India and the World Economy

Lecture 1: Introduction
Some basic information about the course
• One hour closed book end-term examination.

• Reading materials will be uploaded to courseweb or will be distributed in the

class. All professors will not use the same course material.

• Questions will be different in the exam but grades will be normalized

• I use the following classification:

• Suggested Reading: Useful for the exam (If nothing is mentioned, then it is a
suggested reading)
• Additional Reading: Useful for the course but may not be essential for the
exam. Additional readings will be specifically marked.

• Slides will be uploaded in PDF format after the lectures

• Krupa will be helping me in this course

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 Grade normalization target
• A plus: 10% of the students
• A only: 15%
• A minus: 15%
• B plus: 25%
• B only: 15%
• B minus: 10%
• C plus/F: 10%

Note: Actual distribution may slightly vary across sections.

Prof. Mohanty is the course-coordinator

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What do we want to do in this course?
• From theory to practice
• Practical application of your theoretical knowledge (Microeconomics, Macroeconomics)
• Understand the impact of policies
• Understand the relevance of policy instruments
• Understand how things work in a developing country. In some cases we may have to alter our
basic textbook models.

• Understand the Indian Economy :

• Special features of Indian Economy
• Understand India’s integration with the world economy
• Important Sectors: Agriculture, Manufacturing and Services
• Financing of development
• Role of international trade
• Capital flows and its impact
• Central Bank and money supply
• Some major concerns of the Indian economy: poverty, inequality, climate change etc

• How India is placed in the global economic scenario: Opportunities and

challenges.
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India’s integration with
the World economy
Broad Classification of India’s Integration with the world

Ancient to Middle Ages

• India was at the center of the world trade. Big exporter of silk, spices,
manufacturers (textiles)

The Colonial Period

• India loses its prominent position as big exporter of manufacturers, turn

exporter of primary commodities, period of de-industrialization

Period of Planned Economic Development

• Inward looking economic policies, low emphasis on the external sector

Economic Liberalization and beyond

• More emphasis on market economy, more international trade, improved

inflow of foreign capital, steady accumulation of foreign exchange reserve
Once India was a leading trading country…

There was very large volume of exports of spices, cotton textiles,

and jewellery from India. But the West did not have much to sell.
To balance the books, Western merchants had to pay for the
difference in gold and silver. Roman senators complained that
their women used too many Indian spices and luxuries, which
drained the Roman Empire of precious metal. Pliny the Elder, in 77
CE, called India “the sink of the world's gold!”
Ancient globalizers-traders, preachers, soldiers and adventurers
Spices preserve, and they also make the poorly preserved palatable, masking the appetite-
killing stench of decay. After bad harvests and in cold winters the only thing that kept
starvation at bay was heavily salted meat—with pepper. And there was never enough of it.
Thus pepper began the association with gold it still has in the streets of Iddicki, often at a
one-to-one exchange rate. In order to call off their siege of Rome in 408AD, the Visigoths
demanded a bounty in gold, silver and pepper. In the Middle Ages plague added to the
demand for medicinal spices; a German price table from the 14th century sets the value of
a pound of nutmeg at seven fat oxen.

When the Mary Rose, an English ship that sank in 1545, was raised from the ocean floor in
the 1980s, nearly every sailor was found with a bunch of peppercorns on his person—the
most portable store of value available.

The great beneficiaries of Europe's need were the Arabs. Spices could change hands a
dozen times between their source and Europe, soaring in value with each transaction, and
the Arabs were the greatest of the middlemen. Keen to keep it that way, they did
everything possible to confuse consumers about the spices' origins.

http://www.economist.com/node/179810
Trade routes in the Middle-Ages
Colonialism was driven by the first Multinational Companies
from Europe
• Dutch East India Company, or the
United East India Company, Dutch
Vereenigde Oost-Indische
Compagnie, trading company
founded in the Dutch Republic
(present-day Netherlands) in 1602
to protect that state’s trade in the
Indian Ocean and to assist in the
Dutch war of independence from
Spain.
First publicly traded joint stock company of
the world
• The company prospered through
most of the 17th century as the • From 1615 onwards, the Dutch East India
instrument of the powerful Dutch Company traded with Bengals. In 1627, a
trading post was established in Pipely. In 1635
commercial empire in the East a settlement was established at Chinsurah
Indies (present-day Indonesia). It adjacent to Hooghly to trade in opium, salt,
was dissolved in 1799. muslin and spices.
British East India Company
The British Rule and Deindustrialization
• British Colonial period led to massive deindustrialization of India

• One of the most remarkable development of international trade during

the 18th century is that the Europeans managed to alter the commodity
composition of Indian trade completely during this period.

