models, but was not.
private investments are large. Regardless ofis provided by the agriculture/manufacturing
the nature oftheinvestmènt demand func- terms of trade. So long as this figure, on a
trend basis, does not move against agri-
tion,, if private investors are not willing to
tolerate increasing capacity under-utilisation, culture, public expenditure levels may be
ex-ante private investment demand is likely deemed to be adequate.20
In general, this sort of expansionary
to fall considerably short of ex-ante savings.
Thus a generalised aggregate demand pro- government behaviour contains a danger of
blem arises whereby the actual demand- inflation. If there is a downward rigidity of
constrained growth rate falls short of even non-agricultural prices because of mark-up
the structurally-constrained one Moreover, pricing and a ratchet effect in wage formaAt present, therefore, there are four
depending upon the specification of the in- tion, an improvement in agricultural terms
distinct constraints to growth which have
vestment demand function, the system may of trade can come about only through an
been identified in the literature and have
well become unstable or, at the very least, inflationary process. This, however, is a
been analysed to a greater or lesser extent.
However, these are not all that there is todisplay large cyclical swings around a low necessary cost of maintaining growth levels
under uncertainty, and should not be a cause
development strategy formulation. As hastrend growth rate.16
for concern unless indexation is so prevalent
been mentioned, there is moré to develop- This problem is precisely analogous to the
iri the system as to make any inflationary
ment than merely attaining high rates ofwell known instability problem in growth
pressure explosive.21 In such cases the soluGDP growth even on a sustained basis. Each
theory which arises -when the Harrodian
country has a set of minimum socially'warranted* rate exceeds the 'natural' rate.
tion is not to permit the emergence of a
demand-squeeze based recession, the
necessary conditions that economic policy
In such a scenario, public expenditure
dangers of which have already been discusshas to address. Inflation has already been
becomes crucial in order to avoid problems
ed, but to reduce the extent of indexation
mentioned in this context. There can be a of current demand. The issue is the
through political processes. Unfortunately,
number of others. A few which are of
necessary level of public expenditure Let the
the standard-prescription for inflation are
relevance to India, for instance, may savings-constrained
be
growth rate be approxiall based on a savings-constrained view of
mentioned- a minimum rate of employmated by the Harrodian 'warranted' rate as
the economy. As a result the knee-jerk reacment growth, poverty alleviation, andgiven in equation (3). If the structurallytion is to prescribe a dose of monetary and
balanced regional development. Any forconstrainedrate is 'g', then 'v. g' is the growth
fiscal contraction.
mulation of development policies has in
to capacity required to maintain the con-
When the fiscal constraint is in operation,
retain awareness of these conditions and how
straint rate. If the private sector left to itself
however, the danger is much more serious.
they limit attainment of feasible growth
increased capacity at the rate 'i' then the
Since by definition the government is unable
government must spend at a rate of [v. g to raise the required resources for bridging
i] in creating capacity and at [s - v. g - 1],
the gap between ex-ante savings and inConceptual Issues in Development
where Y is the marginal propensity to tax/
vestments through non-inflationary means,
Strategy Formulation
on non-capacity creating expenditure on
targets.
monetary expansion is the most likely result.
domestic goods and services in order to
In the short run, under normal conditions
It should be apparent that the emergence
avoid aggregate demand problems and the
and with widely dispersed holdings of cash
or recognition of additional constraints to
resulting instability. 17
growth hás rendered simplistic the view that
balances, nothing much may happen. If, on
This is
emphasis on non-capacity creating
the other hand, the cash balances are held
accumulation and efficient use of capital
expenditures by the government is most
by aimfew or if the economy is disturbed by
the sole or even primary basis of growth
portant and is totally ignored in virtually
all
exogenous
shocks which lead to a switch in
which underlay virtually all of development
of mainstream economics literature18portfolios
There
from money balances to specu-
planning and policy in thé earlier years.
is a general feeling among most economists
lative real commodity stocks, an inflationary
While it remains true that sustained growth
and
laymen that non-investment expenis impossible without accumulation,
there
cycle may be triggered off. In the longer run,
ditures
loss if the fiscal problem is not solved,
is need to retain awareness of the nature
and of the government are a dead
however,
to if
thethe
system and should be held to a
interrelationship of all the constraints
any adequate and steady rate of growth' will
minimum.
sacrifices made in current consumption
and This is simply not correct. Under inevitably be associated with accelerating
certain
circumstances, over-investment can inflation.22
well-being implied by savings are not to be
be almost as bad as under-investment, and
rendered infructuous.
In addition to the general problem
Of the four growth constraints identified . this must be borne in mind. Therefore, in discussed above, there are a number of other
in the previous section, three- namely, a situation where the binding constraint to differences that arise in policy-making under
foreign exchange, agriculture and fiscal- growth is other than the savings constraint* different operative constraints. First, issues
are considered as 'structural' constraints, in the government not only has to decide on of resource generation and allocative effithe sense that they originate from rigidities the total level of public expenditures, but ciency are much less important for strucin specific sectors. This is in contrast to the also its break-up into investment and con- turally constrained economies than for
general demand-supply indication ^iven by
sumption on the grounds of macro-
savings-constrained ones. The primary
economic stability. This also has to be seen objectives of medium and long-run policyagainst the backdrop of claims on govern- making for the former should be to stabilise
ings cpnstraint has a crucial bearing on the ment finances on the grounds of socially the constraining sector and then to maximise
necessary objectives.
conduct of policy. .
the growth of the other sectors within the
the savings constraint. This distinction bet-,
ween the structural constraints and the sav-
In a structurally-constrained economy, the
Monitoring the necessary level of govern- Limits set by either the acceptable level of
very fact that the saving-constrained growth ment expenditures, although theoretically inflation or by the balance of payments as '
rate is greater than the attainable implies that determinate, is not easy since the parameters the case may be. If doing so requires that
the investment necessary to attain the are likely to change over time. 19 However, in allocative efficiency be sacrificed, it must
maximum constrained growth must be less a predominantly agricultural economy, a rise necessarily be accepted.23
In this context mention must be made of
than the ex-ante savings. This is not a serious in aggregate demand will, ceteris paribus ,
problem in centrally-planned economies raise the prices of agricultural goods relative the larjge volume of literature that has been
where either consumption or planned in- to those of other sectors. This of course does
developed in recent years on the 'rent seek-
vestments in long-gestation projects can be not apply to sectors whichJiave administered ing* or 'directly unproductive* (DUP)
easily adjusted, but it creates complications prices. Thus a convenient rule of thumb for activities that are created by import restricin a market or a mixed economy where judging the adequacy of public expenditures tions in general, and quotas in particular.
