Tuesday 12 July 2016

Solving India's economic woes

The Indian economy is in the doldrums, with no manufacturing growth, negative figures of exports, sluggish real estate market, skyrocketing food prices, alarming level of unemployment, etc

Ruchir Sharma, the Chief Global Strategist of Morgan Stanley, is the latest economic 'wizard', after Raghram Rajan, diagnosing India's economic problems and suggesting a remedy.

His statement that the official figure of India's GDP growth of 7.9% is bogus, is correct. But his remedy for solving India's economic woes is superficial. He says that there must be increase in private investment in India.

" GDP is overstated, higher private investment is needed " says Ruchir Sharma

But who will invest in India when there is a recession going on ? Where is the demand ? And there is lack of infrastructure, corruption, red tape, etc in many parts of India. Businessmen are not doing charity, but seek profits.

Most of the economists in the world are totally superficial, and have no genuine solution to the 
worldwide recession.

Economists with high sounding degrees from Harvard, Yale, London School of Economics, etc have made economics an arcane, esoteric subject. But it is not so. Let me therefore explain the present crisis step by step:

1. The present world wide recession is due to slow down in manufacturing in most parts of the world. But why is there a slow down in production ? It is because of decline in sales, because who will manufacture if the goods manufactured cannot be sold ? And the decline in sales is because of decline of purchasing power in the masses. Let me explain.

2. There is competition in the market. To face the competition in the market and survive, industries have to reduce their cost of production, and for this they have to do two things (1 ) become more and more capital intensive, rather than labour intensive( to reduce labour costs ) and (2) become larger in size ( to effect economy of scale ).

3. Cost of labour is a big chunk of the total cost of production, and so by becoming capital intensive ( by introducing automation or new labour saving technology ) industrialists reduce their cost of labour, and thereby their cost of production. Even though they may have to pay interest on the loans taken from banks to buy the new machinery, this cost is far less than the saving in labour costs by laying off workers.

If an industry does not do this ( introduce automation or capital intensive machinery, and grow larger ) its rival will do it, by becoming larger and and reducing its labour costs, and thereby reducing its cost of production, and eliminate the former by underselling it. So every industry must do it to survive. But in the process it is generating widespread unemployment.

4. This is because the worker is not only a producer he is also a consumer. A steel worker does not merely produce steel, he and his family also consume food, clothing, shoes, and a host of other articles. If he loses his job his purchasing capacity is drastically reduced, and consequently he has to drastically reduce his consumption. He will now buy only essentials like food and medicines ( to survive ) but he stops buying most industrial goods like cars, gadgets, etc

This reduction in spending leads to reduction in sales, and since the same process is broadly followed in most industries, it leads to increasing unemployment, and thereby widespread reduction in the purchasing power of the masses

5. At the same time, industries have to grow larger in size . Large scale production means one can sell at a cheaper price than small scale production ( by effecting economy of scale e.g. by buying raw materials in bulk, and thereby cheaper ). If a businessman does not do that his business rival will do it, and thereby eliminate him by underselling him.

6. Thus the very dynamics of industrialization introduces two contradictory tendencies. On the one hand, production increases ( since industries are growing larger ). On the other hand, purchasing power decreases, as more and more unemployment is being generated ( as automation or capital intensive mashinery is introduced ). How will the goods produced be sold ? This contradictory tendency sooner or later results in a crisis, i.e. a recession, which leads to more unemployment, thus intensifying the crisis. It is a chain reaction.

7. The solution to the problem is therefore to increase the purchasing power of the masses. There is no difficulty in increasing production, but how will the goods produced be sold when most people do not have the money to buy ?

8. The French economist Jean Baptiste Say propounded his well known ' Say's Law ' which says that production will find its own demand, and Adam Smith in his ' The Wealth of Nations ' spoke of ' the invisible hand ' which will lead to unending progress.. But subsequent developments, particularly the Great Depression from 1929 to 1939 have proved these theories false. Keynes theory ( propounded in his book ' The General Theory of Employment, Money and Interest ' in 1936 ), which prescribes large scale government spending as the way out of the contradiction, was really a temporary palliative, and presents no real solution to the problem.

9. Hence the problem is not how to increase production ( that can easily be done with the large number of competent engineers and immense natural resources we have ) but how to raise the purchasing power of the masses, so that the goods produced can be sold. But how is this to be done ? This is the problem to which all serious thinkers must now apply their minds.

10. In socialist countries the method of raising the purchasing power of the masses, and thereby rapidly expanding the economy and consequently abolishing unemployment, was broadly this :

(a) Prices of commodities were fixed by the government.
(b) These prices were reduced by 5-10% every 2 years or so
(c) This resulted in steadily increasing the purchasing power of the masses, because with the same income people could buy more goods. In other words, the real income of the masses went up even if nominally it remained the same ( since real wage is relative to the price index ).
(d) Simultaneously, production was stepped up, and this increased production could be sold in the domestic market, as the purchasing power of people was steadily rising.
(e) This led to rapid expansion of the economy, leading to creation of millions of jobs and thereby abolition of unemployment.

During the Great Depression which hit the Western economies in 1929 ( it continued till the breakout of the Second World War in 1939, despite the New Deal of President Franklin Roosevelt ) when about one third or more people in Western countries were unemployed and factories were shutting down, the Soviet economy was rapidly expanding and unemployment abolished in the Soviet Union by following the above methodology.

Of course this was only possible in a socialist economy, where the problem was solved by state action.

I am not saying that we must necessarily follow the method adopted by socialist countries. We can adopt any other method if thereby we can raise the purchasing power of the Indian masses and thereby rapidly expand the Indian economy, which is the only way of eliminating the recession and abolishing unemployment in India.. The central point, and therefore the main problem before India, is how to raise the purchasing power of the masses ?

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