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    Sam eco e Sam eco e Document Transcript

    • 1 ECONOMICS ESSAYS viation thrives only when there is persistence of poverty. Indian policy making has suffered from a typical anti-agri- AGRICULTURE A COLOSSAL NEGLECT culture bias since 1956, the day Indian policy makersNow one may find that the same has happened with our adopted Mahalanobis model, under which agriculture wasagriculture. The suicides in 2007 and 2008 in Andhra given a step son treatment. Although, agriculture was al-Pradesh are just the beginning. Bihar and other eastern ways out of the purview of direct taxation, yet, it has beenstates have been facing floods on regular basis. Things may proved that it is heavily taxed. Protection accorded to in-go further worse. For example, Bihar has no industry, it has dustry and over-valued exchange rate constitute an indirectlost its minerals and floods are killing agriculture. Under and implicit tax over agriculture.these conditions only God is helping them. Keeping domestic prices below world prices gave negativeWhen Then I was a small boy, I was told that one should protection to agriculture and it was another form of taxa-not neglect those things, which are certain in nature and tion. In this way, agriculture and poor agriculturists had tonot run after uncertain things. If it is done, the uncertain bear the brunt of generating resources for industry, whenbecomes further uncertain and even the certain becomes the sector itself was ailing. Indian agriculture and henceuncertain. rural India has always been betrayed in the past, but, keptAgriculture (including allied activities) accounted for 17.8 alive by occasional injections of technologies, subsidiesper cent of the Gross Domestic Product (GDP-at constant and sops. Formation of Commission for Agricultural Costsprices) in 2007-08 as compared to 21.7 per cent in 2003- and Prices (CACP), introduction of seed-fertilizer-water tech-04. Notwithstanding the fact that the share of this sector in nology, formation of different cooperative societies, market-GDP has been declining over the years, its role remains ing agencies, etc. have created a positive atmosphere forcritical as it accounts for about 52 per cent of the employ- agricultural growth but, all these were short-lived and werement in the country. Apart from being the provider of food unable to compensate it fully. Over the past few years, lib-and fodder, its importance also stems from the raw materi- eralization has meant the withdrawal of several subsidiesals that it provides to industry. The prosperity of the rural from the farming sector, resulting in a sharp increase in theeconomy is also closely linked to agriculture and allied cost of fertilizers and seeds coupled with power hikes. Lib-activities. Agricultural sector contributed 12.2 per cent of eralization and globalisation are the process in the processnational exports in 2007-08. The rural sector (including ag- of elimination of unfair treatment at the national and inter-riculture) is being increasingly seen as a potential source national level. The protection must go. But, a State cannotof domestic demand; a recognition, that is shaping the mar- forget its basic duty to protect a common man. The protec-keting strategies of entrepreneurs wishing to widen the de- tion cannot be withdrawn without the creation of proper in-mand for goods and services. Indian agriculture suffers from frastructure and investment. The subsidies must be I with-a mismatch between food crops and cash crops, low yields drawn in proportion to the investment. There cannot be oneper hectare except for wheat, volatility in production and drug for all the diseases. Liberalisation may be pancea ofwide disparities of productivity over regions and crops. The one, may not be for all. The rural credit system can bedomestic production of pulses and oilseeds are still below streamlined by the following measures:the domestic requirements and India imports pulses and (a) Self-Help Groups must be encouraged for banking inedible oils to satisfy domestic demands. Further, a distinct the rural areas;bias in agricultural price support policies in favour of rice (b) The rural banks must relinquish narrow banking andand wheat has distorted cropping pattern and input usage. must resort to universal banking;Food management is inefficient with unsustainable level of (c) Even Narasimham Committee suggested consolidationfood subsidies imposing heaving burden on Government fi- of rural branches of commercial banks into banking enti-nance. The rural economy and the private sector severely ties;lack the basic infrastructure to build sufficient buffer stocks, (d) There should be separate prudential norms for the ruraland the country remains vulnerable to weather stocks. The banking;rural credit is one of the most concerned areas. The Credit (e) It should be possible to devise a model in which theDeposit Ratio (CDR) in rural areas for both public and pri- resources of commercial banks are available for rural lend-vate sector banks was substantially low compared to ur- ing, which would be carried out through specialised banksban and metropolitan areas. The Gross Capital Formation operating only in rural areas. The main-line commercial(GCF) in agriculture as a proportion to the total GDP has banks can buyout rural loan portfolios of these rural banks;shown a decline from 2.9 per cent in 2001-02 to 2.5 per (f) The government must provide incentives in the form ofcent in 2007-08. exemptions to the commercial banks to operate in ruralThe agriculture sector faces challenges on various fronts. areas;On the supply side, the yield of most crops has not im- (g) The banking system should equip itself to identify theproved significantly and in some cases fluctuated down- eligible clients based on prescribed norms in the govern-wards. The scope for increase in the net sown area is lim- ment-sponsored programmes such as IRDP rather than toited and farm size has been shrinking. In the case of cer- depend on the government agencies;tain crops like sugarcane, extreme variability in the acre- (h) The operating systems of banks and other rural financ-age and production over the years has been a matter of ing institutions (RFIs) like RRBs and District Credit Coop-concern. On the other hand, in the case of pulses, pro- erative Banks (DCCBs) in terms of appraisal, supervisionduction has just not kept pace with the requirement leading and follow up must be properly reviewed and strengthened.to a rise in prices given that its availability in the interna- I strongly feel that there is urgent need to reconsider thetional markets is limited. The ill-treatment of the agriculture following measures:appears to be the best way to preserve poverty on which (a) India’s agricultural policy should continue to be “grain-the sectarian politics survives. The politics of poverty alle- - IInd Floor, Paliwal Market, Gumanpura KOTA (-0744 -2392059 & 3290500
