Themes > Current Issues
8.08.2012
Tweaking Animal Spirits*
C.P. Chandrasekhar
There
is a silent discussion on within India's economic policy establishment.
This relates to the way in which the combination of rising inflation
and slowing growth can be tackled. Till a few months back, when the
recovery from the 2008-09 downturn seemed strong, the focus of policy
was on curbing inflation. But now sustaining growth is also a concern.
The Reserve Bank of India has lowered its growth projection for fiscal
2012-13 to 6.5 per cent. Yet inflation is still high. Hence, as the
central bank puts it in its first quarter review of macroeconomic
and monetary developments during 2012-13: ''Persistence of inflation,
even as growth is slowing, has emerged as a major challenge for monetary
policy.''
Inflation is preventing the central bank from addressing the growth slowdown by reducing interest rates. In the policy follow up to the quarterly review, the RBI announced that it would as of now leave key interest rates unchanged, and merely reduce marginally the share of deposits that banks are statutorily required to invest in specified government bonds. According to the governor of the central bank: ''The primary focus of monetary policy remains inflation control in order to secure a sustainable growth path over the medium-term,'' since ''lowering policy rates will only aggravate inflationary impulses without necessarily stimulating growth.'' This declaration would disappoint a private sector looking for some action to counter the slowing growth rate.
The question is, can they turn elsewhere for support? Conventionally, if the monetary policy lever cannot be used to combat a downturn in growth, the burden falls on fiscal policy. But this too the RBI argues is not all too feasible, because the so-called ''fiscal headroom'' required is not available. To simplify, the RBI along with much of finance capital believes that the government is already over-borrowed relative to GDP, and therefore needs to reduce its fiscal deficit. Since an increase in aggregate expenditures, everything else remaining constant, would increase the fiscal deficit, that is not the central bank's desired option. More so because it believes that more spending implies a larger fiscal deficit and a larger deficit would necessarily aggravate inflation. The possibility that the government could mobilise additional resources through taxation, and thereby expand expenditures without increasing the fiscal deficit is clearly being ignored. So, the fiscal policy option is being ruled out. The government concurs in theory, though in practice it has let the deficit widen.
How then is growth to be revived? The consensus is that, rather than spend itself, the government's role should be to incentivise private investment, which would then drive growth. There seem to be two positions here. The RBI feels that the government should spur growth by expanding investment expenditure, since such expenditure would incentivise private investment by generating demand and relaxing bottlenecks. To finance such investments, it calls upon the government to reduce other expenditures such as those on subsidies. The subsidies specifically to be targeted are those on food and petroleum products, both of which would hurt the poor. But this is a cost that must be paid, says the RBI, since reducing such subsidies would keep the deficit under control while getting growth going. Stated otherwise, while placing the burden of fuelling growth on the well to do by imposing taxes that can finance additional expenditures is not acceptable, reducing subsidies that benefit the poor is eminently so. What is being discounted is the possibility that increases in the administered prices of food (distributed through the PDS) and petroleum products would both directly and through their cost push effects contribute to inflation.
The second position on how private investors can be incentivised can be traced to the government, especially the Prime Minister's office and the Finance Ministry. It holds that ''big ticket reforms'', such as allowing foreign direct investment in multi-brand retail or raising the cap on foreign equity in insurance or privatising public banks, are needed to unleash ''animal spirits'' and spur investment.
Even if not consciously, this argument advocates feeding the predatory appetite for profit of big domestic and foreign private capital. If profits can be inflated, capital would be willing to make investments, it is being argued. This is in keeping with policy in the recent past. Consider the period 2003-2008, when growth rose sharply, corporate profits spiked, and corporate savings and investment boomed. The process through which these occurred is revealing. To start with, since the early 1990s, when liberalisation opened the doors to investment and permitted much freer import of technology and equipment from abroad, productivity in organised manufacturing has been almost continuously rising. Net value added (or the excess of output values over input costs and depreciation) per employed worker (measured in constant 2004-05 prices to adjust for inflation), rose from a little over Rs. 1 lakh to more than Rs. 5 lakh. That is, productivity as measured by net product per worker adjusted for inflation registered a close to five-fold increase over the 30-year period beginning 1981-82. And more than three-fourths of that increase came after the early 1990s.
Unfortunately for labour, and fortunately for capital, the benefit of that productivity increase did not accrue to workers. The average real wage paid per worker employed in the organised sector, calculated by adjusting for inflation as measured by the Consumer Price Index for Industrial Workers, rose from Rs. 8467 a year in 1981-82 to Rs. 10777 in 1989-90 and then fluctuated around that level till 2009-10. The net result of this stagnation in real wages after liberalisation is that the share of the wage bill in net value added or net product, which stood at more than 30 per cent through the 1980s, declined dramatically and fell to 11.6 per cent or close to a third of its 1980s level by 2009-10.
