Monday, April 28, 2008

Economic development and sectoral analysis

The economy of any modern nation comprises of three basic sectors, namely—primary sector, secondary sector and tertiary sector. The primary sector comprises of agricultural and allied activities. Economic activities such as fishing, forestry, horticulture, bee-keeping etc. can be put together under the heading of allied activities. Secondary sector mainly includes mining, industries and manufacturing. The services sector comprises of community, social and personal services, insurance, finance, banking, shipping and transport. All these sectors are inter-related; any imbalance or shock in one sector can produce repercussions in the other two sectors.

Development of an economy can be judged in terms of the sectoral contribution of each of these sectors to the nation’s total output and employment generated. In an underdeveloped economy, majority of the employment is generated by the primary sector. Also, primary sector holds a large share in the total output (or Gross National Product) produced. In the case of India and China 24.7% and 15.2% of the total GDP came from the agricultural sector, respectively. But in case of South Korea[1], only 4.4% of the GDP came from the agricultural sector during the year 2001.

Since most of the people are engaged in agriculture, so we find that land (area-wise) to man (population-wise) ratio is quite low in agriculture for the underdeveloped countries compared to the developed countries. In such a situation, if agricultural land is concentrated (owned by) in few hands, then this will cause landlessness to majority of the people. There will be widespread poverty with very low purchasing power in the hands of majority of the rural population. State intervention in such a situation becomes important—first of all, to carry out land reforms (redistribution of land to the poor landless and marginal labourers and peasants, either by purchasing land from the land rich section and selling it at subsidized rates to the land poor section, or by ‘radical land reforms’ as was carried out in some countries such as China, where State took away the land from the land rich section without paying any kind of economic compensation). One must know that fragmentation of land is a big problem among South Asian nations. Hence, sometimes it is said that land reforms can lead to lower output unless there is creation of land co-operatives or ‘communes’. But this is a difficult task. Formation of communes can fail if there is no trust among the land-owners. Countries where a majority of the population is engaged in agriculture are generally poor. But there are some exceptions such as Australia, New Zealand etc. Second of all, if land reforms were improperly implemented or could not be carried out, then the State can play a crucial role in the creation of the secondary sector (diversification), by investing in the secondary sector through deficit financing. This was done in the case of India during the 2nd and 3rd Five Year Plans based on the Mahalanobis model for industrialisation. However, the plans were criticised for neglecting the agricultural sector, which led to food insecurity and later led to the adoption of green revolution[2].

It becomes necessary to expand the secondary sector for the following reasons:

(i) Technological growth can take place in an economy which has a vibrant secondary sector. It is in the secondary sector where modern inputs such as fertilisers (chemical/ bio), pesticides (chemical/ bio) are manufactured, which are crucial inputs for modern agriculture.
(ii) The newly developed industrial sector will become a new arena for generating employment, which can reduce the pressure on agricultural land. This can help in modernizing agriculture thru mechanisation (like using tractors, electrical harvesters). Again introduction of machines and new technology will raise the productivity of labour in agriculture and hence the purchasing power.
(iii) The growth of the secondary sector is bound to be greater than that of the primary sector in the initial phase because of its comparative advantage in terms of technology. This will lift up the gross output and place the economy in a new steady state growth path. But if the agricultural sector fails to catch up with the growing demand for food grains coming from the growing industrial sector, then this will lead to inflationary tendencies in the economy.

After an economy is already into the modern phase, it is essential to give a thrust to the tertiary sector. There is a substantial amount of difference between the tertiary sector and the other two remaining sectors. In the tertiary sector, no tangible goods are produced. Tertiary sector do not produce anything but services. It is not involved directly in the production process but helps the production process itself by raising the efficiency/ productivity level and reducing transaction costs. Services are intangible goods; they themselves cannot be seen but their effects can be seen. For example, services of a doctor cannot be seen, but its effect can be seen when patient gets cured and starts working, thus contributing to the production of output. In today’s world, the most powerful economy is the one, which has a substantial share of the working population, engaged in the tertiary sector. Labour productivity is very much high in the tertiary sector thus leading to better emoluments of the workers employed in it. One reason behind this is the higher skill levels of the workers engaged in the tertiary sector. According to Simon Kuznets, when the secondary expands along with the growth of GDP during the earlier stage of growth of a developing economy, then income inequality starts rising.

