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Sam eco e

  1. 1. - IIndFloor,PaliwalMarket,GumanpuraKOTA (-0744-2392059&3290500 1 ECONOMICS ESSAYS AGRICULTURE A COLOSSAL NEGLECT Now one may find that the same has happened with our agriculture. The suicides in 2007 and 2008 in Andhra Pradesh are just the beginning. Bihar and other eastern states have been facing floods on regular basis. Things may go further worse. For example, Bihar has no industry, it has lost its minerals and floods are killing agriculture. Under these conditions only God is helping them. When Then I was a small boy, I was told that one should not neglect those things, which are certain in nature and not run after uncertain things. If it is done, the uncertain becomes further uncertain and even the certain becomes uncertain. Agriculture (including allied activities) accounted for 17.8 per cent of the Gross Domestic Product (GDP-at constant prices) in 2007-08 as compared to 21.7 per cent in 2003- 04. Notwithstanding the fact that the share of this sector in GDP has been declining over the years, its role remains critical as it accounts for about 52 per cent of the employ- ment in the country. Apart from being the provider of food and fodder, its importance also stems from the raw materi- als that it provides to industry. The prosperity of the rural economy is also closely linked to agriculture and allied activities. Agricultural sector contributed 12.2 per cent of national exports in 2007-08. The rural sector (including ag- riculture) is being increasingly seen as a potential source of domestic demand; a recognition, that is shaping the mar- keting strategies of entrepreneurs wishing to widen the de- mand for goods and services. Indian agriculture suffers from a mismatch between food crops and cash crops, low yields per hectare except for wheat, volatility in production and wide disparities of productivity over regions and crops. The domestic production of pulses and oilseeds are still below the domestic requirements and India imports pulses and edible oils to satisfy domestic demands. Further, a distinct bias in agricultural price support policies in favour of rice and wheat has distorted cropping pattern and input usage. Food management is inefficient with unsustainable level of food subsidies imposing heaving burden on Government fi- nance. The rural economy and the private sector severely lack the basic infrastructure to build sufficient buffer stocks, and the country remains vulnerable to weather stocks. The rural credit is one of the most concerned areas. The Credit Deposit Ratio (CDR) in rural areas for both public and pri- vate sector banks was substantially low compared to ur- ban and metropolitan areas. The Gross Capital Formation (GCF) in agriculture as a proportion to the total GDP has shown a decline from 2.9 per cent in 2001-02 to 2.5 per cent in 2007-08. The agriculture sector faces challenges on various fronts. On the supply side, the yield of most crops has not im- proved significantly and in some cases fluctuated down- wards. The scope for increase in the net sown area is lim- ited and farm size has been shrinking. In the case of cer- tain crops like sugarcane, extreme variability in the acre- age and production over the years has been a matter of concern. On the other hand, in the case of pulses, pro- duction has just not kept pace with the requirement leading to a rise in prices given that its availability in the interna- tional markets is limited. The ill-treatment of the agriculture appears to be the best way to preserve poverty on which the sectarian politics survives. The politics of poverty alle- viation thrives only when there is persistence of poverty. Indian policy making has suffered from a typical anti-agri- culture bias since 1956, the day Indian policy makers adopted Mahalanobis model, under which agriculture was given a step son treatment. Although, agriculture was al- ways out of the purview of direct taxation, yet, it has been proved that it is heavily taxed. Protection accorded to in- dustry and over-valued exchange rate constitute an indirect and implicit tax over agriculture. Keeping domestic prices below world prices gave negative protection to agriculture and it was another form of taxa- tion. In this way, agriculture and poor agriculturists had to bear the brunt of generating resources for industry, when the sector itself was ailing. Indian agriculture and hence rural India has always been betrayed in the past, but, kept alive by occasional injections of technologies, subsidies and sops. Formation of Commission for Agricultural Costs and Prices (CACP), introduction of seed-fertilizer-water tech- nology, formation of different cooperative societies, market- ing agencies, etc. have created a positive atmosphere for agricultural growth but, all these were short-lived and were unable to compensate it fully. Over the past few years, lib- eralization has meant the withdrawal of several subsidies from the farming sector, resulting in a sharp increase in the cost of fertilizers and seeds coupled with power hikes. Lib- eralization and globalisation are the process in the process of elimination of unfair treatment at the national and inter- national level. The protection must go. But, a State cannot forget its basic duty to protect a common man. The protec- tion cannot be withdrawn without the creation of proper in- frastructure and investment. The subsidies must be I with- drawn in proportion to the investment. There cannot be one drug for all the diseases. Liberalisation may be pancea of one, may not be for all. The rural credit system can be streamlined by the following measures: (a) Self-Help Groups must be encouraged for banking in the rural areas; (b) The rural banks must relinquish narrow banking and must resort to universal banking; (c) Even Narasimham Committee suggested consolidation of rural branches of commercial banks into banking enti- ties; (d) There should be separate prudential norms for the rural banking; (e) It should be possible to devise a model in which the resources of commercial banks are available for rural lend- ing, which would be carried out through specialised banks operating only in rural areas. The main-line commercial banks can buyout rural loan portfolios of these rural banks; (f) The government must provide incentives in the form of exemptions to the commercial banks to operate in rural areas; (g) The banking system should equip itself to identify the eligible clients based on prescribed norms in the govern- ment-sponsored programmes such as IRDP rather than to depend on the government agencies; (h) The operating systems of banks and other rural financ- ing institutions (RFIs) like RRBs and District Credit Coop- erative Banks (DCCBs) in terms of appraisal, supervision and follow up must be properly reviewed and strengthened. I strongly feel that there is urgent need to reconsider the following measures: (a) India’s agricultural policy should continue to be “grain-
