Manifested Errors
   23-Apr-2019
The major economic proposals of Congress manifesto appear to have been drafted by a well-meaning bard with fanciful notions of ‘El Dorado’ than by a hard-nosed, number-savvy economist with a penchant for matching ideas with execution, in what is essentially an imperfect world with scarce resources
Shri Balaji TV
 
Before analysing the Congress manifesto, there is a need to understand how the economy works. A simplified example has been used to explain the same, with the goal of ease of comprehension triumphing exhaustiveness of exposition. Hopefully, the abstraction is adequate to enable the reader to broadly appreciate the impact of the major proposals contained in the Congress manifesto and to conclude about their feasibility.
 
Primer on Macro Economics
Sustained increase in per capita income (PCI) is the economic goal that all elected governments aspire for. PCI is basically the National income divided by the Population. Sustained net growth in National income (overgrowth in population) leads to an Increase in PCI. Since National income is a Derivative of GDP (gross domestic product) which is easier to compute, a secular increase in GDP is used as an apt surrogate for determining the material prosperity of a nation. One of the three ways of measuring/representing GDP is the expenditure method. The expenditure method decomposes the GDP into four categories namely Consumption expenditure (C), Investment Exp (I), Govt expenditure (G) and net exports (NE).
 

 
Smt Sonia Gandhi and Rahul Gandhi releasing their party manifesto for Elections 2019 
 
Let us try to understand the above through a simple example.
Assume a village called UTOPIA wherein live four individuals namely ‘K’ the Kisan (farmer), ‘W’ the weaver, ‘M’ the mason/realtor and ‘R’ the Raja. K, the farmer, produces food. W, the weaver, makes clothes. M, the mason, builds and leases out dwellings and R is the King of the village (who ensures protection for the village from attacks from neighbouring villages, enforces law and order, offers banking services and performs other sovereign functions). The Raja levies taxes for his services and uses the same to fund the aforesaid activities. Let us also assume that the Raja’s Expenditure (called Government expenditure or ‘G’ for short) is equal to the Taxes collected by him, implying a balanced budget.
 
 
 
The villagers pay taxes at the rate of 20 per cent of their production to the Raja. To facilitate exchange and also for having a single measure of values, the Raja prints and circulates currency authorised under his seal, ensuring their due legal acceptance. Presently, he has printed currency (Called Raja’s Shasan or Rs for short) worth say, Rs 300.
Let us try to understand the economic contribution each of the citizens in UTOPIA makes, by taking the farmer as an example.
 
While the country has vast tracts of land, most of them are either wild forest lands or are un-irrigated. It may take at least five years to transform un-irrigated lands into irrigated and cultivable lands (since dams and canals need be built across the seasonal rivers to store water flowing through them and also since land also has to be developed for nutrient adequacy).
 

 
 
The land, which is already irrigated, is say about one acre in size and the farmer gets a total harvest of say 100 kg of foodgrains, pulses, vegetables and fruits every year. Of this, he keeps 40 kg for his own consumption (‘Consumption’ part of GDP), keeps 20 kg of foodgrains as seeds, manure and to swap for other inputs for the next harvest. (‘Investment’ part of GDP). The seed (investment) to harvest (output) ratio is 1:5 in this case. The farmer also gives 20 kg worth food to Raja as Tax (the ‘G’ part of GDP since taxes equal Government expenditure).
The NYAY proposal is fundamentally flawed due to conspicuous silence of the manifesto about supply-side challenges. The proposals on education and health too appear not to have been thought through fully The farmer trades the balance 20 kg of foodgrains with the weaver for clothes and the realtor for renting the house he is staying in and also with neighbouring villages for some other items of consumption. (This is the ‘NE’ portion of GDP. An aside here: The purist may like to distinguish here between trade within the village and with outsiders calling the latter as NE. Since such academic hairsplitting does not detract from the macro points being made in this write-up, let us ignore the same for now). Also, assume that each unit (kg) of foodgrain costs Re 1. Thus, the farmer produces Rs 100 worth of output for the economy.
 
Let us suppose a similar output paradigm exists for the weaver and the mason. (40 units for self-consumption, 20 for investment, 20 for taxes and 20 for NE). Thus, the weaver contributes 100 units towards GDP and so does the mason/realtor another 100 more.
 
Thus, the total GDP of UTOPIA is worth Rs 300. So, the Raja has printed notes worth Rs 300 (again the purist here would like to argue that due to the velocity of circulation—the same note changing hands like a ball in a passing-the-ball contest—the actual currency demanded may be less than 300. Yet, we may ignore the same for the limited purpose of the conclusions we seek to draw from this example). Since the GDP is 300 units and the notes in circulation are Rs 300, the price of each unit of GDP is Re 1 now.
 