All these do not add upto underestimating the role of the primary or more precisely the agricultural sector. Johnston and Mellor in their article ‘The Role of Agriculture in Economic Development’, published in 1961 in The American Economic Review, wrote about the relationship between industry and agriculture in the structural transformation of the modernizing economy. Agricultural development and productivity growth, they argued, not only provided surplus labour and food to the industrial sector, but also created demand for manufacturing sector output and became a source of foreign currency export earnings. Given the labour abundance and capital scarcity that characterised agriculture in many developing countries, they argued that growth could be achieved partly with the application of a rapid succession of labour-intensive, capital-saving innovations. So, instead of going for capital-intensive technology such as application of tractors, electrical harvesters, the developing countries should go for labour-intensive technology such as application of fertilisers, pesticides, hybrid rice (since all these needs more labour). So there are two types of technologies—labour intensive technology and capital intensive technology. Labour intensive technology can be applied in countries with high population density in agriculture (such as South Asian countries), and capital intensive technology needs to be applied in countries with scarce population density in agriculture (such as Western European countries). It has been argued that investment in rural infrastructure, extension and education systems, credit services, farmers' collective action programmes, input industries, and agricultural R & D (research and development) are essential to achieving agricultural sector growth.

Supply-side bottlenecks of the agricultural sector may put an obstacle on the growth of the industrial sector, because this particular sector not only provides ‘wage’ goods to the workers engaged in the industrial sector but is also a source of raw material. It is a fact that Great Britain had to rely on the supply of raw agricultural goods from India such as jute, cotton, indigo during the time of industrial revolution. Price inflation in agricultural goods in general and food grains in particular may begin when the industry starts expanding too fast thus creating demand for food, while the agricultural sector is failing to supply the growing demand. This will set the terms of trade in favour of the agricultural sector, which will be economically beneficial for the big land owning farmers who have the marketable surplus. The small and marginal farmers along with the agricultural labourers in the villages, and the industrial workers of the urban areas will face price inflation in food. Since a major portion of the worker’s budget/ income is spent on food as their marginal propensity to consume is very high vis-à-vis the capitalists/ industrialists, so food price inflation can have serious consequences. It can lead to cost-push inflation in case when industrial workers demand for an increase in the salary / remuneration through the formation of trade unions. Industrial growth may come to a halt since the profit maximising industrialist may think that it is in his/ her best interest, not to invest anymore because the labour costs are too high. It can also happen that capitalists then start moving towards more capital intensive technology. If a country depends on food processing industry and industries where agricultural goods are intensively used as raw material, then in such a case the unresponsiveness of the agricultural sector to the growing demand from the industrial sector may put an impediment on the growth of industry. In both the cases the government can take the following steps:

(i) Modernizing the agricultural sector through adoption of appropriate technology to overcome the supply bottlenecks in agriculture. Investment in R & D becomes pertinent during such times.
(ii) The government can import agricultural goods and food grains provided it has sufficient foreign exchange reserves.
(iii) The industrialists should change the composition of the production basket i.e. switch to producing goods, which requires capital-intensive technology.
(iv) The government can open up rationing system for the distribution of food to rural and urban working people at subsidised rates.
Inter-sectoral analysis of an economy is interesting as it helps us to see the economy in terms of structural changes. In the input-output analysis, we basically try to see the linkages between various sectors of the economy and consequently their relationship to the Gross Domestic Product (GDP). Inter-sectoral analysis becomes essential since all the sectors are not homogenous and the input intensities vary across different sectors and there are sub-sectors too, within each sector. Finally, centralised (socialistic) planning, mixed economic model/s, market based economic planning are just policy choices before any nation.
[1] In the case of S. Korea, there had been lot of investment on human capital formation.
[2] There is also the need to look at employment elasticity of the secondary and tertiary sectors, when the economy is growing.

Monday, April 7, 2008

The demon named ‘inflation’