    • 2oriented”, supplemented by pulses and oilseeds; processed products of the world. This is abysmally low;(b) Seed Act must be introduced which lays down strin- (q) Government should garner some resources by taxinggent punishment to those who sell spurious seeds/fertiliz- income of a few big landlords. This would ensure equityers; and give some money to the exchequer;(c) A more comprehensive and farmer-friendly crop insur- (r) A shift from minimum support price system and devel-ance policy should be formulated; oping alternative product markets are essential for crop di-(d) Food for work programme should be modified. It should versification and broad based agricultural development;be restricted to construction of permanent structures, to (s)The Central government must provide financial assistancestop diversion of grains in the name of short-term fictitious to the state Governments for procurement and distributionprojects; of food grains at subsidized rates, particularly to the fami-(e) The Budget 2004-05 has also admitted that the agricul- lies below the poverty line. Only an enhanced agriculturalture sector requires massive investments. Such investments growth would provide stimulus to other off-farm activities incan be through credit-enabled private investment and en- rural areas due to its forward and backward linkages. Thishanced public investment. For this fiscal instruments to would generate more employment and income in rural ar-boost investment in agriculture would be needed; eas, which in turn would cause reduction of poverty in these(f) The rural credit system must be revamped. The function- areas;ing of Regional Rural Banks (RRBs) and Cooperative Banks (t) APMC Act must be amended and mandi taxes shouldmust be streamlined. A comprehensive rural credit delivery be abolished. It will allow competitive markets to develop.system should be evolved. The Kishan Credit Cards (KCC) Suggestion by Economic Survey 2008-09suffers from adhocism. It should further be simplified; There is clearly a need for a renewed focus on improving(g) Nothing has been done on long-term basis to solve the productivity. At the same time to step up the growth of al-age-old flood problems in Bihar and other eastern states. lied activities and non-farm activities that can help improveThe main cause of flood in North Bihar is the heavy rainfall value addition. The current focus on developing rural infra-in Nepal. The rainwater enters Bihar through Gandak, Koshi, structure particularly rural roads needs to be maintained asAdhawara Group of rivers. We must take immediate mea- it would go a long way in providing connectivity that is es-sures to control the rainwaters; sential for movement of agricultural produce. The irrigation(h) The irrigation facility is only confined to food-grain areas sector requires a renewed thrust both in terms of invest-but it is almost absent in the dry land areas. This averts ment as also modem management. There is considerablecrop diversification. The existing Accelerated Irrigation Ben- scope for development of micro-irrigation systems and wa-efit Programme (AIBP) should be restructured and there tersheds and in the use of a participatory approach for achiev-should be a spatial growth of irrigation system. For this, ing the same.both private and foreign investments should be invited; There is a need to narrow the gap between producer prices(i) Even though the horizontal productivity has been in- and consumer prices through proper marketing support. Thecreased to a very large extent but the vertical productivity development of marketing infrastructure and storage andhas been thoroughly neglected; warehousing and cold chains and spot markets that are(j) The cropping pattern is more or less static not only be- driven by modern technology will go a long way in address-cause of direct neglect of the same by the agricultural policy ing this need.formulators but also because of the failure of various re- As per the Report of the Committee on Financial Inclusionsponsible institutions to change the rigid socio-psycho per- Qanuary 2008), more than 73 per cent of farmer house-spectives of farmers; holds have no access to formal sources of credit. Innova-(k) Introduction of rational market mechanism is indispens- tive institutional mechanisms that provide credit and finan-able for the sustained growth of Indian farmers. For this, cial products (including insurance products) specificallythe subsidy provisions should be minimized and the same designed to meet the needs of the farm sector keepingfinancial resource could be utilised to increase the invest- their risk - bearing ability in view is the need of the hour.ments; The rural economy needs to be viewed as comprising of a(l) Green revolution produced regional disparity in the coun- continuum of interrelated economic activities. Farmingtry. For minimizing this negative fallout, Indian agriculture needs to be dovetailed with viable off-farm and non-farmneeds area specific programmes, which could bring ever- activities. Farmers need to be facilitated to take up valuegreen revolution in the country. But for this, the policy for- addition such as processing of agricultural produce, horti-mulation should depend upon ground realities rather than culture, pisciculture, poultry, development of non-farm ruralthey be knit in air conditioned rooms; enterprises. On the distribution side, there is need to en-(m) The biggest problem of Indian Agriculture is that it is sure that benefits accrue to the targeted population. A mis-still nature ridden. Till it is brought out of the clutches of sion approach for promotion of smart cards and its crossmonsoonal vagaries, it would continue to show skewed re- reference with ration cards and voter ID cards would helpsults; better targeting, lesser leakages and easier administration.(n) Capital formation in agricultural sector should be made An area that requires focused attention is the issue ofgovernment’s responsibility; sustainability of agriculture with due emphasis on environ-(o) A transparent linkage between field and market should mental concerns. Soil erosion, water logging, reduction inbe established so that farmers get remunerative returns and groundwater table and the decline in the surface irrigationrole of intermediaries can be minimized; are the problems faced by agriculture. The consequences(p) Agro-processing industries should be installed all over of climate change on Indian agriculture also need to bethe country. This would help cater domestic as well as for- factored in the strategy for the development of this sector.eign demand. India contributes just 1 per cent of the agro- On the whole, while the challenges faced by the agriculture - IInd Floor, Paliwal Market, Gumanpura KOTA (-0744 -2392059 & 3290500