  2. 2. - IIndFloor,PaliwalMarket,GumanpuraKOTA (-0744-2392059&3290500 2 oriented”, supplemented by pulses and oilseeds; (b) Seed Act must be introduced which lays down strin- gent punishment to those who sell spurious seeds/fertiliz- ers; (c) A more comprehensive and farmer-friendly crop insur- ance policy should be formulated; (d) Food for work programme should be modified. It should be restricted to construction of permanent structures, to stop diversion of grains in the name of short-term fictitious projects; (e) The Budget 2004-05 has also admitted that the agricul- ture sector requires massive investments. Such investments can be through credit-enabled private investment and en- hanced public investment. For this fiscal instruments to boost investment in agriculture would be needed; (f)The rural credit system must be revamped. The function- ing of Regional Rural Banks (RRBs) and Cooperative Banks must be streamlined. A comprehensive rural credit delivery system should be evolved. The Kishan Credit Cards (KCC) suffers from adhocism. It should further be simplified; (g) Nothing has been done on long-term basis to solve the age-old flood problems in Bihar and other eastern states. The main cause of flood in North Bihar is the heavy rainfall in Nepal. The rainwater enters Bihar through Gandak, Koshi, Adhawara Group of rivers. We must take immediate mea- sures to control the rainwaters; (h) The irrigation facility is only confined to food-grain areas but it is almost absent in the dry land areas. This averts crop diversification. The existing Accelerated Irrigation Ben- efit Programme (AIBP) should be restructured and there should be a spatial growth of irrigation system. For this, both private and foreign investments should be invited; (i) Even though the horizontal productivity has been in- creased to a very large extent but the vertical productivity has been thoroughly neglected; (j) The cropping pattern is more or less static not only be- cause of direct neglect of the same by the agricultural policy formulators but also because of the failure of various re- sponsible institutions to change the rigid socio-psycho per- spectives of farmers; (k) Introduction of rational market mechanism is indispens- able for the sustained growth of Indian farmers. For this, the subsidy provisions should be minimized and the same financial resource could be utilised to increase the invest- ments; (l)Green revolution produced regional disparity in the coun- try. For minimizing this negative fallout, Indian agriculture needs area specific programmes, which could bring ever- green revolution in the country. But for this, the policy for- mulation should depend upon ground realities rather than they be knit in air conditioned rooms; (m) The biggest problem of Indian Agriculture is that it is still nature ridden. Till it is brought out of the clutches of monsoonal vagaries, it would continue to show skewed re- sults; (n) Capital formation in agricultural sector should be made government’s responsibility; (o) A transparent linkage between field and market should be established so that farmers get remunerative returns and role of intermediaries can be minimized; (p) Agro-processing industries should be installed all over the country. This would help cater domestic as well as for- eign demand. India contributes just 1 per cent of the agro- processed products of the world. This is abysmally low; (q) Government should garner some resources by taxing income of a few big landlords. This would ensure equity and give some money to the exchequer; (r) A shift from minimum support price system and devel- oping alternative product markets are essential for crop di- versification and broad based agricultural development; (s)The Central government must provide financial assistance to the state Governments for procurement and distribution of food grains at subsidized rates, particularly to the fami- lies below the poverty line. Only an enhanced agricultural growth would provide stimulus to other off-farm activities in rural areas due to its forward and backward linkages. This would generate more employment and income in rural ar- eas, which in turn would cause reduction of poverty in these areas; (t) APMC Act must be amended and mandi taxes should be abolished. It will allow competitive markets to develop. Suggestion by Economic Survey 2008-09 There is clearly a need for a renewed focus on improving productivity. At the same time to step up the growth of al- lied activities and non-farm activities that can help improve value addition. The current focus on developing rural infra- structure particularly rural roads needs to be maintained as it would go a long way in providing connectivity that is es- sential for movement of agricultural produce. The irrigation sector requires a renewed thrust both in terms of invest- ment as also modem management. There is considerable scope for development of micro-irrigation systems and wa- tershedsandintheuseof aparticipatoryapproachforachiev- ing the same. There is a need to narrow the gap between producer prices and consumer prices through proper marketing support. The development of marketing infrastructure and storage and warehousing and cold chains and spot markets that are driven by modern technology will go a long way in address- ing this need. As per the Report of the Committee on Financial Inclusion Qanuary 2008), more than 73 per cent of farmer house- holds have no access to formal sources of credit. Innova- tive institutional mechanisms that provide credit and finan- cial products (including insurance products) specifically designed to meet the needs of the farm sector keeping their risk - bearing ability in view is the need of the hour. The rural economy needs to be viewed as comprising of a continuum of interrelated economic activities. Farming needs to be dovetailed with viable off-farm and non-farm activities. Farmers need to be facilitated to take up value addition such as processing of agricultural produce, horti- culture, pisciculture, poultry, development of non-farm rural enterprises. On the distribution side, there is need to en- sure that benefits accrue to the targeted population. A mis- sion approach for promotion of smart cards and its cross reference with ration cards and voter ID cards would help better targeting, lesser leakages and easier administration. An area that requires focused attention is the issue of sustainability of agriculture with due emphasis on environ- mental concerns. Soil erosion, water logging, reduction in groundwater table and the decline in the surface irrigation are the problems faced by agriculture. The consequences of climate change on Indian agriculture also need to be factored in the strategy for the development of this sector. On the whole, while the challenges faced by the agriculture