A corollary of the decline in the share of wages in net value added was of course a rise in the share of profits. The years after 2001-02 saw the ratio of profit to net value added soar, from just 24.2 per cent to a peak of 61.8 per cent in 2007-08. The driver of this remarkable boom in profits was a rise in the profit margin, or the ratio of profits to the value of output. Increases in profit shares have clearly been the result of the ability of capital to extract more profit from every unit of output.
The question naturally arises as to the factors that explain the sudden and sharp rise in profit margins and shares in the periods after 2002. The answer is that in the name of economic reform, the government, through tax concessions, transfers of various kinds and sale of land and scarce assets to the private sector at extremely low prices, engineered this profit inflation. But to realise those profits the private sector needed a market to produce for. That market was delivered by a credit financed boom in private investment and consumption, which rode on the liquidity infused into the system by the foreign financial inflows attracted by the concessions that the reform offered.
There is a major lesson emerging from this narrative. Neoliberalism is an ambiguous and loosely defined term, even when restricted to the economic sphere. However, an essential feature characterising it is the use of the notion of a minimalist state to legitimise a state-engineered shift in the distribution of income and wealth in favour of the owners of capital and their direct or indirect functionaries and conceal the conversion of segments of the state apparatus into sites for accumulation. The limited evidence pertaining to the organised industrial sector presented above suggests that it was the adoption of such a strategy that allowed for a process of growth based on profit-inflation. Sustaining such growth, therefore, requires sustaining a regime of transfers to private capital. Under neoliberalism, growth is ensured through a predatory regime of accumulation.
Those who advocate ''big ticket reforms'' are essentially arguing that concessions or transfers to the private sector are required to feed the predatory demands of capital to spur investment and growth. The idea is to revive animal spirits with material incentives. Unfortunately, experience shows that such growth while serving a small section of private interests will leave much of the population marginalised and possibly further impoverished. Moreover, the truth is that in the current conjuncture this is unlikely to sustain even this kind of growth. The real problem is slackening demand. Government spending is being reined in. And the accumulated debt burden of households and credit exposure of the financial system appears to be depressing private demand. As a result the market that is needed to realise profits is shrinking. More reform would not expand the market.
This seems to be generating a new policy consensus. One element of that consensus involves spurring demand for the private sector by diverting expenditure away from subsidies for the poor to finance investment. That is the RBI's pitch. Simultaneously, a case is being made for providing more concessions to cajole the private sector into exploiting this opportunity. That is the government's take. This may or may not help sustain growth. But it definitely would be damaging in many ways for a majority of Indians. That would be the real fallout of the obsession to keep growth going without resorting to taxation or enlarging the government's budgetary deficit to finance that growth.
* This article was originally published in Frontline, Vol. 29: No. 16 Aug 11 - 24, 2012.
Inflation is preventing the central bank from addressing the growth slowdown by reducing interest rates. In the policy follow up to the quarterly review, the RBI announced that it would as of now leave key interest rates unchanged, and merely reduce marginally the share of deposits that banks are statutorily required to invest in specified government bonds. According to the governor of the central bank: ''The primary focus of monetary policy remains inflation control in order to secure a sustainable growth path over the medium-term,'' since ''lowering policy rates will only aggravate inflationary impulses without necessarily stimulating growth.'' This declaration would disappoint a private sector looking for some action to counter the slowing growth rate.
The question is, can they turn elsewhere for support? Conventionally, if the monetary policy lever cannot be used to combat a downturn in growth, the burden falls on fiscal policy. But this too the RBI argues is not all too feasible, because the so-called ''fiscal headroom'' required is not available. To simplify, the RBI along with much of finance capital believes that the government is already over-borrowed relative to GDP, and therefore needs to reduce its fiscal deficit. Since an increase in aggregate expenditures, everything else remaining constant, would increase the fiscal deficit, that is not the central bank's desired option. More so because it believes that more spending implies a larger fiscal deficit and a larger deficit would necessarily aggravate inflation. The possibility that the government could mobilise additional resources through taxation, and thereby expand expenditures without increasing the fiscal deficit is clearly being ignored. So, the fiscal policy option is being ruled out. The government concurs in theory, though in practice it has let the deficit widen.
How then is growth to be revived? The consensus is that, rather than spend itself, the government's role should be to incentivise private investment, which would then drive growth. There seem to be two positions here. The RBI feels that the government should spur growth by expanding investment expenditure, since such expenditure would incentivise private investment by generating demand and relaxing bottlenecks. To finance such investments, it calls upon the government to reduce other expenditures such as those on subsidies. The subsidies specifically to be targeted are those on food and petroleum products, both of which would hurt the poor. But this is a cost that must be paid, says the RBI, since reducing such subsidies would keep the deficit under control while getting growth going. Stated otherwise, while placing the burden of fuelling growth on the well to do by imposing taxes that can finance additional expenditures is not acceptable, reducing subsidies that benefit the poor is eminently so. What is being discounted is the possibility that increases in the administered prices of food (distributed through the PDS) and petroleum products would both directly and through their cost push effects contribute to inflation.
