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Theoretical Basis of the Budget 2005-06
Ever since its
presentation to the Lok Sabha, the Central Budget 2005-06 has
been continuously dominating public discussion, though many
other topics have come and gone. Most media people and their pay
masters in trade and industry are euphoric. Tarun Das of CII has
termed it as “a dream budget”. The middle class salaried people
are busy calculating their gains and losses on the basis of
reduction in their tax liabilities and hike in petroleum prices
and 0.1 per cent new tax on the withdrawal of Rs 10,000 or more
from the bank in a single day. Trade and industry people are
happy owing to reductions in corporate income tax and customs.
Economists are debating the likely impact of these proposals on
economic growth and fiscal deficit.
While UPA constituents are showering praise, the NDA is either
ignoring or finding fault with it.
Nobody, however, is trying to discuss the theoretical basis on
which the budget is based. It is needless to add that without
going into it, it is not possible to grasp its various
dimensions and its likely impact on the economy and society. If
we look slightly deeper into the budget and Economic Survey
2004-05, we shall see that it is based on ‘the supply-side
economics’.
Though the theoretical roots of the supply-side economics may be
discerned in the writings of classical economists, it was the
French economist Jean-Baptiste Say (1767-1832) that elaborated
its various aspects more clearly in his magnum opus Traité
d’economie politique (1803), which appeared in English
translation in 1880 as A Treatise on Political Economy. He
maintained that an economy could be self-regulating if all
prices, including wages, were flexible enough to maintain
equilibrium. In other words, the government, trade unions and
organisations of consumers and producers must be barred from
interfering with the working of the market forces. His dictum:
“supply creates its own demand” summed up the essence of his
theory. He ruled out over- and under-production if forces of
supply were allowed to operate without any hindrance.
This dogma ruled unchallenged till the Great Depression
(1929-33) plunged the USA and the rest of the world, barring the
Soviet Union in an unprecedented crisis. John Maynard Keynes
laid bare the weaknesses of Say’s law and its theoretical basis.
To quote, “ From the time of Say and Ricardo the classical
economists have taught that supply creates its own demand; --
meaning by this in some significant, but not clearly defined,
sense that the whole of the costs of production must necessarily
be spent in the aggregate, directly or indirectly, on purchasing
the product.” (The General Theory of Employment, Interest and
Money 1936, p. 18). He demonstrated on the basis of his rigorous
analysis that “Say’s law, that the aggregate demand price of
output as a whole is equal to its aggregate supply price for all
volumes of output, is equivalent to the proposition that there
is no obstacle to full employment. If, however, this is not the
true law relating the aggregate demand and supply functions,
there is a vitally important chapter of economic theory which
remains to be written and without which all discussions
concerning the volume of aggregate employment are futile.”
(Ibid. p.26)
Keynes demonstrated that there was need for an active
intervention by state to ensure that sufficient employment
opportunities were created and national income was properly
distributed so that there was no shortage of effective demand to
clear the market. President Roosevelt based his New Deal on
Keynes’s teachings to take out the American economy from the
abyss in which it had fallen. Britain and other Western
countries too followed his prescription.
For around four and a half decades nobody bothered about Say’s
law, but, come 1970s and it was taken out of the dustbin of
history, dusted and dressed in new and seemingly attractive
clothes to be presented in 1975 by Jude Wanniski, associate
editor of The Wall Street Journal during 1972-78. He called it
the supply-side economics and elaborated it in his book The Way
the World Works (1978). He pleaded for keeping the state’s
economic role to the minimum, reducing tax rates as much as
possible, curbing trade union activities and so on. Wanniski
received strong support from the Nobel laureate Robert Mundell
and Chicago University’s Prof. Arthur B. Laffer. About the
latter, it was propagated that, while sitting in a restaurant.
he drew a curve on a paper napkin demonstrating that there was a
clear-cut relation between average tax-rates and total tax
revenue. Beyond a certain average rate of tax, total tax revenue
would fall because it would adversely affect the incentive to
earn and enjoy. Besides, tax evasion would become more
attractive. If the tax rate was low, the people would be
prompted to work hard so that they could earn as much as
possible and after discharging the tax liability they would be
left with enough money to enjoy and save. The Laffer curve
implied that there was an optimum tax rate that could yield
maximum possible tax revenue and this put a ceiling on public
goods like health, education and other facilities to be provided
by the state. Laffer held that there was no need for indulging
in budget deficit and state should keep its activities within
limits so that expenditures did not exceed its revenue.
