Citizens’ incomes and the engine of economic growth

The purpose of economic growth must be to increase incomes of citizens, especially for those at ‘the bottom of the pyramid’. Moreover, this income should be earned by them as far as possible through some economically or socially useful activity, rather than from grants from the state, so that the overall economy remains healthy.

Structural reforms of the Indian economy are necessary to enable incomes to grow faster, and more sustainably, at the bottom of the pyramid. There is plenty of evidence that incomes are not increasing fast enough and sustainably:

• Repeated needs to forgive loans and to provide income grants to farmers
• ‘Employment’ not increasing fast enough in relation to India’s demographic needs: while exact numbers, and definition of what is a job and what is employment, are contested, the overall conclusion that the Indian economy must generate many more decent sources of incomes at the bottom and the middle of the pyramid is not contestable
• Tiny enterprises, who are the largest sources of incomes and jobs, have great difficulties in performing and growing

Demand growth for many consumer products is not growing as fast as it was, and in many sectors it has declined recently: automobile sector, consumer durables, FMCG products and processed foods, even though inflation seems to be under control. A major cause of slackened demand is the lack of adequate income growth. 

The size of the Indian domestic market is an attraction for foreign FDI investors who have many countries they could invest in, including their home markets. If the Indian consumption market is not growing, India loses attraction as a place to invest in production capacities for both foreign as well as domestic investors. A primary requirement for attracting more investments in productive capacities is an increasing demand. First profits must be made; then the benefits of tax reductions can accrue. And for profits to be made, there must be adequate sales to cover the fixed costs of investments.

To attract investments in India primarily for export is a harder sell because, for this, India must be a country in which it is very easy to set up and operate an enterprise compared with other countries. Which India is aiming to be, but presently is not. Therefore, when both, domestic demand growth is slow, and it is not easy to do business in India, India is not a very attractive investment destination. 

• ‘Hard’ infrastructure—roads, transportation, power, water, sanitation, availability of land, etc.—must be considerably improved to make India an easy country for enterprises to perform and grow. 
• The ‘soft’ infrastructure of governance—government regulations, judicial processes, public services—has to be considerably improved too. 
• Financial infrastructure—Availability of funds at low cost, especially for working capital, is a major constraint for small enterprises. 

The government is working to improve all three forms of infrastructure for the benefit of enterprises. However, more attention must be given to the ‘last mile’ and ‘local’ infrastructure, the lack of which impacts small enterprises most. 

• The last mile in the financial infrastructure is the bridge between the formal financial system and small and tiny enterprises. 
• The last mile and local infrastructure are roads, water supply, power, sewage and sanitation services within clusters of small enterprises, which are very often located in peri-urban or semi-rural areas where they can get space to operate. Surveys show that the inadequacy of last mile and local infrastructure increases the cost of doing business very considerably for small enterprises. Thus, the benefits of investments in major highways and ports, as well as metropolitan urban services, do not ‘trickle down’ to the tiny enterprises who are the principal job and income creators in the economy. 

Whereas the large infrastructure projects are ‘bankable’ and amenable to PPPs with large investors, the government must fund ‘last mile’ and ‘local’ infrastructure more vigorously to improve the performance of small enterprises, who are the largest creators of employment, to enable them to expand employment opportunities further. This requires the strengthening of the ‘soft infrastructure’ of local governance in small towns on a war footing.  

The disappointing slow-down in economic growth is ringing some alarm-bells. Many economists are saying the Indian economy needs deep ‘structural’ reforms, not just a stimulus to move it out of a cyclical downturn.  

Economists say that India must fix its ‘factor markets’ to enable faster growth of enterprises. Markets for land and labour are mentioned as two that need fixes urgently. Markets, in simple terms, have a supply side and a demand side. If a market is not functioning, the problem could be in the functioning of supply side institutions; or it could be in demand side institutions; or it could be in the connection between them. Connections between them are smoothened by price discovery mechanisms which, according to free market advocates, must be free to find their own level. Therefore, according to a simplistic view of free markets, market participants must be able to buy and sell freely amongst themselves whenever they want to: let the market fix the price. 

This simple view of a market works well in markets for commodities, where the product and its consumer can be separated into the supply side and the demand side of the market. However, where the consumer must also be the producer, ‘market forces’ are not easy to disentangle into supply and demand. 

Labour is not a commodity like any other. Labour (i.e. human contribution) can increase its own value if it is motivated to learn and provided the means to do so. Whereas machines, materials, land, and other such factors of production cannot. They do not have a motivation to improve their own abilities. Nor (other than newly developing ‘intelligent’ machines) do they have the ability for this. 

The only resource that an enterprise has, which can have the motivation, and the ability to improve itself, are human beings. Indeed, while the value of all other resources (except land, which is a resource naturally constrained in quantity) depreciates over time, human beings are the only ‘appreciating assets’ of an enterprise—provided they are motivated and enabled to continue to learn.

Education and skill development for making citizens ‘employable’ cannot be left entirely to the government. Humans improve their skills and productivity ‘on the job’ where they actually do what is expected from them. Therefore, employers must invest much more in apprentice and on-the-job learning programs.

In the ‘labour market’, the consumer (employers) of skilled persons must also be producers of skilled persons, so that the volume of supply in the system can be increased, of which the consumer (employers) will be the beneficiary. As Robert Solow said, “sellers of standardized commodities may not be offended by low prices, but a worker’s incentive to provide effort depends on the perceived dignity of working conditions and fairness of wages”. Therefore, employers should have an orientation (and incentives) to retain and invest in their appreciating, human assets, and create good and fair working conditions, rather than to fire them quickly whenever their business does not require them. 

