Meaning of Deflationary Policies & Trade Liberalisation

For the Rural Economy in India

Utsa Patnaik

Utsa Patnaik has contributed an article “Jobs and Food Security in the Era of Deflationary Economic Reforms”. Since this article deals with three issues, it has been split into three parts. Each part is being published as an independent article. The first article is being published in this Issue of PD. The second and the third in the series will be published in the subsequent issues of PD.

DEFLATIONARY macroeconomic policies are beloved by international and domestic financial interest groups who are quite obsessive about controlling inflation and would prefer to see even an economy with a high rate of unemployment, growing slowly and raising unemployment further, rather than risk any possibility of prices rising. International creditors wish to maintain high real interest rates (which inflation would erode) and are happy with bouts of asset deflation in developing countries so that these assets can be snapped up at low prices by their corporations. Their insensate and obsessive fear of inflation can be seen in the policies advised uniformly by the International Monetary Fund (IMF) to 78 developing countries in the 1980s and summarized in Table 1 from an IMF study. The first three policies – restraint on central government expenditure, limits on credit expansion, and reduction of budget deficit to GDP ratio, add up together to a strongly deflationary package and all three were actually implemented at the same time by four-fifths of the concerned countries, while two-thirds capped wages and over half devalued their currency.

The results of deflationary policies of the 1980s in developing have been documented as sharp decline in rates of investment in both capital formation and in the social sectors, leading to reduced or negative GDP growth and negative impact on the human development indicators (see in particular Cornia, Jolly and Stewart 1987, Adjustment with a Human Face).  A number of studies since then have confirmed the adverse impact and have argued for expansionary policies.

Table 1

Policies Followed by 78 countries under Fund-guided Reforms

Source:           Quoted in Cornia, Jolly and Stewart (eds) Adjustment with a Human Face  1987, Vol.1, p.11.                                                         

 Table 2

Source: Calculated using current values, from Reserve Bank of India, Report on Currency and Finance, 1995–6, Statements 8 and 146; and Government of India, Ministry of Finance, Economic Survey, various issues 2001–02 to 2003–04. Rural development expenditures here include plan outlays on agriculture, rural development, special areas programmes, irrigation and flood control, village and small scale industry. Infrastructure includes power and transport.    

Table 3

Source : Government of India, Ministry of Finance, Economic Survey, 2001-02, p.189. Note that slowing down of output growth is much steeper than slowing down of population growth implying falling per head output.

Table 4

Source: Government of India, Ministry of Finance, Economic Survey 2002-03, p.218.

DEFLATIONARY PACKAGE OF POLICIES

India has been following exactly the same deflationary package of policies since 1991, whose impact has been especially severe in India’s agricultural sector which saw sharp reduction in public planned development expenditures in rural areas, which has traditionally included agriculture, irrigation – vital for maintaining output – employment generation programmes, drought- prone areas and special areas programmes, village and small scale rural industry. Out of these the employment- generating programmes had assumed a special importance from the drought year 1987 onwards.

During the Seventh Plan period marking the pre-reforms phase, from 1985 to 1990, Rs 51,000 crore was spent on rural development (including also village and small scale industry), amounting to almost 4 per cent of Net National Product, and Rs 91,000 crore or over 7 per cent of NNP was spent on infrastructure. By the mid- 1990s, annual spending on rural development was down to 2.6 per cent of NNP, and after including infrastructure, less than 7 per cent was being spent compared to 11 per cent during the Seventh Plan. Further declines took place so that by 2000-01 the share of spending under these heads was down to 5.8 per cent of NNP, the rural development part halving to only 1.9 per cent (see Table 2). I estimate that in constant 1993-4 prices about Rs 30,000 crore less was being spent by the end-decade year 1999-2000, compared to the beginning, 1990-91. A crude point-to-point comparison would suggest an annual income loss of between 120,000 to 150,000 crores of rupees assuming a multiplier value between 4 and 5. Actual income loss would have been greater taking the cumulative losses over successive years. This harsh contractionary policy had nothing to do with any objective resource constraint but simply reflected the loan-conditionalities of the BWI which were internalized and sought to be justified by the Indian government.

There is no economic rationale for believing that “public investment crowds out private investment” which is the common argument put forward for reducing the state’s role in rural development. Precisely the contrary has been shown to hold for certain types of investment essential for an irrigation-dependent agriculture like India’s such as irrigation projects of all types. Private tube-well investment is profitable only where the water table remains high owing to seepage from state-built canal irrigation systems, and where community integrated watershed management (planting trees and using check-dams) is encouraged with state help. Private over-exploitation of ground water has now reached a crisis point in many states in India, with the water table falling rapidly and with even the richest farmers unable to reach water after investing heavily in deep bore-wells and submersible pumps. Other infrastructure investment such as rural power projects, roads, bridges, school buildings, clinics and so on, are never undertaken by private investors but are vital for stimulating development and providing livelihoods both directly to those employed in building them and through the important multiplier effects of the increased wage incomes being spent on simple consumer goods and services within the villages. The market for machine made textiles and other goods also expands.

CUT-BACK OF PUBLIC INVESTMENT & RDE

The net result of the unwise cut-back of public investment and in RDE has been a near-halving of both foodgrains and non-foodgrains growth rates in the nineties compared to the pre-reform eighties, and both have fallen below the population growth rate (Table 3) leading to falling output per head during the nineties, continuing at present. The Agricultural Universities had earlier played a major role in developing and helping to disseminate new crop varieties, and the cut in funding for research in these Universities by affecting the search for better rain-fed crop varieties, has also contributed to the deceleration in the growth of yields. With increasing use of land for commercial and residential purposes, the gross sown area in India has remained static since 1991, so it is only through yield rise that output growth can be maintained and it is here that the failure is evident.

The combination of decline in state RDE and the near-halving of agricultural growth has produced a major crisis of rising unemployment. There is fast growing open unemployment and fall in number of days employed of the work force. The share of labour force in population, or the participation rate, has declined reflecting difficulty of finding work, the share of work force to labour force has declined because open unemployment has been growing at over 5 per cent annually (Table 4).

The prospects are dim of unemployed rural workers migrating and finding jobs in industry: there have also been massive job losses in manufacturing during the reform period and the share of the secondary sector in GDP has fallen from 29 to around 22 per cent, indicating de-industrialisation. The agricultural depression has reduced the share of agriculture in GDP from about a third at the beginning of the nineties to just over a fifth a decade later, but the labour force and population dependent on agriculture has hardly fallen reflecting relative decline in per head incomes. The sector which has ballooned in an abnormal manner is the tertiary or services sector which now accounts for over half of GDP.

Only a small share of services is IT-enabled high income services, business process outsourcing, domestic tourism services and the like. The major part in employment terms, is still low-productivity activities in which the rural displaced workers stagnate at low income levels, servicing the requirements of the upper income elites who have been improving their real income position fast. Disposable incomes have risen even faster for this segment since a part of the neo-liberal reforms include reduction in direct tax rates. Advanced countries usually have this upper-income 10 to 15 per cent minority of Indians in mind when they demand market access for their manufactures and agricultural products, and no doubt 100 to 150 million people is a large potential market. But the situation of the vast majority of the mainly rural population who not merely stagnate at low income levels but whose position is considerably worse today than a decade earlier, cannot be ignored: a potentially highly destabilising situation is in the making.

While income and employment reduction through deflationary policies is the first main reason for loss of purchasing power in rural India, the second main reason is the unwise opening to global markets through full trade liberalization at a time from the mid-1990s, when global markets went into recession and primary product prices started falling – a fall which continues to this day.