Chapter 1 Introduction
Economics is the study of how goods and services are produced, distributed and consumed. As resources are always in short supply, the British economist Lionel Robbins in 1935 described the discipline as ‘the science of scarcity’.*
▷ More Than A Dismal Science
Economics has been called a dismal science, precisely a depressing and poor science. Other than this the discipline has also been criticised for being a kind of riddle for common people to comprehend. Last but not the least, it has been called a ‘failed science’ also (more so after its failure to predict the US sub-prime crisis of 2008) .Still, nobody can deny the invaluable role played by economics to make this world a better place for humanity.
Understanding Economics Understanding economics and its nuances have always been a challenge, especially, for those who come from no background in it. It doesn’t mean that those with a background (university-educated) in it are very comfortable—great many of such people face an altogether different sort of problem—they understand less economics than they know! Missing the applicatory dimension of economics is a general problem among such people. Today, emphasis being on the applications of economics (especially in the competitive exams) ‘knowing’ economics is not enough rather one is required to have the ability to apply economics in everyday life—and this is only possible if one ‘understand’ economics!
Making economics easier for both categories of the readers have been one of the prime aims of this book. Rather this has not been an easy task for two reasons—firstly, keeping the soul of concepts intact while simplifying them and secondly, educating the reader about the contemporary economic issues. Developing a book on Indian Economy would have been an easier task had simplifying economics not been among the aims. This is why along with the analyses of economic issues there flows an undercurrent of economic theory throughout the book. For this, it will be wiser on the part of the reader to keep in touch with the footnotes and glossary to feel and comprehend the subject matter in a desired way.
▷ Defining Economics
Simply put, ‘economics studies economic activities of the human being’ (a working definition). Humanities are intricately connected as all aim to study the differentiated human activities—that is why inter-disciplinary approach to study humanities is considered wiser.
What are Economic Activities? In a very simple way, all activities where money is involved can be called economic activities. And wherever money comes in question, there comes the economic motive/gain—several examples can be taken of it—getting job, giving a job, buying and selling something, doing a business, so on and so forth. Things are still a bit complicated! Visiting religious places for prayer is clearly not an economic activity but what about giving alms to beggars there or putting some money on the places of worship or for that matter religious donations. Can we call them our economic activities? It looks difficult to say! Here, other than the activity of prayer all are economic activities!
However, defining economics has not been as easy as it has been presented here—defining every discipline has been a complex and contentious task for that matter. Widely used and quoted definitions of the discipline revolve around the uses of resources and their distribution. Let us feel the technicality involved in a typical definition with the help of two such acclaimed definitions taken as reference—
Economics is the study of how societies use scarce resources to produce valuable commodities and distribute them among different people.
Economics studies how individuals, firms, governments and other organisations within our society make choices and how these choices determine a society’s use of its resources.
Economics is the study of ‘how society uses its scarce resources’ is probably the most used definition which is catchy as well as concise also.
▷ Micro and Macro
After the Great Depression (during the 1930s) the domain of economics got divided into two broad branches—the micro- and macro-economics. John Maynard Keynes is considered the father of macroeconomics (the branch came into being after the publication of his seminal work, The General Theory of Employment, Interest and Money, in 1936) .
Simply put, if macroeconomics (macro) is about the forest, microeconomics (micro) is about the trees. While the former deals with the big picture (the forest) the latter deals with the details (the trees) that make up the forest. Micro and macro are the Greek words which mean ‘small’ and ‘big’, respectively.
While micro takes a bottoms-up approach to analyse economy, macro takes a top-down approach. Taking an example, while micro tries to understand the choices which consumers make and the income they earn, macro tries to understand the dynamics of inflation and growth. Though, they appear to be different, they are actually interdependent and complementary since there are many overlapping issues between them. For example, a rise in inflation (macro effect) will cause rise in the cost of raw materials leading to rise in prices which consumers will pay (micro effect) .
Micro theory evolved from the theories of how prices are determined, macro, on the other hand, is rooted in empirical observations that existing theory could not explain. While there are no competing schools of thought in micro, macro has schools like New Keynesian or New Classical. Since the late 1980s rather these divisions have been narrowing.
Econometrics is the third core area of economics other than the micro and macro. This field seeks to apply statistical and mathematical methods to economic analysis. The sophisticated analyses of micro and macro sub-fields would not have been possible without the major advances made in econometrics over the past century or so.
▷ What is an Economy?
Economy is economics in action. It is a still-frame picture of the economic activities. A country, a company and a family all have their economies. It is popularly used in case of countries—Indian economy, the US economy, the Japanese economy, etc. While the principles and theories of economics remain the same, economies (of countries) show diversities given the socio-economic diversities countries have.
Sectors & Types of Economies
Economic activities in a country/economy are broadly divided into three main sectors and by their dominance economies get their names also:
Primary Sector: The economic activities which take place while exploiting the natural resources fall under it, such as mining, agricultural activities, oil exploration, etc. When agriculture sector (one of the sub-sectors of the primary sector) contribute minimum half of the national income and livelihood in a country it is called an agrarian economy.
