OPINION : Ila Patnaik
Yashwant Sinha’s totem-pole
Business Standard, July 26, 2001
We should permit only talk about a moving average growth number
Recently, Yashwant Sinha talked of over 6 per cent GDP growth in the current year. When finance ministers talk about the growth rate, they seem to speak of it as an achievement of the government. But both the numbers and their implications are often misleading. Perhaps, government officials should not be allowed to talk about GDP growth figures at all.
First, this is because the implication is that short-term growth is the main objective of economic policy or at least of short-term policy. Luckily for the government, current unemployment figures are not available in India because then, who knows, Mr Sinha may have sounded less pleased with himself.
It is easy in India to get away with merely talking about annual growth rates. Few economic targets are set against which the public can judge the performance of the government. There is no strict inflation target as in some countries.
There is no exchange rate target as the exchange rate mechanism (ERM) in Europe. Poverty, health and literacy targets are not taken seriously anymore. As a result, the growth rate appears to be the one closest to what may be considered serious.
But as GDP growth targets set by the Planning Commission in the long term are at unrealistic levels of 8 or 9 per cent, what remains is short-term growth. It is no doubt still important, but it shifts the focus from long-term sustained growth that the economy needs as also from the investment numbers that the government should be discussing about. This is because even if GDP is higher this year, it will not push the production function outward. Only investment can do that.
Considering that investment is the main culprit in the current slowdown, the finance minister should be getting his act together on policies to raise investment. That’s what India needs, both public and private, in agriculture and manufacturing, instead of momentary optimism induced by the rains.
His attempts to improve the investment climate with the budget were jolted because of the crisis in the stock market, poor business sentiment and the adverse effect of last year’s bad monsoon. The second-generation reforms presented in the budget depend on too many independent bills and will not be easy to come about.
Even if agricultural output rises because of good monsoon, there may be only a short-term effect on it. To raise private investment in agriculture, farmers’ incomes must rise. For the good monsoon to induce investment in industry, rural demand must rise. For that again, farmers’ incomes must rise.
This means that, over time, the terms of trade between agriculture and industry must be stable. On the one hand, they must not move against agriculture and reduce farm incomes, thereby leading to a fall in both investment and consumption demand that arise from agriculture.
On the other, if terms of trade start moving against industry, investible surplus would fall. Thus, a good monsoon, or rather consecutive good monsoons, can impact on both agricultural and industrial investment positively only if terms of trade are stable.
The second reason why government officials should not claim credit for success by simply talking about the GDP data is because GDP growth numbers tell different stories far too often. A few weeks ago, a growth forecast of over 6 per cent was considered overly optimistic.
But come rain and a little data revision, and now that is the favourite figure. This is because not only will the monsoon be doing its job better, last year’s production numbers have been revised downwards. On the lower base, even though the actual production numbers will be exactly the same as predicted a few weeks ago, growth will appear to be much stronger.
Earlier this year, there was news of 6 per cent GDP growth in 2000-01. But as this was based on unreliable data, the correction was made. I have no doubt that it was necessary. Indeed, I argued in this column that since the monsoon was bad and industry down, the numbers were too good to be true. They had to be revised.
But as the effect of this revision is also to improve this year’s projected growth figures, we should allow government officials to talk only about a moving average growth number. So instead of growth in 2001-2, they can only talk about growth in the three-year period 2000-03. At least that way, there will be no attempt to make a PR exercise of data revisions.
This is necessary because otherwise their lower credibility would soon reduce the impact of a better performance. The impact of better growth figures can be positive if they are able to improve expectations. When the revised GDP statistics were released last month, an economist with a private company was reported as saying: “Now I will have to revise my forecast”. Improved GDP forecast could induce more investment as it would be expected to lead to higher income and demand.
Yet, a feel-good factor can be created only as long as the government’s numbers remain credible. This problem of time consistency is similar to that of a central bank. When a central bank sets inflation targets, inflation numbers match this target only as long as the central bank is credible. People expect the targets to be met. Then inflationary expectations are low. And when these low expectations are built into the wage-price system, wages and prices remain low.
It may be possible for a central bank to achieve higher growth by inducing unanticipated inflation. In this situation since inflationary expectations were low, a sudden increase in prices lowers real wages and raises output.
But if a central bank repeatedly indulges in surprise inflation trying to achieve higher growth, the bank loses credibility. Expected inflation rates that are built into the wage system are higher, resulting in higher actual inflation.
Similarly, if a government repeatedly indulges in using the much-revised GDP numbers to raise hopes, its credibility falls. People become more cautious before raising their expectations, thus dampening investment.
And, the monsoon is not the only misleading factor. As Ashok Desai pointed out in one of his columns, it may be the effect of a higher cost of government services. Thus, a pay commission can raise growth. GDP is higher if the government pays itself more for whatever little work it does. And that’s not all. A change in the base year, change in composition or in the price deflator — all contribute to variations in annual growth rates.
As the old saying goes, you cannot fool all the people all the time. So, when Mr Sinha next decides to tell us about the success of the government, he should give us news about investment.
Taking credit for the rain does not lend credit to his position. He should concern himself with taking India to a higher growth path, not do little jigs round the growth totem-pole when it rains well.