Only last spring, as the country was gearing up for elections, we were hearing about a growth rate of 7 per cent, the highest in the world. Various new statistics were trotted out to suggest that the growth rate since 2014 had been higher than that under the previous regime. Those of us who looked at other economic indicators such as the unemployment rate and growth in tax revenue sensed the clear signs of the onset of an economic slowdown, but were dismissed as compulsive contrarians.
Yet, as winter approaches, the debate is no longer about how high the growth rate is, but about whether we are in a structural recession or a cyclical one, with clear signs of growth dropping sharply across sectors. Even the government's spokesmen and sarkari economists are not singing the "all izz well" tune.
But the chronicle of this economic downturn was foreshadowed even by official statistics. Take the successive rounds of revised estimates of GDP put out by the Central Statistical Organisation (CSO). On January 7, when the CSO released the first advance estimate of GDP for 2018-19, the yearly growth rate was reported as 7.2 per cent. On February 28, when the second advanced estimate was published, the number was revised down to 7 per cent. By May 31, when the provisional estimate for the 2018-19 GDP was published, the number had fallen to 6.8 per cent. When the CSO published its first quarter estimate of GDP for 2019-20 in late August, the reported quarterly growth rate was 5 per cent, the lowest quarterly figure in more than six years.
What caused the economic downturn? It would be tempting to blame global conditions and the slowdown caused by trade wars. While there is a global slowdown, the IMF in its latest World Economic Outlook (July), has adjusted the projections for India's 2019-2020 growth rates downwards by more than those for advanced economies or Asian developing countries. This suggests that the source of the problem is domestic, rather than a global trend; there is emerging consensus that a slowdown in consumer spending, which accounts for nearly 60 per cent of GDP, is to blame.
This is largely due to self-inflicted blows. The misguided shock therapy of demonetisation delivered a massive shock and little therapy. In principle, the GST was a good idea, but it was implemented in a hasty, chaotic, and ham-handed way, like surgery without anaesthetic. All this was done with the deeply misguided vision of converting a largely informal economy to a formal one overnight through diktat. All it did was simply dry up the informal sector, where nearly 80 per cent of the population is engaged, leading to massive losses in employment and income not fully captured by the GDP.
A more accurate picture of the economic downturn would have been available if we had the detailed NSS (National Sample Survey) report on consumption expenditure, as it is based on random sampling of households over the whole population, including those who are in the informal sector. However, while the full report is long overdue, a recent analysis has uncovered direct evidence of the economic downturn from a different series on consumption expenditure collected by the NSSO: average consumption expenditure at current (2018) prices fell from Rs 1,587 per person per month (ppm) in 2014 to Rs 1,524 ppm in 2017-18 in rural areas, while the corresponding figures for urban areas were Rs 2,926 ppm in 2014 and Rs 2,909 ppm in 2017-18. This kind of a decline in average consumption levels in a supposedly growing economy is striking. Given that consumer spending is the main driver of demand, the loss of income and jobs in the informal sector clearly affected the formal sector (e.g. the fall in biscuit sales) from the demand side, as well as disrupting the supply chain through the inter-sectoral linkages between the informal sector and the formal sector.
The government's reaction to the unfolding economic crisis has followed the classic stages of grief. It has moved from denial (e.g. the refusal to release government reports on unemployment rates before the election) to anger (accusing anyone concerned about the economy of political bias) to bargaining - acknowledging a problem but not its full extent and expecting that some small measures will solve it. The Finance Minister has said yes, the growth rate has slowed down, but it is still higher than that of US or China. This ignores the obvious fact that the richer economies tend to have lower growth rates since they start with a high base. Also, corporate tax cuts, mergers of some public sector banks, and interest rate cuts by the RBI are like pulling on thin strings to get a car out of a hole when a thick rope and big push are needed.