The second position on how private investors can be incentivised can be traced to the government, especially the Prime Minister's office and the Finance Ministry. It holds that ''big ticket reforms'', such as allowing foreign direct investment in multi-brand retail or raising the cap on foreign equity in insurance or privatising public banks, are needed to unleash ''animal spirits'' and spur investment.
Even if not consciously, this argument advocates feeding the predatory appetite for profit of big domestic and foreign private capital. If profits can be inflated, capital would be willing to make investments, it is being argued. This is in keeping with policy in the recent past. Consider the period 2003-2008, when growth rose sharply, corporate profits spiked, and corporate savings and investment boomed. The process through which these occurred is revealing. To start with, since the early 1990s, when liberalisation opened the doors to investment and permitted much freer import of technology and equipment from abroad, productivity in organised manufacturing has been almost continuously rising. Net value added (or the excess of output values over input costs and depreciation) per employed worker (measured in constant 2004-05 prices to adjust for inflation), rose from a little over Rs. 1 lakh to more than Rs. 5 lakh. That is, productivity as measured by net product per worker adjusted for inflation registered a close to five-fold increase over the 30-year period beginning 1981-82. And more than three-fourths of that increase came after the early 1990s.
Unfortunately for labour, and fortunately for capital, the benefit of that productivity increase did not accrue to workers. The average real wage paid per worker employed in the organised sector, calculated by adjusting for inflation as measured by the Consumer Price Index for Industrial Workers, rose from Rs. 8467 a year in 1981-82 to Rs. 10777 in 1989-90 and then fluctuated around that level till 2009-10. The net result of this stagnation in real wages after liberalisation is that the share of the wage bill in net value added or net product, which stood at more than 30 per cent through the 1980s, declined dramatically and fell to 11.6 per cent or close to a third of its 1980s level by 2009-10.
A corollary of the decline in the share of wages in net value added was of course a rise in the share of profits. The years after 2001-02 saw the ratio of profit to net value added soar, from just 24.2 per cent to a peak of 61.8 per cent in 2007-08. The driver of this remarkable boom in profits was a rise in the profit margin, or the ratio of profits to the value of output. Increases in profit shares have clearly been the result of the ability of capital to extract more profit from every unit of output.
The question naturally arises as to the factors that explain the sudden and sharp rise in profit margins and shares in the periods after 2002. The answer is that in the name of economic reform, the government, through tax concessions, transfers of various kinds and sale of land and scarce assets to the private sector at extremely low prices, engineered this profit inflation. But to realise those profits the private sector needed a market to produce for. That market was delivered by a credit financed boom in private investment and consumption, which rode on the liquidity infused into the system by the foreign financial inflows attracted by the concessions that the reform offered.
There is a major lesson emerging from this narrative. Neoliberalism is an ambiguous and loosely defined term, even when restricted to the economic sphere. However, an essential feature characterising it is the use of the notion of a minimalist state to legitimise a state-engineered shift in the distribution of income and wealth in favour of the owners of capital and their direct or indirect functionaries and conceal the conversion of segments of the state apparatus into sites for accumulation. The limited evidence pertaining to the organised industrial sector presented above suggests that it was the adoption of such a strategy that allowed for a process of growth based on profit-inflation. Sustaining such growth, therefore, requires sustaining a regime of transfers to private capital. Under neoliberalism, growth is ensured through a predatory regime of accumulation.
Those who advocate ''big ticket reforms'' are essentially arguing that concessions or transfers to the private sector are required to feed the predatory demands of capital to spur investment and growth. The idea is to revive animal spirits with material incentives. Unfortunately, experience shows that such growth while serving a small section of private interests will leave much of the population marginalised and possibly further impoverished. Moreover, the truth is that in the current conjuncture this is unlikely to sustain even this kind of growth. The real problem is slackening demand. Government spending is being reined in. And the accumulated debt burden of households and credit exposure of the financial system appears to be depressing private demand. As a result the market that is needed to realise profits is shrinking. More reform would not expand the market.
This seems to be generating a new policy consensus. One element of that consensus involves spurring demand for the private sector by diverting expenditure away from subsidies for the poor to finance investment. That is the RBI's pitch. Simultaneously, a case is being made for providing more concessions to cajole the private sector into exploiting this opportunity. That is the government's take. This may or may not help sustain growth. But it definitely would be damaging in many ways for a majority of Indians. That would be the real fallout of the obsession to keep growth going without resorting to taxation or enlarging the government's budgetary deficit to finance that growth.
* This article was originally published in Frontline, Vol. 29: No. 16 Aug 11 - 24, 2012.
© MACROSCAN 2012