• India was a major producer of textiles in the early 18th century. In 1750,
India produced nearly 25 percent of the world’s textile output. But by
1900, this figure has drastically reduced to only 2 percent (Colin
Simmons 1985).

• By the middle of the 19th century India had lost all its export market and
a very significant part of its domestic market. India experienced secular
deindustrialization during the period 1750-1860.

• India became an exporter of raw materials and importer of

manufactured goods.
The Discovery of India- Jawaharlal Nehru
Post-Independence Indian Economy
• Very low rate of growth- almost stagnant GDP
• During 1900 to 1947 India’s national income Poor
grew at less than 1 per cent per annum Low
Country
Growth
with high
Rate
poverty
• Low saving, acute shortage of material capital

• Predominantly agricultural economy

• Even with large proportion of the population

engaged in agriculture, the country was not self- Low MPC close
sufficient in food and raw materials for industry. Investment to 1

• Colonial pattern of trade ensured India became a

peripheral country which exported raw materials and
Low
imported manufactured goods.
Savings
• Very narrow industrial base with the production
structure locked into
• producing labour intensive and
• resource intensive goods Vicious Circle of Poverty
Objectives of the development planning policy:
• Achievement of high rate of economic growth

• Accelerated effort to remove poverty and reduce inequality

• Rapid industrialization with a diversified industrial sector.

• To achieve these goals it was felt necessary to overcome shortage of

capital

• Development of a mixed economy with a strong public sector

• Achievement of a high order of self-reliance

• Promotion of balanced regional development

What is Planning?...1
• What is “Planning”?- possible answers include

• An economic system based on ‘command and control’ which is

an alternative to the ‘market economy’ system’,

• Instrumental inference to an economic system,

• Which essentially implies setting the prices right based on social criteria and not
solely base them on the market

• A system which sets the broad macro goals of an economy.

• So, is it essentially a question of “Market vs State”? Or

what are the roles of government in a market based
economy? The debate still rages on….
What is Planning?...2
Amaresh Bagchi on need of indicative Planning in a market
economy

• If public resources are to be used optimally to advance growth and welfare

of citizens, planning is needed even in a market economy. However, the
function of planning in a predominantly market-driven economy has to be
indicative, coordinative and prescriptive.

• There is also need for a central agency to perform these functions. That
provides the justification for India’s Planning Commission to engage in the
task of preparing development plans for the economy periodically even
after liberalisation.

• However with control over investment in the private sector beyond its
purview such planning can at best be indicative.

Full paper on courseweb

Essential Roles of the State
• Essential roles of government even in a market
based economy (Stiglitz)
• Promotion of education/social public and private goods and
services
• Promotion of technology
• Creating institutions for the financial sector and supporting them
• Investing in infrastructure (public investment)
• Providing the essential public goods
• Managing the environment
• Creating and maintaining social safety nets (UBI ?)
• Provision of public goods like national security

• There is a sort of ‘return of State’ in recent times.

Role of state: From the Economic Survey
• The sixth lesson relates to the ongoing international and national debate on the
role of markets and states, private capital and public institutions.

• All over the world, there is a reassessment of the respective roles of the two
with a clear tilt toward greater state involvement.

• The new international case is based on the need to redistribute to check

growing inequality and cushion against the impact of globalization.