During the last year or so, the global economy has seen various crises, and will no doubt see more, as have been predicted by numerous reports sponsored by the United Nations and the World Bank. It is feared that due to stagflation occurring in the United States along with the real estate crisis (sub prime crisis), with many of the export-oriented countries relying for its exports on the US, the growth rate of the world’s gross income/ product, would slow down in 2008. Doomsday economists, have alleged that this phenomenon is somewhat related to the crisis with the global capitalist order, where countries are much more interconnected and interdependent in terms of global finance capital and trade flows compared to the past because of the openness policies being adopted during the post-WTO era. The credit led economic growth of the US has come to a standstill in the backdrop of the so called subprime crisis—a phenomenon which took place due to economic short-sightedness and mismanagement, which led to lowering of the real value of assets and estate.[1] It is high-time to bid farewell to the defenders of free-market capitalism who could not even learn from events of the past such as the 1997 South-East Asian financial crisis, the bubble burst of 2001 at NASDAQ during the beginning days of dot-com era and the present sub-prime mortgage crisis in the United States when banks are unable to collect capital. Sub-prime mortgage loans are usually considered as risky in the present context. These loans are given to people with unstable incomes or low creditworthiness. These individuals borrowing loans are not financially sound enough to be given as loan when judged from the point of view of strict standards that should normally be followed by a bank or lending institution. It has been found that the crisis is spreading from sub-prime to prime mortgages, home equity loans, to commercial real estate, to unsecured consumer credit (credit cards, student loans, auto loans), to leveraged loans that financed reckless debt-laden leveraged buy outs, to municipal bonds, to industrial and commercial loans, to corporate bonds, to the derivative markets whose risk are indeterminate, etc. This time, however, the crisis began with the bursting of the United States housing bubble. One could thus see with open eyes a slowing US economy, high interest rates, unrealistic real estate prices, high level of inflation and rising oil tags together. All these have led to growth stagnation, job losses, low level of consumer spending, shortfall in creation of new jobs, and foreclosures and defaults by banks such as Lehman Brothers Holdings Inc. The stock markets all over the world too have been affected. It is high time that economists recognize the problem of crony capitalism which could be seen from the case studies of Enron, Arthur Andersen LLP et al.

Let us look at the figure above to check the trend in the WPI of selected commodities. Similarly, have a look at the next figure which provides the time trend of consumer price index in various South Asian countries.

During the past 3-4 months, both India and the rest of the world have experienced inflation, over which many of the incidents have cropped up such as food riots, political bashing of the government/s in power, abusing of the accountable institutions et al. The present article is intended to understanding the inflationary situation, academically. The monetarist school might relate the present inflationary trend to India’s rising foreign exchange reserves (see: table 1) and growth in money supply (see table 2). Hence, the obvious policy choices would be to go for sterilization, raise cash reserve ratio, raise interest rates etc. However, the Keynesian school might relate the inflationary trend with rising effective demand, which has been generated in the economy pertaining to India, with inadequate supply. In such a situation, the obvious policy choices would to build capacity of production by investing in infrastructure, increasing food production, banning of exports and reducing of duties, and tariff rates of those goods, which are facing inflationary buoyancy. However, all these measures can be looked critically. There exist arguments and counter-arguments among economists and social scientists’ regarding which measure is the appropriate one. It is also important to see whether the measure taken does not adversely affect economic growth, consumption, savings and investment both in the long and the short run.

One of the most amazing things about these global crises is that India’s economic growth and prospect would not be affected by it in the short-run due to its relative insulation in term of capital inflows (see table 3). Although many scholars around are more interested to provide answers to this new ‘discovery’ but the present article here would however look at a completely different story—the story of inflation, which has gripped India and the rest of the globe. According to standard economic theory, price-inflation not only affects the trade balance of a country (by creating competitive disadvantage), but also adversely impacts upon the distribution of income. Price inflation arising due to cost-push inflation (because of pressures for keeping the real wage rate same as before, by the trade unionists or working classes) can also lead to higher unemployment rates. In the case of India, one finds that the wholesale price index increased by 6.68 per cent between March 17, 2007 and March 15, 2008.[2] The wholesale price index on March 17, 2007 and March 15, 2008 were 209.6 and 223.6, respectively. Wholesale price index rose due to rise in prices of food articles. There was also rise in cost of living of agricultural and rural labourers.[3]

Factors,[4]that could have triggered or are responsible for this inflationary trend are:

a. India is dependent on imports of various commodities such as crude oil/ petroleum, oilseeds (edible) and pulses. Due to rise in crude oil prices to more than US $ 100 a barrel (in the past one year or so), the import bills of India have risen (see the figure above). But an economy, which continuously has to maintain its fiscal deficit vis-à-vis the gross domestic product (GDP) at a lower level, thanks to the Fiscal Responsibility and Budget Management Act 2003, the domestic price of the oil needs to be raised (without going for excessive subsidization). Under the FRBM Act, it was promised that fiscal deficit as percentage of GDP would be brought down to 3 per cent by the 2007-08 Budget, as part of fiscal disciple. Due to this, transportation cost has risen, and so one could observe a rise in prices of various commodities. The cost of fertilizers, which is made from ‘crude’, has also increased that led to price rise of food commodities (assuming farmers want to keep the profit margin for production the same as before, while facing rise in input costs).