  3. 3. - IIndFloor,PaliwalMarket,GumanpuraKOTA (-0744-2392059&3290500 3 ECONOMIC GROWTH HARROD-DOMAR MODEL, INSTABILITY OF EQUILIBRIUM. NEOCLASSICAL GROWTH SOLOW’S MODEL, STEADY STATE GROWTH. MODELS OF GROWTH OF JOAN ROBINSON AND KALDOR; TECHNICAL PROGRESS HICKS, HARROD AND LEARNING BY DOING, SOME GROWTH MODELS THE HARROD-DOMAR MODELS The Harrod-Domar models of economic growth are based on the experiences of advanced economies. They are primarily addressed to an advanced capitalist economy and attempt to analyse the requirements of steady growth in such economy. Requirements of Steady Growth Both Harrod and Domar are interested in discovering the rate of income growth necessary for a smooth and uninterrupted working of the economy. Though their models differ in details, yet they arrive at similar conclusions. Harrod and Domar assign a key role to investment in the process of economic growth. But they lay emphasis on the dual character of investment. Firstly, it creates income, and secondly, it augments the productive capacity of the economy by increasing its capital stock. The former may be regarded as the ‘demand effect’ and the latter the ‘supply effect’ of investment. Hence so long as net investment is taking place, real income and output will continue to expand. However, for maintaining .a full employment equilibrium level of income from year to year, it is necessary that both real income and output should expand at the same rate at which the productive capacity of the capital stock is expanding. Otherwise, any divergence between the two will lead to excess or idle capacity, thus forcing entrepreneurs to curtail their investment expenditures. Ultimately, it will adversely affect the economy by lowering incomes and employment .in the subsequent periods and moving the economy off the equilibrium path of steady growth. Thus, if full employment is to be maintained in the long run, net investment should expand continuously. This further requires continuous growth in real income at a rate sufficient enough to ensure full capacity use of a growing stock of capital. Thus required rate of income growth may be called the warranted rate of growth or “the full capacity growth rate.” Assumptions The models constructed by Harrod and Domar are based on the following assumptions. (1) There is an initial full employment equilibrium level of income. (2) There is the absence of government interference. (3) These models operate in a closed economy which has no foreign trade. (4) There are no lags in adjustments between investment and creation of productive capacity. (5) The average propensity to save is equal to the marginal propensity to save. (6) The marginal propensity to save remains constant. (7) The capital coefficient, i.e., the ratio of capital stock to income is assumed to be fixed. (8) There is no depreciation of capital goods which are assumed to possess infinite life. (9) Saving and investment relate to the income of the same year. (10) The general price level is constant, i.e., the money income and he real income are the same. (11) There are no changes in interest rates. (12) There is a fixed proportion of capital and labour in the productive process. (13) Fixed and circulating capitals are lumped together under capital. Lastly, there is only one type of product. All these assumptions are not necessary for the final solution of the problem; nevertheless they serve the purpose of simplifying the analysis. THE DOMAR MODEL Domar builds his model around the following question: since investment generates income on the one hand and increases productive capacity on the other, at what rate investment should increase in order to make the increase in income equal to the increase in productive capacity, so that full employment is maintained? He answers this question by forging a link between aggregate supply and aggregate demand through investment. Increase in Productive Capacity. Domar explains the supply side like this. Let the annual rate of investment be / , and the annual productive capacity per dollar of newly created capital be equal on the average to s (which represents the ratio of increase in real income or output to an increase in capital or is the reciprocal of the accelerator or the marginal capital-output ratio). Thus the productive capacity of /dollar invested will be I.s dollars per year. But some new investment will be at the expense of the old. It will, therefore, compete with the latter for labour markets and other factors of production. As a result, the output of old plants will be curtailed and the increase in the annual output(productivecapacity)oftheeconomywillbesomewhat less than I.s. This can be indicated as la; where a (sigma) represents the net potential social average productivity of investment ( I/YÄ= ). Accordingly la is less than I.s. la is the total net potential increase in output of the economy and is known as the sigma effect. In Domar’s words this “is the increase in output which the economy can produce,” it is the “supply side of our system.” Required Increase in Aggregate Demand. The demand side is explained by the Keynesian multiplier. Let the annual increase in income be denoted by ÄY and the increase in investment by A/and the propensity to save by a (alpha) (= Ä S/ Ä Y). Then the increase in income will be equal to the multiplier (I/α) times* the increase in investment. á 1 IÄYÄ = Equilibrium. To maintain full employment equilibrium level of income, aggregate demand should be equal to aggregate supply. Thus we arrive at the fundamental equation of the model ∆I I 1 α σ= Solving this equation by dividing both sides by /and
  4. 4. - IIndFloor,PaliwalMarket,GumanpuraKOTA (-0744-2392059&3290500 4 multiplying by we get : ∆I I = ασ This equation shows that to maintain full employment the growth rate of net autonomous investment ( I/IÄ ) must be equal to ασ (the MPS times the productivity of capital). This is the rate at which investment must grow to assure the use of potential capacity in order to maintain a steady growth rate of the economy at full employment. Domar gives a numerical example to explain his point: Let σ =25 per cent per year, α=12 percent and Y=150 billion dollars per year. If full employment is to be maintained, an amount equal to 150x12/100=18 billion dollars should be invested This will raise productive capacity by the amount invested ‘y times, i.e., by 150x12/100x25/100=4.5 billion dollars, and the natioiial income will have to rise by the same amount. But the relative rise in income will equal the absolute increase divided by the income itself, i.e., 150 12 100 25 100 150 12 100 25 100 3x x x percent= = =ασ Thus in order to maintain full employment, income must grow at a rate of 3 per cent per annum. This is the equilibrium rate of growth. Any divergence from this ‘golden path’ will lead to cyclical fluctuations. When I/IÄ is greater than aa, the economy would experience boom and when I/IÄ is less than acr, it would suffer from depression. The Harrod Model Professor R.F. Harrod tries to show in his model how steady (i.e., equilibrium) growth may occur in the economy. Once the steady growth rate is interrupted and the economy falls into disequilibrium, cumulative forces tend to perpetuate this divergence thereby leading to either secular deflation of secular inflation. The Harrod Model is based upon three distinct rates of growth. Firstly, there is the actual growth rate represented by G which is determined by the saving ratio and the capital- output ratio. It shows short-run cyclical variations in the rate of growth. Secondly, there is the warranted growth rate represented by Gw which is the full capacity growth rate of income of an economy. Lastly, there is the natural growth rate represented by Gn which is regarded as ‘the welfare optimum’ by Harrod. It may also be called the potential or the full employment rate of growth. The Actual Growth Rate. In the Harrodian model the first fundamental equation is: GC = s ...