The Telegraph
Since 1st March, 1999
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- A mindless appeal to market forces alone will cause inequities

The author is an economist at the Indian Statistical Institute, Calcutta

It is time again for the finance minister to hand out a Central budget, an act that has acquired monumental significance, going at least by the quantum of speculations it attracts during the pre-budget weeks and the furious analyses that follow thereafter. One might wonder if it is worthwhile to be exercised over an economic event that appears to have short-term significance at best. The Central budget is an annual event after all, guided mostly by political exigencies. And it does not call for a hardened cynic to recognize politicians as rational human beings, driven like everyone else by the instinct of survival.

Yet, looking backwards, no annual event is exactly an occurrence in a timeless vacuum. An annual budget is only one amongst a series of them and when one filters out the short-run political compulsions faced by successive governments, a discernible pattern emerges out of the obfuscating mess. In the Indian context, there have been common ingredients in the concoctions brewed in the secret chambers of the North Block each February for the last many years now. The direction of movement is fairly clear. The economy is moving more and more towards a free market society. And as it does so, it is expected to cure itself of the much-dreaded infection called economic inefficiency. As the preaching goes, scarce economic means allocated in the competitive quest of profits involve less misuse of resources than allocations guided by the bureaucrats’ or ministers’ hunger for power in a centralized planned economy.

Economic efficiency is thought to be desirable for two reasons at least. First, a given resource base, when efficiently employed, achieves better standards of living at any point of time. Less waste, hence the same resources yielding a larger harvest, so to speak. Secondly, the economy is believed to grow faster when left to the competitive will of individual economic agents, thus achieving higher standards of living over time. Despite the appealing common sense of the two notions of efficiency, the second one is probably a little less innocuous than the first. The point is best appreciated by appealing to basic principles of economic theory.

Does a high rate of growth necessarily signify greater efficiency of resource allocation' To answer this question, consider a diehard miser whose sole source of satisfaction lies in seeing his stock of wealth grow with time. Since nothing comes from nothing, there is a price to be paid for realizing this dream. The miser pays the price in the form of foregone current consumption. Given that consumption is the final goal of all economic activity, however, it is doubtful if an average man in the street would be impressed by the miser’s lifestyle. Indeed, the common man might reason as follows. A huge stock of wealth thirty years from now would probably help me turn into a sizable consumer. But, I must then forsake my claim to a reasonable level of consumption today, though it is only now that I have a digestive system that is in order. In the distant future, my metabolism will be weak and my dinners, even if sumptuous, yield little pleasure. Thus, compromising a large rate of growth in favour of a realistic consumption in the immediate future may be a distinctly preferable objective.

It takes different sorts of people to make an economy. But in all likelihood, the non-misers dominate societies across the world. A high rate of growth per se, however obvious it might sound, cannot therefore be the policy objective for a government. Rather, one must speak in terms of a reasonable rate of growth subject to the maintenance of equally reasonable levels of consumption over time. How well does a free market society ensure the attainment of these objectives'

Economic theory has discovered at least two different reasons why competitive forces left to themselves might lead to high rates of saving (and growth of assets and incomes if you will) at the cost of distorted consumption patterns across time. The first of these is linked to the fact that any individual must save for his old age. Even a non-miser accounts for the fact that his income generating capacity at the age of seventy-five would be substantially less than that at thirty-five. A market society offers a range of saving instruments for protecting one’s purchasing power in later stages of life. None of these, however, is perfect, since the future is uncertain. There are uncertainties regarding prices, medical expenses, a daughter’s marriage and a host of other things. Depending on the state of development of market-oriented (as opposed to government-protected) savings instruments, the ability of individuals to hedge against uncertainties will differ. Even under the best of circumstances, perfect insurance markets are hard to come by. Add to this the current downward trend of returns on savings instruments in India in line with international rates and a tendency for asset over-accumulation begins to appear as a distinct possibility.

The second reason why the free market growth rate is often higher than optimal lies at the heart of modern day competition. Markets for most commodities have varying degrees of monopoly or oligopoly built into them. Moreover, intense competition between producers normally assumes the form of total annihilation of rivals. The idea essentially revolves around market capturing, the creation of new varieties of products through research and development with a view to rendering previous generations of products obsolete. There are examples of this phenomenon with which many are familiar. Recall the days when 78-RPM records were in vogue. 45-RPM and long playing records replaced these in due course. With the arrival of the latter, electrically-operated record players came to roost.

Then followed the age of sound cassettes and compact discs, both substituting the earlier products as well as the hardware required for their use. Similarly, video cassette recorders, which used to be popular among household equipment, are now hard to come by. Video cassettes were usurped by video compact discs and the latter by the digital video discs and so on. Each invention is caused by the lure of profits, creating simultaneously a new commodity that destroys an old. The fiercer the competition, the higher perhaps is the corresponding growth rate.

But this excessive rate must be weighed on the one hand against the premature drying up of profits of previous producers on account of obsolescence and the inconvenience caused to households by the need to replace consumer equipment before they die a natural death. These, strictly speaking, are losses that are bearable by an economy that has already attained high standards of living. Average Americans are known to change their cars several times during their lives. But a poorer society, on its way to economic development, may find the cost a little too high.

And of course, resources need to be diverted towards R & D activities and away from the production of currently consumable commodities for sustaining the struggle for existence among producers. This engenders, once again, abstinence from immediate consumption (as was the case of the miser) in favour of future gains, a prospect that could have dubious significance. Therefore, a society (such as India) that is still bogged down by controversies relating to the number of people below the poverty line has to tread the path of market competition with caution.

Does all this mean that one must relinquish markets altogether and settle for an indifferent growth rate' Certainly not. The failure of planned economies is a well-established fact now. But a market economy too has its illnesses. It calls for a competent doctor to keep these under check. The successive budgets that emerge over the years ought to contain the right degree of controls to help markets support the process of economic development. Or else, a mindless appeal to market forces alone might precipitate as much inequity as a dogged pursuit of centralization.

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