To revive the economy, Modi must turn to maximum government

Revival is contingent on demand. Demand is contingent on investment. And investment needs State spending

Addressing the annual session of the Confederation of Indian Industries (CII) on June 2 via video conferencing, Prime Minister (PM) Narendra Modi spoke of getting growth back. He emphatically stated that “We will get our growth back” once Unlock 1.0 commenced and greater relaxations kicked in. It seems he had in mind a V-shaped, ie, a quick recovery. He explained that his confidence was based on his trust in the capabilities and intellect of India, and the fact that the reforms undertaken recently by his government were systemic.

At a time of national dejection, if not despair, the words of a leader have a role in instilling self-belief in the population. But unless they are accompanied by concrete action, they will not amount to much. The sparkling speeches of Winston Churchill may have encouraged his people when Britain was attacked during World War II. But they were unlikely to have sufficed had the United States not intervened. Presumably, the analogy will not be lost on the PM as he uses the metaphor of war when characterising the necessary response to Covid-19. In this context, it is his government that would be expected to act, not the industrialists whom he had exhorted to do so in his address. One can go further and state that, right now, the private sector cannot do much on its own to get growth back.

To appreciate why the government is central, it needs to be understood that in an economy with excess capacity, income is determined by the expenditure on goods or “aggregate demand”. When an economy has been shocked into a lower level of activity, it could well remain there, unless aggregate demand revives. For aggregate demand to revive, there has to be investment.

To understand this, think of demand as having two parts, namely consumption and investment. Consumption is largely determined by income, and cannot rise unless the latter does so first. Right now, in India, income is depressed due to the economic shock. On the other hand, investment is not constrained by income and can be fuelled by credit. With greater investment, aggregate demand rises, and as a consequence so does production or income. But private investment, though based on expectation of the future, is at least partly driven by its current state. So, with output depressed by a 68-daylong lockdown, private investment, and thus growth, could be held back even after the lockdown is lifted. The PM is optimistic when he expresses confidence that we will get our growth back. Fortunately, economic reasoning shows a way out of the present situation. This is that the government should raise aggregate demand, preferably through investment, to take the economy back to where it was in late March.

Again, in his address to the members of CII, the PM spoke of the growth potential of the reforms implemented by his government, especially in agriculture. These are needed and significant but they are aimed at the supply side of the economy while the problem today is a demand shortfall. We see this all around us in the economy — when shopkeepers in Mumbai speak of how their daily sales are, on average, a quarter of what they were before the lockdown, and when migrant workers, having reached their homes in Odisha by sea, speak of returning to Chennai in search of work. So, a shortage of demand for goods and labour is what is at stake, and a stimulus alone can address it.

The economic package announced by the finance minister in mid-May was not a stimulus, as it does not inject demand into the economy. Greater public spending alone can do that at the present juncture. But, for some reason the government has shied away from undertaking it.

Finally, the PM stressed that getting growth back is not so difficult as now Indian industry has a clearly defined goal in Aatmanirbhar Bharat. This is intriguing. Of what help can a declaration of independence can be to Indian industry is not clear. The point is that self-reliance is often neither possible nor desirable to a firm. In a modern economy, one firm is dependent on others for its inputs. Some of these are unavailable on the market. These are the producer services vital for efficient production. We may term these collectively as infrastructure. Physical infrastructure encompasses electricity, water supply, roads, and industrial waste management among other inputs. The huge initial investment necessary to supply these producer services and the fact that some of them are public goods, and therefore, unlikely to be provided by the private sector, leaves it to the government to provide them if we are to have an economy that generates wealth and creates jobs while doing so. For India’s producers, Atmanirbhar Bharat will remain just another slogan as long as a supportive eco-system does not exist.

A recovery post-lockdown would require the government to pull out all stops. For this, the PM would have rethink his maxims. There are times when “maximum governance” means maximum government. It is not too late to stimulate India’s economy.

THE ECONOMIC PACKAGE

ANNOUNCED BY THE FINANCE MINISTER IN MID-MAY WAS NOT A STIMULUS, AS IT DOES NOT INJECT DEMAND INTO THE ECONOMY. GREATER PUBLIC SPENDING ALONE CAN DO THAT