Secondary Sector: It contains all of the economic activities under which the raw materials extracted out of the primary sector are processed (also called industrial sector). One of its sub-sectors, manufacturing, has proved to be the largest employer across the western developed Economies.When secondary sector brings in minimum half of the national income and employment in a country it is called an industrial economy.
Tertiary Sector: All of the economic activities where services are produced falls in this sector, such as education, healthcare, banking, communication, etc. When this sector contributes minimum half of the national income and livelihood in a country it is called a service economy. Later on, experts created two more sectors of economy—quaternary and quinary. Though, they are sub-sectors of the tertiary sector.
Quaternary Sector: Known also as ‘knowledge’ sector, the activities related to education, research and development, etc. come under it. The sector plays the most important role in defining the quality of the human resources an economy has.
Quinary Sector: All activities where top decisions are made fall under it. The highest level of decision makers in governments (inclusive of their bureaucracy) and the private corporate sector fall under it. The number of people involved in this sector is very low rather they are considered the ‘brain’ behind socio-economic performance of an economy.
Stages of Growth Looking at the way developed countries did grow, a theory about it was proposed by W.W. Rostow in 1960 as per which economies grow following five linear stages through the three main sectors i.e., agriculture, industry and services. However, several countries did show exceptions to this standard pattern—India and many other South East Asian countries such as Indonesia, Philippines, Thailand and Vietnam fall under this category. These countries moved from the stage of agrarian to service economy without much healthier expansion of their industrial sector.
India saw a transition from the dominance of the agriculture to services sector by late 1990s when the contribution of services in her national income crossed 50 per cent mark.
▷ Economic Systems
Human life depends on uses (consumption) of certain things (goods and services) some of which, upto a level, are also essential (such as food, water, shelter, cloth, etc.) for survival. How to let people have these things was the first challenge for the humanity. This challenge has two dimensions of it—firstly, these things need to be created (produced) and secondly, they should reach (distributed/supplied to) the needy people. For production one needs to set up productive assets for which money needs to be spent (known as investment). But ‘who’ will invest and ‘why’? In the process of taking on this challenge there evolved different types of economic systems (i.e., different ways of organising an economy). We can prepare a long list of economic systems, however, three of them are considered the major ones—a brief over view of which follows below.
This is considered the first formal economic system emerging out of the traditional economic system. Its origin is traced back to the work (An Inquiry into the Nature and Causes of the Wealth of Nations, 1776) of the Scottish philosopher-economist Adam Smith (1723-90). His main ideas can be summed up, in a simplified way, in the following way—
■ It is the self-interest which motivates individuals/firms to do economic activities out of which society gets goods and services supplied with. It means the products society gets is unintended social benefits of someone’s self-interested actions. Adam Smith called this motivating factor the invisible hand (often called as the ‘animal spirit’). This way the questions like ‘who’ will invest in productive assets and ‘why’ seem get answered.
■ To attain higher prosperity there should be increasing division of labour (specialisation of labour force by breaking down large jobs into small components). Specialisation brings in speed, precision and quality in the labour force.
■ For invisible hand to operate properly a suitable environment (i.e., market) determined by the forces of demand and supply (called the market forces) is required. What to produce, how much to produce and at what price to sell (i.e., supply) all such decisions depend on these forces.
■ Such an economic system needs to be regulated by competition prevailing in the market.
■ For efficient operation of the economic activities, government should follow a policy of laissez faire (French word which means ‘leave it alone’ which is generally translated by economists as ‘non-interference’). Lesser the government, better the economic performance. Here, non-interference by government means great many different things such as—government playing no or least economic role (producing none of the goods and services) , no economic regulation, no taxes imposed, etc.
Adam Smith himself called such an economic system as ‘the system of natural liberty’. Rather these ideas were the drivers of two major economic systems— ‘capitalism’ and ‘free market economy’. Though, they are based on the same economic environments (demand and supply) , there are subtle differences between them:
■ While capitalism is focused on creation of ‘wealth’ and ownership of productive assets, free market economy is focused on ‘exchange’ of wealth (through production and supply of goods and services) .
■ In a capitalist system there might be some government regulation but private owner can have monopoly on the market and thus prevents competition. However, a free market economy is solely based on market forces (demand and supply) , and there is little or no government regulation. That is why in free market economy free competition is possible without any intervention from outside forces.
Such an economic system got first tried in the USA in 1777 from where capitalism spread across the whole Euro-America (Northern America and Western Europe). These economies enjoyed high prosperity and operated well till got hit with the Great Depression in 1929. By that time great capital was amassed by few (the multi- and trans- national companies) while majority remaining poor—widening inequality in the process over the time. Taxes were imposed but they were very few in number and at very lower rates with state playing negligible welfare role.
Cons of this System Supported by the democratic rights and freedoms, this system had great environment for individual success, innovation and business activities. Though, it looks smoothly operating for over one and half centuries (with subtle changes) it had its own set of limitations which can be summarised precisely in the following way—
■ There was almost no tool to look after those who have lower purchasing power (i.e., the poor) .