(1) where G is the rate of growth of output in a given period of time and can be expressed as Y/YÄ ; C is the net addition to capital and is defined as the ratio of investment to the increase in income, i.e., YÄ/I and s is the average propensity to save, i.e., S/Y. Substituting these ratios in the above equation we see SIor Y S Y I or Y S YÄ I Y YÄ ===× The equation is simply a re-statement of the truism that expost (actual, realized) savings equal expost investment. The above relationship is disclosed by the behaviour of income. Whereas S depends on Y, I depends on the increment in income ( )YÄ , the latter '. nothing but the acceleration principle. The Warranted Rate of Growth. The warranted rate of growth is, according to Harrod, the rate “at which producers will be content with what they are doing.” It is the “entrepreneurial equilibrium; it is the line of advance which, if achieved, will satisfy profit takers that they have done the right thing.” Thus this growth rate is primarily related to the behaviour of businessmen. At the warranted rate of growth, demand is high enough for businessmen to sell what they have produced and they will continue to produce at the same percentage rate of growth. Thus, it is the path on which the supply and demand for goods and services will remain in equilibrium, given the propensity to save. The equation for the warranted rate is GwCr=s ...(2) where Gw is the “warranted rate of growth” or the full capacity rate of growth of income which will fully utilize a growing stock of capital that will satisfy the entrepreneurs with the amount of investment actually made. It is the value of Y/YÄ Cr, the ‘capital requirements’, denotes the amount of capital needed to maintain the warranted rate of growth, i.e., required capital-output ratio.It is the value of YÄ/I or C. s is the same as in the first equation, i.e., S/Y. The equation, therefore, states that if the economy is to advance at the steady rate of Gw that will fully utilize its capacity, income must grow at the rate of s/Cr per year i.e., Gw=s/Cr. If income .grows at the warranted rate, the capital stock of the economy will be fully utilised and entrepreneurs will be willing to continue to invest the amount of saving generated at full potential income. Gw is therefore a self-sustaining rate of growth and if the economy continues to grow at this rate it will follow the equilibrium path. Genesis of Long-run Disequilibria. Full employment growth, the-actual growth rate of G must equal Gw, the warranted rate of growth that would give steady advance to the economy and C (the actual capital goods) must equal Cr (the required capital goods for steady growth). If G and Gw are riot equal, the economy will be in disequilibrium. For instance, if G exceeds Gw, then C will be less than Cr. When G>Gw, shortages result. “There will be insufficient goods in the pipeline and/or insufficient equipment.” Such a situation leads to, secular inflation because actual income grows at a faster rate than that allowed by the growth in the productive capacity of the economy. It will further lead to a deficiency of capital goods, the actual amount of capital goods being less than the required capital gods (C<Cr). Under the circumstances, desired (ex-ante) investment wouldbegreaterthansavingandaggregateproductionwould fall short of aggregate demand. There would thus be chronic inflation. This is illustrated where the growth rates of income are taken on the vertical axis and time on the horizontal axis. Starting from the initial full employment level of income Y0 , the actual growth rate G follows the warranted growth path Gw upto point E through period t2 . But from t2 onwards, G deviates from Gw and is higher than the latter. In subsequent periods, the deviation between the two becomes larger and larger.
  5. 5. - IIndFloor,PaliwalMarket,GumanpuraKOTA (-0744-2392059&3290500 5 It, on. the other hand, G is less than Gw, then C is greater than Cr. Such a situation leads to secular depression because actual income grows more slowly than what is required by the productive capacity of the economy leading to an excess of capital goods (C>Cr). This means that desired investment is less than saving and that the aggregate demand falls short of aggregate supply. The result is fall in output, employment arid income. There would thus be chronic depression. This is illustrated when from period t2 onwards G falls below Gw and the two continue to deviate further away. Harrod states that once G departs from Gw, it will depart further and further away from equilibrium. He writes: “Around that line of advance which if adhered to would alone give satisfaction, centrifugal forces are at work, causing the system to depart further and further from the required line of advance.” Thus the equilibrium between G and Gw is a knife- edge equilibrium. For once it is disturbed, it is not self- correcting. It follows that one of the major tasks of public policy is io bring G and Gw together in order to maintain long-run stability. For this purpose, Harrod introduces his third concept of the natural rate of growth. The Natural Rate of Growth. It “is the rate of advance which the increase of population and technological improvements allow.” The natural rate of growth depends on the macro variables like population, technology, natural resources and capital equipment. In other words, it is the rate of increase in output at full employment as determined by a growing population and the rate of technological progress. The equation for the natural rate of growth is Gn. Cr = or # s Here Gn is the natural or full employment rate of growth. Divergence of G, Gw and Gn. Now for full employment equilibrium growth Gn=Gw=G. But this is a knife-edge balance. For once there is any divergence between natural, warranted and actual rates of growth conditions of secular stagnation or inflation would be generated in the economy. IfG>Gw,investmentincreasesfasterthansavingandincome rises faster than Gw. If G<Gw, saving increases faster than investment and rise of income is less than Gw. Thus Harrod points out that if Gw> Gn secular stagnation will develop. In such a situation Gw is also greater than G because the upper limit to the actual rate is set by the natural rate. When Gw exceeds Gn, C>Cr and there is an excess of capital goods due to a shortage of labour. The shortage of labour keeps the rate of increase in output to a level less than Gw. Machines become idle and there is excess capacity. This further dampens investment, output, employment and income. Thus the economy will be in the grip of chronic depression. Under such conditions saving is a vice. If Gw<Gn, Gw is also less than G as shown in the tendency 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 by permitting capital and labour substitution in the production function, by making the saving ratio a function of the profit rate and the growth rate of labour force as a variable in the growth process. The policy implications of the model are that saving is a virtue in any inflationary gap economy and vice in a deflationary gap economy. Thus in an advanced economy, s has to be moved up or down as the situation demands.. A Comparative Study of the two Models Points of Similarity THE DOMAR MODEL áó I IÄ I YÄ ó == YÄ SÄ I YÄ I IÄ YÄ SÄ á ×== I SÄ I IÄ = or SÄIÄ = THE HARROD MODEL SIor Y S s Y S Y I YÄ I C Y S YÄ I Y YÄ or Y YÄ GsGC = === ==× == = Given the capital-output ratio, as long as the average propensity to save is equal to the marginal propensity to save, the equality of saving and investment fulfils the conditions of equilibrium rate of growth. Looked at from another angle the two models are similar. Harrod’s s is Domar’s ∝ . Harrod’s warranted rate of growth