    • 3 ECONOMIC GROWTH (8) There is no depreciation of capital goods which are HARROD-DOMAR MODEL, assumed to possess infinite life. INSTABILITY OF EQUILIBRIUM. (9) Saving and investment relate to the income of the same NEOCLASSICAL GROWTH year. SOLOW’S MODEL, (10) The general price level is constant, i.e., the money STEADY STATE GROWTH. income and he real income are the same. MODELS OF GROWTH OF (11) There are no changes in interest rates. JOAN ROBINSON AND (12) There is a fixed proportion of capital and labour in the KALDOR; productive process. TECHNICAL PROGRESS (13) Fixed and circulating capitals are lumped together under HICKS, capital. HARROD AND Lastly, there is only one type of product. LEARNING BY DOING, All these assumptions are not necessary for the final solution SOME GROWTH MODELS of the problem; nevertheless they serve the purpose of THE HARROD-DOMAR MODELS simplifying the analysis.The Harrod-Domar models of economic growth are based THE DOMAR MODELon the experiences of advanced economies. They are Domar builds his model around the following question: sinceprimarily addressed to an advanced capitalist economy and investment generates income on the one hand and increasesattempt to analyse the requirements of steady growth in productive capacity on the other, at what rate investmentsuch economy. should increase in order to make the increase in incomeRequirements of Steady Growth equal to the increase in productive capacity, so that fullBoth Harrod and Domar are interested in discovering the employment is maintained?rate of income growth necessary for a smooth and He answers this question by forging a link betweenuninterrupted working of the economy. Though their models aggregate supply and aggregate demand throughdiffer in details, yet they arrive at similar conclusions. investment.Harrod and Domar assign a key role to investment in the Increase in Productive Capacity. Domar explains theprocess of economic growth. But they lay emphasis on the supply side like this. Let the annual rate of investment be /dual character of investment. Firstly, it creates income, and , and the annual productive capacity per dollar of newlysecondly, it augments the productive capacity of the created capital be equal on the average to s (whicheconomy by increasing its capital stock. The former may represents the ratio of increase in real income or output tobe regarded as the ‘demand effect’ and the latter the ‘supply an increase in capital or is the reciprocal of the acceleratoreffect’ of investment. Hence so long as net investment is or the marginal capital-output ratio). Thus the productivetaking place, real income and output will continue to expand. capacity of /dollar invested will be I.s dollars per year.However, for maintaining .a full employment equilibrium level But some new investment will be at the expense of the old.of income from year to year, it is necessary that both real It will, therefore, compete with the latter for labour marketsincome and output should expand at the same rate at which and other factors of production. As a result, the output ofthe productive capacity of the capital stock is expanding. old plants will be curtailed and the increase in the annualOtherwise, any divergence between the two will lead to output (productive capacity) of the economy will be somewhatexcess or idle capacity, thus forcing entrepreneurs to curtail less than I.s. This can be indicated as la; where a (sigma)their investment expenditures. Ultimately, it will adversely represents the net potential social average productivity ofaffect the economy by lowering incomes and employment investment ( = Ä Y / I ). Accordingly la is less than I.s. la.in the subsequent periods and moving the economy off theequilibrium path of steady growth. Thus, if full employment is the total net potential increase in output of the economyis to be maintained in the long run, net investment should and is known as the sigma effect. In Domar’s words this “isexpand continuously. This further requires continuous growth the increase in output which the economy can produce,” itin real income at a rate sufficient enough to ensure full is the “supply side of our system.”capacity use of a growing stock of capital. Thus required Required Increase in Aggregate Demand. The demandrate of income growth may be called the warranted rate of side is explained by the Keynesian multiplier. Let the annualgrowth or “the full capacity growth rate.” increase in income be denoted by Ä Y and the increase inAssumptions investment by A/and the propensity to save by a (alpha)The models constructed by Harrod and Domar are based (= Ä S/ Ä Y). Then the increase in income will be equal toon the following assumptions. the multiplier (I/α) times* the increase in investment.(1) There is an initial full employment equilibrium level ofincome. 1 ÄY = ÄI(2) There is the absence of government interference. á(3) These models operate in a closed economy which has Equilibrium. To maintain full employment equilibrium levelno foreign trade. of income, aggregate demand should be equal to aggregate(4) There are no lags in adjustments between investment supply. Thus we arrive at the fundamental equation of theand creation of productive capacity. model(5) The average propensity to save is equal to the marginalpropensity to save. 1 ∆I = Iσ(6) The marginal propensity to save remains constant. α(7) The capital coefficient, i.e., the ratio of capital stock to Solving this equation by dividing both sides by /andincome is assumed to be fixed. - IInd Floor, Paliwal Market, Gumanpura KOTA (-0744 -2392059 & 3290500
    • 4multiplying by we get : income. Whereas S depends on Y, I depends on the ∆I = ασ increment in income (ÄY ), the latter . nothing but the I acceleration principle.This equation shows that to maintain full employment the The Warranted Rate of Growth. The warranted rate ofgrowth rate of net autonomous investment ( ÄI / I ) must be growth is, according to Harrod, the rate “at which producersequal to ασ (the MPS times the productivity of capital). will be content with what they are doing.” It is theThis is the rate at which investment must grow to assure “entrepreneurial equilibrium; it is the line of advance which,the use of potential capacity in order to maintain a steady if achieved, will satisfy profit takers that they have done thegrowth rate of the economy at full employment. right thing.” Thus this growth rate is primarily related to theDomar gives a numerical example to explain his point: Let behaviour of businessmen. At the warranted rate of growth, σ =25 per cent per year, α=12 percent and Y=150 billion demand is high enough for businessmen to sell what theydollars per year. If full employment is to be maintained, an have produced and they will continue to produce at the sameamount equal to 150x12/100=18 billion dollars should be percentage rate of growth. Thus, it is the path on which theinvested This will raise productive capacity by the amount supply and demand for goods and services will remain ininvested ‘y times, i.e., by 150x12/100x25/100=4.5 billion equilibrium, given the propensity to save. The equation fordollars, and the natioiial income will have to rise by the the warranted rate issame amount. But the relative rise in income will equal the GwCr=s ...