■ Negligible to total absence of welfare actions from the state.
■ Widening economic inequality even after launching distributive measures such as progressive taxation (in which richer are taxed with higher rates) .
The existing set of policy approaches could not help these economies to recover out of the Depression. It was in wake of this crisis that we see the rise of a new branch of economics—the macroeconomics—proposed by the British economist John Maynard Keynes (1883-1949) in his seminal work The General Theory of Employment, Interest and Money, 1936. Together with analysing the causes which might have caused this crisis, Keynes suggested a new set of policy approach also to help economic recovery. In very simple term, Keynes suggested these economies to include certain traits from the other economic system (Non-Market Economy) to correct the crisis faced by them. After including the Keynesian advices these economies recovered out of the Depression and in this process (practically) the mixed economic system evolved.
Rooted (immediately) in the ideas of Karl Marx (1818-83) , it had two variants—socialist and communist. While in the socialist model (ex-USSR, 1917-89) state was having ownership control on only natural resources, in the communist model (China, 1949-85) the state used to have ownership control over labour also. It got also known by its other names such as State Economy, Command Economy, Centrally Planned Economy. Basically, this system evolved in ‘reaction’ to the market economy and was based on the following main beliefs—
■ Resources of a country should be used for the wellbeing of all.
■ Resources are best used once they are under the ownership of society/community (Socialism/Communism). Thus, all economic roles will be played by the state only.
■ No property rights given to individuals guided by the belief that it promotes exploitation of the labourers (i.e., proletariat) and helps a small minority (i.e., bourgeoisie) to get richer over time—resulting into increasing economic inequality.
■ Absence of market (i.e., inter-play of demand and supply was totally absent) .
■ No idea of competition (i.e., total state monopoly is economic sphere) .
■ People to play economic role (employed in the state-owned enterprises) according to their ability and in return to get all facilities from the state as per their needs.
■ The decisions such as what to produce, how much to produce and how to supply them to people were taken by the state itself.
This system first got tried by the Bolsheviks in the ex-USSR (in 1919) from where it spread across the whole eastern Europe (the so-called socialist bloc countries) of the time, finally getting its purest form in the communist China (in 1949) —emergence of the socialist and communist models of the non-market economy.
Cons of this System Even after being fully committed to the ‘wellbeing of masses’ with virtual absence of poverty this system had its own limitations which can be summarised briefly in the following way—
■ Though, the aim was to serve all there was no idea of creating capital or wealth—which created a scarcity of investible capital in the coming times.
■ State used to prioritise the uses of resources—thus the best or optimum uses of resources (driven by market forces) were denied leading to their misallocation and wastage.
■ In the absence of property rights there was no motivation to work hard and tap the animal spirit of the people (as no money was paid to them) —leading to virtual absence of innovation (i.e., research and development) —a process of internal decay.
■ Being non-democratic political systems the things like liberty and freedom were totally absent. Aimed at avoiding exploitation of the labourers at the hand of the capitalist state itself emerged as the sole agent of exploitation—critics called this ‘State Capitalism’.
A process of internal decay was being faced by these economies since early 1970s caused by the in-built shortcomings they had. It was way back in mid-1950s that the Polish philosopher Oskar Lange had advised these economies to embrace ‘market socialism’ which was outrightly rejected by both Soviet Bloc and China. At last by mid-1980s state economies moved to modify their economic systems by including certain traits of the market economy—
■ Ex-USSR, by late 1980s, announced the twin policies of Perestroika (restructuring) and Glasnost (openness) switching over to mixed economy with fundamental traits of market economy. Similar changes were adopted by the existing East European socialist economies and the CIS (Confederation of Independent States) .
■ China, by mid-1980s, announced its Open-Door Policy embracing mixed economy with fundamental traits of the market economy. Rather China had started preparations for this change by mid-1970 itself but they were not explicit in nature.
In a way the two major and contrasting economic systems of the time had completed the full circle and moved closer to borrowing traits from each other—the evolution of the mixed economy (where we find the mixture of traits of both of the economic systems). This event has been also termed as the end of ideology—as the ideological divide between these economic systems looked bridged now—eventually ending the long-drawn Cold War which originated from this ideological difference.
In practice, mixed economic system was already there (by late 1930s) once the market economies adopted certain policy changes (borrowing from the non-market economy) to recover out of the Depression. But first country to announce adopting this system was France (in 1944-45, with the announcement to adopt national planning). The system got further strengthened once the non-market economies started modifying themselves by mid-1980s. It was with few reports of the World Bank that helped world agree on the best model of the economic system—
■ World Bank accepted the need of ‘state intervention’ in the economy (i.e., the market economy) which used to be an ardent advocate of the free market economy. But the time and nature of the intervention cannot be universal.
■ World Bank further concluded that neither of the economic systems (market and non-market) are free from flaws and even a novice of economics can agree that the best economic system can be the mixture of the both. But the state and market mix in any country has to be decided by its socio-economic needs of the time as there cannot be a fixed model of mixed economy.
The chief characteristics of the mixed economy may be summarised in the following way—
■ State and private sector both to have economic roles.
