The growth rate is slowing down in India neither because of lower productivity of the labourers or that of the land, nor because of shortage of labour or productive capacity, but because of the lack of demand at the aggregate level. It means that the aggregate actual level of activity is way below the potential national income, given the size of the labour force, labour productivity, land size and productivity, and the productive capacities in the industries and services. The actual growth rate is much lower than the full employment or full capacity growth rate. There are unemployed labourers ready to work at the ongoing wage rates, given their skill levels, and there is unutilised productive capacity at the aggregate level. Also, the ongoing wage rate is lower than the marginal productivity of labour i.e. if the capitalists employ one more unit of labour, the extra cost (wage rate) would be less than the value of output that the extra unit of labour produces. Therefore, it would be profitable to employ more labourers and unemployed labourers would also get jobs at the ongoing wage rates.
However, this profit would be realised only if the producers can sell their products in the market at the ongoing prices. If there is not enough demand in the market, either they have to reduce prices of their products or they would not be able sell their extra output at the existing prices to realise profit. In that case, inventories would be piled up. The investment rate would come down and unemployment would rise in the economy. This is called a demand-constrained situation in the literature of economics when national income cannot grow beyond a point because of lack of aggregate demand.
There are four sources of this aggregate demand viz. i) domestic private consumption, ii) (net) export demand from abroad, iii) demand by the government and iv) aggregate investment demand. In national income accounting, our GDP is estimated in the country by simply adding these four components mentioned above. The first component is dependent on the purchasing power of the people (net income) and their average propensity to consume domestic (not imported) goods and services out of their total income. The second component is largely dependent on the demand from abroad, which is exogenous. The third component is dependent on the government whether they want to increase government expenditure or not on the face of slowdown. Lastly, the aggregate investment demand primarily depends on the expected aggregate demand relative to the full capacity output. These variables, in turn, depend on various other factors like interest rate, exchange rate, inflation etc. However, for simplicity, we are assuming these factors to remain unchanged for the time being.
Now, if the government increases its expenditure to boost aggregate demand and does not allow the fiscal deficit to go up, then the tax revenue also has to increase by the same amount. But, then peoples’ purchasing power and investors’ net profit would decline, which would have a negative impact on the aggregate demand through reduction in domestic private consumption demand and private investment demand respectively. To inject extra demand in the economy, therefore, government has to increase expenditure through deficit financing. To revive the growth rate, government has to spend more money and allow the fiscal deficit to go up.
Reduction in corporate profit tax (by 0.75% of GDP) may eventually lead to a reduction in aggregate government expenditure to GDP ratio, given the fiscal deficit to GDP ratio (because of FRBM Act). In that case, there would be no addition to aggregate demand through fiscal stimulus. In fact, if the fiscal deficit does not rise in the same magnitude of corporate tax concession, ceteris paribus, there would be reduction of aggregate demand. The government expenditure must rise (and not fall) as a proportion of GDP to tackle a situation of slowdown led by lack of aggregate demand.
Now, the question is more money should be spent in which all areas. The answer is simple—more money should be spent in those areas where it would be most effective in boosting the aggregate demand under a demand-constrained situation. We know that the richer people save more and poorer people consume more out of their total income, on an average. Saving or import do not add to the aggregate domestic demand but, the consumption demand does. If poorer section of population gets more income, then they will spend a large proportion of that on domestically produced goods and services. Some other domestic people would earn income by selling those commodities and services. Then they will spend part of that income on consumption of domestically produced goods and services and so on and so forth. The aggregate demand would rise more than the initial rise in government expenditure. The purchasing power of poor people can be raised indirectly by reducing the out of pocket expenditures on health and reducing cost of educational services by providing government sponsored quality education and health facilities for all. The income of poor people may directly be enhanced by strengthening the MGNREGA. Many studies have shown that government investment in infrastructure attracts private investment; therefore, capital expenditure on infrastructure is another area to give a boost.
The ongoing MGNREGA programme in 2,62,637 Gram Panchayats, in 6921 blocks of 691 districts have more than 26 crore MGNREGA workers in the country. In 2018-19, 7.7 crore workers from 5.3 crore households worked under the scheme. The average days of jobs provided per household has only been 50, instead of 100 days, in the last financial year (2018-19) at an average wage rate of less than Rs180 per day per person. The total expenditure of government was less than Rs 70,000 crore. One percent of GDP means around Rs 2 lakh crore in India. Even if the wage rates under MGNREGA are doubled (i.e. to an average of Rs 360 per day per person) and if jobs are provided for at least 100 days in a year (of course subject to demand for jobs) as per the law, the extra expenditure would not exceed 1% of GDP. The government expenditure on this scheme is only 0.35% of GDP at present. The coverage of this ‘employment of last resort’ programme can be extended to urban areas also, under crisis. Urban areas do not mean only the cities, but they also cover small towns and sub-urban areas, where incidence of unemployment and poverty is no less.
If the poorer section of population earns 1% of GDP amount of extra money, the multiplier effect of that on the aggregate demand would be maximum—growth would revive substantially. Estimates show that the impact multiplier is more than 1.4 for MGNREGA for the lower strata (income-wise) of population. And, this would also help in reducing unemployment, poverty and inequality in the country. The government would also be popular and the domestic market size (aggregate demand) for the producers would be substantially expanded. As the MGNREGA has been identified as the core of the core centrally sponsored scheme, it would not put any extra pressure on the state governments either. So, this would be a win-win situation for all. If 8 crore households get the benefit, given the average family size of five, it would help one third of the country’s (poor and vulnerable) population. The commercial banks would also be more than happy to give more risk-free loans to the government under a situation of lower non-food credit offtake as a result of lower investment demand in the country. Therefore, the concrete policy suggestion is to make the employment guarantee programme (of at least 100 days) universal at a double average wage rate with just 1% of GDP amount of extra government expenditure financed by borrowing.
Also read: Rural Development Minister Made a Mockery of MGNREGA, Says Activist Group