(2)absolute increase divided by the income itself, i.e., where Gw is the “warranted rate of growth” or the full capacity rate of growth of income which will fully utilize a growing 12 25 stock of capital that will satisfy the entrepreneurs with the x 12 25 150 x 100 100 = x = ασ = 3percent amount of investment actually made. It is the value of 150 100 100 ÄY / Y Cr, the ‘capital requirements’, denotes the amountThus in order to maintain full employment, income must of capital needed to maintain the warranted rate of growth,grow at a rate of 3 per cent per annum. This is the equilibrium i.e., required capital-output ratio.It is the value of I / ÄY orrate of growth. Any divergence from this ‘golden path’ will C. s is the same as in the first equation, i.e., S/Y.lead to cyclical fluctuations. When ÄI / I is greater than The equation, therefore, states that if the economy is toaa, the economy would experience boom and when ÄI / I advance at the steady rate of Gw that will fully utilize itsis less than acr, it would suffer from depression. capacity, income must grow at the rate of s/Cr per yearThe Harrod Model i.e., Gw=s/Cr.Professor R.F. Harrod tries to show in his model how steady If income .grows at the warranted rate, the capital stock of(i.e., equilibrium) growth may occur in the economy. Once the economy will be fully utilised and entrepreneurs will bethe steady growth rate is interrupted and the economy falls willing to continue to invest the amount of saving generatedinto disequilibrium, cumulative forces tend to perpetuate at full potential income. Gw is therefore a self-sustainingthis divergence thereby leading to either secular deflation rate of growth and if the economy continues to grow at thisof secular inflation. rate it will follow the equilibrium path.The Harrod Model is based upon three distinct rates of Genesis of Long-run Disequilibria. Full employmentgrowth. Firstly, there is the actual growth rate represented growth, the-actual growth rate of G must equal Gw, theby G which is determined by the saving ratio and the capital- warranted rate of growth that would give steady advance tooutput ratio. It shows short-run cyclical variations in the the economy and C (the actual capital goods) must equalrate of growth. Secondly, there is the warranted growth rate Cr (the required capital goods for steady growth). If G andrepresented by Gw which is the full capacity growth rate of Gw are riot equal, the economy will be in disequilibrium.income of an economy. Lastly, there is the natural growth For instance, if G exceeds Gw, then C will be less than Cr.rate represented by Gn which is regarded as ‘the welfare When G>Gw, shortages result. “There will be insufficientoptimum’ by Harrod. It may also be called the potential or goods in the pipeline and/or insufficient equipment.” Suchthe full employment rate of growth. a situation leads to, secular inflation because actual incomeThe Actual Growth Rate. In the Harrodian model the first grows at a faster rate than that allowed by the growth in thefundamental equation is: productive capacity of the economy. It will further lead to a GC = s ...(1) deficiency of capital goods, the actual amount of capitalwhere G is the rate of growth of output in a given period of goods being less than the required capital gods (C<Cr).time and can be expressed as ÄY / Y ; C is the net addition Under the circumstances, desired (ex-ante) investmentto capital and is defined as the ratio of investment to the would be greater than saving and aggregate production would fall short of aggregate demand. There would thus be chronicincrease in income, i.e., I / Ä Y and s is the average inflation. This is illustrated where the growth rates of incomepropensity to save, i.e., S/Y. Substituting these ratios in are taken on the vertical axis and time on the horizontalthe above equation we see axis. Starting from the initial full employment level of income ÄY I S I S Y 0, the actual growth rate G follows the warranted growth × = or = or I = S path Gw upto point E through period t2. But from t2 onwards, Y ÄY Y Y Y G deviates from Gw and is higher than the latter. InThe equation is simply a re-statement of the truism that subsequent periods, the deviation between the two becomesexpost (actual, realized) savings equal expost investment. larger and larger.The above relationship is disclosed by the behaviour of - IInd Floor, Paliwal Market, Gumanpura KOTA (-0744 -2392059 & 3290500
    • 5 is for secular inflation to develop in the economy. When Gw is less than Gn,C<Cr. There is a shortage of capital goods and labour is plentiful. Profits are high since desired investment is greater than realised investment and the businessmen have a tendency to increase their capital stock. This will lead to secular inflation. In such a situation saving is a virtue for it permits the warranted rate to increase. This instability in Harrod’s model is due to the rigidity of its basic assumptions. They are a fixed production function, a fixed saving ratio, and a fixed growth rate of labour force, Economists have attempted to relieve this rigidity byIt, on. the other hand, G is less than Gw, then C is greater permitting capital and labour substitution in the productionthan Cr. Such a situation leads to secular depression function, by making the saving ratio a function of the profitbecause actual income grows more slowly than what is rate and the growth rate of labour force as a variable in therequired by the productive capacity of the economy leading growth process.to an excess of capital goods (C>Cr). This means thatdesired investment is less than saving and that theaggregate demand falls short of aggregate supply. The resultis fall in output, employment arid income. There would thusbe chronic depression. This is illustrated when from periodt2 onwards G falls below Gw and the two continue to deviatefurther away.Harrod states that once G departs from Gw, it will departfurther and further away from equilibrium. He writes: “Aroundthat line of advance which if adhered to would alone givesatisfaction, centrifugal forces are at work, causing thesystem to depart further and further from the required line of The policy implications of the model are that saving is aadvance.” Thus the equilibrium between G and Gw is a knife- virtue in any inflationary gap economy and vice in aedge equilibrium. For once it is disturbed, it is not self- deflationary gap economy. Thus in an advanced economy,correcting. It follows that one of the major tasks of public s has to be moved up or down as the situation demands..policy is io bring G and Gw together in order to maintain A Comparative Study of the two Modelslong-run stability. For this purpose, Harrod introduces his Points of Similaritythird concept of the natural rate of growth. THE DOMAR MODELThe Natural Rate of Growth. It “is the rate of advance ÄY ÄIwhich the increase of population and technological ó= = áóimprovements allow.” The natural rate of growth depends I Ion the macro variables like population, technology, naturalresources and capital equipment. In other words, it is the ÄS ÄI ÄY ÄS á= = ×rate of increase in output at full employment as determined ÄY I I ÄYby a growing population and the rate of technologicalprogress. The equation for the natural rate of growth is ÄI ÄS = Gn. Cr = or # s I IHere Gn is the natural or full employment rate of growth.Divergence of G, Gw and Gn. Now for full employment or ÄI = ÄSequilibrium growth Gn=Gw=G. But this is a knife-edge THE HARROD MODELbalance. For once there is any divergence between natural,warranted and actual rates of growth conditions of secular ÄYstagnation or inflation would be generated in the economy. GC = s G=If G>Gw, investment increases faster than saving and income Yrises faster than Gw. If