■ Private sector to play those roles where invisible hand (the motive of profit) can work properly. Production and supply of the ‘private goods’ (which people use by purchasing them from their own income) is the best example in this case. But state is not prohibited from playing this role.
■ Those roles which private sector will not be motivated to play (due to absence of any profit element) should be better taken care of by the state. Supply of the ‘public goods’ is the best example in this case. But private sector is free to play this role also.
■ The economic roles played by either state or private sector may not remain fixed for all times to come and may get modified as per the needs of the time.
■ Regulation (things like rules, competition, taxation, etc.) of the economic system to be taken care of by the state.
It means, mixed economic system is not a kind of finality which the market or non-market economic systems used to be rather continuous change looks its main feature—capable to modify as per the socio-economic needs of the hour. This way, the long-drawn debate about the possible role of state in economy also got decided.
Along with the three economic systems there evolved three distribution systems also. While capitalist economy distributed the goods and services through market (people buying their needs from the market at a price decided on market principles) , state economy distributed them without taking the help of market (directly state used to supply them to the people without any payments). In the case of mixed economy, the distribution system was a hybrid of the former two models of distribution—state and market both being used (certain goods and services people used to buy from market while certain others being supplied by the state either free or at subsidised prices) .
Though, we see a kind of consensus emerging in favour of the mixed economic system, the future had much in store. Over the time, it came under influence of several ideologies some of which also left enduring impact on the world economies—major ones have been briefed below.
▷ Washington Consensus
It is a set of reform policy package which was suggested by the International Monetary Fund, World Bank and the US Department of the Treasury (i.e., the US finance ministry) to the developing countries faced with economic crisis. Since all of these institutions were based in Washington, the policy prescription was called Washington Consensus by the US economist John Williamson. The 10-point reform policy prescriptions are as given below:
(i) Fiscal discipline
(ii) A redirection of public expenditure priorities toward fields offering both high economic returns and the potential to improve income distribution, such as primary health care, primary education, and infrastructure.
(iii) Tax reform (to lower marginal rates and broaden the tax base)
(iv) Interest rate liberalisation
(v) A competitive exchange rate
(vi) Trade liberalisation
(vii) Liberalisation of FDI inflows
(ix) Deregulation (in the sense of abolishing barriers to entry and exit)
(x) Secure property rights
However, in coming times, the term became synonymous to neo-liberalism (in Latin America) , market fundamentalism (as George Soros told in 1998) and even globalisation across the world. It has often been used to describe an extreme and dogmatic commitment to the belief that markets can handle everything.
But the reality has been different—the set of polices was already being recommended by the IMF (International Monetary Fund) and the WB (World Bank) together with the US Treasury, especially during the period of the eighties and early nineties. The prescription was originally intended to address the real problems occurring in Latin America at the time, and their use later to handle a wide array of other situations has been criticised even by original proponents of the policies. The name of the Washington Consensus has often been mentioned as being somewhat unfortunate, especially by its creator. John Williamson, says that audiences the world over seem to believe that this signifies a set of neo-liberal policies that have been imposed on hapless countries by the Washington-based international financial institutions and have led them to crisis and misery—there are people who cannot utter the term without foaming at the mouth. He further adds that many people feel that it gives the impression that the points outlined represent a set of rules imposed on developing nations by the United States. Instead, Williamson always felt that the prescription represented a consensus precisely because they were so universal. Many proponents of the plan do not feel that it represents the hard-line neo-liberal agenda that anti-free-trade activists say it does. They instead present it as a relatively conservative assessment of what policies can help bring a country to economic stability.
But the policy prescription led to processes which are known as Liberalisation, Privatisation, Globalisation, thus cutting down the role of the State in the economy—more so in the nations which got developmental funding from the WB or went to the IMF in times of the Balance of Payment crises (as in the case of India which commenced its reform process in 1991 under the ‘conditions’ of the IMF). It was as if the Adam Smith’s prescription of ‘free market’ (liberalism) has taken its rebirth (in neo-liberalism) .
Experts believe that the US sub-prime crisis of 2008 followed by the great recession across the western developed economies were rooted in the ideas promoted by the Washington Consensus. Post-recession period has seen a clear erosion of faith in market and a rising sentiments in favour of ‘state intervention’ in the economy (i.e., rising faith in the idea of development state) .
▷ Beijing Consensus
Economic rise of China since mid-1980s needs no introduction. Whether this rise was led by any conscious development model has been an issue of scholarly debate. Finally, the idea of Beijing Consensus was forwarded by Joshua Cooper Remo in 2004.
Also known as Chinese Model of economic development, this refers to the policies which were followed by Deng Xiaoping since 1976 (the year Mao Zedong died). This model is believed to be forwarded as an alternative to the Washington Consensus (i.e., an anti-Washington Consensus view) for the developing countries. Over the time experts interpreted this model in different ways rather it is believed to be based on three main pillars—
1. Constant experimentation and innovation;
2. Peaceful distributive growth with gradual reforms;
3. Self-determination and inclusion of selective foreign ideas.
The model received higher attention in wake of the great recession hitting the western economies (when China remained still dynamic) —experts portraying it as China’s alternative to the liberal-market approach of the Washington Consensus.Whether the developing countries should embrace the Chinese model has been a contentious issue. Experts believe that the things which worked for China may not work for others looking at the heterogeneity of Chinese performance. Again, in wake of the rise of China, experts almost declared the ‘death of market’ and ‘rise of state-led growth’ rather such hurried conclusions might be misplaced because China’s best economic performance came when market was the dominant force.
