People's Democracy

The Twelfth Five Year Plan and the External Sector

Prabhat Patnaik

THE Twelfth Five Year Plan is being finalised at a time when the capitalist world is sunk in a severe crisis. Between 2008 and 2011, the advanced capitalist countries as a whole have had a growth rate of 0.3 per cent, which is virtual stagnation. In 2012, while the US is supposed to increase its growth rate somewhat, the Eurozone economies are expected to remain mired in the acute crisis that they have been facing for some time. The stagnation in advanced capitalist countries has meant reduced demand for India’s exports. Our imports however have not reduced; on the contrary they have got an additional boost in recent months from gold imports. Our trade deficit as a consequence has widened alarmingly, and so has our current account deficit, which reached 4.2 per cent of the GDP at current prices in 2011-12. Indeed in the January-March quarter of 2012, it had even reached 4.5 per cent which is the highest ever.

QUESTIONABLE

ASSUMPTIONS

Financing such an enormous current account deficit poses a serious problem. Taking the year 2011-12 as a whole, the net inflows of FDI, FII, bank loans and other financial flows were not enough to cover this massive current deficit; as a result some foreign exchange reserves had to be used up. This however portends danger in a “liberalised” economy since it sends a signal to speculators that defending the currency would become that much more difficult in the future. Running down reserves therefore cannot constitute a viable way of financing a current deficit of this order in a “liberalised” economy. The question that arises in this context is: how does the Twelfth Plan cope with this problem? And the simple answer is that it does so by making two assumptions, each of which is extremely questionable.

The first assumption is that the intensity of the world capitalist crisis will abate soon, because of which our exports will pick up, so much so that exports as a percentage of GDP at current prices, which were on average at 14.7 per cent for the eleventh plan period, will reach, again on average, 18.0 per cent for the Twelfth Plan period. In 2012-13 itself, exports as a percentage of GDP are visualised in the Plan document to reach 17.8 per cent; since an average growth rate of 8.2 per cent in real terms is expected over the Plan period, what this means is that (assuming that the export price index and the GDP price deflator move at more or less the same rate over the Plan period) exports in real terms will also increase at over 8 per cent during this period. Now, unless significant growth gets generated in the advanced capitalist countries this is simply not possible. And what is more, the Obama administration is likely to put stronger restrictions on outsourcing of work by US companies than it has done so far, if the crisis continues, which would make the going even tougher for our exports.

The Twelfth Plan document’s assumption therefore is that the crisis will not continue. But there is no reason why this should be so. The Eurozone is still in the woods, with tight austerity measures in place. The US may well decide to come down from the so-called “fiscal cliff” that has been in the news of late, by cutting government expenditure and raising taxes, which would push the economy back into stagnation or even recession; and even if no effective tightening occurs as a result of the “fiscal cliff” negotiations, the fiscal policy in general will nonetheless be shaped on the basis of agreement between Obama and the Congress, which will almost certainly entail some austerity. Hence the crisis of the advanced capitalist countries will continue in the foreseeable future, and may even call forth protectionism in the US, all of which makes the assumption with regard to exports in the Twelfth Plan untenable.

The second assumption made in the Plan document is even more questionable, and this is that raising the domestic savings rate relative to the investment rate will bring down the current account deficit. This is bizarre since it amounts to saying, for instance, that no matter what the world scenario is we can always, in a “liberalised” economy, manage our current account deficit with impunity, ie, without causing a domestic recession, by reducing our fiscal deficit (which is one way of raising the domestic savings rate relative to the investment rate). This is a novel argument for “austerity”, that says in effect that “austerity” in a “liberalised” economy can resolve the balance of payments problems in all seasons without any adverse impact on the GDP.