G<Gw, saving increases faster than = ÄY I S Iinvestment and rise of income is less than Gw. Thus Harrod or × = C= Y ÄY Y ÄYpoints out that if Gw> Gn secular stagnation will develop. In I S Ssuch a situation Gw is also greater than G because the = = s=upper limit to the actual rate is set by the natural rate. Y Y YWhen Gw exceeds Gn, C>Cr and there is an excess of or I = Scapital goods due to a shortage of labour. The shortage oflabour keeps the rate of increase in output to a level less Given the capital-output ratio, as long as the averagethan Gw. Machines become idle and there is excess propensity to save is equal to the marginal propensity tocapacity. This further dampens investment, output, save, the equality of saving and investment fulfils theemployment and income. Thus the economy will be in the conditions of equilibrium rate of growth.grip of chronic depression. Under such conditions saving is Looked at from another angle the two models are similar.a vice. Harrod’s s is Domar’s ∝ . Harrod’s warranted rate of growthIf Gw<Gn, Gw is also less than G as shown in the tendency - IInd Floor, Paliwal Market, Gumanpura KOTA (-0744 -2392059 & 3290500
    • 6(Gw) is Domar’s full employment rate of growth ( ∝ ó ). productivity investment) to fluctuate.Harrod’s Gw=s/Cr=Domar’s áó . (7) While Domar demonstrates the technological relationshipTo prove it between capital accumulation and subsequent full capacity growth in output, Harrod shows in addition a behavioural S relationship between rise in demand and hence in currentá= or S = áY ...... (1) output on the one hand, and capital accumulation on the Y other. In other Words, the former does not suggest any ÄY behaviour pattern for entrepreneurs and the proper changeó= or ÄY = Ió ....... (2) in investment comes exogenously, whereas the latter I assumes a behaviour pattern for entrepreneurs that inducesSince S=I and substituting S for I in equation (2) we have the proper change in investment. Limitations of these Models ÄY = áYó [ S = áY ] ∴ Some of the conclusions depend on the crucial assumptions ÄY made by Harrod and Domar which make these models or = áó ...... (3) unrealistic: Y  ÄY  ( ) (1) The propensity to save ∝ or s and the capital-output ∴ Gw = áó  Since Gw =   Y  ratio (ó) are assumed to be constant. In actuality, they are likely to change in the long run and thus modify theWe have proved mathematically that Harrod’s Gw is the requirements for steady growth. A steady rate of growthsame as Domar’s ∝ ó . But, in reality, Domar’s rate of can, however, be maintained without this assumption. Asgrowth r=αs is Harrod’s Gw, and Domar’s r = ∝ ó Harrod’s Domar himself writes, “This assumption is not necessary for the argument and that the whole problem can be easilynatural growth rate. In Domar’s model s is the annualproductive capacity of newly created capital which is greater reworked with variable ∝ and ó .”than ó which is the net potential social average productivity (2) The assumption that labour and capital are used in fixed proportions is untenable. Generally, labour can beof investment. It is,the lack of labour and other factors of substituted for capital and the economy can move moreproduction which reduces Domar’s growth rate from smoothly towards a path of steady growth. In fact, unliker =∝ s to r =∝ ó . Since labour is involved in’ ó therefore Harrod’s model, this path is not so unstable that theDomar’s potential growth rate resembles Horrod’s natural economy should experience chronic inflation orrate. We may also say that the excess of s over ó in unemployment if G does not coincide with Gw.Domar’s model expresses the excess of Gw over Gn in (3) The two models also fail to consider changes in theHarrod’s model. general price level. Price changes always occur over timePoints of Difference. There are, however, important and may stabilize otherwise unstable situations. Accordingdifferences in the two models. to Meier and Baldwin, “If allowance is made for price changes:(1) Domar assigns a key role to investment in the process and variable proportions in production, then the system mayof growth and emphasises on its dual character. But Harrod have much stronger stability than the Harrod modelregards the level of income as the most important factor in suggests.”the growth process. Whereas Domar forges a link between (4) The assumption that there are no changes in interestdemand and supply of investment, Harrod, on the other hand, rates is irrelevant to the analysis.” Interest rates changeequates demand and supply of saving. and affect investment. A reduction in interest rates during periods of overproduction can make capital-intensive(2) The Domar model is based on one growth rate r = ∝ ó processes more profitable by increasing the demand forBut Harrod uses three distinct rates of growth: the actual capital and thereby reduce excess supplies of goods.rate (G), the warranted rate (Gw) and the natural rate (Gn). (5) The Harrod-Domar models ignore the effect of government(3) Domar uses the reciprocal of marginal capital-output programmes on economic growth. If, for instance, theratio, while Harrod uses the marginal capital-output ratio. In government undertakes a programme of development, thethis sense Domar’s ó = 1 / Cr of Harrod. Harrod-Domar analysis does not provide us with causal(4) Domar gives expression to the multiplier but Harrod uses (functional) relationship.the accelerator about which Domar appears to say nothing. (6) It also neglects the entrepreneurial behaviour which(5) The formal identity of Harrod’s Gw equation and Domar’s actually determines the warranted growth rate in theequation’s maintained by Domar’s assumption that economy. This makes the concept of the warranted growth ÄI / I = ÄY / Y . But Harrod does not make such rate unrealistic. (7) The Harrod-Domar models have been criticised for theirassumptions. In Harrod’s equilibrium equation Gw, there is failure to draw a distinction between capital goods andneither any explicit or implicit reference to ∆I or I. It is, consumer goods.however, in his basic equation G=s/C that there is an implicit (8) According to Professor Rose, the primary source ofreference to I, since C is defined as I / ÄY . But there is no instability in Harrod’s system lies in the effect of excessexplicit or implicit reference to ÄI .. demand if supply on production decisions and not in the(6) For Harrod the business cycle is an integral part of the effect of growing capital shortage cr redundancy onpath of growth and for Domar it is not so, but is, investment decisions.accommodated in his model by allowing ó (average Despite these limitations, “Harrod-Domar growth models - IInd Floor, Paliwal Market, Gumanpura KOTA (-0744 -2392059 & 3290500