Till 2010 we find rising interest in this model across the developing world but once the Chinese growth took a downturn in recent times, experts have advised double caution in blindly following this model. Some experts believe that the rising protectionism across the world (especially the USA, the UK and other places) has been caused by an inclination towards this model only.
▷ Santiago Consensus
This is yet another alternative to the Washington Consensus. Put forward by the then World Bank group President James D. Wolfensohn (in Santiago) for the developing countries. Core idea of this model is inclusion which should not be only economic but social too. This way, this is a socio-economic development model and is bound to have its local characteristics. This way, it looks similar to the Beijing Consensus which also includes the social overtones.
In addition to financial resources the World Bank proposed to harness the incredible power of the information technologies and new spirit of openness and partnership (under the spell of rising globalisation) to make knowledge of global best-practice in development accessible to all. World Bank started building an internal architecture of a ‘knowledge bank’ for the purpose.
This proposal from the World Bank inspired the world governments to focus more on aspect of inclusive socio-economic growth. We see this happening in India also—with the Government launching the third generation of economic reforms in 2002 (which was aimed at making the fruits of reforms inclusive in nature) .
Capitalism as a Tool of Growth Promotion
Capitalism as an economic system failed in the wake of the Great Depression (1929) and got purposefully modified into the mixed economy. But we find countries coming under the spells of capitalism in coming times too. Two such clear spells can be cited—the first under the influence of the Washington Consensus (post-1985) and the second after the official acceptance to Globalisation (via the WTO, post-1995). Experts believe that the ensuing Great Recession (after the US sub-prime crisis of 2007) among the developed countries was largely caused by the extreme capitalistic inclinations (neo-liberal policies) found among them. This way, the world has witnessed the devastating effects of capitalism twice by now.
Over the time, a kind of agreement has emerged across the world that though capitalism is not an ideal (or sustainable) type of an economic system rather such policies can be quite helpful in promoting the cause of growth. This is why today, we find countries across the world having capitalistic policy orientation (i.e., pro-business policies) under the overall design of a mixed economy—one set of policies (capitalistic) aiming higher growth while the other aiming at effective welfare. Such a clear policy shift has been seen in India too—it was in wake of the criticism to the Union Budget 2015–16 (of being pro-rich or pro-corporate) that the erstwhile Finance Minister categorically clarified that the Budget was trying to be pro-corporate as well as pro-poor. Basically, over the time, experts treat capitalism less as an economic system and more as tool of promoting growth and income.
▷ National Income
Measuring progress has been a major riddle for experts. Income as an indicator of progress was tried by many before the idea of the gross domestic product (GDP) was put forward by the US-economist Simon Kuznets in 1934. The method tries to calculate (account) a country’s income at domestic and national levels—in gross and net forms—having four clear concepts (GDP, NDP, GNP and NNP) —a brief and objective overview is presented below.
Gross Domestic Product (GDP) is the value of the all final goods and services produced within the boundary of a nation during one year period. For India, this calendar year is from 1st April to 31st March.
It is also calculated by adding national private consumption, gross investment, government spending and trade balance (exports-minus-imports). The use of the exports-minus-imports factor removes expenditures on imports not produced in the nation, and adds expenditures of goods and service produced which are exported, but not sold within the country.
It will be better to understand the terms used in the concept, ‘gross’, which means same thing in Economics and Commerce as ‘total’ means in Mathematics; ‘domestic’ means all economic activities done within the boundary of a nation/country and by its own capital; ‘product’ is used to define ‘goods and services’ together; and ‘final’ means the stage of a product after which there is no known chance of value addition in it.
The different uses of the concept of GDP are as given below:
(i) Per annum percentage change in it is the ‘growth rate’ of an economy. For example, if a country has a GDP of Rs. 107 which is 7 rupees higher than the last year, it has a growth rate of 7 per cent. When we use the term ‘a growing’ economy, it means that the economy is adding up its income, i.e., in quantitative terms.
(ii) It is a ‘quantitative’ concept and its volume/size indicates the ‘internal’ strength of the economy. But it does not say anything about the ‘qualitative’ aspects of the goods and services produced.
(iii) This is the most commonly used data in comparative economics. The GDPs of the member nations are ranked by the IMF at purchasing power parity (PPP). India’s GDP is today 3rd largest in the world at PPP (after China and the USA) ., While at the prevailing exchange rate of Rupee (into the US dollars) India’s GDP is ranked 5th largest in the world. [for detailed discussion on the PPP see Glossary].
