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Faltering National and Global Growth Prospects

What are the causes of the sudden adverse change in the economic scenario in India and the world? Growing disparities, financial uncertainty, a weakening dollar, the falling share of labour in aggregate income and rampant speculation in commodities are together forcing the economic slowdown. Rising disparities are aggravating the tendency towards "underconsumption", while the high rates of surplus generation driving investment are likely to result in "overproduction".

COMMENTARYEconomic & Political Weekly EPW july 12, 200815Faltering National and Global Growth ProspectsArun KumarWhat are the causes of the sudden adverse change in the economic scenario in India and the world? Growing disparities, financial uncertainty, a weakening dollar, the falling share of labour in aggregate income and rampant speculation in commodities are together forcing the economic slowdown. Rising disparities are aggravating the tendency towards “underconsumption”, while the high rates of surplus generation driving investment are likely to result in “overproduction”. Arun Kumar ( is at the Centre for Economic Studies and Planning, School of Social Sciences, Jawaharlal Nehru University, New Delhi.In the week ending January 5, 2008, the Wholesale Price Index (WPI) based inflation rate in India was 3.8 per cent and the year was expected to close with a real gross domestic product growth rate of 8.5 per cent with the industrial sector growing at about 10 per cent. By April, this rosy picture had undergone a dramatic change. Currently, the rate of inflation has gone up to 11.45 per cent and the latest fig-ures for industrial growth show a sharp decline to about 5 per cent. The trade defi-cit is rising rapidly. Infrastructure growth has also come down sharply, and various services – financial, software, trade, real estate, air travel and tourism – are in the midst of a slowdown. If this continues, could the rate of growth in 2008-09 go back to the earlier figure of 5 per cent? There have been straws in the wind for the perceptive. Some of these indications within the country are the narrow growth path of the Indian economy which makes it prone to instabilities, the rising food and energy prices and the slowdown in growth. Internationally, the western front is not stable with crisis brewing on many fronts, for instance, the sub-prime melt-down in the USA leading to a crisis in the financial institutions and in the stock markets globally. Losses have run into tens of billions of dollars for the largest financial corporations and the US government put together a bail out package of $180 billion.According to the latest indications, the US stock market is in a bear phase. TheUS economy has slowed down and has possi-bly entered a recessionary phase with em-ployment dropping since January 2008. This has led to rising uncertainty in the world economy, including a recession in Spain, falling business confidence in Japan, slowdown of industrial production in Thailand and Korea, retail sales decline in Hong Kong and falling corporate profits in China. To complicate matters, prices of petroleum products are rising sharply, global food prices are ruling at high levels and the dollar has declined in relation to the other major currencies. Are all these interlinked or separate events? This article analyses the causes of this sudden change in the economic scenario in India and the world.What is alarming is that the policy-makers have misread the situation so much that they have been caught un-awares and have not at all been prepared for it. Recently, in India, a spokesperson of the ministry of finance said that the rate of inflation will continue to be double digit and nothing much can be done about it, whereas, a few months back, it was being confidently predicted that the rate of infla-tion for 2008-09 would be about 5 per cent. Today, there is an element of throw-ing up of hands. The public needs some assurance that the policymakers are on top of the situation rather than being told that nothing can be done.Decoupling DebunkedPolicymakers in India had internalised the idea that the Indian economy would be insulated from the major worldwide changes and that they are in control of the economic situation and can continue to coax growth by giving more and more concessions to business so that invest-ments rise. For a while, during the grow-ing financial crisis in the latter part of 2007, a decoupling theory was being pro-pagated by analysts suggesting that the downturn in theUS economy would be compensated by the strong growth in China and India. According to these experts (and Indian policymakers), the world economy would be able to weather the gathering storm and India would do well. Any serious analyst should have real-ised that for this to happen, for every 1 per cent drop in the rate of growth of the US economy, the rate of growth of these two economies would have to go up by 4 per-centage points each, which is unlikely to happen given that these economies have been already growing at about the maxi-mum that they can achieve. Further, this rise in the rate of growth has to be a co-ordinated one which is rather difficult to achieve. Finally, given the strong links of