    • 7are purely laissez-faire ones based on the assumption of Pc. Gnfiscal neutrality and designed to indicate conditions of rn=progressive equilibrium for an advanced economy.” They eare important because they represent a stimulating attempt Taking the values of Pc and Gn- as given, the natural rate ofto dynamize and secularise Keynes’ static short-term saving interest depends on the value of e which is assumed to beand investment theory. less than unity, rn and e are inversely related to each other. APPLICATION OF HARROD-DOMAR MODELS TO When e is small, rn is high and vice versa. UNDERDEVELOPED COUNTRIES The capital requirements, Cr, depend on the rate of interest,Growth theory in advanced economies has been associated Cr =f(rn). Rather, Cr is a decreasing function of rn. The higherwith three principal concepts: the saving function, the rate of interest, the lower the capital requirements, andautonomous vs. induced investment, and the productivity vice versa.of capital. The Harrod-Domar models are based on these The savings Requirements Sr, like Cr, are.also-of muchconcepts and were primarily developed in order-to illuminate importance in underdeveloped countries. But the averagesecular stagnation that was threatening the advanced propensity to save s is not necessarily equal to socialeconomies in the post-war period. The application of these requirements of savings, Sr, The actual savings S may bemodels has now been extended to the development- greater or less than Sr, i.e., S ≠ Sr. If S>Sr then’ Gw>problems of underdeveloped economies. As Hirschman Gnwhich means that actual savings being larger in thewrites: “The Domar model, in particular, has proved to be community, entrepreneurs would desire to invest more? Inremarkably versatile, it permits us to show not only the rate the long run however Gw cannot continue to be greater thanat which the economy must grow if it is to make full use of Gn which is the highest growth rate that can be attained. Inthe capacity created by new investment but inversely, the such a situation, the actual growth rate would attain fullrequired savings and the capital-output ratios if income is employment and will be less than Gw, i.e., G<Gw. This willto attain a certain target growth rate. In such exercises, the lead to depression in the economy. On the contrary, if S<Sr,capital-output ratio is usually assumed at some value then Gw<Gn. It implies that actual savings being less thanbetween 2.5 and 5; sometimes several alternative projections the required savings in the community, there would be fallare undertaken; with given growth rates, overall or per capita, in investment. In the long run, it would lead to a fall in theand with given population projections, in the latter case, warranted growth rate below the actual growth rate, i.e.,total capital requirements for five- or ten-year plans are then Gw<G and the level of investment would increase. Ultimatelyeasily derived. Let us see how these models can be used there will be chronic inflation.for planning in underdeveloped countries. Since low savings, high level of investment and chronic in-Suppose the capital-output ratio is assumed to be 4:1 and flation are some of the features of underdeveloped coun-the full capacity growth rate or the warranted growth rate is tries, Harrod suggests the financing of large investmentsestimated at 3 per cent per annum for the economy. By through the expansion of bank credit and automatic invest-applying either the Harrod or the Domar formula, the planners ment of inflationary profits in the capital markets. But therecan find out the saving income ratio required to sustain the are no organised capital markets in such economies, there-growth rate of 3 per cent per annum. fore, expansion of bank credit is the only way to financeIn Harrod’s model: investments and generate economic growth. Low savingsGw.Cr=s and by applying the assumed rates we get, in an underdeveloped country are responsible for its low3/100x4/1=12/100 or 12 per cent which is the saving-income rate of growth and the existence of mass unemploymentratio. Similarly, in Domar’s model : and underemployment. Thus the actual level of saving should be raised to the level of required rate of savings by a com- ÄY / Y = á ∝ pulsory levy or a surplus budget to that S=Sr Besides,=3/100x4/1=12/100 or 12 per cent (a being the reciprocal Harrod also emphasizes the need for changes in socialof Harrod’s Cr), and institutional factors in such economies. For social andThus, if the capital-output ratio is assumed as 4:1 in an institutional obstacles may be the cause of a low growtheconomy, the community will have to save 12 per cent of rate rather than the lack of savings -in underdeveloped coun-its annual income, if its annual growth rate of output is to tries, Under the circumstances, Sr will also be low and Sbe 3 per cent. Let us work it out in practice. Given the may approximate to it.saving ratio and the capital-output ratio, the Harrod formula LIMITATIONS OF THESE MODELS FROM THE STAND-for calculating the growth rate is POINT OF UNDERDEVELOPED COUNTRIESGw=s/Cr, If s is 12 per cent and the value of Cr 4, then The Harrod-Domar models are not applicable to underde-Gw=12/4=3 per cent. veloped countries for the following reasons:Sir Roy Harrod in the Second Essay an Dynamic Theory 1. Different Conditions. The Harrod-Domar analysis washas tried to make his model more applicable to evolved under different set of conditions. It was meant tounderdeveloped countries. He has elaborated the supply prevent an advanced economy from the possible effects ofside of his fundamental equation by introducing the role of secular stagnation. It was never intended to guide industri-interest rate in determining the supply of savings and the alization programmes in underdeveloped economies. Thedemand for savings. The natural rate of interest in is defined limitations of these growth models, as applied to suchas the ratio of the natural growth rate of per capita output economies, therefore, stem from this fact.Pc and the natural growth rate of income Gn to the elasticity 2.Saving Ratio. These growth models are characterized,of diminishing utility of income e. Thus by a high saving ratio and a high capital-output ratio. In an underdeveloped economy, however, decisions to save and invest are generally undertaken by the same group of per- - IInd Floor, Paliwal Market, Gumanpura KOTA (-0744 -2392059 & 3290500
    • 8sons. The vast majority of the people live on the margin of implications are very opposite of what one might expect ofsubsistence and thus very few are in a position to save. an underdeveloped economy,” yet “the growth models have3.Capital-Output Ratio. Similarly, it is difficult to have a this positive lesson for underdeveloped economies, that thecorrect estimate of the capital-output ratio where normal state should be allowed to play not Only a stabilizing roleproductivity is often inhibited by shortages and bottlenecks. but also a development role, if these economies are toWhen they are removed, there is considerable increase in industrialize more effectively and rapidly than the nowthe productivity of already invested capital. Such an industrialized economies did in conditions of laissez-faire.”economy, therefore, would have either to increase its saving He further opines that because of the universal character ofratio or capital-output ratio by improving methods of saving-income ratio and capital-output ratio (or its reciprocal)production arid removing the various obstacles to investment. as measurable strategic variables, the growth mechanismProf. Hirschman is of the view that the ‘predictive and discussed by Harrod and Domar is