The components of the GDP of UTOPIA are (i) Total Consumption of 120 (3*40 each): (ii) Total Investments of Rs 60 (3*20) (iii) Govt exp of Rs 60 (3* 20) and (iv) Exports (NE) of Rs 60 (3*20). The Raja uses the Rs 60 received as taxes towards services rendered by him (viz; defence, maintenance of law/order and others, including banking).
The village enjoys perfect bliss since all the 4 residents get what they need. The existing capacities are fully engaged. New capacities can be created if needed, given a few years of time.
 
But now comes the twist
Let us suppose one more person by name 'Needy’ comes to settle down in the village and Raja so permits him. Needy does not have any skill. So, the Raja has decided to take care of him, till he is able to contribute to Utopia’s economy. The Raja thinks (wrongly) that printing additional currency of Rs 100 and transferring the same to Needy will solve all the problems. In Raja’s opinion, money with Needy will create additional demand for Rs 100 worth of new goods and thus automatically increase supply to meet the demand. Alas, things aren’t as simple.
 
The farmer, the weaver and the mason, however, sound the alarm bells (mind you, these are the only three who produce tangible goods as of now. Raja only delivers service and Needy is too raw and unskilled to produce anything).
 
The farmer says that existing irrigated land can only give 100 kg of foodgrains, which is sufficient only for the four of them. For needy, a 25 per cent increase in production of food is needed, but the same can’t be organised immediately since cultivable lands are not readily available. The same opinion is shared by the weaver and the mason with respect to their respective areas of production since all existing capacities are fully used and new capacities need be created for the additional demand by ‘Needy’ but the supply can’t be increased overnight. And as mentioned elsewhere, additional capacity in any area may take about five years to come to fruition.
 
Disregarding the above sane advice, the Raja goes ahead with the printing of Rs 100 worth of additional notes and gives the same to Needy. Needy, who is desperate simply uses the currency to bid up the prices of all products (food, clothing, shelter etc). At the end of the year, the production is still 300 units (100 units of food, 100 units of clothes and 100 units of dwelling. As mentioned earlier, these are the only three who produce tangible goods as of now. Raja only delivers service and Needy is too raw and unskilled to produce anything). Since 400 units of currency are chasing 300 units of total production, the price of each unit of GDP is increased to Rs 1.25 from Rs 1.00 earlier and the farmer, the weaver and the mason have seen their standard of living fall, due to having to share their GDP with a 5th person now. Thus, the Raja realises that mere printing of notes will not enhance GDP but will only stoke inflation.
 
But the Raja still does not want to give up. Hence, he now proposes higher taxes and offers to part with the additional taxes to Needy. The new tax rate proposed is 30% from the current year.
 
The farmer, weaver and mason are disturbed. Where will the additional tax of Rs 10 each come from? For the farmer (as for the others) consumption of Rs 40, tax of Rs 30, and (NE) trade of Rs 20 are non-negotiable for his very existence, leaving just Rs 10 for Investment. Remember, his investment was Rs 20 earlier. Ditto for the weaver and the mason. Thus, private investment loses out due to sovereign action. (This is called in Macroeconomic parlance as ‘Crowding out of Investment’). Now the total investment is Rs 30 (3*10 each) down from the earlier level of Rs 60.
Consequently, in the following year, the GDP shrinks to Rs 150 (from Rs. 300 earlier) since the ratio of investment to GDP is 1:5 and since the investment has shrunk to Rs 30 (Previous year: Rs 60). Thus by hiking the tax, all that the Raja has managed to do is to effectively crowd out investment and bring down the GDP significantly making the country poorer.
 
All the above is due to the wrong view of the Raja that giving money to Needy—either by printing additional money or by hiking taxes—can help increase the demand and thus automatically increase GDP. Unfortunately, supply augmentation (critical for meeting additional demand for GDP) is a long term process and assuming its automatic increase along with an increase in demand was faulty. The short to medium term consequence of money transfer schemes is either hyperinflation or paring of growth (recession) or worse still a depression, the magnitude of each of which will be proportional to the volume of money being transferred. The above example is to be kept in mind while understanding the NYAY scheme announced by Congress.
 
NYAY to Nation’s Economy
Congress manifesto talks about a guaranteed yearly income of Rs 72,000 for five crore households. The cost is Rs 3.6 lakh crore every year. Let us examine the above in the light of other relevant economic parameters. The GDP of our country (equal to Rs 300 in the UTOPIA example) in FY 2019 was nearly 188.41 lakh crore. The size of the Government Budget (equal to Rs 60 in the Utopia example) is Rs 24.57 lakh crore.
 