  6. 6. - IIndFloor,PaliwalMarket,GumanpuraKOTA (-0744-2392059&3290500 6 (Gw) is Domar’s full employment rate of growth ( ó∝ ). Harrod’s Gw=s/Cr=Domar’s áó. To prove it )2(.......óIYÄor I YÄ ó )1(......YáSor Y S á == == Since S=I and substituting S for I in equation (2) we have [ ]       ==∴ = =∴= Y YÄ GwSinceáóGw )3(......áó Y YÄ or YáSóYáYÄ We have proved mathematically that Harrod’s Gw is the same as Domar’s ó∝ . But, in reality, Domar’s rate of growth r=αs is Harrod’s Gw, and Domar’s ór ∝= Harrod’s natural growth rate. In Domar’s model s is the annual productive capacity of newly created capital which is greater than ó which is the net potential social average productivity of investment. It is,the lack of labour and other factors of production which reduces Domar’s growth rate from órtosr =∝=∝ . Since labour is involved in’ ó therefore Domar’s potential growth rate resembles Horrod’s natural rate. We may also say that the excess of s over ó in Domar’s model expresses the excess of Gw over Gn in Harrod’s model. Points of Difference. There are, however, important differences in the two models. :(1) Domar assigns a key role to investment in the process of growth and emphasises on its dual character. But Harrod regards the level of income as the most important factor in the growth process. Whereas Domar forges a link between demand andsupplyofinvestment,Harrod,ontheotherhand, equates demand and supply of saving. (2) The Domar model is based on one growth rate ór ∝= But Harrod uses three distinct rates of growth: the actual rate (G), the warranted rate (Gw) and the natural rate (Gn). (3) Domar uses the reciprocal of marginal capital-output ratio, while Harrod uses the marginal capital-output ratio. In this sense Domar’s ó = 1 / Cr of Harrod. (4) Domar gives expression to the multiplier but Harrod uses the accelerator about which Domar appears to say nothing. (5) The formal identity of Harrod’s Gw equation and Domar’s equation’s maintained by Domar’s assumption that Y/YÄI/IÄ = . But Harrod does not make such assumptions. In Harrod’s equilibrium equation Gw, there is neither any explicit or implicit reference to ∆I or I. It is, however, in his basic equation G=s/C that there is an implicit reference to I, since C is defined as YÄ/I . But there is no explicit or implicit reference to IÄ .. (6) For Harrod the business cycle is an integral part of the path of growth and for Domar it is not so, but is, accommodated in his model by allowing ó (average productivity investment) to fluctuate. (7) While Domar demonstrates the technological relationship between capital accumulation and subsequent full capacity growth in output, Harrod shows in addition a behavioural relationship between rise in demand and hence in current output on the one hand, and capital accumulation on the other. In other Words, the former does not suggest any behaviour pattern for entrepreneurs and the proper change in investment comes exogenously, whereas the latter assumes a behaviour pattern for entrepreneurs that induces the proper change in investment. Limitations of these Models Some of the conclusions depend on the crucial assumptions made by Harrod and Domar which make these models unrealistic: (1) The propensity to save ( )sor∝ and the capital-output ratio ( )ó are assumed to be constant. In actuality, they are likely to change in the long run and thus modify the requirements for steady growth. A steady rate of growth can, however, be maintained without this assumption. As Domar himself writes, “This assumption is not necessary for the argument and that the whole problem can be easily reworked with variable ∝ and ó .” (2) The assumption that labour and capital are used in fixed proportions is untenable. Generally, labour can be substituted for capital and the economy can move more smoothly towards a path of steady growth. In fact, unlike Harrod’s model, this path is not so unstable that the economy should experience chronic inflation or unemployment if G does not coincide with Gw. (3) The two models also fail to consider changes in the general price level. Price changes always occur over time and may stabilize otherwise unstable situations. According to Meier and Baldwin, “If allowance is made for price changes and variable proportions in production, then the system may have much stronger stability than the Harrod model suggests.” (4) The assumption that there are no changes in interest rates is irrelevant to the analysis.” Interest rates change and affect investment. A reduction in interest rates during periods of overproduction can make capital-intensive processes more profitable by increasing the demand for capital and thereby reduce excess supplies of goods. (5) TheHarrod-Domarmodelsignoretheeffectofgovernment programmes on economic growth. If, for instance, the government undertakes a programme of development, the Harrod-Domar analysis does not provide us with causal (functional) relationship. (6) It also neglects the entrepreneurial behaviour which actually determines the warranted growth rate in the economy. This makes the concept of the warranted growth rate unrealistic. (7) The Harrod-Domar models have been criticised for their failure to draw a distinction between capital goods and consumer goods. (8) According to Professor Rose, the primary source of instability in Harrod’s system lies in the effect of excess demand if supply on production decisions and not in the effect of growing capital shortage cr redundancy on investment decisions. Despite these limitations, “Harrod-Domar growth models
  7. 7. - IIndFloor,PaliwalMarket,GumanpuraKOTA (-0744-2392059&3290500 7 are purely laissez-faire ones based on the assumption of fiscal neutrality and designed to indicate conditions of progressive equilibrium for an advanced economy.” They are important because they represent a stimulating attempt to dynamize and secularise Keynes’ static short-term saving and investment theory. APPLICATION OF HARROD-DOMAR MODELS TO UNDERDEVELOPEDCOUNTRIES Growth theory in advanced economies has been associated with three principal concepts: the saving function, autonomous vs. induced investment, and the productivity of capital. The Harrod-Domar models are based on these concepts and were primarily developed in order-to illuminate secular stagnation that was threatening the advanced economies in the post-war period. The application of these models has now been extended to the development- problems of underdeveloped economies. As Hirschman writes: “The Domar model, in particular, has proved to be remarkably versatile, it permits us to show not only the rate at which the economy must grow if it is to make full use of the capacity created by new investment but inversely, the required savings and the capital-output ratios if income is to attain a certain target growth rate. In such exercises, the capital-output ratio is usually assumed at some value between2.5and5;sometimesseveralalternativeprojections are undertaken; with given growth rates, overall or per capita, and with given population projections, in the latter case, total capital requirements for five- or ten-year plans are then