applicable to alloperational value’ of a model based on the propensity to economic systems, albeit with due modification. That issave and on the capital-output ratio is low and is bound to why, these growth models are applicable to thesebe far less useful ‘in underdeveloped than in advanced underdeveloped countries in Which the technique of planningeconomies. with ‘balanced growth’ is adopted because under this4.Structural Unemployment. According to Professor technique, saving-income ratio and capital-output ratioKurihara, the Harrod-Domar growth rate of investment fails remain constant during the plan period.to solve the problem of structural unemployment to be foundin underdeveloped countries. It can tackle the problem of‘Keynesian unemployment’ arising out of deficiency ofeffective demand or due to under-utilization of capital. Butwhen population grows faster than accumulation of capitalin an underdeveloped country, structural unemployment willarise due to lack of capital equipment.5.Disguised Unemployment. These models start with thefull employment level of income but such a level is not foundin underdeveloped countries. There exists disguisedunemployment in such countries which cannot be removedby the methods suggested by Harrod-Domar. Thus the mainassumption of the Harrod-Domar models being absent inunderdeveloped Countries, these models are not applicableto them.6.Government Intervention. The Harrod-Domar modelsare based on the assumption that there is no governmentintervention in economic activities. This assumption in notapplicable to underdeveloped countries because they cannotdevelop without government help. In such countries the roleof the state as a ‘pioneer entrepreneur’ in starting largeindustries and in regulating and directing private enterprisehas been increasingly recognised.7. Foreign Trade and Aid. The Harrod-Domar models arebased on ‘ the assumption of a closed economy. Butunderdeveloped countries are open rather than closedeconomies where foreign trade and aid play very crucialroles in their economic development. Both these factorsare the bases of their economic progress.8. Price Changes. These models are based on theunrealistic assumption of a constant price level. But inunderdeveloped countries price changes are inevitable withdevelopment .9.Institutional Changes. Institutional factors have beenassumed to be given in these models. But the reality isthat economic development is not possible withoutinstitutional changes in such countries. Therefore, thesemodels fail to apply in underdeveloped countries.Conclusion. Thus is appears from the above discussionthat the Harrod-Domar models, based as they are onunrealistic assumptions, have little practical application inunderdeveloped countries, Hirschman, therefore, suggeststhat “economics of development, like the underdevelopedcountries themselves, must learn to walk on its own feet,-that is, it must work out its own abstractions.But Professor Kurihara is of the view that though “their policy - IInd Floor, Paliwal Market, Gumanpura KOTA (-0744 -2392059 & 3290500
    • 9 IMPORTANT POINTS • Slier Sha surveyed and graded lands for the imposition of land taxes based on productivity. INDIAN ECONOMICS • Akbar fixed land taxes based on the average price of ANCIENT & MEDIEVAL INDIAN ECONOMY land.• Basic features of an economy- Unlimited wants, limited • The founders of modem Indian economic thought areresources have alternative uses. Dadabai Nauroji, Ranade, and RC. Dutt and Ghokale.• Basic problems of an economy- What to produce, how to • Ancient literature recognized 4 factors of production.produce, whom to produce, and growth • Commercialization of agriculture—Production of cropsof resources. for sale rather than for family consumption.• Kautilya Artha sastra gives details of political, social, eco- • Cash crops Cotton, Jute, Sugar cane. Ground nuts andnomic, and military organisation of the Mauryan empire Rubber.• Subsistence agriculture - Production of crops for the sake INDIAN ECONOMY DURING BRITISH RULEof self consumption by the farmer and the family and not for • Dadabai Nauroji first estimated national income of Indiasale in the market. unofficially.• In urban areas, the group of handcrafters having common • During pre British period, Textiles and Handicrafts wereinterests is called as guilds enjoyed world wide reputation.• Sher Shaw Suri first introduced rupee coins in India in • First jute mill was started in Calcutta in 1855.1809. • First iron and steel company was started by Jamshed ji• Kautilya Arthasastra has been considered as the most Tata in 1907 in Jamshedpur.authoritative work on ancient Indian economic thought. • The first modern industry stated in India is- Iron and Steel• Kautilya Arthasastra deals with state craft. • Indian Handicrafts are badly affected due to industrial revo-• Arthasastra and Neeti sastra deals with the production lution in Britainand exchange. • Poverty and Un British rule in India was written by Dadabai• Arthasastra felt material wealth is not an end in itself but Nauroji. In this book, he analyzed how Britishers are re-as an important means to achieve the objectives of life. sponsible for drain of wealth and to increase poverty in In-• In ancient India Vartha means the branch of knowledge dia.dealing with agriculture, commerce, cattle breeding, money • The triangular trade system prevails during British rulelending and artisanship. among three nations i.e. India, China and Britain.• Arthasastra is broader than Varta, because Arthasastra • Indigo (useful for coloring textiles) cultivation during Brit-deals with jurisprudence, politics, and economics. ish rule prevails under two systems (1) Ryot system (2) Nij• During Sher Sha tenure, lands were surveyed and land systemtax were determined scientifically based on productivity. • Absentee land lordism - Zamindars sublet their zamindari• Jagir system was abolished by Akbar. right to some body on commission basis to collect land• Akbar introduced land tax based on last ten years aver- revenue from peasants.age land price. • Most of the sugar factories are set up by Europeans in• Laissez-fair (freeness) principle was followed during India were shut down, following the fall in prices of sugar.ancient India. • East India company is a joint stock company.• In ancient Indian economy agriculture and animal hus- • Home charges in the form of salaries, pension, interestbandry was occupies important place as occupations. on debt, expenditure, for the maintenance of Army and Navy.• Kharaj- Fax on cultivation • Essay on Indian political economy was written by M.G.• Charat Tax on milch cattle Ranade.• Ghari- Tax on houses. • The word political economy first used by Ranade. He stated• The first Portuguese explorer ,Vascoda Gama opened that economic laws are not universal and economic growthsea route to India in 1498. not an isolated phenomenon it depends up on social, politi-• Grand trunk road was constructed by - Sher Shaw Suri cal and religious factors.• Main cereals grown during ancient period were Wheat • Ranade is the first Indian economist criticized classicaland Barley. economic model.• Jizia is a tax imposed on Hindus , who failed to preach • GK.Ghokale stated that Swadeshi is the only means toIslam . initiate industrial growth in the country.