PE-64 Economic and Political Weekly July 27, 1991
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The ^argument is that in such restrictive
regimes real productive factors are used not
for production but for cornering scarcity
rents. This represents a net loss to the
economy. It should be remembered, however,
that this argument applies only when the
resources used in the DUP activity are the
constraining factors. For the most part, such
resources are capital and not agricultural
goods or foreign éxchange. Thus the argument applies mostly to savings-constrained
economies arid not to the structurally-
constrained ones - a distinction not drawn
Efforts at curbing such inflation by confects are asymmetric, ih thatincreasedsavings may well result in the demand contraint tractionary means are distinctly counter-
becoming effective such that the level of productive. In the first instance, it can be
current output falls» whereas decreased sav- achieved only by reducing non-agricultural
ings will have no output expanding ¿¡ffeçt output-which simply means adding output
since the problem is one of aft overall supply contraction to output contraction. Moreover,
constraint. The most likely outcome in such the massive reduction in the income terms
a case will be a deterioration of the balance of trade of the agricultural sector caused by
of payments and a tightening of the foreign this may trigger off hardship selling of
assets, and consequently^ lead to an un- .
exchange constraint.
With the foreign exchange constraint, alterable structural change within the sec- ;
where the bottleneck is a shortage of pro- tor. This will almost certainly have longer-
ducer goods or relative luxuries, both of run consequences on the position of the
by the proponents of this theory, although which are demanded more out of non-wage various constraints and on the attainment
it is obviously crucial. In the case of the incomes than wages, a more (less) egalitarian of socially necessary objectives.
fiscal constraint, it may be argued that tax incomes policy will increase (decrease) the
The alternatives to contraction are either
evasión is a major source of such funds and constrained growth rate: In case of the to impose a wage-price freeze on the nontherefore compounds the problem. However, agricultural constraint, however, where the agricultural sector as a whole, which reduces
it seems to be a little far-fetched to claim that bottleneck is in necessities which are
non-agricultural real incomes at a given out-
tax evasion is resorted to for generating primarily wage goods, increased egaliput level, or simply to allow inflation to
of
'slush funds-the implication is a very tarianism will tend to reduce the. ratecontinue
and make what adjustments ere
the
peculiar form of the 'Laffer curve* indeed.24 growth. The fiscal constraint, unlikerequired.
The first option in general will imthe
Second, the effects of one-off aid and others, places a direct limitation onply
a tightening of the savings, fiscal and
foreign borrowing are very different under conduct of an incomes policy. Since taxes
agricultural constraints, and a relaxation of
the various constraints. With the savings and are assumed to be rigid, any fiscal rethe foreign exchange one. Thus, other than
the fiscal constraints, foreign resource distribution necessarily implies á reduction
the political and administrative problems
inflows do not cause output to be higher in in public investments in favour of higher curinvolved, this option is credible only when
the short to medium run, but allow extra rent expenditures. This will almost always
the foreign exchange constraint is binding
The
capacities to be installed for higher output lead to a reduction in the growth rate.and
slack is available in the others.
in later years. With the other two constraints, problem gets further compounded if the tax.
As
however, foreign funds can have a more system is truly progressive In such cases, far as the second option is concerned,
the major problem lies in the balance of
immediate impact by allowing the import of income redistribution will lead to a reducconstraining goods, if the resources are so tion in tax receipts and hence to a further payments implications. The rise in thé
domestic price level will ceteris paribus lead
used. These 'windfall' foreign exchange tightening of the fiscal constraint.
to increased non-competitiveness, of
receipts, therefore, cause only step changes
domestic products vis-a-vis foreign ones, and
in output levels under the agriculture and
Short-Run Policy-making in
thereby to a deterioration of the trade
foreign exchange constraints with very litDeveloping Countries
balance.
The subsequent price decline which
tle growth effects, but have the potential for
to occur
the with the recovery of agricultural
a more sustained growth-raising effect under The points made above relatewill
does not in itself solve the problem
longer-run considerations that mustoutput
underlie
the savings and the fiscal conštraints.
non-agricultural prices would have
strategy.
Sustained inflows of aid or debt receipts, the formulation of any development since
settled at a permanently higher level. Finanon the other hand, have the potential of rais- A distinction is often drawn between
cing the increased trade gap by drawing
ing growth rates in all cases. The magnitude development strategy- and short-run policydown reserves or by borrowing is a temof these effects, however, is very different making for meeting exogenous Shocks. This
measure which is permitted only if
between the different structural constraints.
is wrong. It should be remembered thatporary
all
the foreign exchange constraint is nonThe output response of the economy to ad-economic shocks affect each of the conbinding. In all other eases, some form of real
ditions in import-capacity in any year straints to a greater or lesser extent. The
effective exchange rate adjustment must be
depends upon the foreign exchange multi- policy response should therefore be basejd on
an awareness of which constraint bites posbimplemented.
plier. With the foreign exchange constraint,
imports are required only for the 'non- shock and the extent of slack available in the
The other major source of exogenous
competitive* forms of imported goods. With others. Proximate indicators may well lead shocks is international developments such
the agricultural and the fiscal constraints, to inoptimal policy responses.
as the oil price shocks or world recession.
however, marginal requirements of agri- A major source of short-run fluctuations If the shock is a transient one, and the
cultural goods or competitive imports of in-in developing countries is weather-relatedforeign exchange constraint is not binding,
frastructural capital goods also have to beagricultural failure. In most cases this is a financing the increased trade gap or minor
provided. As a result, the foreign exchangetransient shock and does not affect the long-reallocation of imports is usually sufficient.
multiplier in any given country and at a run position of the various constraints iA any If, on the other hand, the foreign exchange
given constrained level of output is always significant manner. It is therefore un- constraint is binding, some reduction in
less in agriculture- or fiscal-constrained necessary to take any steps which would lead short-run growth performance is inevitable.
scenarios than in a foreign exchangeto irreversible changes in the economic struc-Ťhis may be achieved by an appropriate
constrained one.
ture. The immediate outcome of such shocks reduction in the import-intensive comThird, domestic income policies which at-is some degree of inflation. It is, however,ponents of government expenditure, such as
tempt to bring out desired income distribuimportant to bear inmind the fact that with public investments. It should be noted,
tions also have very different effects depen-an oligopolistic industrial structure, relativehoweveť, that in such a situation there is a
ding upon the operative constraint. With theprice adjustments can take pláce only with strong danger of a generalised demand prosavings constraint, if marginal propensity tosome inflation. Such inflation, therefore, blem arising which will drive down the
save is positively related to real income levels,
should be viewed not as a disequilibrium,growth, rate to below that warranted by the
all other considerations apart, greater
but as an adjustment phase in which relative foreign exchange constraint. Therefore, care
(lesser^ inequality of incomes will ceteris prices are adjusting to changed supply con- must be taken to ensure that the cut-back
paribus result in a higher (lower) rate of ditions within a 'competitive' market in import-intensive government expenditure
grówth. In the short run, however, the ef- framework.25
is matched by an increase in domestic
Economic and Political Weekly July 27, 1991 PE-65
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resource-intensive forms of government
expenditures.26
the country in the past. This threw up a processes was provided by what is now
challenge to Indian economists and plan- known as the Harrod-Domar model. It may
national shocks, which involve a shift not
ners, who had little to go on by way of past be recalled that the Harrod-Domar model
experience in either India or abroad, to chart hinged on three critical parameters - the
only in the intercept of the foreign exchange
constraint function but also in the slope, an
entire reappraisal has to be made of the con-
agricultural economy to a powerful and self- incremental capital-output ratio (v); and the
reliant industrial power.29 The Planning rate of growth of population (n). These were
In the case of more permanent inter-
straints scenario. If the foreign exchange
constraint remains non-binding, nothing
much needs to be done except for some
reallocation of imports for ensuring that the
reduction in the slack falls only on non-
essential imports and not on essential ones.