Net Domestic Product (NDP) is the GDP calculated after adjusting the weight of the value of ‘depreciation’. This is, basically, net form of the GDP, i.e., GDP minus the total value of the ‘wear and tear’ (depreciation) that happened in the assets while the goods and services were being produced. Every asset (except human beings) go for depreciation in the process of their uses, which means they ‘wear and tear’. The governments of the economies decide and announce the rates by which assets depreciate (done in India by the Ministry of Commerce and Industry) and a list is published, which is used by different sections of the economy to determine the real levels of depreciations in different assets. For example, a residential house in India has a rate of 1 per cent per annum depreciation, an electric fan has 10 per cent per annum, etc., which is calculated in terms of the asset’s price. This is one way how depreciation is used in economics. The other way it is used in the external sector while the domestic currency floats freely as against the foreign currencies. If the value of the domestic currency falls following market mechanism in comparison to a foreign currency, it is a situation of ‘depreciation’ in the domestic currency, calculated in terms of loss in value of the domestic currency.
Thus, NDP = GDP – Depreciation.
This way, NDP of an economy has to be always lower than its GDP for the same year, since there is no way to cut the depreciation to zero. But mankind has developed several techniques and tools such as ‘ball-bearing’, ‘lubricants’, etc., to cut the loss due to depreciation.
The different uses of the concept of NDP are as given below:
(a) For domestic use only: to understand the historical situation of the loss due to depreciation to the economy. Also used to understand and analyse the sectoral situation of depreciation in industry and trade in comparative periods.
(b) To show the achievements of the economy in the area of research and development, which have tried cutting the levels of depreciation in a historical time period.
However, NDP is not used in comparative economics, i.e., to compare the economies of the world. Why this is so? This is due to different rates of depreciation which is set by the different economies of the world. Rates of depreciation may be based on logic (as it is in the case of houses in India—the cement, bricks, sand and iron rods which are used to build houses in India can sustain it for the coming 100 years, thus the rate of depreciation is fixed at 1 per cent per annum). But it may not be based on logic all the time, for example, upto February 2000 the rate of depreciation for heavy vehicles (vehicles with 6-wheels and above) was 20 per cent while it was raised to 40 per cent afterwards—to boost the sales of heavy vehicles in the country. There was no logic in doubling the rate. Basically, depreciation and its rates are also used by modern governments as a tool of economic policymaking, which is the third way how depreciation is used in economics.
Gross National Product (GNP) is the GDP of a country added with its ‘income from abroad’. Here, the trans-boundary economic activities of an economy is also taken into account. The items which are counted in the segment ‘Income from Abroad’ are:
(i) Private Remittances: This is the net outcome of the money which inflows and outflows on account of the ‘private transfers’ by Indian nationals working outside of India (to India) and the foreign nationals working in India (to their home countries). On this front India has always been a gainer- till the early 1990s from the Gulf region (which fell down afterwards in the wake of the heavy country-bound movements of Indians working there due to the Gulf War) and afterwards from the USA and other European nations. As per the World Bank, in 2019 too, India remained world’s top recipient of remittances (US $80 billion) followed by China (US $67 billion) , Mexico (US $34 billion) and Philippines (US $26 billion) .
(ii) Interest on External Loans: The net outcome on the front of the interest payments, i.e., balance of inflow (on the money lend out by the economy) and outflow (on the money borrowed by the economy) of external interests. In India’s case it has always been negative as the economy has been a ‘net borrower’ from the world economies.
(iii) External Grants: The net outcome of the external grants i.e., the balance of such grants which flow to and from India. Today, India offers more such grants than it receives. India receives grants (grants or loan-grant mix) from few countries as well as UN bodies (like the UNDP) and offers several developmental and humanitarian grants to foreign nations. In the wake of globlisation, grant outflows from India has increased as its economic diplomacy aims at the playing bigger role at international level.
Ultimately, the balance of all the three components of the ‘Income from Abroad’ segment may turn out to be positive or negative. In India’s case it has always been negative (due to heavy outflows on account of trade deficits and interest payments on foreign loans). It means, the ‘Income from Abroad’ is subtracted from India’s GDP to calculate its GNP.
The normal formula is GNP = GDP + Income from Abroad. But it becomes GNP = GDP + (– Income from Abroad) , i.e., GDP – Income from Abroad, in the case of India. This means that India’s GNP is always lower than its GDP.
The different uses of the concept GNP are as given below:
(i) It is a more exhaustive concept of national income than the GDP as it indicates towards the ‘quantitative’ as well as the ‘qualitative’ aspects of the economy, i.e., the ‘internal’ as well as the ‘external’ strength of the economy.
(ii) It enables us to learn several facts about the production behaviour and pattern of an economy, such as, how much the outside world is dependent on its product and how much it depends on the world for the same (numerically shown by the size and net flow of its ‘balance of trade’) ; what is the standard of its human resource in international parlance (shown by the size and the net flow of its ‘private remittances’) ; what position it holds regarding financial support from and to the world economies (shown by the net flow of ‘interests’ on external lending/borrowing) .
Net National Product (NNP) of an economy is the GNP after deducting the loss due to ‘depreciation’. The formula to derive it may be written like:
NNP = GNP – Depreciation or,
NNP = GDP + Income from Abroad – Depreciation.