• Muhammed bin Tuglak introduced token currency. • Mahatma Gandhi’s economic thought was influenced by• Jajirs means the group of villages. Ruskin• Begar means land less labour • Colonial economy - Country is treated as a colony of rul-• Jajimani system- It is the system prevails in rural India ing foreign country to serve their own interests (rulers).between farmers and the village artisans. Generally reward • British used colonial economies as suppliers of raw ma-for service is paid in the form of kind as per contract terials and market for finished goods.• According to Dharmasastras consumption should be • Britishers invested their capital in India through Managingbased on dharma. Artha, Kama, Moksha Agency system• Dharma sastra deal with consumption and distribution. • Two major forms of British investment in India are — Pri-• Role ol state is limited in economic decision making in vate foreign direct investment in mines, mills and plantationancient India. (2) sterling loans for infrastructure projects.• The three distinct classes in villages in ancient India are - • Managing agency system can be defined as partnershipThe agriculturists, village artisans. Menials and village offi- of companies formed by group of persons having huge fi-cials. nancial resources and business experience. - IInd Floor, Paliwal Market, Gumanpura KOTA (-0744 -2392059 & 3290500
    • 10• During colonial period the large a’mount of British capital tive because of political, social and economic reasons.was invested in infrastructure • Features of Indian economy as a mixed economy- Exist-• The chief industry spread over the whole nation is Textiles ence of public and private sectors, joint sector, licensingand handicrafts. and controls, economic planning.• The industry first hit during the British rule are Textiles • Features of Indian economy as a developing economy-and handicrafts. Saving, capital accumulation, national income. Percapita• The opening of Sue/ Canal reduced transport costs and income is increasing, development is occurring in infra-made the exploitation of Indian markets easier. structure and all the three sectors i.e primary, secondary• Progressive Ruralization means during British period be- and tertiary sectors.cause of loses occurred from the production and sale of • Economic history of India was written by R.C.Dutt.industrial goods and closures of industrial units, un em- • Poverty and un British rule in India was written by Dadabaiployed craft men returned to agriculture. Nauroji.During British rule major crops in India are — Rice and • The only journal in the subject of economics during Brit-Wheat. ish rule The Indian economist.• Main agricultural exports during British rule - Jute and • The founders of modern Indian economic thought wereCotton raw materials. Dadabai Nauroji. Ranade. R.C. Das, and Ghokale• During British period, India is the main exporter of pri- • Drain theory was advocated by Dadabai Nauroji.mary goods. • National income of India was written by V.K.R.V.Rao in• During major period of British rule, India’s foreign trade 1939. to In 1793. permanent settlement act was enactedwas in positive balance. in Bengal presidency.• During British period 75% of the trade confined with Brit- • First Railway line was constructed from Bombay to Flume.ain. In 1853.• The most important function of managing agency system • The trade monopoly of East India Company was abol-is to provide finance to set up Jute mills and Tea planta- ished in 1853 by the British parliament. to Between 1 829tions. to 1838, India had positive trade balance with Britain and• Features of Indian economy during British rule - Stagnant China.and weakened economy, low levels of living, predominance • During British rule greater degree of monetization of theof agriculture as’an occupation. economy was occurred due to inflow of silver.• On the eve of independence the nature of Indian economy • First Cotton mill in Bombay was started in 1854. to FirstUnder developed economy, stagnant economy, semi feu- Jute mill was started in 1855 in Calcutta.dal economy, depreciated economy, disintegrated economy. • Bombay plan was prepared by industrialists for the period• Causes of stagnation of Indian economy during British of 15 years for India.rule- Backward and age old techniques of production, cus- • The aim of devaluation is to increase exports and de-toms, traditions, colonial policy of British, and economic crease imports.drain. • Economic history of India was written by R.C. Dutt. to• Semi feudal economy- It is an economy in which the The first country was established trade relations with India-means of production are in the hands of rich people, who Portugal.lease their lands to tenents by charging exploitative rent. • The main aim of east India company is - To earn profitsEast India company was established in AD 1600. through trade• During British period India’s foreign trade is protective • Permanent settlement implies The amount of land rev-and discriminatory. enue the xamindari is supposed to pay is fixed for 30 or 35• Britishers mainly interested in production of plantation years, but the rate of land tax and the amount of land rev-crops. enue is to be colleted from the farmers was not specified.• Subsistence farming prevails during British rule. Main • Mugalzari settlement means -It combines the features ofpower used for agricultural operations are human and Bul- both the permanent zamindari and Ryotwari systems.lock power. • East India company and traders enjoyed monopoly over• Depreciated economy- During II world war Indian economy the forced cultivation of the cash crops i.e. Indigo and Poppy.was depreciated due to excessive use of machinery by in- • Dadabai Nauroji calculated Percapita income per annumcrease in production, to meet war needs but the broken Rs 20, during the three years from 1867 to 1870.machinery was not replaced by new. • The burden of tax on Indian people was about 2.5 times• Disintegrated economy- During British rule India was di- greater than on the people of England.vided into small states and units. It is anti for the adoption • During British rule tax revenue is 22% of GDP now it isof uniform and integrated economic policy for the whole not more than 15%.nation. • The champion of historical method to study Indian economy• Nature of Indian economy as an underdeveloped economy is Ranadeon the eve of independence- Backward agriculture, short- • The idea of economic nationalism was advocated byage of basic industries, industrial backwardness, low capi- Ranade.tal formation and low standards of living. • The book famines in India were written in 1900 by R.C• Features of Indian economy as an underdeveloped Dutt.economy- Agriculture dominance, shortage of capital, preva- • Tax and expenditure system prevails during British rule islence of unemployment and underemployment, shortage of regressive.infrastructure, backward and low techniques. • Mahatma Gandhi’s economic thought was influenced by• Stagnant economy- GDP growth rate is very low or nega- Ruskin’s book Un to the last. - IInd Floor, Paliwal Market, Gumanpura KOTA (-0744 -2392059 & 3290500