If, however, the foreign exchange constraint
replaces some other as the binding con-
the course of development from a poor, marginal propensity to save (s); the
Commission, established in 1950 under the assumed to be exogenously given and consstewardship of P С Mahalanobis, was more tant for the period of analysis.
It is not surprising therefore that the
than equal to the challenge. The early plan-
ning framework established by these Indian planners explicitly identified the
pioneers has gone down in the history of availability of investible resources or savings,
economic thought as an outstanding exam- as the primary constraint to growth in the
ple of vision coupled with technical
excellence.
Indian context. But they did not stop there.
Borrowing from the Soviet experiment, they
believed that neither V nor V should be
The subsequent economic history of .
India, on the other hand, shows a relatively treated as exogenously given parameters.
this new'reality. Failure to do so will involve dismal record of awareness and creativity in This recognition resulted in formal articulalarge and totally avoidable costs.
economic management. It illustrates the tion of the so-called 'Feldman-Mahalanobis'
straint, the entire policy framework will have
to bé re-evaluated in order to accommodate
The confusion between the short run and extent of inertia in Indian planning and model which stressed the role of heavy
the long run is rampant. Most often it in-policy-making, and its insensitivity to struc- industries in increasing the savings rate of
volves treating short-term transient changestural issues. It is not as if now challenges the economy.30
as if they are permanent. Sometimes, did not come up during this period. Indeed,
The innovativeness of Indian planners did
however, it works in the opposite directionthe past three decades of Indian economic not stop there. Foreign exchange was also
as well. A classic example of this is -the history, if properly analysed, presents an in- perceived to be a serious problem, and it was
paradox that has been observed of efforts teresting case study of how the binding con- felt that the pattern of growth should be
at increasing urban employment in develop- straints to growth can change in response to such that it could be sustained even without
ing countries actually leading to even greater not only various exogenous shocks, but also large inflows of foreign capital. Although
urban unemployment in the medium to long to development strategies and short-run this view was never formalised in a specific
•run. This phenomenon, which has receivedmacro-management policies.
considerable attention in the development
The lacuna was elsewhere. It lay in the
' literature, strongly suggests the existence ofsteady increase in the powers of functional
adjustment mechanisms which are usually ministries, and the consequent marginalisa-
not present in developed countries, andtion of the Planning Commission, in
which argue for an entirely different macro-economic decision-making in the country.
economics for developing countries. Unfor-As a result, policy-making no longer
tunately, such an integration of the micro-emanated from an overall macro-economic
model, there is not doubt that the Indian
planners had to a very large extent anticipated the Two-Gap' model that dominated
growth theory in the mid-1960s.
But these conceptual innovations were not
enough. The ground realities had also to be
taken into account. It was recognised that
the nature of Indian exportables was such
economic phenomenon with the develop-perspective, but got fragmented into sectoral
that it would not be possible to increase their
ment strategy framework is as yet not domains. This led to the loss of a long-term
output rapidly enough for meeting the imavailable.
system-wide vision, which precluded not
port requirements.31 It was also believed
Another such instance relates to the advice
only any substantive course correction but that the new industries that were to be
that is frequently given to developing coun- also any recognition of such a need. The fact
established would not be able to achieve very
tries which have chronic balance of pay- that incremental short-run policy changes
much in the way of exports until at least a
ements problems to allow large inflows can have substantial cumulative effects has
fair amount of learning-by-doing experience
of direct foreign investment. Although not been adequately appreciated. Indian
the motivation is more often than not
ideological, the arguments are usually
economic history is a testament to this.
had been gained.32 Moreover, an overriding
consideration of the political cohesion of the
It is not within the scope of this paper to
young Indian state required that developcouched in terms of short run positive BOP provide a detailed exegesis or rigorous
ment and growth had to be regionally
effects. It can be shown, however, that in analysis of these developments. Therefore
balanced. This had the implication that pure
what follows is more in the nature of laying
developing countries such inflows will
economic considerations, which are the sine
down some of the broad contours of the
almost invariably be assoiciated with a
qua non of^any export-oriented strategy,
negative BOP effect in the short run.27 evolution of the Indian economy based on
could not necessarily govern the establishThus if any argument in favour of such a existing literature. The objective of this
ment of industries. Thus the strategy of impolicy is to be advanced, it must be made historical detour is to indicate the organic
port substitution' behind a high protective
in long-run terms, and incorporated into a linkage between the development process,
wall was born.
wider policy framework.
conduct of policies and the nature of the
Given the perception of a binding savings
binding constraints to growth. It is from
constraint, the development strategy had to
Ill
this that an argument for a complete rebe aimed at utilising the available investible
evaluation of Indian development policies
Indian Experience
resources most productively and in a
is developed and an alternative strategy for
regionally dispersed manner. In order to en-
Background
development proposed.
sure that the available resources were not
wasted through unnecessary duplication of
The first, and possibly only, comprehenNlhru Era
capacities, an administrative devicesively articulated development strategy for
India is to be found in the First and Second
industrial licensing- was evolved. The obAt the time that the Planning Commisjective of this device was to establish a
Five-Year Plans and in the Industrial Policy sion led by Mahalanobis began formulation
Resolution (IPR) of 1956.28 The im-,
mechanism
of the development strategy for
India, by which the sectoral and
regional
capacity allocations made by the
peratives of fulfilling the aspirations of the growth theory was still in its infancy.
It was
Planning
people of the newly-emergent nation state believed that the only requirement
forCommission could be effectively
implemented
and monitored. Further teeth
dictated a sharp and decisive break from the growth was capital accumulation.
The
colonial economic structure imposed upon theoretical underpinning for suchwas
growth
added by the establishment of the Ďirec-
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torate General of Technical Development
famine of 1965-66 and the Indo-Pakistan
attainable. The real negative effects of the
(DGŤD), which wai^ charged with thefunction of ensuring that the technologies used
in various investments were optimal for the
country, not only in terms of the state-of-
war of 1965, it was realised thi^t aid could mismatch between the perceived and the acnot be relied upon and self-sufficiency in tual constraints were brought to the fore in
food had to be achieved at all costs. This led 1973-74, when the economy was subjected
to an increased emphasis being placed on to the dual shocks of an agricultural failure
agricultural growth and the consequent ad- and the first oil price shock. This period has
vent and spread of the 'Green Revolution' been extensively studied in Sen (1986b), Sen
in India.