b. The rise in prices of oilseeds and pulses could be because of low production of the same, domestically. Their productions have come down in the recent years, since the government is not eager to provide economic incentives to farmers in terms of higher minimum support prices (one should not forget to mention about Technology Mission on Oilseeds and Pulses)[5]. Hence, in order to meet the domestic demand, India relies increasingly on imports of oilseeds and pulses. One can mention here that opening up of the economy for cheaper imports, had also attracted criticisms and agitations by various farmers’ lobbies in the past.

c. In countries from Latin America, and in the US, a huge share of cereals and oilseeds are increasingly diverted to produce bio-fuels (an alternative to petroleum), for reducing their import dependence on petroleum particularly from the Gulf-region, for strategic reasons—both economic and ‘geo-political’. Some earlier thinkers had the idea that biofuel production would be environmentally and economically sustainable, and hence it is justified. But since a huge share of cereals/ foodgrains (like soyabean, corn, wheat) and oilseeds (including sugarcane) go for biofuel production (for energy requirements), without satisfying the existing consumption needs of the human population, so a mismatch is created between demand and supply (--a kind of shortage) that leads to inflation in these commodities. Moreover, biofuel production as a part of large-scale industrial production (which includes mono-cropping) has adversely affected biodiversity, soil health and fertility, and productivity of agriculture. All these factors have overall contributed to shortages (fall in supply vis-à-vis demand), that is leading to inflation. In this connection, one should also consider the adverse impact of ‘commercialization’ of Indian agriculture on food security.

d. In India and elsewhere, there had been change in the consumption pattern of the population. Compared to the past, the better-off sections of the Indian population now spend more share of their incomes for consuming meat, milk (and other dairy products), eggs etc, in the face of globalization (as part of changes in lifestyle) and increase in real income of a section of population. (One should not forget to mention Bennet’s law). But in order to grow and maintain livestock, a huge share of foodgrain and cereals now is being diverted, without satisfying the existing direct consumption need (as staple diet), in the backdrop of stagnant foodgrain and cereals production. So, this artificially created shortage has led to inflation in such food commodities.

e. Processed food is now more preferred (viewed as a part of commercialization of agriculture) since it adds value and provide better returns to the growers and the rest in the supply chain, and can be preserved for long. Processed food is also considered important for earning valuable foreign exchange via exports. Due to this, a vast share of foodgrain is diverted for consumption purposes of the elites (or goes as exports) without satisfying the existing consumption need of the domestic poorer sections (as staple diet). This created shortage can be another factor behind inflation.

f. Scientists have found that emission of green house gases (GHGs) has contributed to global warming and climate change, which adversely affects biodiversity and global food production. Perhaps, the current trend of inflation, is somewhat related to global warming, directly or indirectly.

g. A common argument among economists has been that agricultural productivity has gone down, and the initial push for green-revolution towards more production has come to an end. Green revolution, which initially centred on wheat and then on rice, has proven to be affecting soil health (due to over usage of chemical fertilizers, chemical pesticides et al), causing over-exploitation of resources, bringing down water-table etc, that affected productivity in the long-run. This ‘technological fatigue’ has been well-discussed within the circles of Indian economists. Agricultural productivity is also affected due to fall in the share of public investment in agriculture[6]. Institutional factors such as land reforms[7], tenancy reforms, creation of land banks, crop-insurance, better credit facilities etc. can also affect agricultural production and productivity. Some economists think that falling agricultural productivity can lead to inflationary trend due to shortages. A major question is whether rise in food prices is going to increase productive investment in agriculture (if and only if the rising economic returns/ gains due to price rise are going directly to the growers, who are eager to re-invest). Diversification of Indian agriculture although have raised returns to farmers/ growers, but one could also see that area under horticulture and floriculture have gone up along with falling area under cereals, that affected food self-sufficiency.

h. For taking advantage of the current rise in prices of food commodities, hoarders and agents engaged in black marketing have entered into various speculative malpractices. The rise in prices of important food articles in the short-run can be due to this particular phenomenon. Presence of too many middlemen between the growers and sellers may have also contributed to inflation. A certain section of economists feel that existence of multi-commodities exchange (MCX), NCEDX etc. has led to speculative behaviour among traders, thus leading to the present inflationary trend.

i. There exist a growing number of believers who argue that farming is no more profitable. So, farmers are increasingly switching towards other professions or occupations. Agricultural land is now increasingly sold for industrial purposes. One can thus point out that agricultural production, in this connection, is bound to slow down, without meeting the existing demand, thus leading to inflation.

j. Some have argued that the current inflationary pressures in food commodities could be due to breakdown of the existing public distribution system (in the era of globalization), and the (unnecessary) amendments made to the Essential Commodities Act, in 2000.[8]

k. Some of the countries, who are major exporters/ sellers of rice (like Thailand, Vietnam) and wheat in the global market have recently put curbs on their exports, in order to ensure their own food security, in the backdrop of global crisis in food grain production. This can create further shortage in food supply, thus leading to inflation.