COMMENTARYjuly 12, 2008 EPW Economic & Political Weekly16these economies with the US economy, a slowdown there was more likely to result in a drop in their own rates of growth rather than a rise and that is already play-ing itself out. The idea of decoupling is now safely buried under the tattered illusions of the optimists.Slowdown in India: Its CausesIt has also been on the cards that the Indian economy was going to start slowing down after five years of strong 8 per cent+ growth since 2003-04. After all it had picked up from a lower base of about 4.7 per cent rate of growth in the three-year period 2000-01 to 2002-03. This is a classic pattern of a business cycle – of ups and downs.Based on the strong rise in the savings and investment rate in the economy in the last six years (from 23 per cent to about 35 per cent), the government has argued that the economy has transited to a higher growth path in the first decade of the new century. While this argument is correct in the short run, a classic lesson of a business cycle is that investments continue to rise in the recession phase and as the capital stock accumulates, overcapacity builds up, resulting in a cutback in investments with a lag and then a slump. What can prevent this slump is a strong anti-cyclical public investment programme if initiated well in time, but today, with the economy follow-ing the neoclassical path which requires a strategic retreat of the state, this has neither been initiated nor is it likely to be.Further, under the grip of the new poli-cies, the government has given concessions to big business so that corporate profits have risen dramatically in the last six years and raised disparities markedly [Alternative Survey Group 2007]. This major shift in national income in favour of the corporate sector is the underlying cause of the sharp rise in the savings and investment rates. But this kind of rise in inequity in the economy also makes de-mand narrowly based and, therefore, makes the path of growth rather narrow and also unstable. Growth has been depen-dent primarily on private investment and that too of the corporate sector (which has risen from 5.5 per cent of GDP in 2001-02 to 12.4 per cent in 2006-07). Any setback to the investment process in the corporate sector would immediately lead to a sharp decline in the overall investment level and to a reduction in the rate of growth of the economy. Overcapacity can be one such trigger and there are indications of this.Uncertainty in the Indian stock market, which is now globalised and takes its cues from the major economies of the world, has already taken a toll of investments in the economy. The booming real estate market had grown too fast and was ex-pected to go into a correction phase and there are signs of that. There is over-capacity here and the earlier boom in in-vestments in construction is petering out. The infrastructure sector has considerably slowed down. Thus, there are signs of a slowdown in investments and build-up of overcapacity in some sectors and this is leading to a fall in the rate of growth.Rising levels of inflation, based on a rise in food and energy prices, can only result in a worsening of the income distribution in the economy. As much as 93 per cent of the workforce is in the unorganised sector and by definition their wages are not infla-tion indexed so that they lose income share in a phase of rapid rise in the rate of inflation. It is this section which has a nar-row consumption basket with heavy de-pendence on food and energy. Thus, a dramatic rise in the food and energy pric-es in the last six months has affected it the most. Amongst the various consumer price indices, the one for agricultural labour has risen the most. Thus, demand for goods and services from this segment can only fall.The organised sector worker is also get-ting squeezed due to its reduced bargain-ing power. Trade unions the world over have weakened. Further, theWPI-based inflation index is way out of line with the actual inflation faced by this segment of the population. They consume a substan-tial amount of services and these are not factored into the inflation index [Alter-native Survey Group 2006]. In the recent phase, the prices of many of these services have risen substantially due to greater privatisation and the decline of the public sector. One may mention medical expenses, school fees, entertainment costs, house rentals and water charges as exam-ples of this trend. Thus, inflation index-ation of wages, even for the organised sec-tor workers, is inadequate and even this segment will have to cut back demand.In brief, mass demand is weak and this cannot be compensated for by the rise in demand from the well-off sections linked to the corporates who constitute a narrow segment of the population. The data from the National Sample Survey Organisa-tion’s 61st round for 2004-05 presented in the Report of the National Commission for Enterprises in the Unorganised Sector [GOI 2007] shows that 77 per cent of the population consumes less than Rs 20 per