(1987) and Sen (1988). The basic argument
and thè need for regional dispersal could not
rely entirely on private sector initiatives. The
Although the green revolution worked to made in these studies is that the government
some extent - the growth rate of agriculture over-reacted to the shocks and instituted a
rising to about 2.8 to 3 per cent - it had no number of severely contractionary stabilisasignificant effect on the rate of growth of tion measures which had the effect of trig-
the-art but also in terms of indigenous
availability of the requisite capital goods.
The strategy of heavy industrialisation
then-nascent Indian capitalist class had
neither the resources to meet the heavy
the economy. From the agricultural con- gering off substantial income and asset
redistributions.38 These stabilisation
jects nor the inclination to invest in
straint, equation (1), it can again be
uneconomic locations. This, coupled withcalculated that with g(a) = 2.8 per cent,policies, which were very much of the orthodox IMF type, were appropriate for a savan ideological desire to have a 'socialist* n = 2.2 per cent and E = 0.5; the constrainings constrained economy but not for an
form' of development, led to an emphasis on ed rate of growth of GDP, g(y) = 3.4 per
agriculturally constrained one.
the role of the public sector in industrialcent- roughly the actual growth rate over
growth.33
the period (which was about 3.1 per cent).37 These distributional changes had a
capital costs involved in long-gestation pro-
Therefore, the development strategy formulated by the Indian planners held together
as an integrated system which met the imperatives arising out of not only economics,
Thus, by chance or deisgn, the growth pernumber of major effects. First, consumption
formance of the economy during the 1960s
shifted towards non-agricultural products,
was more or less at the constrained level even thereby lowering the aggregate income
when the development strategy and policies
elasticity of demand for agricultural goods
continued 'o be determined on the basis of
from 0.5 to 0.29. This, combined with a high
administrative needs. There is no doubt at
a wrongly perceived savings constraint. growth performance of agriculture of 4.1 per
all that the strategy worked very well indeed. But the strategy should have been changcent per annum between 1974 and 1979,
but also political and social ideology and
Given the constraints faced by the economy, ed. A non-binding savings constraint implies
would have permitted an agriculturally conan average annual growth of 3.4 per cent was a domestic resource slack which can be used
strained growth rate of 7.1 per cent on
most commendable. Equally importantly,for relaxing the binding constraint. The average. Second, the savings rate of the
the savings rate of the country increasedagricultural constraint could have been economy rose very sharply indeed from 16
steadily by about 0.5 percentage points per relaxed by larger imports of foodgrains andper cent in 1973 to 23 per cent in 1979. This
year, implying a marginal propensity to savě by increasing even further the investmentsimplies that the marginal propensity to save
of about 19 per cent - which is remarkable in agriculture, particularly those of the went
4
up from 19 per cent in the late 1960s
by any standard.34 The rapid diversificationlonger-gestation type. The first would requireto about 35 per cent by 1979-80. 39 Such a
and regional spread of the industrial baseadditional foreign exchange which could besavings propensity would permit a savings
of 'the country too was commendable par- obtained partly from reorienting the importconstrained growth rate of about 9 per cent.
ticularly in view of the limited resources and basket
.
(to take advantage of the foreign Foreign exchange too was not a problem,
the narrow infrastructural base.
exchange slack) and partly from increasingsince a fairly liberal aid regime, rapid growth
Emergence of Agricultural
Constraint
In the euphoria of these remarkable
achievements what was not recognised was
the fact that the agricultural sector was
growing at a rate (2.6 per cent) only
exports by instituting a more attractive of exports and increasing remittances froYn
export incentive system. Although this wasIndian workers led to a balance of payments
done to a small extent, over-reliance on thesurplus by 1979.
import substituting strategy prevented any
The conclusion is inescapable that the
major change in the policy framework. As
Indian economy during this period was not
? result, although exports grew, the addiconstrained by any supply-side constraint
tional foreign exchange earneďcontinued to
but by demand.40 This should never have
be spent primarily on imports of industrial
happened. The costs borne by the Indian
marginally higher than the rate of popula- capital goods and intermediates. Thus theeconomy in terms of the deterioration of the
tion growth (2.4 per cent). As a result, while agricultural constraint remained binding atincome distribution were not compensated
the savings constraint was being relaxed at a fairly low level of GDP growth.
by the growth that had been made possible.
a steady and a fairly rapid pace, the
There is no doubt that the rigidity of the
Turbulent Years
agricultural constraint to growth was becomlicensing system was very largely responsiing more binding.35 In order to sustain
ble for turthe missed growth opportunities of
The 1970s were a period of great
whatever agricultural slack that existed in the
theeconomy,
mid-1970s and for the emergence of the
bulence not only for the Indian
early-1950s at a GDP growth rate of 3.4 per
large 'black
economy'.41 The utility of the
but for the world. The major events
of this
cent and an income elasticity of demand of
licensing regime had been over for some
period were:
about 0.7, the necessary growth rate of the
time, and this episode simply highlighted the
agricultural sector was 3.1 per annum.36(1) The prolonged agricultural failure of
Thus, the agricultural slack was being eroded
1970 to 1973.
costs of the anachronism. But this lesson still
remains to be learned.
at a rate of 0.5 percentage points per year-(2) The Bangladesh war of 1971.
(3) The first oil price shock of 1973-74.
which is very rapid indeed.
It is fairly clear that the savings constraint(4) The Emergency of 1975-77.
'Liberalisation' Phase
was dominated quite quickly by the agri-(5) The first Janata government of 1977-79.The next landmark was in 1979-8Q, when
the second oil price shock occurred and the
cultural constraint. There is no precise(6) Return of the Congress(I) government
estimate of when this happened. In the most
in 1979.
world economy went into recession shortly
detailed and comprehensive study of this(7) Start of the second oil price shock inthereafter. It was by now clear that the
1979.
issue, Sen (1981) indicates that the
foreign exchange constraint was in opera-
agricultural constraint certainly was fully inDespit^all of these, the growth rate of thetion. The income redistribution of the 1970s
operation by 1960. There was, however, no
Indian ecqriomy rose to 4.8 per cent duringand the consequent sharp fall in the incom
major shift in the policy regime as interthis period. Although this was well above theelasticity of demand for agricultural good
national food aid was fairly liberal until
'Hindu rate of growth* of 3.4 per ¿ent of thehad introduced a large slack in the agri_ cultural constraint which expressed itself in
1965. In the aftermath of the disastrous
previous two decades, it was well below the
Economic and Political Weekly July 27, 1991 PE-67
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the form of huge government holdings of
agricultural stocks.