• It is also based on the need to regulate, for example, the financial sector to
minimize risks and the technology sector to check growing market power and its
misuse as a communications medium

Vol 1, page 8
Five Year Plans in India
Five Year Plans Years Main Focus
First Five Year Plan 1951-56 Concentrated on raising the level of investment in irrigation,
power and other infrastructure for accelerating growth
Second Five Year Plan 1956-61 Emphasized the development of heavy industry under the public
sector

Third Five Year Plan 1961-66 Similar to second plan but with more importance given to
agriculture
Disruption to the FYPs due to war with neigbouring countries
1966-67, 1967-68 and 1968-69 were three annual plans, Two successive years of drought, devaluation of the currency, a general rise
in prices and erosion of resources disrupted the planning process

Fourth Five Year Plan 1969-74 Period of increased emphasis on food sovereignty-
phase of Green Revolution

Fifth Five Year Plan 1974-79 Poverty Reduction was made a major goal

1979-80 – Annual Plan

Sixth Five Year Plan 1980-85

Transition period
Seventh Five Year Plan 1985-90
1990-91 and 1991-92- Annual Plans

Eighth Five Year Plan 1992-97

Ninth Five Year Plan 1997-2002

Era of liberalization
Tenth Five Year Plan 2002-2007
Eleventh Five Year Plan 2007-2012

Twelfth Five Year Plan was meant for the period 2012-17, but in 2015 government disbanded the Planning
Commission and replaced it by NITI Aayog
So called Hindu rate of growth period
Main Features of Planning in India
• Industrialization based on Import substitution and Infant Industry protection

• In industrialization, significant emphasis was given to public sector [The raison

d'etre of a planned economy is the fullest mobilisation of available resources and their allocation
so as to secure optimum results]

• Private sector was highly regulated with large number of restrictions and
guidelines

• Exchange rates were regulated, India maintained an overvalued exchange rate

regime for most of the planning period.

• Agriculture was treated a sector whose role was to provide cheap labour, food
and raw materials to the industry.

The tilt was more towards state…

1991- The
Year of
Massive
Economic
Reform
Some Important Concepts

• GDP and Growth Rates

• Fiscal Deficit
• Current Account and Capital Account
• Exchange Rates
• Inflation

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What exactly are
we measuring?
• Growth rate of what?
Calculation of GDP…1

Item Price No of Units Total value of

Output

Wheat 5000 per tone 5 tonnes =25000

Bicycles 2000 per unit 100 =200000

Cloth 200 per meter 500 meters =100000

Gross Domestic Product for year 1 325,000

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Calculation of GDP…2
Case 1 Case 2

(same price as before, output doubles) (same output as before, price doubles)
Item Price No of Total Item Price No of Total
Units value of Units value of
Output Output

Wheat 5000 per 10 tonnes 50000 Wheat 10000 per 5 tonnes 50000
tonne tonne

Bicycles 2000 per unit 200 400000 Bicycles 4000 per unit 100 400000

Cloth 200 per meter 1000 200000 Cloth 400 per meter 500 200000

Gross Domestic Product for year 2 650,000 Gross Domestic Product for year 2 650,000

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Real and Nominal GDP
• Using GDP estimates at constant prices help us eliminate the
effects of price level changes on the GDP. When GDP calculations
are done using current prices, it is called ‘nominal’ GDP. But when
GDP calculations are made using constant prices, it is called ‘real’
GDP

• When a country’s growth rate is measured, unless otherwise

mentioned, it is the growth rate of real GDP. That means, the
growth rate is adjusted for changes in price level.

• In India, GDP estimates are published by the Central Statistics

Office (CSO)

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To measure how fast a country’s economy is growing,
generally the rate of growth of real GDP is used.
Annual rate of growth of real GDP is calculated using
the following formula

Real GDP growth rate for year (t+1) =

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Different Approaches of Calculating GDP
• What is the 'production' approach to estimating GDP?
• The 'production' approach to estimating GDP looks at the contribution of each economic unit by
estimating the value of an output (goods or services) less the value of inputs used in that
output's production process.

• What is the 'income' approach to estimating GDP?

• The income approach to estimating GDP measures the incomes earned by individuals
(e.g. wages) and corporations (for example, profits) in the production of outputs
(goods or services).

• What is the 'expenditure' approach to estimating GDP?

• The expenditure approach to estimating GDP measures total expenditure on finished
or final goods and services produced in the domestic economy. [Y=C+I+G+ (X-M)]
A change in methodology of calculating GDP in India

From Nagraj and Srinivasan 2016

A Change in the methodology and base year
• India now measures GDP by Gross Value
Added method instead of factor costs.