The analytical error of this argument can be seen from a simple numerical example. In any economy, a part of the total income is consumed, a part is invested and a part constitutes current surplus (a deficit is merely a negative surplus). For example if an economy has a total income of 100, its consumption (taking both government and private sectors together) may be 70, its investment (again taking both sectors together) may be 35, in which case its current deficit will be 5. This current deficit in turn is nothing else but the excess of imports (both merchandise and services) over the aggregate of its exports (both merchandise and services), its net investment incomes from abroad and its net remittance inflows. Let us for simplicity ignore all these other items, and assume that the deficit arises from an export of 15 against an import of 20. The excess of income over consumption (both government and private) constitutes domestic savings, which in our example is 30. Hence the current deficit is nothing else but the excess of domestic investment over domestic savings (ie, 35-30 in our example). And this is ostensibly why the Plan says that we can close our current deficit by, say, keeping investment at 35 but raising savings also to 35.

The fallacy of this argument however is this: our exports, determined by world conditions, will not necessarily change if we tax more at home; they will remain, say, at 15. Now, a rise in savings by 5, or a fall in consumption from 70 to 65, will close the current deficit while keeping total income at 100, only if the entire reduction in consumption is of imported consumption goods. If the reduction in consumption is of domestically-produced consumption goods, then the current deficit will not be affected while there will be a recession at home. (This recession may have second-order effects on the current deficit, reducing it; but the basic point is that income can no longer remain at 100, and any closing of the current deficit occurs because of the fall in income). Even if the reduction in consumption falls partly on imported goods and partly on domestically-produced goods, even then there will be a recession, and income will fall below 100.

The Draft Plan however does not visualise any possibility of recession at all. It assumes an 8.2 per cent growth rate in GDP over the Twelfth Plan for an average fixed investment rate of 34 per cent, which gives a capital-output ratio (incremental) of 4.15. In the eleventh plan period, there was according to it a growth rate of 7.9 per cent for an average fixed investment rate of 32.9 per cent which again gives a capital-output ratio of 4.16. The Draft Plan therefore has assumed that the increase in output in the Indian economy will be determined entirely by the increase in its fixed capital stock, ie, from the supply side, which means that there will be no demand-side constraints on output, ie, no recession. By assuming that there will be no shortfall in demand, and that the output will be at its maximal level (given the capital stock), even when the domestic savings are being raised to curtail the current balance, the Draft Plan is implicitly supposing that the entire rise in savings will be immediately at the expense of imports, ie, the entire reduction in consumption will be directly at the expense of imported goods.

RECESSIONARY

EFFECT

Not only is this unrealistic in general; but given the manner of increasing savings that it suggests, it is wholly absurd. One way of raising savings it suggests for instance is through cutting subsidies which would increase government savings (by reducing the fiscal deficit). Now, the poor hardly consume any imported goods directly; whatever imported goods they consume are consumed indirectly (through, for instance, imported oil going as diesel input into the ferrying of some goods they consume). A reduction in subsidies that curtails their consumption therefore must reduce the demand for home-produced goods (even if the second-order effects of such reduction is to curb imports). In other words raising the domestic savings ratio by curtailing the consumption of the poor will necessarily have a recessionary effect on the economy, which would then mean that the entire Twelfth Plan calculations, based on the assumption of a constant capital-output ratio (ie, the absence of any demand constraint) become invalid.

The real reason for asking for a curtailment of subsidies and a reduction of the fiscal deficit through these means (rather than by taxing the rich), is that this is exactly what finance capital wants. It will countenance neither a large fiscal deficit nor an increase in taxes on the rich, as is evident from fiscal policies being pursued all over the world, starting from the US itself, in the contemporary era of hegemony of international finance. The government of India, precisely because it wishes to appease globalised finance in order to induce it to flow into the country to bridge the current account deficit, is keen not only on reducing the fiscal deficit, but on doing so at the expense of the people rather than at the expense of the rich. What the Draft Plan presents is spurious theory to justify this attack on the people.

But no matter what it does, financial inflows are unlikely to bridge the current account deficit, even as the basic calculations of the Plan are invalidated by this deficit. The alternative is to put in place suitable controls on imports and on cross-border capital flows, which not only constitute an effective means of coping with current account deficits, but also promise freedom to the State from the obligation to pursue policies in keeping with the caprices of finance capital. But this alternative requires a different class orientation on the part of the State.