Although the government hád learned
some lessons from the past and correctly
diagnosed the dangers, consequently stepping up investments in both the public and
terms of increasing the competitiveness of
policy regime that supports it. All lhat has
the Indian economy.
been done is periodic marginal adjustments
In view of the foreign exchange constraint,
to certain policy parameters for addressing
the proper reaction would have been to step
specific short-run problems. Such patchup export efforts substantially and to come
work tinkering will no longer suffice, in any
down even harder on unnecessary imports.case
,
the Indian economy has suffered con-
the private sectors, the latter did not rise suf-
The effect of the liberalisation was almost
ficiently.42 To a large extent this continued
the opposite. The import intensity of in development perspectives. The situation
to be due to the fact that the licensing regime
domestic production, which had more or lesstoday is so acute that any delay in altering
remained constant between 1968 and 1980,the development strategy and the supporting
rose by more than 50 per cent between 1980policies will have unbearably large adverse
still had not adapted to the sudden increase
in investible resources. As a result, government expenditures had to increase more than
was desirable in order to prevent yet another
siderably over the years for the lack of a shift
and 1989. Import substitution became evenconsequences.
more attractive than before with large and The single most important point to bear
round • of missed opportunities and a.
entirely unjustified increases in the effective
in mind while formulating an alternative
demand-based recession.
rates of protection, and exports more or lessdevelopment strategy for India is that the1
It is interesting to note that despite the oil remained where they were.45 It has beensayings constraint is not, and has not been
price' shock and the resulting balance ofestimated that the effective protection en-for a long time, the dominant constraint. At
an estimated marginal propensity to save of
payments difficulties, the government did joyed by imporbsubstituters is more than
27 per cent and a capacity utilisationnot resort to contractionary measures. Ittwice that given to exporters.
preferred to finance the deficit. This had an This liberalisation, in the context of a corrected incremental capital-output ratio of
4, the 'warranted' growth rate of the Indian
important consequence. The rapid structural foreign exchange constraint, had the effect
economy is 6.75 per cent per annum, which
transformation that was taking place in theof not only forcing the economy to borrow
is substantially higher than the actual.47:
1970s was arrested and the economy settledin foreign capital markets for financing cur-
Thus there is considerable domestic savings
down to a new sectoral configuration. Inrent consumption, but also of widening the
particular, the share of the agricultural sec- gap between the foreign exchange constraintslack in the economy. Any development
strategy must take this factor into account
tor in GDP, which had declined from 47 per and the savings constraint. This meant that
in order to ensure that distortions are not
cent in 1970 to a mere 32 per cent in 1979, government expenditures had to go up even
introduced for reasons which are no longer
stabilised at that level. This was accomplish-higher in order to preserve demand stabilivalid.
ed primarily by reversing the secular ty. This set off a double-helix of public
downward trend in the agricultural terms ofborrowing- on the international markets for
trade that had characterised the earlier
period.
On the negative side, the rapid increase in
the savings rate of the 1970s too was reversed. After reaching a high of 23 per cent in
1979-80, it declined to 20 per cent by 1982-83
and stagnated at that level till 1984-85. This
the necessary foreign exchange and in theImplications of Non-Binding Savings
Constraint
domestic market to finance the burgeoning
budgetary gap.
The recognition that savings is no longer
By 1989 the process was complete. In a
rigorous analysis of the constraints to the binding constraint to the Indian
growth in the 1980s, Sen and Sen (1990) economy has a number of implications.
found that by 1989 the binding constraintFirst, policy measures aimed at restricting
and directing the use of domestic investible
resources in order to prevent duplication of
exchange
one,
but
the
fiscal.
It
was
estimated
tion of the economy in the 1980s. A sudden
capacities and other forms of wastage are
that if present rends were to be continued,
behaviour can also be traced to the stabilisa-
to Indian growth was not the foreign
and regressive change in the income distribunot only unnecessary, but have become
tion, particularly-frf the presence of 'perma- the fiscal position would become so acute
counter-productive.
They have not only,
nent income* type consumption behaviour, by 1995 that the maximum supportable non-
stifled the emergence of internal competiwill drive up the marginal propensity to save inflationary growth rate would be only 2.5
per cent. The Gulf war has of course com- tion, but have also prevented the economy
(MPS) to abnormal levels in the short
from taking full advantage of the opporrun.43 Once the distribution stabilises, the plicated matters to some extent, and the tunities that became available. In order to
MPS! settles down to its long-run value and foreign exchange constraint seems to be back
prevent such situations from occurring
may even dip for a short period as exces sav- in operation. But it should be recognised
again, it is imperative that the entire
ings are adjusted. Since 1985, the savings rate that the fiscal constraint is not too far off
industrial licensing regime be dismantled.
has started increasing again, although at a at all, and neither for that matter is the
There
is more than enough savings slack in
slower pace of about 0.35 percentage points agricultural constraint.46 Any easing of the
the economy to absorb fairly substantial
oil
situation
will
almost
certainly
have
the
per year. This indicates a long-run MPS of
'wastage' of investible resources.48 It makes
27 per cent-- which is considerably higher fiscal constraint back in full operation.
much more sense today to allow the finanthan the 19 per cent which prevailed during Development strategy and policy formula-cial institutions to determine investment
the 1950s and 1960s.
tion must take this possibility into account
allocations.
if the mistakes of the past arc not to be
While increases in public investments
Second, the anti-luxury' bias and heavyrepeated.
though excessive, were in tfie right direction,
the same cannot be said of the import
industrialisation approach designed to
IV
liberalisation that took place since 1979, and
more particularlyLafter 1984. It appears that Development Strategy for '90s
the gainers from the 1970s redistribution-
urban capitalists, bourgeoisie and the
emergent industrial and rural middle-
Need for New Strategy
increase the savings rate of the economy are
of much lesser relevance today. The distributional shifts that took place in the mid-1970s
were most unfortunate to say the least. But
they are today a fait-accompli. It is much
It should be clear from the preceding
secmore
important to ensure that the produc-
classes - demanded a consumption pattern
tions that the objective conditionstion
of the
structure of the economy is Consistent
which could riot be met without the inflow
Indian economy are very different
today
with
the demand patterns generated by the
of imported capital and intermediate goods,
from what they were in the mid-1950s.