It needs to be noted that, in spite of the myth created about
the origin of the Laffer curve, history testifies to the fact
that this idea was presented as early as 1844 by French
economist Jules Dupuit (1804-66) in 1844.
A powerful and concerted push was given to the supply-side
economics. Books and newspaper write-ups began coming in
torrents. While Wanniski set up a Supply State University,
Victor Canto, a disciple of Laffer came out with The Foundations
of Supply-side Economics (1983), focusing on the effects of
marginal tax rates on the incentive to work and save, which
affected the potential output.
In the 1980s, the supply-side economics had powerful
conservative supporters of the free-market system at its back.
They demanded cuts not only in the average tax rates but also in
social welfare spending by the state. The tax revolt in
California in the 1970s and economic difficulties during the
Carter administration were used to assert that there was no
alternative to the supply-side economics. The supply-side
economics became the sheet anchor of economic policies during
Reagan administration. Tax rates were cut substantially and “the
magic of the market place” was installed as the supreme deity.
Although the protagonists of the supply-side economists maintain
that tax cuts of the 1980s were responsible for the decade’s
high economic growth rate, there are others who argue that tax
cuts led to massive federal deficits and the poor and middle
class people were made to suffer as the expenditures on the
programmes intended for their benefit were drastically reduced.
The supply-side economics came to form the basis of what came to
be widely known as Reagonomics. Robert Mundell advised Reagan in
1981 to lap up the Laffer prescription and substantially bring
down the tax rates. This would, in turn, induce massive
investments, leading to huge increase in production, employment
opportunities, income and, ultimately, market would be cleared.
Besides, there would be no inflationary pressures as budget
deficit would be wiped out and there would be a perfect match
between demand and supply. Reagonomics, in essence, consisted of
four elements, namely, (1) a restrictive monetary policy
designed to stabilise the value of the dollar and contain the
runaway inflation, (20 tax cut to the tune of 25 per cent vide
The Economic Recovery Tax Act of 1981, designed to encourage
savings, investment, work, and economic efficiency, (3) balanced
budget through a restraint on domestic spending, and (4) an
agenda to roll back government regulations.
Unfortunately, these goals were not realised. David Stockman,
budget director during the Reagan administration is on record
saying that the “Rosy Scenario” was “cooked”. Nobel laureate
Joseph Stiglitz in his book The Roaring Nineties tore the
arguments of the supply-siders to pieces. A number of critics
called in question the academic credentials of prominent
supply-siders like Jude Wanniski and Robert Bartley.
Now, let us return to our budget of 2005-06. During the Lok
Sabha election the Congress had raised the slogan: “Congress Ka
Hath Aam Adami Ke Sath” and invoked the legacy of Mahatma Gandhi
and Pandit Nehru, but this budget which is more loyal to the
Washington Consensus and the supply-side economics has made it
clear that those who look after the economy do not care a damn
for what was said nine months ago. There are two important
paragraphs (1.63 and 1.69) in Economic Survey 2004-05 that amply
demonstrate it. Since the authors of this document firmly
believe in the supply-side economics, they are ready to
prostrate before the investors, especially foreign ones and
refashion labour laws to suit their needs. Paragraph 1.63 talks
of “the issue of simplifying procedures and relaxing entry-exit
barriers. The ease with which firms are able to enter into and
exit from business activities is an important determinant of the
investment climate. For business start-ups, a large number of
clearances have to be taken both at the Central and State level.