person per day and 96 per cent consumes less than Rs 48 per person per day. The consumption base is indeed narrow. Even in purchasing power parity (PPP) terms it is not too flattering.Often incomes are presented inPPP terms to show that the economy is much larger than when measured in dollar terms. But this would make little differ-ence to a broadening of demand. Usually, it is argued that inPPP terms the Chinese and the Indian economies are much larger and they can generate a lot of demand for the world economy. Expressing expendi-tures of the poor inPPP terms (the majori-ty of the population) makes little sense since it is their low wages that are the cause of services (non-traded) being cheap and due to which the value of the rupee turns out to be higher inPPP terms than in $ terms. They themselves consume little of the services they provide since their consumption bundle is heavily weighed in favour of food and energy and other ba-sics which are tradable and have one price (adjusted for taxes and transportation) in any case. It is only for the better off sec-tions that measuring incomes inPPP terms makes a difference. This picture of very low expenditures by Indians gets modified somewhat when the substantial black economy, which mostly escapes the official statistics, is taken into account. As shown in Kumar (1999), the black economy was 40 per cent of GDP in 1995-96 and was concentrated in the hands of the top 3 per cent in the incomes ladder. The size of the black economy is likely to have gone up rather than down but let us assume it is unchanged. The implication of all this is that income distribution is even more skewed and the consumption propen-sity even lower than what official data sug-gests. Yet, it is this section of the population with substantial black incomes that really
COMMENTARYEconomic & Political Weekly EPW july 12, 200817constitutes the consuming class in the economy. Since, this is a narrow segment it cannot keep up the growth of the economy on its own, especially when investments begin to decline. We need only recall that the previous high rate of growth of the economy in 1995-96 petered out in two years and fell in 1997-98. The situation today is worse if anything.International TrendsThe above-mentioned national trends overlie the international trends. Since the Indian economy is substantially glo-balised, it gets impacted quickly by the global trends.The world economy has also witnessed rising disparity, whether in China, Russia or the US. Thus, the base of growth every-where has narrowed and the world econo-my as a whole has been open to increasing instability. Since mid-2007 it has been triggered by the financial markets that have grown increasingly complex and are little understood even by experts. That is why the sub-prime market collapse and its consequences were not anticipated by the experts. The decline of the dollar has add-ed to the complexity confronting the global financial markets.TheUS economy was slowing down and as soon as the sub-prime crisis surfaced, the housing market went into a tailspin with foreclosures. A large number of the poor have been most adversely affected. TheUS economy slowed down rapidly and has been losing employment since Janu-ary 2008, which is a sign of a slide into a recession (defined as a fall inGDP in two successive quarters). Of course, recession has not been declared but data comes with a lag and we may learn later that the US eco-nomy went into a recession in early 2008.The slowdown has also been on the cards due to the strong rise in petroleum and food prices. This has adversely af-fected the poor the world over, including in theUS and has contributed to the slowing down of the economy. The rise in petroleum prices has also affected several industries, like the automobile industry, travel and tourism and air transport. The middle classes in theUS are also feeling the pinch and this is further slowing down demand, increasing the chance of a slide into a recession. In earlier phases of sharp increases in petroleum prices, in 1973, 1980 and 1990, the petro dollars used to come back to the US economy since dollar was the reserve currency but now that is hardly the case. The dollar has declined against most major currencies of the world so that sud-denly it is no more a safe haven. The huge overhang of dollars in the world economy, a remnant of the past export of the US deficits is adding to the problems. Also, several oil exporting countries are now delinked from the dollar so that the oil-based surplus funds are looking for alter-native investment opportunities.This means that theUS cannot any more export its deficits like in the past and can-not spend its way out so that it is likely to remain in a recessionary/low growth phase for much longer than in the past and since it is the largest economy, this is going to set everyone else also back. The oil surplus countries are suspected to be investing in commodities to take advan-tage of shortages and this has driven com-modity prices higher and led to the infla-tion that we are witnessing and this fur-ther slows down the world economy. Since the financial markets are in turmoil, the