It income distribution and export
existing
which had been restricted earlier.44 The does not seem reasonable therefore to possibilities.
expect
This is achieved better by
liberalisation was an outcome of pressures
that a strategy which was valid then will
con-forces than by inaccurate demand
market
exerted by these groups and partly of thetinue to be valid now. However, inforecasts.
the
Efforts at imposing a specific conpressures of the multilateral aid agencies,
intervening three decades there has sumption
been no pattern are doomed to failure as
although the ostensible argument was in
significant change in the strategy andthe
in experience
the
of the USSR and east Europe
PE*68 Economic and Political Weekly July 27, 1991
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have shoWn. Increased consumption of luxuries' may have a mildly depressive effect on
the savings rate in the short run? ntost of
which ha$ already occurred and is now in
the past, but much more positive results are
likely to arise by drawing black incomes into
directly. The REPs are tradeable import
licences which are issued as a given percentage of export earnings. The REP premium
represents the transfer of 'windfall' profits
from importers to exporters. Currently imports against REPs are only about 7 per cent
productive use.
of total imports.
economy is constrained by some other constraint, and is well below the 'warranted*
rate, the danger of a generalised aggregate
cover at least 40 per cent of all imports. In
Third, since the growth rate of the
demand problem and the resulting instability
; will always be there. This places an enormous responsibility on the government for
not only monitoring the adequacy of aggregate demand, but also forsaking corrective action.. At present there is no system in
place which can.undertàke this function on
a regular basis. Individual administrative
ministries do keep track of demand for their
specific sectors, but there is no macro-
economic evaluation. Such a mechanism has
to be evolved if a flexible and sensitive
This scheme can be easily extended to
the present import basket, roughly 40
per cent is composed of petroleum and
petroleum products and edible oils, all on
the government account. Imports of other
intermediates and private sector capital
goods from hard currency areas account
again for roughly 40 per cent.50 It is this
component which can be covered by the
extended REP scheme. A REP entitlement
of 100 per cent of export value coupled with
allowing non-governmental imports only
against REPs or with special licences will
serve the purpose. In order to make the
The complete switch-over may be effected
when capacity utilisation is sufficiently high.
In order to make this choice effectively, the
government will have to set up an appropriate monitoring and implementing
mechanism. The Planning Commission can
possibly take up this role.
Reducing Fiscal Burden
Given the uncertainties regarding the
fiscal constraint, immediate steps need to be
taken to increase revenues and reorient the
pattern of government expenditures. It needs
to be stressed again that the wide gap between the savings and the fiscal constraints
implies that the availability of investible
resources is not the problem, but the government's access to such funds. It would be trite
to assert that the government should increase
its tax revenues - it would surely have done
so if the political and administrative climate
had permitted. This of course does not
scheme meaningful, access to free foreign
preclude coming up with more imaginative
exchange by importers has to be restricted,
ways of rising tax revenues, particularly from
otherwise the premium on the REPs will be
direct taxes.
Foreign-Trade Regime
virtually non-existent, thereby rendering the
A more meaningful approach would be
incentive component negligible.
As has been mentioned, it appears that
to look for alternative methods of not only
It is recognised of course that the above
at present the binding constraint is scheme
foreign
raising funds, but also of passing a part of
will in effect roll back some of the
exchange, but the fiscal constraint is very
the social burden on to the private sector
import liberalisation that has taken place in
close indeed. There is thus an imperative
which has the necessary resources. In this
the past. But, in view of the foreign exchange
need to step up exports rapidly, and in such
context, the import-export scheme outlined
constraint, import liberalisation is a luxury
a way that direct fiscal involvement
of the
above will contribute, hopefully to a substanthat India can ill afford. It is often claimed
government is not required. The first and the
that import liberalisation is a necessary steptial extent. It not only reduces the governmost obvious instrument for achieving this
towards achieving production and allocativement's revenue-account liabilities in terms of
objective is exchange rate management. Durefficiency improvements. However, with aexport subsidies, but the increased import
ing the 1980s the government had followed
structural constraint, this factor is not ancapacity that will be permitted by larger
a policy of allowing the real effective
imperative. More importantly, the experienceexport earnings should help generate more
macro-policy environment is to exist.
exchange rate of the rupee to depreciate
of other countries clearly shows that import-revenues by way of import duties. In
steadily. This policy will have to based
be concompetition is not essential for effi-addition, the anti-luxury bias that has
tinued in the future as well, at least until the
ciency. Just as good results can be obtainedcharacterised production controls should
foreign exchange barrier is overcome.
through domestic competition. The internalgive way to using such goods as a major
But this is not enough. Governmental
liberalisation proposed through doing awaysource of revenue. This requires a much more
decision-making is seldom responsive
with the licensing system should more thanflexible and non-ideological approach to.
capacity creation.
enough to meet the fairly rapid changes that take care of this problem.
are required by market conditions. Moreover,
Even with these changes, one problem will
On the expenditure side, it is clear that in
the present lack of linkage between export
remain. This inyolves the deployment ofthe Indian context, the effective utilisation
earnings and import entitlements permits the
foreign exchange between capacity creationof existing capacities, and hence the invest-
balance of payments to go out of control. and increased capacity utilisation.51 Thement behaviour of the private sector, operate
Most importantly, however, exchange rate growth rate of GDP can be broken into twothrough and are enhanced by infrastructural
adjustments do not change the relative levels components - increase in capacity at cons-development. Therefore it is essential
of protection enjoyed by exporters and tant capacity utilisation; and the effect of that
"
the government withdraws from nonimport-substituters. At present Indian increased capacity qtilisation. It has been infrastructural investments and concentrates
exporters get less than half the protection noted in Sen and Sen (1990) that in the pre-its resources on rapidly building up infraafforded to import-substituters. This must sent Indian context, with capacity utilisation structural facilities. The private sector can
change. One way to overcome all these pro- in the non-agricultural sectors of 86 per cent also be involved to the extent possible for
blems is to effect a wholesale change in the or less, the latter effect requires less foreigntaking some of the -burden off. There is
import-export policies such that a direct link exchange than the former to attain the same enough administrative experience with
is drawn between export activity and
imports.
At present the government intermediates
between the two activities in the sense that
the foreign exchange earned by the exporter
is turned over to the government, which in
turn makes available the foreign exchange
to the importer. Similarly, the government
collects tariff revenues from the importer
and gives export subsidies to the exporter.49
There is only a small component- the
Import Replenishment (REP) scheme- in,
which the exporter and importer interact
rate of GDP growth. This is of course possi-operating administered prices to ensure that
ble only for a finite period of time, but ad-such involvement does not lead to undue
vantage should be taken of it while possi-concentration of economic powers.52
ble. In order to do so, however, the change This will of course have an effect on the
in the import-export mechanism outlinedexpansion of the PSUs. However, it is to be
above cannot be complete. The governmentnoted that the regional development funcneeds to retain enough control to direct thetion of the PSUs can be more effectively
allocation of foreign exchange between substituted by improving the infrastructural
capital goods and intermediates as dictated attributes of backward areas. The growth of
by the macroeconomic requirements of the the PSUs should therefore be determined
system. This consideration lends additional more by considerations of resource availsupport for only a partial implementation ability and monopoly-control than by
of the above proposal as has been suggested. ideological considerations. Even the control
Economic and Political Weekly July 27, 1991 PE-69
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of monopoly powers is better served by
all labour which would be consistent with
degree of indexation which did not exist
the country's resource endowments, suoi
earlier. The possibility of sustained inflation,
that technology choices would be based on
and its well known implications for the poor,
and private sector capacities than by
rational economic considerations rather than
reserving areas purely for public sector has thus been enhanced and will continue
determining an optimal ratio between public
to become more so over time as the reliance on grossly distorted wage rates.
investments.
on non-farm inputs spreads.