The different uses of the concept of NNP are as given below:
(i) This is the ‘National Income’ (NI) of an economy. Though, the GDP, NDP and GNP, all are ‘national income’ they are not written with capitalised ‘N’ and ‘I’.
(ii) This is the purest form of the income of a nation.
(iii) When we divide NNP by the total population of a nation we get the ‘per capita income’ (PCI) of that nation, i.e., ‘income per head per year’. A very basic point should be noted here that this is the point where the rates of depreciation followed by different nations make a difference. Higher the rates of depre-ciation lower the PCI of the nation (whatever be the reason for it logical or artificial as in the case of depreciation being used as a tool of policymaking). Though, economies are free to fix any rate of depreciation for different assets, the rates fixed by them make difference when the NI of the nations are compared by the international financial institutions like the IMF, WB, ADB, etc.
The ‘Base Year’ together with the ‘Methodology’ for calculating the National Accounts were revised by the Central Statistics Office (CSO) in January 2015, which is given in the forthcoming pages.
Cost and Price of National Income
While calculating national income the issues related to ‘cost’ and ‘price’ also needs to be decided. Basically, there are two sets of costs and prices; and an economy needs to choose at which of the two costs and two prices it will calculate its national income. Let us understand its relevance—
(i) Cost: Income of an economy, i.e., value of its total produced goods and services may be calculated at either the ‘factor cost’ or the ‘market cost’. What is the difference between them? Basically, ‘factor cost’ is the ‘input cost’ the producer has to incur in the process of producing something (such as cost of capital, i.e., interest on loans, raw materials, labour, rent, power, etc.). This is also termed as ‘factory price’ or ‘production cost/price’. This is nothing but ‘price’ of the commodity from the producer’s side. While the ‘market cost’ is derived after adding the indirect taxes to the factor cost of the product, it means the cost at which the goods reach the market, i.e., showrooms.
India officially used to calculate its national income at factor cost (though the data at market cost was also released which were used for other purposes by the governments, commerce and industry). Since January 2015, the CSO has switched over to calculating it at market price (i.e., market cost). The market price is calculated by adding the product taxes (generally taken as the indirect taxes of the Centre and the States) to the factor cost. This way India switched over to the popular international practice. Once the GST has been implemented it will be easier for India to calculate its national income at market price.
(ii) Price: Income can be derived at two prices, constant and current. The difference in the constant and current prices is only that of the impact of inflation. Inflation is considered stand still at a year of the past (this year of the past is also known as the ‘base year’) in the case of the constant price, while in the current price, present day inflation is added. Current price is, basically, the maximum retail price (MRP) which we see printed on the goods selling in the market.
▷ Revised Method
The Central Statistics Office (CSO) , in January 2015, released the new and revised data of National Accounts, effecting two changes:
1. The Base Year was revised from 2004–05 to 2011–12. This was done in accordance with the recommendation of the National Statistical Commission (NSC) , which had advised to revise the base year of all economic indices every five years.
2. This time, the methodology of calculating the National Accounts has also been revised in line with the requirements of the System of National Accounts (SNA) -2008, an internationally accepted standard.
The major changes incorporated in this revision are as given below:
(i) Headline growth rate will now be measured by GDP at constant market prices, which will henceforth be referred to as ‘GDP’ (as is the practice internationally). Earlier, growth was measured in terms of growth rate in GDP at factor cost and at constant prices.
(ii) Sector-wise estimates of Gross Value Added (GVA) will now be given at basic prices instead of factor cost. The relationship between GVA at factor cost, GVA at basic prices, and GDP (at market prices) is given below:
GVA at basic prices = CE + OS/MI + CFC + production taxes less production subsidies.
GVA at factor cost = GVA at basic prices – production taxes + production subsidies.
GDP = GVA at basic prices + product taxes – product subsidies.
[Where, CE : compensation of employees; OS: operating surplus; MI: mixed income; and CFC: consumption of fixed capital (i.e., deprication). Production taxes or production subsidies are paid or received with relation to production and are independent of the volume of actual production. Some examples of production taxes are land revenues, stamps and registration fees and tax on profession. Some production subsidies are subsidies to Railways, input subsidies to farmers, subsidies to village and small industries, administrative subsidies to corporations or cooperatives, etc. Product taxes or subsidies are paid or received on per unit of the product. Some examples of product taxes are excise tax, sales tax, service tax and import and export duties. Product subsidies include food, petroleum and fertilizer subsidies, interest subsidies given to farmers, households, etc., through banks, and subsidies for providing insurance to households at lower rates].
(iii) Comprehensive coverage of the corporate sector both in manufacturing and services by incorporation of annual accounts of companies as filed with the Ministry of Corporate Affairs (MCA) under their e-governance initiative, MCA21. Use of MCA21 database for manufacturing companies has helped in accounting for activities other than manufacturing undertaken by these companies.