Such a system introduces delays and creates avenues for
corruption. Studies show that with a heavy regulatory burden on
business, India still ranks in the bottom quartile of comparable
nations in the ease of doing business…. Indian labour laws,
particularly Chapter VB of the Industrial Disputes Act, 1947,
allow firms less latitude … Small-scale reservation has not
succeeded in producing the expected results, and has constrained
investment in some critical sectors, such as knitwear, with
large growth potential. There is little justification for
continuance of such reservations….
Easing the entry-exit barriers will be critical…” In a word, let
the interests of the toilers be sacrificed to please the
prospective investors.
Now, paragraph 1.69. It rules out Gandhi, Nehru, the Karachi
Congress resolution and the formulations of the National
Planning Committee and the experiences with MNCs during Nehru-Indira
Gandhi regimes more particularly with reference to oil sector as
totally irrelevant to present-day India. This is being done not
on the basis of any resolution of the Indian National Congress
after a thorough discussion but because a group of people, loyal
to the Fund-Bank line, occupying high echelons in the
government, think so. Paragraph 1.69 reads as follows: “… the
need for higher investment, in the form of foreign direct
investment (FDI) and FII. Such investment triggers technology
spillovers, assists human capital formation, contributes to
international trade integration and particularly exports, helps
create a more competitive business environment, enhances total
factor productivity and, more generally, improves the efficiency
of resource use. Progressive global integration of the Indian
economy has resulted in successful assimilation of many domestic
industries in global production chains.” Unmindful of the
consequences in terms of unemployment and social unrest, it goes
on to stress the urgent need for FDI in retail trade. This, even
a man in the street knows, will strengthen the BJP and the RSS.
It is strange that this has not occurred to those wise men in
power. Moreover, the authors of economic policies are not aware
of the recently published book by John Perkins, for a long time
an economic hitman for the MNCs. Nor are they bothered about the
UN’s annual report World Economic Situation and Prospects 2005”
where the Fund-Bank and their approach have been castigated.
Following the supply-side economics, the Finance Minister has
brought down the rate of corporate tax from 35 per cent to 30
per cent. The rates of personal taxation have also been modified
to bring down the tax liabilities. Customs duties too have been
reduced. All these steps have been taken without paying any heed
to raising resources to meet obligations and promises to Aam
Adami. Andy Mukherjee of Bloomsberg News in his column in
International Herald Tribune (March 2, 2005) has termed P.
Chidambaram’s budget as “India’s supply-side budget”. His main
mission, according to Mukherjee has been “to live up to his
reputation as a supply-sider.” In 2005-06, notwithstanding all
the rhetoric public investments will be down by 24 per cent as
compared to 2004-05. It is a matter of time that disinvestment
or, plainly speaking, privatisation will be resumed because the
choice posed is that you cannot have both: building irrigation
canals and power plants and sinking money into inefficient state
enterprises and the business of giving subsidies on one pretext
or the other.
Just as this piece is being written Financial Times has come out
with a report that the government has decided to allow its 29
States to set up SEZs (special economic zones) where labour laws
of the land will not apply and investors will be unhindered in
their operation.
Indian economy is going to grow at 7 per cent this year. Last
year the growth rate was even higher. How far Aam Adami has
benefited is clear from the fact over the past five years,
employment opportunities increased by less than one per cent per
annum while the size of labour force went up by 2 per cent per
annum. Obviously the backlog of unemployment increased even
though we do not take into account de-industrialisation that has
set in in certain sectors since the beginning of reforms.
Another dimension of the supply-side economics is “trickle-down
strategy” of which Montek Singh Ahluwalia has been a committed
proponent. This strategy informs economic reforms since 1990s.
The paucity of space forces us to postpone a discussion of this
strategy to some future date.
Girish Mishra,
E-mail: gmishra@girishmishra.com
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