Notes
Third, the inability or unwillingness of the
agricultural sector to absorb more labour has
1 Indeed today 'growth theory* is considered
Apart from the technical issued involved
fprced the government to rapidly increase its
to be a 'dead' subject and research students
in maximising growth under the . operative
rural non-agricultural employment schemes.
are encouraged to stay away from it.
constraint, any development strategy
" This must
has resulted in a huge burden on the 2 Oddly enough, the only new developmenaddress the minimum socially necessary
obpublic exchequer, which is becoming increastal perspective to emerge during this era jectives: In the Indian context there
are
at
ingly
difficult
to accommodate in the current
the 'Dutch disease^- was applicable only to
least two which are of great urgencyfiscal-constrained scenario.
the newly-rich oil exporting countries. The
poverty alleviation and a growth rate
of
Much of these developments has possibly
oil-importing developing countries, who
employment of at least 2.8 per cent
arisen per
out of some valuable conventional
were affected most adversely, were by and
annum.53 The two are of course intimately
wisdom being ignored or overlooked. In the large ignored.
linked, and have to be discussed together.
3 DMEC stands for 'developed market
1960s, a large and very persuasive literature
By and large, poverty in India ishad
a rural
come up on the issue of land-holding economy countries' in the new jargon.
phenomenon, although the incidence
4 The reality of growth and development is
size and of
productivity, where it was convincurban poverty is very much in evidence
inglyThe
demonstrated that the two were probably not much more complicated than
most striking feature of the employment
pat-related. It was also shown that the before, but theoretical recognition òf addiinversely
Poverty and Employment
tern in India in the last decade is that the
employment-to-land ratio was inversely tional complications èmphasises the neeď
agricultural sector, which traditionally
related to the size of the holdings. Therefore, for even greater care in policy formulation
if past' mistakes are not to be repeated.
absorbed the largest number of workers, has
the nation would have been much better
5 This problem arises when the 'natural
shown virtually zero growth in employment.
served if the land ceiling laws that exist on
growth rate (determined by the growth rate;
The roots of this problem can be traced back
the books had been invoked after the rural
of the labour force) is below the 'warranted*.
to the distributional changes of the 1970s.asset redistributions of the 1970s. It would
6 Interestingly, the expansion of the role of
There is clear evidence that during the
have required much less fiscal involvement
policies also led to the recognition of trade1974-1979 period, substantial asset (land)
of the government, in terms of agricultural
offs. For instance* when Mahalanobis idenredistribution occurred from the small and
subsidies, rural employment schemes and
tified the relationship between the lack of
marginal farmers and tenants towards midfinances locked into huge agricultural stocks,
capital goods production and low domestic
dle peasants and the landlord/trader for getting at least comparable agricultural
savings, it was also realised that a capital
class.54 This *kulaki sation' of Indian agrioutput growth. In any case, it is not too late
goods sector would lead to an increase in
culture has had a number of implications.
even now.
V (see Chakravarty, 1989).
First, it has led to the emergence and con- The other dimension of the employment
7 This arises directly from the national
solidation of capitalist farming in India. Asproblem is the lack of jobs bçing^created
accounts identity
which equates the balance
in
a result, the substitution of capital and other
payments
the organised industrial sector of
despite
a position with the savingindustrially-produced inputs in place of
gap.
rapid growth in output.57 Indeed, investment
in recent
8 In the 1950s and 1960s there? were a number
labõur is well on its way. It is this factor
years this sector häs shown negative
employof academically
which is probably responsible for the almostment growth. This implies that the shift
from * based organisations which
gave relatively unbiased advice on developzero employment elasticity of this sector over
relatively labour-intensive to capital-intensive
strategy and policies, such as the
'the last few years. The process has been given
technologies in this sector is not ment
confined
Harvard Group.
an added boost by the subsidisation, both
to new units, but that retro-fitting of existing
9 Although the 'agricultural constraint' has
implicit and explicit, of these non-labour
capacities is also taking place. On the other
been implicit in much of the development
inputs by the government. This has led nothand, the unorganised sector has
shown
literature in India for quite some time, its
only to the substitution behaviour, but alsofairly rapid and sustained growth in
employmost
formal and rigourous expression is in
to the increasing fiscal burden on the
government.
ment. The conclusion drawn from this dif-
Sen (1981).
ferential behaviour is that there should be 10 The lack of impact of this theory was as
Second, the growing political power of the deliberate propagation of /the unorganised
much in India as it was internationally.
large/middle farmers has expressed itself in sector through government policies such as
Otherwise things may have been very different in India and a number of African
the form of the agricultural price support reservations and subsidies.
The above conclusion does not necessarily countries during the 1970s and 1980s.
system becoming more credible in the sense
that the procurement price is now very close follow. It should be realised that the substan- 11 This expression is similar to the one used
to the farm-gate price.55 This has led to a tial differences, in wages and wage forma- by Kalecki for characterising the consumpsituation where the benefits to the surplus tion between the two sectors, which led to tion eoods sector of mixed economies.
producing farmers has increased at the cost this observed difference in employment12 For instance, suppose the agricultural conof all net purchasers of food, such as the behaviour, are primarily the. result of govern- straint is sought to be relaxed by imports
marginal farmers and landless labour - the ment policies and legislations. It appears, of agricultural goods, the immediate effect
would be to make the foreign exchange conreal poverty groups in the rural areas.56 The that the over-protection of organised sector
straint more stringent. In addition, the
¡other effect has been that the price support labour and the under-protectiun of the rest
terms of trade effects of easier availability
system provides a safety-net to private has led to the creation of a dualistic
of agricultural goods would undoubtedly
speculative holdings of real agricultural economy even within the urban sector itself.
affect income distribution and thereby
stocks. It is little wonder then that private * As it happens, organised labour is protected
demand patterns. This would have the effect
stocks of agricultural goods, which had vir- 1 not only by the strength of its trade unions,
of shifting all three constraints through
tually disappeared by the late 1970s, have but also by a host of legislations. Unorganischanges in У, 'E' and the marginal propen-
ed labour, on the other hand, has neither.
agàin gone up in recent years.
sity to import. It is not at all obvious what
In addition, the cost formula used today It would seem logical to have less legislations
the final outcome would be.
for determining the procurement price ha si protecting organised labour and more 13
See Bacha (1988) and Tbylor (1988) for
prodetails. Some hints of this are also to be
a very large industrial input content. This: tecting the unorganised. Thus, a much more
has introduced a direct link from non-
found in the Indian literature.
sensible system would be to have a common,
14 for
This behaviour is referred to as the
agricultural to agricultural prices and and
a somewhat lower, level of protection
PE-70
Economic and Political Weekly July 27, 1991
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'crowding-in' phenomenon, as opposed to
the 'crowding-out' hypothesis proposed in
the monetarist counter-revolution literature.