(iv) Comprehensive coverage of the financial sector by inclusion of information from the accounts of stock brokers, stock exchanges, asset management companies, mutual funds and pension funds, and the regulatory bodies including the Securities and Exchange Board of India (SEBI) , Pension Fund Regulatory and Development Authority (PFRDA) and Insurance Regulatory and Development Authority (IRDA) .
(v) Improved coverage of activities of local bodies and autonomous institutions, covering around 60 per cent of the grants/transfers provided to these institutions.
▷ Comparing GVA & GDP
Economic growth is estimated using two main methods—demand side and supply side. Under supply side, the value-added by the various sectors in the economy (i.e., agriculture, industry and services) are added up to derive the gross value added (GVA). This way, it captures the income generated by all economic actors across the country. Under the demand side, GDP is arrived by adding up all expenditures done in the economy. Broadly speaking there are four sources of expenditures in an economy—namely, private consumption (individuals and households) , government, business enterprises, and net exports (exports minus imports). It includes all the taxes received and all subsidies disbursed by the government. Thus, GDP is equal to GVA added with the net taxes (taxes minus subsidies) .
While GDP is a good measure in comparative studies (comparing economies) , GVA is a better measure to compare different sectors within the economy. GVA is more important when looking at quarterly growth data, because quarterly GDP is arrived at by apportioning the observed GVA data into different spender categories.
▷ Fixed-Base to Chain-Base Method
Government is at present exploring the idea of shifting to the chain-base method for calculating the GDP from the fixed-base (year) method. In the new method GDP estimates are compared with those of the previous year instead of a fixed base year which is revised every five years.
In a fixed-base method, the weights assigned (in the index) to various economic activities (i.e., the goods and services produced) stay unchanged even if the economy changes structurally. Besides, this method does not factor in relative changes in prices and impact on demand. While in a chain-base method weights assigned to economic activities changes annually and thus captures structural changes more quickly. The current gig economy India is argued to reflect in the current GDP statistics of India, for instance. The new method will have several advantages over the exiting one—
■ It will capture structural changes in the economy faster by allowing new activity and items to be added every year. Current GDP estimates are based on data for 2011-12 (the base year) and are due for revision. New items and firms involved in production process will be captured more quickly rather than a gap of 5 years (which practically takes 7-8 years to reflect) .
■ Comparing India’s growth datasets with other countries will get easier and better as this is the best international practice today. In globalising world economy investment and trade decisions depend heavily in such comparative datasets.
■ It is believed to prevent the ongoing controversies related to datasets also.
▷ Standing Committee on Economic Statistics
Aimed at looking into collection of economic datasets, the Government by late December 2019, set up the Standing Committee on Economic Statistics (SCES). Headed by the ex-Chief Statistician Pronab Sen, the 28-member broad-based committee has members coming from the UNO, RBI, Ministry of Finance, Niti Aayog, Tata Trust, economists and statisticians from several universities.
The committee has been given wide-ranging mandate which includes looking into datasets such as the Periodic Labour Force Survey, Annual Survey of Industries, Annual Survey of Services Sector Enterprises, Annual Survey of Unorganised Sector Enterprises, Time Use Survey, Index of Service Production, Index of Industrial Production, Economic Census and other surveys or statistics brought before it. The new panel subsumed all existing Standing Committees on labour, industry, services, etc.
Experts believe that the Government’s step to set up the SCES came in the backdrop of India’s failure to comply with the requirements of the SDDS (Special Data Dissemination Standard) of the IMF (International Monetary Fund). Several experts in the country had shown their reservations about the economic datasets and their way of publication since early 2015 itself.
SDDS of the IMF Aimed at guiding members to enhance data transparency and help financial market participants to assess the economic statistics of individual countries, the IMF launched the SDDS in 1996. It has over 20 data categories including national income accounts, production indices, employment, and central government operations. As per the report of the IMF, India did show the following three types of deviations from the SDDS—
(i) Delays in data dissemination from the periodicity prescribed.
(ii) Not listing data category in the Advance Release Calendar (ARC) as mandated.
(iii) Data not disseminated at all for a particular period.
The IMF acknowledged India’s deviations but termed them ‘non-serious’. However, independent observers see these deficiencies as a result of indifference to data dissemination procedures.
▷ Income Estimates for 2019–20
The latest national income estimates of Indiafor 2019-20 are as given below:
GDP (Gross Domestic Product) is estimated to be—Rs. 147.8 lakh crore at constant prices (showing a growth rate of 5.0 per cent in comparison to 6.8 per cent of the preceding year) and Rs. 204.4 lakh crore at current prices (showing the nominal growth rateof 7.5 per cent over the preceding year) .
GVA (Gross Value Added) is estimated to be—Rs. 135.4 lakh crore at constant prices (showing a growth rate of 4.9 per cent in comparison to 6.6 per cent of the preceding year) and Rs. 185.0 lakh crore at current prices. Deceleration in GVA growth is estimated across all sub-sectors (except ‘Public administration, defence and other services) with GDP at market prices estimated to be -1.8 per cent over the preceding year.
PCNI (Per Capita Net National Income) is estimated to be Rs. 1,35,050 at current prices (6.8 per cent higher over the preceding year) .