petroleum surpluses cannot go there either. The avenues for investment are few and, therefore, there is further destabili-sation of the world economy.There have been discussions regarding whether the recovery from the slowdown will be V shaped or U shaped, that is, whether it will be a quick or a gradual recovery. This is based on the past experi-ence when the above-mentioned structur-al changes had not taken place and so many adverse factors had not come together at the same time. The US eco-nomy could spend its way out but since that option is now limited, one needs to discuss whether recovery can take place with the current policy framework and how soon in a far more complex macro-economic framework.Impact of the Petroleum EconomyThe Organisation of Petroleum Exporting Countries (OPEC) has argued that output has not been falling in the recent phase. Further, it is being supplemented with bio-fuel production. It is estimated that if these fuels had not come into the picture, today crude prices would be higher by $30. It is also known that demand has been rising slowly in the past few years, so, why the sudden spurt in prices of crude oil?The rise in petroleum prices have resulted in huge surpluses for the oil ex-porters and the oil companies whose prof-its have soared. This is simultaneous with the non-availability of safe investment channels like securities, stocks or curren-cies. It is believed that the surplus funds have moved into speculation. In the New York Mercantile Exchange (NYMEX), after 2002, speculative activity in oil has in-creased five times more than trading ac-tivity. Further, it is suggested that demand increased by the build-up of reserves by those who are betting on rising prices, in-cluding some national governments. This is also a kind of speculation.However, some analysts point to diffi-culties with production for some producers and especially some non-OPEC oil produc-ers. Output has fallen in Nigeria and Mexico and stagnated in Russia and Venezuela. There are disruptions in pro-duction in Venezuela, Iran, Iraq and Nigeria. Most of these are linked to ac-tions and/or threats by the US. Conse-quently, spare capacity to raise production has fallen. This has also signalled price rise and consequent big increases in prof-its of petroleum producing companies. One may ask where are these profits being invested. Given the current scenario, what better investment than in oil itself.Some experts argue that one cannot put the blame on speculation and there is a dis-equilibrium due to demand not declining even after the massive rise in petroleum prices. In earlier phases of oil shock in 1973, 1980 and 1990, demand had fallen but this time that has not been the case. So, given the inelastic demand, prices had to go up.However, the definition of speculation used by these experts differs from that used by those arguing that speculation is taking place in the petro product markets. Speculation means buying on the basis of expected prices. If price is expected to rise, inventories may pile up with produc-ers or futures prices reflect in current prices and everyone pays more expecting prices to go up later. Further, one may ask, with petroleum goods prices going up, demand has gone down or stagnated, so, since
COMMENTARYEconomic & Political Weekly EPW july 12, 200819could simply import when there was a shortage. This was also the advice given in India and implemented at that time by the current top Indian policymakers.Free markets were supposed to take care of shortages, etc. Following such advice, Indian food markets were substan-tially opened up. Consequently, acreage has shifted from less profitable grains to the more profitable commercial crops so that the per capita availability of food has declined in the country [as suggested in Kumar 1994]. Food availability has fallen from 510 grams per day in 1990-91 to 444 grams per day in 2005-06 [GOI 2008]. Since the better off sections are continu-ing to eat more and better, it is the poor who are losing out and that is why 50 per cent of children and women in India remain malnourished. This has also hap-pened in many other countries in the world. In brief, food security has been dented the world over.Fertiliser companies, grain trading com-panies, like Cargill, seed companies like Monsanto and pesticide companies like Syngenta are making more profits and so are the food processing companies likeNestle and Unilever. Retailers like Wal-Mart have increased profits from food sales. So, everyone in agribusiness is reaping higher profits at the expense of the people.Amongst other factors, in China, due to urbanisation and industrialisation, acre-age under food has dropped by 6 per cent between 1997 and 2007. In India also, agricultural land is getting diverted to mega projects – power stations, steel plants, highways, airports,SEZs, etc. Fur-ther, rising energy prices lead to less use of fertilisers and a fall in productivity. Finally, due to rising prices of oil, biofuel production has grown. In the US, corn used for ethanol production amounts to 20 per cent of the production, thereby aggravating food shortages.Low income countries with a larger