The 18th century British lexicographer, Samuel Johnson, is said to have quipped that there is nothing quite like the prospect of a hanging to concentrate the mind. With six successive quarters of deceleration in real gross domestic product (GDP), or equivalently of falling GDP growth, there appears to be a renewed emphasis on economic policy both from the government as well as among the commenting class.
When Prime Minister Narendra Modi himself jumps into the fray to defend his government’s economic record, as he did in a widely publicized speech to the Institute of Company Secretaries of India on 4 October in New Delhi, it surely sends a signal that criticisms of the government’s economic policy management, both from within and without the governing Bharatiya Janata Party (BJP), have elicited sufficient concern to warrant a brisk rebuttal from the very top.
Unfortunately, the degradation of the discourse is such that among commentators, and the government’s defenders and detractors, the view appears to be either that nothing is wrong and all of the recent hand-wringing about the economy is misguided, or that the sky is about to fall and economic catastrophe awaits. Both views may be politically useful, but both are misleading and pose their own dangers: complacency, on the one hand, and premature panic, on the other.
It helps to take a longer view. The chart shows quarterly, seasonally adjusted, constant price GDP growth on a year-on-year basis from 1997:Q2 to 2017:Q1, using internationally comparable data from the Organization for Economic Cooperation and Development (OECD) and collated by the Federal Reserve Bank of St Louis.
The data make it clear that as in most emerging economies, GDP growth in India is highly volatile. The last deep trough was 2009:Q1, when growth was actually -0.14%, sharply rebounding by 2010:Q1 to a new peak of 13.88%. The next major trough was 2012:Q2, with growth falling to 3.8%, after which GDP growth has been generally on an upward trajectory, peaking again in 2016:Q1 at 8.66%, after which it has been falling and is yet to reach a new trough before again rebounding. If forecasts from the Reserve Bank of India (RBI) and others prove to be correct, the recovery is likely to occur by the end of the 2017-18 fiscal year and continue into the next fiscal year.
The lesson: Data support neither panic nor complacency. It is true that GDP growth has been decelerating, and this ought to be of concern, but it is also true that recent fluctuations are much smaller in amplitude than we have observed in earlier years.
The immediate policy implication is that injecting a large dose of fiscal stimulus at this juncture, on the cusp of an incipient recovery, is likely to do more harm than good in the long run, leading only to a temporary growth spurt purchased with permanently higher inflation, as argued in this column last time.
As a corollary, the only way to get India on to a high growth trajectory in any sustainable fashion is to press ahead with supply-side or structural reforms that boost the potential or long-run level of GDP, rather than trying to slide along the Phillips curve corresponding to the current potential level.
Lest we get sidelined by a sterile debate about what is meant by structural reform, a theoretically impure but practically useful definition would be to look at the doing business climate, with the hypothesis that an improvement in the tax and regulatory environment corresponds in a rough and ready fashion to progress on supply-side reforms and improvement in the quality of institutions. The body of evidence bears out a robust and reliable correlation between various metrics of the “ease of doing business” and the level, and growth rate, of GDP, and this finding is reconfirmed most recently in the NITI Aayog/IDFC Institute state-level survey of enterprises, released on 28 August, of which I was co-lead researcher.
The Modi government has made admirable progress in fixing the plumbing of the economy, and attempting to cleanse the system of corruption, tax evasion and informality, even if this imposes a transitory cost on the economy. What has lagged are the necessary and concomitant tax and regulatory reforms, to ease the doing business climate, that provide the carrots corresponding to the sticks of demonetization and enforced compliance with the goods and services tax (GST) and income tax. As economics teaches us, a stick only, to force compliance, without a carrot, to change incentives, cannot succeed in changing behaviour beyond a certain point.
Vivek Dehejia is a Mint columnist and resident senior fellow at IDFC Institute, Mumbai.