15 Capacity under-utilisation is inherent in
both the foreign exchange and agricultural
constraint models as the natural adjustment
mechanism, but has not been used as
goods whose output, unlike that of
and the poverty alleviation programmes,
industrial goods, could be expanded only such as the Integrated Rural Development
slowlv.
-Programme (I RDP) and the Jawahar
32 The 'infant industry' argument had already Rojgar Yojana (JRY), will have no effect.
been developed by then.
If they do, the value of E will certainly rise
33 Pandit Nehru strongly believed that
and push down the sustainable value of
". . .defects are not due to industrialism as
g(y).
explicitly as in the fiscal constraint models.
such but to the capitalistic system which is 47 This figure has been computed on the basis
16 Whether the process is completely unstable based on the exploitation of others..."
of the well known Harrod-Domar equation
or shows cyclicity depends upon whether the [Quoted in PPST Bulletin , May 1983.1
for the warranted growth rate:
savings rate falls faster or slower than the
34 This figure for the mps can be calculated g(y)=s/v; where: s = marginal propensity to
investment rate with decreases in real
from the following formula:
save; v = ICOR.
output.
17 The case of the 'fiscal' constraint is a little
more complicated since 'i' will become a
function of government investments.
mps = aps + [A aps.y/Ay]; where y = real48 It is not as if such wastage is not taking
place today, as the figures on industrial
national income.
The same figure of 19 per cent has also been
sickness indicate. The point is that the licen-
estimated by Krishnamurthy and Saibaba sing mechanism prevents new capacities
(1981) and Madhur (1984).
18 The nearest one com« lo such a recognifrom coming in when and where required.
tion is the treatment of non-productive 35 The agricultural constraint is defined with
49 It should be noted that the Duty Drawback
investments and potlatch in Rakshit.
respect to the maximum non-irtflationary (DD) and a component of the Cash Com19 See note 12.
GDP growth rate permitted by the growth pensatory Support (CCS) are. not really
20 Some corrections would of course have to
rate of the agricultural sector.
export subsidies since they merely reimburse
be made for the effects of world inflation,36 This figure may be calculated from equa- to the exporter taxes and duties already
exchange rate changes and changes in the tion (3) by putting g(y) = 0.034; n = 0.024; paid.
interest rate.
E = 0.7; and solving for g(a).
50 The remaining 20 per cent is capital goods
37 The fall in E from 0.7 in the mid-1950s to
21 The Latin American hyper-inflation stories
on government account and non-oil imports
have this sort of a problem at their root. 0.5 in 1970 was due to the normal opera- from the rupee payment areas (RPA).
See Sunkel (1960) and Cardoso (1981).
tion of the Engel curve for agricultural51 Although this choice was implicit in the
22 This may be one possible explanation of the goods.
'Two-Gap' model, and Indian planners have
38 The details of these redistributions and the
vertical Phillip's curve which has been the
been aware of it for some time, it has not
comer-stone of the monetarist attack on
causal factors are given in Sen (1986b).
found any explicit reflection in the Indian
Keynesianism. This explanation, however,
39 The latter period figure of 35 per cent has planning process. With the foreign exchange
has not been discussed in the literature, and been computed in Sen (1987).
constraint binding, this seems to be the
it has little to do with either monetarism or 40 The emergence of the demand constraint
most important function of the planning
rational expectations. In fact, the solution during the mid-1970s is supported by the
system today.
to this problem is a structural one.
fact that the terms of trade moved against 52 An extension of the Essential Commodities
23 It may be argued, as is apparently done by agriculture more or less steadily over the
Act and a strengthening of the Bureau of
Little, Scitovsky and Scott and implicitly by period 1974 to 1981.
Industrial Costs and Prices (BICP) should
Bhagwati and Srinivasan (1975), that an in41 The rapid growth of private savings in the
be sufficient for this purpose.
crease in allocative efficiency through a 1970s was faced with a situation where ade53 This is the minimum rate of employment
more liberal trade policy would lead to a quate investment opportunities were not
growth which will hold the current
sufficiently high growth of exports so that available in the productive sectors of the
unemployment rate steady.
the structural constraint barriers may be economy. The surplus resources leaked into 54 See Sen (1986b) for details.
crossed and the savings constrained rate at- the black sectors, and set off a speculative 55 Earlier the procurement price used to be
tained. For this to happen, however, a rather bubble which continued to attract resources
substantially below the farm-gate price in
extreme form of export optimism has to ob- well into the 1980s because of the high prosnormal years. The two actually came close
tain. A more likely outcome of such efforts pective capital gains. See Sen (1977).
only in bumber years, which was the objecis that the economy will grow at a rate lower
42 By 1980-81 the investment rate was up to
tive of the support-price system.
than the structurally-cQnstrained one, and 24 per cent as compared to 18 per cent in 56 This would not be so bad if the public
with a much larger requirement of foreign 1970-71 and remained more or less steady
distribution system (PDS) had a wide
investible resources during the adjustment at that level. More importantly, the share
coverage in rural areas. But this is not the
nhase. which mav be nroloneed.
of the government and the parastatals in
24 In this case it has to be argued that a reductotal investments rose from 38 per cent in
tion in trade barriers, such as the import
1980-81 to 47 per cent in 1988-89.
duty, will lead to increased tax collection
43 The existence of permanent income type
behaviour in the Indian economy has been
25 It is being assumed of course that destabiliconfirmed by Madhur (1984).
sing commodity speculation does not occur. 44 This point has also been mentioned in
Chakravarty (1989).
If it does, necessary steps will have to be
taken. .
45 The liberalisation of imports took place
26 Note that such an increase is permitted by
only at the level of capital goods and inthe fact that the fiscal constraint is assumtermediates and not for finished goods. As
from other sources.
ed not to bite.
a result, the effective protection on inputs
27 See Sen (1990) for details.
declined whereas that on finished products
28 The initial attempts at developing such a
went up substantially.
perspective was through the formation of 46 In the present situation, with the
agricultural growth rate [g(a)j at 2.8 per
the National Planning Committee by the
Indian National Congress in 1938.
cent, population growth (n) at 2.1 per cent
and E at 0.29, the maximum sustainable rate
29 The post-revolution USSR was the only
available model for study and emulation.
of growth of GDP which Xvill preserve the
30 The long-run viability of the heavy
existing agricultural slack is 4.5 per cent per
industrialisation strategy, despite its leading
to an increase in V in the medium run,
gained theoretical legitimacy from the 'turn-
pike' analysis of the 1960s.
II The bulk of Indian exports were primary
Economic
and
annum. Any g(y) above this figure will erode
the slack and make the agricultural con-
straint more binding. This assumes that the
regressive income distribution changes that
occurred in the 1970s will not be reversed
Political
Weekly
July
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27,
1991
PE-71
case. The PDS even today is effective only
in the urban areas.
57 See Päpola (1988).
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