easily derived. Let us see how these models can be used for planning in underdeveloped countries. Suppose the capital-output ratio is assumed to be 4:1 and the full capacity growth rate or the warranted growth rate is estimated at 3 per cent per annum for the economy. By applying either the Harrod or the Domar formula, the planners can find out the saving income ratio required to sustain the growth rate of 3 per cent per annum. In Harrod’s model: Gw.Cr=s and by applying the assumed rates we get, 3/100x4/1=12/100 or 12 per cent which is the saving-income ratio. Similarly, in Domar’s model : ∝= áY/YÄ =3/100x4/1=12/100 or 12 per cent (a being the reciprocal of Harrod’s Cr), Thus, if the capital-output ratio is assumed as 4:1 in an economy, the community will have to save 12 per cent of its annual income, if its annual growth rate of output is to be 3 per cent. Let us work it out in practice. Given the saving ratio and the capital-output ratio, the Harrod formula for calculating the growth rate is Gw=s/Cr, If s is 12 per cent and the value of Cr 4, then Gw=12/4=3 per cent. Sir Roy Harrod in the Second Essay an Dynamic Theory has tried to make his model more applicable to underdeveloped countries. He has elaborated the supply side of his fundamental equation by introducing the role of interest rate in determining the supply of savings and the demand for savings. The natural rate of interest in is defined as the ratio of the natural growth rate of per capita output Pcand the natural growth rate of income Gn to the elasticity of diminishing utility of income e. Thus r n Pc Gn e = . Taking the values of Pc and Gn- as given, the natural rate of interest depends on the value of e which is assumed to be less than unity, rn and e are inversely related to each other. When e is small, rn is high and vice versa. The capital requirements, Cr, depend on the rate of interest, Cr =f(rn). Rather, Cr is a decreasing function of rn. The higher the rate of interest, the lower the capital requirements, and vice versa. The savings Requirements Sr, like Cr, are.also-of much importance in underdeveloped countries. But the average propensity to save s is not necessarily equal to social requirements of savings, Sr, The actual savings S may be greater or less than Sr, i.e., S ≠ Sr. If S>Sr then’ Gw> Gnwhich means that actual savings being larger in the community, entrepreneurs would desire to invest more? In the long run howeverGwcannot continue to be greater than Gn which is the highest growth rate that can be attained. In such a situation, the actual growth rate would attain full employment and will be less than Gw, i.e., G<Gw. This will lead to depression in the economy. On the contrary, if S<Sr, then Gw<Gn. It implies that actual savings being less than the required savings in the community, there would be fall in investment. In the long run, it would lead to a fall in the warranted growth rate below the actual growth rate, i.e., Gw<Gand the level of investment would increase. Ultimately there will be chronic inflation. Since low savings, high level of investment and chronic in- flation are some of the features of underdeveloped coun- tries, Harrod suggests the financing of large investments through the expansion of bank credit and automatic invest- ment of inflationary profits in the capital markets. But there are no organised capital markets in such economies, there- fore, expansion of bank credit is the only way to finance investments and generate economic growth. Low savings in an underdeveloped country are responsible for its low rate of growth and the existence of mass unemployment andunderemployment. Thustheactuallevelof savingshould be raised to the level of required rate of savings by a com- pulsory levy or a surplus budget to that S=Sr Besides, Harrod also emphasizes the need for changes in social and institutional factors in such economies. For social and institutional obstacles may be the cause of a low growth rate rather than the lack of savings -in underdeveloped coun- tries, Under the circumstances, Sr will also be low and S may approximate to it. LIMITATIONS OF THESEMODELS FROM THE STAND- POINT OF UNDERDEVELOPED COUNTRIES The Harrod-Domar models are not applicable to underde- veloped countries for the following reasons: 1. Different Conditions. The Harrod-Domar analysis was evolved under different set of conditions. It was meant to prevent an advanced economy from the possible effects of secular stagnation. It was never intended to guide industri- alization programmes in underdeveloped economies. The limitations of these growth models, as applied to such economies, therefore, stem from this fact. 2.Saving Ratio. These growth models are characterized, 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-
  8. 8. - IIndFloor,PaliwalMarket,GumanpuraKOTA (-0744-2392059&3290500 8 sons. The vast majority of the people live on the margin of subsistence and thus very few are in a position to save. 3.Capital-Output Ratio. Similarly, it is difficult to have a correct estimate of the capital-output ratio where normal productivity is often inhibited by shortages and bottlenecks. When they are removed, there is considerable increase in the productivity of already invested capital. Such an economy, therefore, would have either to increase its saving ratio or capital-output ratio by improving methods of productionaridremovingthevariousobstaclestoinvestment. Prof. Hirschman is of the view that the ‘predictive and operational value’ of a model based on the propensity to save and on the capital-output ratio is low and is bound to be far less useful ‘in underdeveloped than in advanced economies. 4.Structural Unemployment. According to Professor Kurihara, the Harrod-Domar growth rate of investment fails to solve the problem of structural unemployment to be found in underdeveloped countries. It can tackle the problem of ‘Keynesian unemployment’ arising out of deficiency of effective demand or due to under-utilization of capital. But when population grows faster than accumulation of capital in an underdeveloped country, structural unemployment will arise due to lack of capital equipment. 5.Disguised Unemployment. These models start with the full employment level of income but such a level is not found in underdeveloped countries. There exists disguised unemployment in such countries which cannot be removed by the methods suggested by Harrod-Domar. Thus the main assumption of the Harrod-Domar models being absent in underdeveloped Countries, these models are not applicable to them. 6.Government Intervention. The Harrod-Domar models are based on the assumption that there is no government intervention in economic activities. This assumption in not applicable to underdeveloped countries because they cannot develop without government help. In such countries the role of the state as a ‘pioneer entrepreneur’ in starting large industries and in regulating and directing private enterprise has been increasingly recognised. 7. Foreign Trade and Aid. The Harrod-Domar models are based on ‘ the assumption of a closed economy. But underdeveloped countries are open rather than closed economies where foreign trade and aid play very crucial roles in their economic development. Both these factors are the bases of their economic progress. 