• The base year has been shifted to 2011/12

from 2004/05 earlier.

• The Indian statistics ministry said that after

updating the base year used for marking
trends in the economy and switching to a
market-price calculation of gross domestic
product, the economy grew by 6.9% in the
year that ended last March. Using the
previous methodology, GDP expansion that
year was 4.7%.

• These new and higher figure seems quite at

odds with other economic indicators such
as the growth in bank credit, the Index of
Industrial Production and corporate
performance
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The relationship between gross value added (GVA) and gross
domestic product (GDP)
• What is GVA?
GVA measures the contribution to the economy of each individual producer,
industry or sector in country

Put simply, it is a measure of total output and income in the economy. It provides
the rupee value for the amount of goods and services produced in an economy
after deducting the cost of inputs and raw materials that have gone into the
production of those goods and services. It also gives sector-specific picture like
what is the growth in an area, industry or sector of an economy.

• What is it used for?

• GVA is used in the estimation of Gross Domestic Product (GDP).
• While GVA gives a picture of the state of economic activity from the
producers’ side or supply side, the GDP gives the picture from the consumers’
side or demand perspective. Both measures need not match because of the
difference in treatment of net taxes. This is one of the reasons that in the first
quarter of 2015, GDP growth was stronger at 7.5%, while GVA growth was
6.1%.

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The relationship between gross value added (GVA) and gross domestic product (GDP)

How does GVA relate to GDP?

• The link between GVA and GDP can be defined as:
• GVA (at current basic prices; available by industry only)
• plus taxes on products (available at whole economy level only)
• less subsidies on products (available at whole economy level only)
• equals GDP (at current market prices; available at whole economy level only)

In summary:
GVA + taxes on products - subsidies on products = GDP

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Main Differences in Results due to the new methodology

From Nagraj and Srinivasan 2016

From Nagraj and Srinivasan 2016
More recent concerns about GDP…1
• Gross domestic product is a measure of output, income and spending all at the
same time. In post-war Europe and America, the growth in living standards and in
GDP were synonymous.

• GDP growth became a target for politicians and a scorecard by which they were
judged by voters. Even so, it has always had critics.

• Environmentalists have long lamented that GDP treats the plunder of the planet as
something that adds to income, rather than being treated as an expense.

• A repeated charge is that GDP is divorced from notions of spiritual well-being.

Robert Kennedy once famously took aim at GDP which, he said, counted cigarette
advertising and jails but did not include “the beauty of our poetry or the strength of
our marriages”.

• Still, GDP growth was a decent, if rough, guide to material progress. The more
output and income was generated (after adjusting for inflation), the better off we
were.
More recent concerns about GDP…2
• That equation worked pretty well when the economy was still mostly farms and factories, producing things of similar
quality that could easily be counted.

• But GDP is less suited to the task of measuring modern, service-led economies that are geared towards the quality of
consumer experience, rather than consumption of greater quantities.

• It is far harder to identify the extent to which changes in price reflect a better service. When medical charges rise, it
will generally count as inflation, even if the quality of health care is improving faster than prices are rising. And where
consumers pay nothing, as is often now the case with digital services, they do not register in GDP. The consumer
benefits from Google and Facebook are thus excluded.

• Previously paid-for things, such as maps, encyclopedias and music recordings, are now free. So they have dropped out
of GDP. Online shopping, banking and travel-arranging is more convenient for consumers. To the extent that all this
saves on buildings, it detracts from GDP.

• For the most part, the trickiness of measuring the output of services leads real GDP to be understated.

• But mis-measurement works the other way, too. For instance, if an airline squeezes more (and thus cheaper) seats on
to a plane, it counts as extra output, even thought the quality of service falls. Perversely, the more risks bank take, the
more they contribute to GDP, even as the quality of lending falls.
The Economist explains
Why GDP is a poor measure of progress
http://www.economist.com/node/21698128/print
Readings
• The Indian Economy- Up o 1991 and Since by
Kaushik Basu (uploaded)

• Paper by Bagchi on Planning

• Paper by Nagraj on GVA