Recently, the Government of India has undertaken certain steps to curtail inflationary pressure, which include:

i. Elimination of import duty on non-refined vegetable oils
ii. Ban on export of non-basmati rice
iii. Rise in the minimum export price of basmati rice

Inflation is not only an economic but a social and political problem as well. There is a lot of hue and cry currently about containing inflation in food articles. It is imperative for the government to curb this trend as soon as possible through a prudent mix of fiscal, monetary and trade policies and measures. There is also the need for ‘political will’ to see inflation as a menace, which can do ‘big’ damage to the economic growth, which India is currently facing. Policy-makers should also bear in mind that it is the poor who suffer the most due to inflation, particularly, when one could see the corrosion of the public distribution system in India. The rationing system in India in the past has overlooked the idea of providing coarse cereals like: bajra, maize etc., particularly to the poorer sections of the population.

[The present article has been written to disseminate information and not to hurt anybody. The views expressed and conclusions drawn in this article belong solely to the author. ]

[1] Some of the earlier writings which can be mentioned here are: i. Jayati Ghosh and CP Chandrasekhar The Global Liquidity Paradox, March 2008,; ii. Jayati Ghosh, ‘Global Stagflation’, Frontline, Volume 25-Issue 07::Mar.29-Apr. 11, 2008,; iii. National Bureau of Economic Research, US Business Cycle Expansions and Contractions,
[2] The present article has been written in the backdrop of a handful of farmers/ potato-growers committing suicides in West Bengal, a state from eastern part of India. These potato farmers, who borrowed from moneylenders (informal source) instead from the rural-banks/ co-operatives (formal source), spent nearly INR 250 to INR 300 per quintal for producing potato. However, due to excess production, the market price of potato has come down to INR 100 to INR 120 per quintal of potato. These farmers were afraid that they would not be able to cover the cost of producing potato, despite the Government of West Bengal’s promise of minimum support prices for potato that comes around INR 250 per quintal of potato. Hence they would be unable to repay back their loans to the moneylenders. Lack of proper marketing channels, lack of spending on innovation and R&D, and shortage of cold storage facilities have led to distress sale of potato by the farmers (from Burdwan district, etc.). Some have argued that government’s help and initiative would be inefficient, cumbersome and time consuming. There are allegations that only big farmers are getting cold storage facilities. It is pertinent to ask whether the farmers would have benefited had there been presence of contract farming in rural West Bengal. The situation would have been different, had these farmers who committed suicides had borrowed from rural banks/ co-operatives, that are supported by the government, given the fact that the Government of India in its 2007-08 Budget has promised a massive loan waiver scheme for small and marginal farmers (owning up to 2 hectares of cultivable land).
[3] India has also experienced rise in prices of steel. The competition policy of the Government of India is geared towards removing all forms of cartels and monopolistic practices as could be observed in product markets for rubber, steel, iron, cement et al.
[4] Some of the earlier writings which can be mentioned here are: Joachim von Brauer, The World Food Situation, Food Policy Report No. 18, December 2007, IFPRI,; Dipankar Dasgupta, Links in the food chain, The Telegraph, March 17, 2008,
[5]Raising Minimum Support Price (MSP) or procurement price may not be the only policy choice to raise production as this can lead to buoyancy in price level, particularly, when the gap between MSP and prices at which commodities are sold via the rationing system goes up, with the policy-makers emphasizing upon reduction in subsidies on food.
[6] The need for public investment in irrigation (micro-irrigation, watershed management etc.) has been stressed upon by a number of economists, for raising agricultural productivity.
[7] In the context of land reforms, it is important to consider whether smaller farms are more productive compared to bigger ones in terms of return and profitability.
[8] The EC Act, 1955 gives powers to control production, supply, distribution etc. of essential commodities for maintaining or increasing supplies and for securing their equitable distribution and availability at fair prices. Using the powers under the Act, various Ministries/Departments of the Central Government have issued Control Orders for regulating production/distribution/quality aspects/movement etc. pertaining to the commodities which are essential and administered by them