OPINION

Public investment: for a new normal



The Indian economy is not exactly “in a bright spot”. That is what most observers, barring those like the International Monetary Fund (IMF), appear to think. One can, of course, see where the IMF is coming from. Multilateral agencies, though armed with a cookie-cutter approach, do take a global view and it is true that India is today the world’s fastest-growing large economy. Cheer on this front must, however, be mediated by an awareness that India has a far lower per capita income compared to other countries in the Brazil, Russia, India, China, South Africa (BRICS) grouping. Moreover, early indications are that India’s growth rate is slowing this financial year.

All this is far from what some observers had expected when Narendra Modi became the Prime Minister in May 2014. Mr. Modi was seen as decisive and growth-oriented, his credentials burnished by his record as the Chief Minister of Gujarat. Expectations of a new dynamism in the economy were rife, at least among the corporates and the middle class.

The enthusiasm has dissipated by now. Mr. Modi is under pressure to show results on the economy front when, in fact, on the core issues, he has not been able to even show much initiative. Part of this situation may be out of his control as the bureaucracy matters when it comes to crucial decisions. However, as far as the core of the economic policy is concerned, not much has changed since the second term of the United Progressive Alliance (UPA II). I elaborate on both these points.

In thrall of the Washington Consensus

Since 1991, the bureaucracy and the technocrats in government have looked at economic policy through the prism of the so-called Washington Consensus, leaving it with less than the desired degree of flexibility. Even independently of this, the consensus within the political class militates against change. Both have a bearing on the current situation. So, how is the current situation to be understood?

The recent stagnation, if not further decline, in the rate of growth is a continuation of the decline seen since the 2008 financial crisis. We are possibly facing a ten-year cycle here. Part of it has to do with the global slowdown but it is also to be attributed to internal factors. Agricultural performance has been poor since the boom of the 2003-08 phase and the pace of infrastructure growth driven by public investment has slowed. It bears mentioning that in this period, when India had come close to achieving a double-digit growth rate, private investment in infrastructure was very high but yet eclipsed by the growth of public investment. This should make us accept the idea that publicly-created infrastructure is to be a component of any high-growth plan for the foreseeable future.

Second, in purely macroeconomic terms, there are moments when public investment serves as a deus ex machina . This is when the private investor is skittish on spending. It is likely that we are facing such a situation at present.

When it comes to economic change, it is devilishly difficult to separate the demand-side causes from the supply-side ones. However, the present slowing of growth, to a great extent, points to the recent slowdown in demand. The growth slowdown has taken place when the supply side, governed by policy, has not seen any great worsening for firms in the non-agricultural sector. In the past, even at times when the supply side was not much more favourable than it is now, private investment has been high. It stands depressed today, leaving the economy almost entirely dependent upon public investment.

The ‘mid-year review of the economy’ issued by the Finance Ministry — excellent both for its incisiveness and style — states that there are only two sources of demand growth in India today, private consumption and public investment. However, with exports having stagnated for close to a year now and private consumption largely tied to income, public investment remains the only source of demand growth. It may be too hasty to term this situation as ‘the new normal’ but it certainly is a noteworthy aspect of what we are up against.

Even if a slowdown in global demand has not caused the present slowing down of growth, it is clear that we must now rely on our own devices to grow, in the sense of finding the source of demand. Enter, with enervating effect, an element of the Washington Consensus, which in reality is no more than an ideological construct, that stands in the way of such a project. This is the axiom that ‘an expansion in the role of government is not good for the economy’.

In a situation when private investment is not forthcoming, public investment has a role not only as a source of aggregate demand but also as catalyst. This it does by anchoring profit expectations. Private investment is based on expectations of profit, called the ‘internal rate of return’ for a project. In the slightly more academic language of behavioural economics, expectations of profit are captured by the ‘marginal efficiency of capital’.

Profit expectations, far from being known with certainty, are highly subjective. They are based on anticipations of the future state of the economy on which little is known. However, private investors need to have an idea of it as demand for their products depends upon the aggregate demand and this depends upon investment, both public and private. In the absence of public investment, each private investor must guess what the others are going to do. To use the pithy phrase of John Maynard Keynes, investors now end up “chasing each other’s tails”.

In a situation of contagious pessimism, no increase in private investment will take place. The Government of India would have a unique role to play now. For, substitute ‘State governments’ for ‘private investors’ and we have a replay of the investment game where everyone is waiting for someone else to make the first move. Public investment provides forward guidance to the economy.

Being flexible on fiscal consolidation

Even when the Finance Minister is convinced of the necessity of public investment, he is berated by admirers of the Washington Consensus who argue against an expansionary budget on grounds that fiscal consolidation will be damaged. India’s fiscal consolidation programme is based on norms drawn from the European Union (EU). There is no basis in economic theory for a specified fiscal deficit target. And, in any case, the EU’s economy is in such a mess that no self-respecting economist would adopt its macroeconomic architecture uncritically.

Fiscal policy is to be used imaginatively according to the needs of the economy as they arise. Instead, we run the danger of tying it to unjustified targets. If an increase in the fiscal deficit is used to expand public infrastructure, it will serve a useful purpose, both in the current context and with regard to the longer-term trajectory of the economy.

We may conclude with two observations. First, it is not absolutely essential that the fiscal deficit must expand substantially to enable a programme of increased public spending on infrastructure. Here, a sort of ‘New Delhi Consensus’, shared by all political parties, stands in the way of the expansion of public infrastructure. There is reluctance to raise public revenues even in the face of inflation.

At the Finance Minister’s annual meeting with economists in 2015, someone in the gathering had pointed out that the real value of railway fares had been eroded by up to 40 per cent due to inflation. If public bodies are starved of funds, they cannot expand. This acts as an in-built depressor. Even Mr. Modi is quick to expound that he intends not to cut subsidies, only to target them better. Is it possible that at least some of the subsidies of the Government of India may be bad for growth, and therefore employment, in the sense that they constrain expanding public investment? Possibly.

Political parties are reluctant to review the subsidy regime. They are also reluctant to divest. This stance is an exact mirror image of the position that any expansion of government is bad. It is considered a mistake to even suggest sale of public assets. But why should we not consider sale of assets in areas where a public presence is no longer considered as essential as it was some decades ago?

There can be no intrinsic argument against the government selling some assets only to acquire others. It can be beneficial for growth and employment, and therefore for welfare. It is a no-brainer to choose between a publicly-owned airline that charges more than its private sector counterparts and a stronger infrastructure in the form of roads, bridges and irrigation channels. The guiding principle for our Finance Minister should be: “don’t take your foot off the accelerator of public capital formation”. A rationalisation of subsidies and some asset swapping would ensure that he can do this without much more borrowing.

( The author teaches economics at Ashoka University. The views expressed are personal .)



A sort of ‘New Delhi Consensus’, shared by all political parties, stands in the way of the expansion of public infrastructure. There is reluctance to raise public revenues even in the face of inflation





Indian economy finds itself in a situation of contagious pessimism. The Finance Minister has his task cut out: step up public capital formation, even if it involves greater rationalisation of subsidies and divestment in some public sector undertakings



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