Photo: Pradeep Gaur/Mint
Photo: Pradeep Gaur/Mint

Indian economy: To plan or not to plan

The extent to which India should conform to wisdom received from the developed world needs to be debated

Does India need a Planning Commission? Should India be concerned about its fiscal deficit? Are extant fiscal and monetary policy thumb rules optimum?

These are all issues of fundamental importance to economic policy, and keenly debated among academics, policymakers and financial dailies. Unfortunately, there is also avoidable confusion surrounding them deriving mostly from the ahistorical manner in which they are viewed.

Let us consider the Planning Commission, which has been abolished altogether and replaced by a think tank. It is frequently argued that the high noon of planning is long over. The experience of the erstwhile Soviet Union, whose Gosplans initiated planning in the wake of the Russian revolution in the interwar period, is cited in evidence.

However, unlike countries of the former Soviet Union, India is still a developing country in the early stages of putting in place a modern physical and social infrastructure. Historically, public investment, directly or indirectly through tax breaks, has played a major role in infrastructure investment. Public-private partnerships (PPP) have only a marginal role to play—in projects that generate good, and equally important certain and frontloaded, cash flows. But much of public infrastructure investment will not fall in this space.

Private investment did indeed play a significant role in Western countries that were the earliest industrializers. But this was phased over multiple decades. In contrast, economic development in emerging markets in the post-war period is telescoped over a few decades, necessitating a greater role for public investment.

The former Soviet Union could do away quickly with its Gosplans once it broke up in the 1990s because they had achieved the job of putting modern infrastructure in place. India is still a very long way from this. This is not to say that the Planning Commission in its present form was necessary. But we do need to plan ahead for plugging the huge infrastructure deficit piled up over the years of relative inattention. It is for this reason that South Korea recently revived planning to transit to a faster growing smart and green economy.

Let us consider the fiscal deficit next. Economic theory, indeed plain arithmetic, tells us that as long as fiscal deficits are aligned to the potential growth rate of the economy, they are eminently sustainable. Economists and policymakers in India, however, have for some reason got locked intellectually into a 3% norm for fiscal deficits that has its origins in the Maastricht Treaty of the European Union, and therefore correlated to the potential growth rate of the European Union rather than of India. Although states are allowed another 3% deficit over and above the Union deficit, the Maastricht number has got imprinted into the Indian debate, sanctified by Finance Commissions over the years. As a result, India’s public debt-to-gross domestic product (GDP) ratio has shrunk despite major slippages in achieving fiscal deficit targets.

The potential growth rate of fast-growing emerging markets is much higher than that of mature economies in demographic decline. Indeed, rapid growth generates its own fiscal space for financing the infrastructure investment necessary to sustain high growth over an extended period.

China used this fiscal space to sustain high growth over three decades. India, on the other hand, has been squandering this space—first, through a conservative estimation of its fiscal space, and second by using this space for politically expedient and untargeted subsidies instead of infrastructure investment. Rather conveniently, it has shifted the burden—to the extent of 50%, which has never been achieved anywhere—onto the private sector through PPPs. Unsurprisingly, both high growth and PPP in infrastructure are groaning under the onerous burden.

Finally, let us turn to macroeconomic policies. The received wisdom, derived from the application of Keynesian macroeconomic policies in Organisation for Economic Co-operation and Development (OECD) countries, is that fiscal and monetary policies play a key role in macroeconomic stabilization through stimulative or contractionary fiscal and monetary policies, as appropriate.

Since discretionary fiscal policy came to be seen as destabilizing because of its overtly political overtones, this now mostly consists of self-limiting contra-cyclical automatic stabilizers. The pole position in macroeconomic stabilization has devolved on independent central banks through rule-based monetary policies targeting a mix of inflation and unemployment/growth, such as the widely popular Taylor rule.

It needs to be recognized however that OECD is an organization of developed economies with modern infrastructure already in place. Stabilization is consequently the primary focus of macroeconomic policy. While stabilization policies have a role in emerging markets as well, the demand for large-scale infrastructure investment means that there is a major role for fiscal policy in all stages of the business cycle.

Likewise, monetary policy in emerging markets has other developmental functions over and above the stabilizing role. Since financial markets are much less developed, savings tucked away under the proverbial mattress, or in unproductive assets such as gold, need to be channelized into investment. Making financial savings more attractive may well mean tweaking the 2% constant above the target inflation rate that generates the policy rate in the Taylor rule equation.

Monetary policy in emerging markets cannot also be exclusively focused on the domestic business cycle as it needs to respond to volatile capital flows that destabilize domestic business cycles. They need to “taylor" solutions to the impossible trinity based on their own individual circumstances.

Alok Sheel is a civil servant. These are his personal views.

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