8. Price Changes. These models are based on the unrealistic assumption of a constant price level. But in underdeveloped countries price changes are inevitable with development . 9.Institutional Changes. Institutional factors have been assumed to be given in these models. But the reality is that economic development is not possible without institutional changes in such countries. Therefore, these models fail to apply in underdeveloped countries. Conclusion. Thus is appears from the above discussion that the Harrod-Domar models, based as they are on unrealistic assumptions, have little practical application in underdeveloped countries, Hirschman, therefore, suggests that “economics of development, like the underdeveloped countries 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 implications are very opposite of what one might expect of an underdeveloped economy,” yet “the growth models have this positive lesson for underdeveloped economies, that the state should be allowed to play not Only a stabilizing role but also a development role, if these economies are to industrialize more effectively and rapidly than the now industrialized economies did in conditions of laissez-faire.” He further opines that because of the universal character of saving-income ratio and capital-output ratio (or its reciprocal) as measurable strategic variables, the growth mechanism discussed by Harrod and Domar is applicable to all economic systems, albeit with due modification. That is why, these growth models are applicable to these underdeveloped countries in Which the technique of planning with ‘balanced growth’ is adopted because under this technique, saving-income ratio and capital-output ratio remain constant during the plan period.
  9. 9. - IIndFloor,PaliwalMarket,GumanpuraKOTA (-0744-2392059&3290500 9 IMPORTANT POINTS INDIAN ECONOMICS ANCIENT & MEDIEVAL INDIAN ECONOMY • Basic features of an economy- Unlimited wants, limited resources have alternative uses. • Basic problems of an economy- What to produce, how to produce, whom to produce, and growth of resources. • Kautilya Artha sastra gives details of political, social, eco- nomic, and military organisation of the Mauryan empire • Subsistence agriculture - Production of crops for the sake of self consumption by the farmer and the family and not for sale in the market. • In urban areas, the group of handcrafters having common interests is called as guilds • Sher Shaw Suri first introduced rupee coins in India in 1809. • Kautilya Arthasastra has been considered as the most authoritative work on ancient Indian economic thought. • Kautilya Arthasastra deals with state craft. • Arthasastra and Neeti sastra deals with the production and exchange. • Arthasastra felt material wealth is not an end in itself but as an important means to achieve the objectives of life. • In ancient India Vartha means the branch of knowledge dealing with agriculture, commerce, cattle breeding, money lending and artisanship. • Arthasastra is broader than Varta, because Arthasastra deals with jurisprudence, politics, and economics. • During Sher Sha tenure, lands were surveyed and land tax were determined scientifically based on productivity. • Jagir system was abolished by Akbar. • Akbar introduced land tax based on last ten years aver- age land price. • Laissez-fair (freeness) principle was followed during ancient India. • In ancient Indian economy agriculture and animal hus- bandry was occupies important place as occupations. • Kharaj- Fax on cultivation • Charat Tax on milch cattle • Ghari- Tax on houses. • The first Portuguese explorer ,Vascoda Gama opened sea route to India in 1498. • Grand trunk road was constructed by - Sher Shaw Suri • Main cereals grown during ancient period were Wheat and Barley. • Jizia is a tax imposed on Hindus , who failed to preach Islam . • Muhammed bin Tuglak introduced token currency. • Jajirs means the group of villages. • Begar means land less labour • Jajimani system- It is the system prevails in rural India between farmers and the village artisans. Generally reward for service is paid in the form of kind as per contract • According to Dharmasastras consumption should be based on dharma. Artha, Kama, Moksha • Dharma sastra deal with consumption and distribution. • Role ol state is limited in economic decision making in ancient India. • The three distinct classes in villages in ancient India are - The agriculturists, village artisans. Menials and village offi- cials. • Slier Sha surveyed and graded lands for the imposition of land taxes based on productivity. • Akbar fixed land taxes based on the average price of land. • The founders of modem Indian economic thought are Dadabai Nauroji, Ranade, and RC. Dutt and Ghokale. • Ancient literature recognized 4 factors of production. • Commercialization of agriculture—Production of crops for sale rather than for family consumption. • Cash crops Cotton, Jute, Sugar cane. Ground nuts and Rubber. INDIAN ECONOMY DURING BRITISH RULE • Dadabai Nauroji first estimated national income of India unofficially. • During pre British period, Textiles and Handicrafts were enjoyed world wide reputation. • First jute mill was started in Calcutta in 1855. • First iron and steel company was started by Jamshed ji Tata in 1907 in Jamshedpur. • The first modern industry stated in India is- Iron and Steel • Indian Handicrafts are badly affected due to industrial revo- lution in Britain • Poverty and Un British rule in India was written by Dadabai Nauroji. In this book, he analyzed how Britishers are re- sponsible for drain of wealth and to increase poverty in In- dia. • The triangular trade system prevails during British rule among three nations i.e. India, China and Britain. • Indigo (useful for coloring textiles) cultivation during Brit- ish rule prevails under two systems (1) Ryot system (2) Nij system • Absentee land lordism - Zamindars sublet their zamindari right to some body on commission basis to collect land revenue from peasants. • Most of the sugar factories are set up by Europeans in India were shut down, following the fall in prices of sugar. • East India company is a joint stock company. • Home charges in the form of salaries, pension, interest on debt, expenditure, for the maintenance of Army and Navy. • Essay on Indian political economy was written by M.G. Ranade. • The word political economy first used by Ranade. He stated that economic laws are not universal and economic growth not an isolated phenomenon it depends up on social, politi- cal and religious factors. • Ranade is the first Indian economist criticized classical economic model. • GK.Ghokale stated that Swadeshi is the only means to initiate industrial growth in the country. • Mahatma Gandhi’s economic thought was influenced by Ruskin • Colonial economy - Country is treated as a colony of rul- ing foreign country to serve their own interests (rulers). • British used colonial economies as suppliers of raw ma- terials and market for finished goods. • Britishers invested their capital in India through Managing Agency system • Two major forms of British investment in India are — Pri- vate foreign direct investment in mines, mills and plantation (2) sterling loans for infrastructure projects. • Managing agency system can be defined as partnership of companies formed by group of persons having huge fi- nancial resources and business experience.