share of food in the consumption basket are being more strongly affected and will face a more difficult current account position (both be-cause of food and petro products). It is also being suggested that the food exporters are trying to panic the countries into accepting the new GM technology package in the name of increases in productivity and fac-ing the challenge of shortage.In brief, the energy and the food sectors have got interlinked in a way that is detri-mental to the poor people and the poorer countries. The cropping pattern shifts are aggravating the situation further. The ris-ing indirect demand for food from the well-off sections has added to the food in-security faced by the poor. All this in the context of the earlier advice to the devel-oping countries that they need not worry about food security is proving to be detri-mental to their national interest. There is an international shift in terms of trade due to the food price rise also but this is rela-tively small compared to the oil price effect. Finally, food price rise is also lead-ing to a terms of trade shift within the national economies and that is the big effect. It is not only leading to inflation but given the weight of food in the developing countries’ consumption basket, they are leading to a slowdown in demand and a downturn nationally.ConclusionsToday, there is growing disparity the world over, rising financial uncertainty, weakening dollar, falling share of labour in GDP and speculation in commodities. We have pointed to the interlinkage amongst these problems and how they are together forcing the slowdown in the world economy. These trends have result-ed in rising petroleum prices and also, through diversion of acreage to biofuels, to rising food prices. This has become a vicious cycle for the poor. Further, since theUS economy cannot spend its way out in the changed situation, the prospects for a deep recession are high.The rising disparities cause the tendency for under-consumption to aggravate and high rates of surplus generation driving investment are likely to result in over- production. This is not just true for India or the US but for the world economy as a whole. The rise in food and energy prices will affect the balance of payments of the poorer countries more adversely. The poor everywhere and the poorer countries are likely to bear the brunt of the downturn as is usually the case. There is no decoupling to protect India’s growth and its rising rate of investment is likely to result in excess capacity that would cause the downturn to accelerate. While every situation has some positives, like, India may get more outsourced jobs from companies trying to reduce costs or people may shift to smaller cars or surpluses from commodities may flow to some of the poorer countries, etc, the global macroeconomic effects will overwhelm these micro-level changes. Since the problem is structural and not emanating in any one aspect even though the trigger may have been the financial markets, it can only be resolved by a reform of the structures of the current glo-bal economy and the national economies. Since the current orthodoxy in the world economy only understands the situation in one way, it is incapable of providing the needed structural reform whether in the financial markets or for the new global sit-uation of absence of a reserve currency. Consequently, the current slowdown turn-ing into a recession promises to be both deep and long.In India, government has suffered from complacency because it was “feeling good” about the record rate of growth even though there may be some doubts as to how good it is [Alternative Survey Group 2007]. Hence the turnaround in the economic scenario has come as a shock. Further, since the government swears by the current orthodoxy, it has little idea of how to change the present policy framework. It is clear that when the going was good, the government could have done more to ward off the impend-ing problems but it was not willing to con-sider this and now that the scenario is turning adverse, it is likely to do even less, thereby aggravating the problem.ReferencesAlternative Survey Group (2006): ‘Flawed Macro Sta-tistics: Overestimated Growth and Under-estimated Inflation’,Alternative Economic Survey, India, 2005-2006, Disempowering Masses, Daanish Books, New Delhi.– (2007): ‘The Macro View’,Alternative Economic Survey, India 2006-07, Pampering Corporates, Pauperising Masses, Daanish Books, New Delhi.Government of India, National Commission for Enter-prises in the Unorganised Sector (2007):Report on Conditions of Work and Promotion of Liveli-hoods in the Unorganised Sector. Government of India, Ministry of Finance (2008):Eco-nomic Survey 2007-08.Kumar, A (1994): ‘Proposals for a Citizens Union Budget for the Nation for 1994-95: An Alternative to the Fund-Bank Dictated Union Budget for 1994-95’, mimeo, presented to the Citizens’ Com-mittee on February 12, 1994 at Gandhi Peace Foundation, New Delhi, prepared for the Prepara-tory Committee for Alternative Economic Policies. – (1999):The Black Economy in India, Penguin (India), New Delhi.

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