Funds needed for the NYAY scheme can be found only in three ways. One, use of outlays from existing schemes. This means many existing subsidies will vanish. Then Congress’s ‘NYAY’ is nothing more than a mere renaming of existing schemes. Or NYAY outlay can be funded by (ii) printing notes or (iii) by raising taxes, both of which are fiscally imprudent given the example of the UTOPIA village. One is inflationary and another stunts growth. Congress manifesto by presuming that the additional demand created by NYAY transfers will automatically translate into additional GDP seems to reflect an opinion that is popular amongst a few consumption/demand-side economists and is seductively appealing too, but is fundamentally flawed, since supply—to meet the new demand for additional GDP—can’t grow magically.
 
Supply-side augmentation is a long run phenomenon. Else, if a mere demand increase can increase GDP ‘Ipso facto’, then why stop with transferring Rs 72,000 per family per year. Why not transfer Rs 72 lakh or even 72 crore family per year. After all, transferred money increases demand and increase in demand automatically enhances GDP, supply-side constraints be dashed! Thus, the NYAY proposal is fundamentally flawed due to conspicuous silence of the manifesto about supply-side challenges.
 
Thoughtless Proposals on Education and Healthcare
Congress manifesto has also proposed an increase in the outlay on education and healthcare as: “Congress promises to double the allocation for Education to 6 per cent of GDP in the five years ending 2023-24.”
 
The above 6 per cent in the manifesto represents the total expenditure by both the Centre and the states. Since we are here dealing with what the centre can do, we need to extricate the relevant information from the budget documents of the GOI. Union Budget outlay reveals that presently all governments (Centre and states put together) contribute 2.7% of the GDP towards education and about 1.4% of the GDP towards health. Identifying the Centre’s share of the above from the Budget documents of 2019 and extrapolating the same for 2024 based on equitable distribution of the hikes (in %) between the states and the Centre one notices that the outlay on education by the Centre needs to rise from Rs 0.99 lakh crore (BE 19-20) to Rs 3.67 lakh crore (in FY 2024—in line with the manifesto proposal) under education and from Rs 0.87 (BE 19-20) to Rs 2.97 lakh crore under health (in FY 2024 in line with Manifesto proposal). This implies that the union budget outlay for education/health has to grow by more than 37% year-on-year for the next few years upto FY 23-24. This is highly unrealistic, to say the least.
 
Together these three outlays on NYAY, education and healthcare will need an expenditure of Rs 10.54 lakh crores out of a total budget expenditure of Rs 45.91 lakh crore in 2023-24 (Table C). The discomfort stems from the fact that these three proposals alone will swallow 23% of the budget in 2023-24, while presently these 3 (DBT, education and health) account for only 7.6% of the budget outlay in 2019-20. Hence, the proposals on education and health also appear not to have been thought through fully.
 
‘Manufactured’ Economics of Indian Industry
Congress also promises to increase the share of India’s manufacturing sector from the current level of 16 per cent of GDP to 25 per cent within a period of five years.
 
The above implies that manufacturing, which accounts for Rs 31.71 lakh crore out of Rs 188.41 lakh crore of nominal GDP in 2019 will have to move to Rs 89.25 lakh crore out of Rs 355.69 lakh crore of Nominal GDP by 2024 i.e., industry has to grow at the rate of 23% YOY for the next five years! This hasn't happened in India even in three successive years in the past, let alone for five consecutive years. Thus, the proposal to enhance the contribution of manufacturing in the country's GDP also appears not to have been comprehensively thought through.
 
There is also a fifth proposal to fill up all the central Government vacancies (4 lakh positions) in a year’s time and also to persuade the state governments to fill in all the pending vacancies with them (20 lakh more). Additionally, there is a proposal to create ‘Seva Mitra Positions’ (estimated at 10 lakh nos) for local bodies. This will also be inflationary till the time supply side rises sufficiently enough to buffer the same which may not happen anytime too soon.
 
In summary, it can be said that the major economic proposals of the manifesto appear to have been drafted by a well-meaning bard with fanciful notions of ‘El Dorado’ than by a hard-nosed, number-savvy economist with a penchant for matching ideas with execution, in what is essentially an imperfect world with scarce resources.
(The writer is a financial consultant with over 30 years of experience. He held senior positions in illustrious corporate houses like Eicher Group, ING Vysya, Reliance Group, etc. He is also a visiting faculty in business schools of repute like Symbiosis, Bangalore and IIM Bangalore)