  10. 10. - IIndFloor,PaliwalMarket,GumanpuraKOTA (-0744-2392059&3290500 10 • During colonial period the large a’mount of British capital was invested in infrastructure • The chief industry spread over the whole nation is Textiles and handicrafts. • The industry first hit during the British rule are Textiles and handicrafts. • The opening of Sue/ Canal reduced transport costs and made the exploitation of Indian markets easier. • Progressive Ruralization means during British period be- cause of loses occurred from the production and sale of industrial goods and closures of industrial units, un em- ployed craft men returned to agriculture. During British rule major crops in India are — Rice and Wheat. • Main agricultural exports during British rule - Jute and Cotton raw materials. • During British period, India is the main exporter of pri- mary goods. • During major period of British rule, India’s foreign trade was in positive balance. • During British period 75% of the trade confined with Brit- ain. • The most important function of managing agency system is to provide finance to set up Jute mills and Tea planta- tions. • Features of Indian economy during British rule - Stagnant and weakened economy, low levels of living, predominance of agriculture as’an occupation. • On the eve of independence the nature of Indian economy Under developed economy, stagnant economy, semi feu- dal economy, depreciated economy, disintegrated economy. • Causes of stagnation of Indian economy during British rule- Backward and age old techniques of production, cus- toms, traditions, colonial policy of British, and economic drain. • Semi feudal economy- It is an economy in which the means of production are in the hands of rich people, who lease their lands to tenents by charging exploitative rent. East India company was established in AD 1600. • During British period India’s foreign trade is protective and discriminatory. • Britishers mainly interested in production of plantation crops. • Subsistence farming prevails during British rule. Main power used for agricultural operations are human and Bul- lock power. • Depreciated economy- During II world war Indian economy was depreciated due to excessive use of machinery by in- crease in production, to meet war needs but the broken machinery was not replaced by new. • Disintegrated economy- During British rule India was di- vided into small states and units. It is anti for the adoption of uniform and integrated economic policy for the whole nation. • Nature of Indian economy as an underdeveloped economy on the eve of independence- Backward agriculture, short- age of basic industries, industrial backwardness, low capi- tal formation and low standards of living. • Features of Indian economy as an underdeveloped economy- Agriculture dominance, shortage of capital, preva- lence of unemployment and underemployment, shortage of infrastructure, backward and low techniques. • Stagnant economy- GDP growth rate is very low or nega- tive because of political, social and economic reasons. • Features of Indian economy as a mixed economy- Exist- ence of public and private sectors, joint sector, licensing and controls, economic planning. • Features of Indian economy as a developing economy- Saving, capital accumulation, national income. Percapita income is increasing, development is occurring in infra- structure and all the three sectors i.e primary, secondary and tertiary sectors. • Economic history of India was written by R.C.Dutt. • Poverty and un British rule in India was written by Dadabai Nauroji. • The only journal in the subject of economics during Brit- ish rule The Indian economist. • The founders of modern Indian economic thought were Dadabai Nauroji. Ranade. R.C. Das, and Ghokale • Drain theory was advocated by Dadabai Nauroji. • National income of India was written by V.K.R.V.Rao in 1939. to In 1793. permanent settlement act was enacted in Bengal presidency. • First Railway line was constructed from Bombay to Flume. In 1853. • The trade monopoly of East India Company was abol- ished in 1853 by the British parliament. to Between 1 829 to 1838, India had positive trade balance with Britain and China. • During British rule greater degree of monetization of the economy was occurred due to inflow of silver. • First Cotton mill in Bombay was started in 1854. to First Jute mill was started in 1855 in Calcutta. • Bombay plan was prepared by industrialists for the period of 15 years for India. • The aim of devaluation is to increase exports and de- crease imports. • Economic history of India was written by R.C. Dutt. to The first country was established trade relations with India- Portugal. • The main aim of east India company is - To earn profits through trade • Permanent settlement implies The amount of land rev- enue the xamindari is supposed to pay is fixed for 30 or 35 years, but the rate of land tax and the amount of land rev- enue is to be colleted from the farmers was not specified. • Mugalzari settlement means -It combines the features of both the permanent zamindari and Ryotwari systems. • East India company and traders enjoyed monopoly over the forced cultivation of the cash crops i.e. Indigo and Poppy. • Dadabai Nauroji calculated Percapita income per annum Rs 20, during the three years from 1867 to 1870. • The burden of tax on Indian people was about 2.5 times greater than on the people of England. • During British rule tax revenue is 22% of GDP now it is not more than 15%. • The champion of historical method to study Indian economy is Ranade • The idea of economic nationalism was advocated by Ranade. • The book famines in India were written in 1900 by R.C Dutt. • Tax and expenditure system prevails during British rule is regressive. • Mahatma Gandhi’s economic thought was influenced by Ruskin’s book Un to the last.