The Indian economy has been going through a very bad patch recently. Last quarter’s GDP growth rate fell to 5%, the growth in the previous quarter being slightly higher at 5.8%. Many international organisations and private entities in the business of forecasting are projecting current fiscal year GDP growth at below 6%.
The private consumption expenditure growth rate saw a huge crash from 11% to 3% between the last two quarters. The manufacturing sector is stagnating, led by the dismal performance of the automobile industry. Construction and real estate are also in bad shape. The Periodic Labour Force Survey (PLFS) estimated India’s unemployment rate in 2017-18 to be 6.1%, which is over double that in 2011-12 when the unemployment rate was 2.7%. The labour force participation rate is also abysmally low at 37%.
Many experts are calling this an aggregate demand problem. I don’t disagree. However, it is quite likely that the current aggregate demand problem is a symptom or manifestation of a problem that is primarily structural. If India’s manufacturing sector had been more competitive internationally, it wouldn’t be so dependent on domestic demand. With a larger share in the world export market, it would also employ more people, and through them, domestic demand would also, in turn, be higher.
But why are India’s manufactures performing so poorly? Take automobiles. This sector is highly protected by tariff rates in the range of 60-125%, varying by automobile type and price.
Taking into account the fact that auto parts and components have a much lower import duty of 12.5% on average, the effective rate of protection could be well over 150%. Such high walls of protection would obviously make any industry lazy and inefficient. It is no surprise then that the Indian auto sector is so highly dependent on the domestic market.
Let’s next take textiles and apparel. Here, of course, outdated labour regulations that put extreme restrictions on hiring, firing and task reassignment make this labour-intensive sector highly uncompetitive internationally. Add to it the high import tariffs on artificial fibre and fabrics made from it, making India’s artificial fibrebased textiles, and apparel out of them, highly uncompetitive in the world market. Obviously, these high prices also constrain their domestic quantities demanded.
Import Walls Block Exports
Over the last five years, there has also been a hike in tariffs on electronic products, including parts and components. This hurts the activity of assembly and processing, one of the main engines of China’s growth over the last three decades. Even though duties on imports of inputs into exports are reimbursed, they do hurt production for the domestic market, most often needed for reaching the minimum scale of production after which exports can begin.
Besides, high import tariffs increase the demand for domestic resources by import-competing industries, making them costlier to obtain for producers of exports. Thus, an import tax acts also like an export tax (Lerner symmetry theorem in international economics). Hence, it becomes impossible to push for exports, when there is apolicy of import protection in place.
So, it is essential to reverse the tariff increases of the last five years and continue with trade reforms beyond even those of the P V Narasimha Rao and Atal Bihari Vajpayee administrations. Labour law reforms have begun in a few states. But Prime Minister Narendra Modi needs to use his political capital to push even deeper labour reforms through. The problem of land acquisition also needs to be tackled skilfully.
There is a demand problem. Structural reforms mentioned above will take time to have an impact. So, something more needs to be done to immediately fix the short-term health of the economy. This is the right time to be a bit flexible about deficit targets. Also, the different types of government expenditures are not the same in terms of their impact. Expenditures on infrastructure, which improve private sector productivity and provide employment opportunities directly and indirectly, are easier for GoI to pay off than those on government subsidies that primarily benefit the middle class.
Thus, GoI can be more creative about the type of spending. It can also provide tax cuts to the middle class and the poor, thereby putting in their hands higher disposable incomes. At the same time, GoI can be more innovative in finding alternative sources of revenues that don’t represent reductions in real personal disposable incomes. For instance, privatisation can raise revenues from the sale of public sector enterprises.
The recent corporate tax cuts are an important reform in the right direction. This can stimulate both domestic and foreign investment. With relatively advanced technology coming with the latter, it can boost both export volume as well as the sophistication of Indian exports, both of which have been known to stimulate growth. The immediate impact of these reforms would be an increase in aggregate spending by firms. Also, multiplier effects through consumption by workers should be expected.
Credit Where It’s Due
While cleansing the banking sector was essential, it has made credit more difficult to obtain, thereby negatively affecting aggregate expenditure, especially on consumer durables. Creditworthy consumers and producers need to obtain credit more easily. GoI seems to be aware of this problem and is trying to come up with plans to deal with it.
The economy’s temporary problems can easily become more permanent unless both long-term and short-term measures are taken simultaneously. The silver lining here is that crises bring about reforms, and there is no reason not to be optimistic in this regard in the case of the current economic crisis.
The writer is professor of economics, Syracuse University, New York, US