The Sensex is now lower than it was six months ago and has resumed its downward drift after a temporary rise right after the announcement of the corporate tax cut. The RBI has lowered the key lending rate by 1.35 percentage points in 2019 to 5.15 per cent, a nine-year low, without any noticeable effect. Some are suggesting an across the board income tax cut, forgetting that only 3% of the adult population actually pays income taxes.
After being chastened by the financial crisis and its aftermath, the Western world has gradually weaned itself off of the fairy tale called supply-side economics - the idea that cutting taxes for the rich and corporations will stimulate investment and spur growth. India seems to have embraced it enthusiastically, like we used to do with outdated gadgets and discarded technology in the pre-liberalisation days. Take the corporate tax cut, introduced in the hope of stimulating investment demand. While it will raise corporate earnings, the reaction of the Sensex suggests that there is little chance that it will stimulate new investment and reverse the downward trend in investment in new projects, which reached a 15-year low in the quarter ending in June 2019, according to the CMIE (Centre for Monitoring Indian Economy).
Another common argument is that formalisation is necessary and therefore, these "short-run" pains are inevitable. Yes, the argument would go, there is a decline in informal-sector growth and jobs, but more productive formal-sector firms, better able to absorb the cost of GST by combining lower prices and higher quality, will absorb the informal sector workers. This view completely ignores the demand side. The decline in the informal sector growth and jobs also depresses consumption demand. Eventually, the expanded formal sector workforce will generate demand as consumers, but this then becomes a chicken-egg problem. Without a pull from the demand side, formal sector firms will not invest and expand, and without that, jobs and income growth will stagnate, keeping demand depressed.
The economic downturn cannot be reversed without generating more purchasing power for the vast majority of the population. Just as one needs a tide to lift boats, without a big demand-side push from the government, private investment will not move and the supply-side will not respond, corporate tax cuts or downward interest rates notwithstanding. The government can only provide this by stepping up infrastructure spending that will boost demand, by expanding demand for labour, equipment and various ancillary private industries and business. This should be complemented by expanding the scope of schemes such as PM Kisan (as I have advocated elsewhere) and increasing the allocation for MGNREGA in real terms.
Does all this sound familiar? Yes, this is pure Keynesianism, the hard-learnt lesson from the Great Depression: namely, when an economy is in recession, expansionary fiscal policy - government expenditure in simple terms - is the only way forward. Yes, inflation is a worry (though, recall that revenue loss due to the corporate tax cut is twice the amount spent on MGNREGA), yes, factor market reforms are needed, and yes, it is important to create a congenial environment for businesses, small and big, to lower the costs of doing business (which include taxes, regulatory burdens, and fear of harassment by government officials). But to jump-start the recovery, demand-side policies are needed.
In the classic film "Being There" (1979), Peter Sellers plays the role of a simple-minded gardener who, through various dramatic twists, becomes a sage-like figure whose advice is sought by even the US President, even when he gives answers that only reflect his views from his experience as a gardener. When asked by the President if temporary incentives can stimulate growth, he says, "As long as the roots are not severed, all is well. And all will be well in the garden." He goes on to say "In the garden, growth has its seasons. First comes spring and summer, but then we have fall and winter. And then we get spring and summer again." The President interprets this as a deep metaphor for the economy, and the gardener sends him to heights of optimism by confirming that "Yes! There will be growth in the spring."
The supply-siders are increasingly sounding like the gardener. Will there be growth in the spring? That would depend on the budget taking the demand-side seriously and coming up with a stimulus package that invokes the spirit of Keynes. After all, even Robert Lucas, the Nobel-Prize winning economist from the University of Chicago and a pioneer of "new classical" macroeconomics which forms the theoretical foundation of supply-side economics, acknowledged in 2008: "I guess everyone is a Keynesian in a foxhole." Now that there is no doubt that the economy is in a foxhole, the time for tinkering with piecemeal supply-side policies is over.
Maitreesh Ghatak is Professor of Economics at the London School of Economics. He was recently elected Fellow of the British Academy.
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