No doubt, enterprise owners and employers must have ‘flexibility’ to adjust the sizes of their work-forces in an open economy, in which economic fluctuations, and changes in competitive positions, can result in fluctuations in demands for an enterprise’s products and services. However, it is the very dynamism in the economy that also requires that managers and workers in enterprises acquire new skills rapidly. Therefore, if enterprises keep discharging employees with little interest in improving their skills, where will workers improve their skills and learn the new skills required? Employers have been using ‘labour contractors’ to provide them workers whenever they need them, and at the lowest cost possible too. Thus, contractors are giving employers the flexibility they need, and lower costs too. However, the contractors are not motivated to add any value to the workers. They merely provide a market mechanism to connect demand with supply. 

Employers in India often complain about talent and skill shortages as constraints on the growth of their enterprises. India does not have a shortage of human resources: it has the largest pool of young people of employment age in the world. They lack good education and opportunities to acquire skills. 

Far-sighted employers should consider their employees as valuable ‘assets’ with whom they can improve the ‘total factor productivity’ of their enterprises. Employees must be perceived as assets on the balance sheets of enterprise accounts rather than as disposable costs on the P&L accounts where accountants put them.

Much greater effort and investment is necessary to build the country’s education and public health systems. India must ‘catch up’ with China, Vietnam, Thailand, and other developing countries in its human development if it wants its enterprises to compete with enterprises in other countries. 

Even far-sighted employers must have some flexibility to adjust the sizes of their workforces to fit the conditions of their businesses. If their business is stagnant for long, they may have to let go some employees till the business recovers. However, a nation does not have this flexibility to adjust its workforce to fit economic exigencies. If the economy is slack, the ‘surplus’ human beings cannot be sent out of the country, to be recalled when the economy improves again! They must be taken care of in the down-turns too. Therefore, the nation needs a good social security system.  

The burden of social security cannot be put entirely onto employers. Not only will this increase their costs. It is also the wrong solution for social security because when the intention is to give employers more flexibility to let go employees in a down-turn, employees could lose their social security just when they need it most! 

A national, publicly regulated, and largely publicly funded, social security system is essential to enable both, flexibility for employers, and fairness for citizens. Moreover, with new forms of contracts for work such as the ‘gig economy’, and more start-up enterprises being encouraged too, a sound, national security system has become even more urgent. 

Subsidies for capital invested or for investments in human development

The prevalent economic paradigm gives primacy to capital investments to grow the economy. The theory is that more investments will create more economic activity and more economic activity will increase the GDP and the overall size of the pie. Therefore incentives are given in various forms, such as reduced taxes, interest subventions, land at preferential rates, etc, to attract more capital investment. 

The hope is that the capital investments will result in benefits that will very soon trickle down into the economy, even to the bottom of the pyramid. However, focusing on incentives at the top, for capital, has a perverse effect of encouraging the use of even more capital, and the substitution of labour with capital. Therefore wealth and capital accumulate at the top of the pyramid and too little trickles down. Moreover, tax reductions and subsidies to attract capital squeeze government’s budgets. Which makes it harder for governments to fund social security and human development programs. India cannot afford this. India must ensure that more people are engaged in productive, and dignified work so that they can earn adequate incomes to look after their own needs. 

If the government must provide incentives to attract capital, it must relate the incentives provided to the amount of employment created, and to investments in human development within the enterprises. Encourage the capital to help itself, by improving the human resource available to it, increase incomes, and expand demand.

Government policies must stimulate an engine of inclusive growth:

1. Growth of small enterprises, and growth of employment in them (and also in large enterprises), grows incomes at the bottom and the middle of the pyramid
2. Growth of incomes grows demand
3. Growth of demand attracts investments
4. Incentivise investments that stimulate more employment and more skills
5. More employment with more skills increases incomes further 
6. The economy gets into a more inclusive and sustainable cycle

The government should support this growth engine by:

1. Investing more in human development—education and health
2. Improving the ease of doing business for small enterprises—last mile and local infrastructures for finance, hard infrastructure, and governance
3. A universal social security system

These are the core elements of an inclusive growth model. However, these are not the only things that the government must do: 

• It must build the country’s transport and energy infrastructure even more vigorously. 
• Trade policy must be improved to support India’s internal engine of growth. (In fact, the stronger India’s internal growth engine becomes, the more clout India will have in trade negotiations).
• Environmental issues—water, pollution, soil degradation etc—must be managed much more effectively along with economic growth
• (And other matters)

India must increase the employment elasticity of its economic growth (employment created per unit of GDP growth), is reported to be amongst the poorest in the world, whereas India should have the highest employment elasticity to reap its demographic dividend. 

India is also becoming amongst the most environmentally stressed countries in the world along with growth of its economy and its population. Indian cities rank amongst the most polluted cities in the world. NITI Aayog projects that by 2030 India’s needs of fresh water will be double of the availability. 

What sort of country do we envision we will become, and what will citizens lives be like when we become a 5 trillion dollar economy (and then a 10 trillion dollar one hopefully) if citizens do not have jobs and there is no clean water to drink? 

The pace of increase in citizens incomes, and the pace of conservation of natural resources (and reduction of pollution) must be measured along-side the measurement of GDP to assess the nation’s progress.

Faster, more inclusive, and more sustainable, growth requires ‘whole of government’ policy coordination to stimulate it. Coordinated ‘whole of government’ policies are required at the centre, in the states, and in the cities. The performance of governments at all levels—national to local—must be measured by the increase in citizens incomes they generate and the conservation of natural resources.