Is it best to minimise government intervention in the economy? Do you believe in the invisible hand?

“If economics were only about profit maximization, it would be just another name for business administration. It is a social discipline, and society has other means of cost accounting besides market prices.” - Dani Rodrik

Adam Smith, in his ‘The Wealth of Nations,’ talked about what he termed the ‘invisible hand,’ saying that it ensures that people working in their self-interests will actually and miraculously lead to the benefit of everybody, i.e. an unfettered and a free market with minimal to no government intervention, will lead to great social outcomes. This was the accepted paradigm till the 1930s among economists and policy-makers. For the next 4 decades, till the 1970s, this proposition was put under severe interrogation, if not outright rejection. However, post the 1970s, this theory of the operation of the Invisible Hand, propagating minimal government intervention in the economy for best social outcomes, has again come to be accepted as a mainstream paradigm.

This claim builds on the Virtue of Selfishness, and ensures complete consonance among various private interests and public benefits, subject to the condition of the government refraining from intervening in the market. It believes that competition among larger numbers of independent producers and consumers will lead to an increase in quality and decrease in prices in a capitalist economy with the pillars of private property, profit-maximisation and competitive free markets.

However, a critical historical analysis of this paradigm of the Invisible Hand reveals serious instances of market failure to the case of a free capitalist economy. It has been found that the free market has often failed to deliver socially good outcomes, especially with regards to the basic needs of life. As this perpetuates, a welfare democratic state has to intervene. Which is to say, that it is not in the States’ best interest to minimise government intervention in the market.

Based on concepts of exclusion (whether or not the producer can stop someone from consuming it) and rivalry in consumption (can the same unit of good be consumed by more than one consumer at the same time?), goods can be classified into private, artificially scarce, common and public.

Rival in Consumption Non-rival in ConsumptionExcludable Private goods Artificially scarce goodsNon-excludable Common resources Public Goods

Krugman and Wells prove that markets cannot simply supply goods and services efficiently unless they are private goods, i.e., they are excludable and rival in consumption. That is to say that the invisible hand operates only with private goods. A profit maximisation private firm will never produce a good or a service that is non-excludable, because self-interested consumers won’t pay for it. They will just take a free ride on anyone who pays. This is what Krugman and Wells call the Free-Rider Problem, because of which forces of self-interest alone will not lead to an efficient and optimal level of production for a non-excludable good leading to overall public benefit, resulting in the non-excludable goods to suffer from inefficient and low rates of production in a free market economy. This explains why no profit-maximisation private firm could come forward with a plan to end London’s Great Stink. This is why a welfare state needs to intervene to achieve socially desirable outcomes.

It is important to consider the rates of returns as well. There is a Private Rate of Return and a Social Rate of Return. For public goods like health and education, SRR>PRR. Whenever there are "externalities"—where the actions of an individual have impacts on others for which they do not pay, or for which they are not compensated—markets will not work well. Some of the important instances have long understood environmental externalities. Markets, by themselves, produce too much pollution—carbon dioxide is dumped into the atmosphere, where the public pays extraordinary environmental costs, whereas the producer of carbon dioxide pays nothing for the free use of the atmosphere. This is classic market failure by externalities. So when it comes to negative externalities like mining activities, alcohol production and the like, PRR>SRR.

Moreover, in spheres like infrastructure, there is a lumpiness of investment. There is also a dissonance between needs and demands. For example, when sleeping sickness was rampant in Africa, a private firm came up with a drug to cure it. However, because the drug was priced very high to meet the investment, the African people who most needed it couldn’t afford it. To avoid losses, the private firm converted it into a hair removal cream for women. This clearly goes to show that a free market does not always cater to the needs of the larger public good, and government intervention thus becomes pertinent.

Mention examples: Ashoka University is a visible hand. They recognise there is not only market failure but also state failure. In Denmark if you get cancer, the state pays for it. Reform for India in the past twenty years has only meant privatisation. Why are the basic requirements of the Indian people not being fulfilled? Would private sector have delivered if Nehru didn’t bring the state in? This has been the discourse for the past 20 years. Mention the recession and the great financial crisis. The Free Market has failed to deliver.

The main reasons for policy intervention are:

1. To correct for market failure

2. To achieve a more equitable distribution of income and wealth

3. To improve the performance of the economy

Government Intervention to Overcome Market Failure

1. Public Goods: In a free market, public goods such as law and order and national defence would not be provided because there is no fiscal incentive to provide goods with a free rider problem (you can enjoy without paying them). Therefore, to provide public goods like lighthouses, police, roads, etc. it is necessary for a government to pay for them and out of general taxation.

2. Merit Goods / Positive Externalities: Goods like education and health care are not strictly public goods (though they are often referred to as public goods). In a free market, provision tends to be patchy and unequal, often because of high prices as well. Universal education provided by the government ensures that, in theory, everyone has the opportunity to gain an education, which has a strong social benefit.

3. Negative Externalities: The free market does not provide the most socially efficient outcome, if there are externalities in consumption and production. For example, a profit maximising firm will ignore the external costs of pollution through burning coal. This leads to a decline in social welfare. By contrast other forms of energy production, like solar power, are environmentally friendly and have a positive externality. By taxing production which causes pollution costs and using the subsidy to encourage other forms of energy production, there is a net gain in social welfare.

4. Regulation of Monopoly Power: In a free market, firms may gain monopoly power which enables them to set higher prices for consumers. Government regulation of monopoly can lead to lower prices and greater economic efficiency.

5. Demerit Goods: Over-consumption of certain products leads to negative externalities. This is a consequence of market failure. Government can intervene in the form of information campaigns and setting minimum age for consumption.

6. Merit Goods: Sometimes under-consumption of certain goods with positive externalities leads to decline in social welfare. The government has intervened in the past in the form of subsidies.

What would you regard as Keynes’ most significant contribution to economics and why?

Before Keynes postulated his theories, mainstream economics assumed the impossibility of the existence of involuntary unemployment in a capitalist economy. This is what can be phrased as “Supply creates its own demand,” as per Say’s Law. Unemployment could only be voluntary if union wages were high not letting the labour market operate freely or if there was a mismatch between characteristics of supply and demand in the labour market creating frictional unemployment—both cases where the free market paradigm did not operate.

In the 1930s Keynes’ theory created a revolution in economics by questioning this fairy-tale of capitalism. His significant contribution was to emphasise the role of expectations, and to focus on the ‘realisation’ problem. His most significant contribution to economics was his Theory of Uncertainty which placed the main challenge of capitalism in the uncertainty of the future. More specifically, this uncertainty can be phrased as, “Will I be able to sell what I produce in a way that enables me to make profits?”

Keynes postulated that the previous theories assume that we have knowledge of the future of a different kind from the one we actually possess. The hypothesis of a calculable future leads to a wrong interpretation of the principles of behaviour and to an underestimation of the concealed factors of doubt, hope, fear and precariousness.

He said that at any given time, facts and expectations were assumed to be given in a definite and calculable form. Risks, even though not significantly noticed, were supposed to be capable of exact computation. The calculus of probability, he said, was supposedly capable of reducing uncertainty to the same calculable status as that of certainty itself! In actuality, though, only a vaguest idea can be possessed of the direct consequences of our actions. Keynes’ idea of ‘uncertain’ knowledge is not merely to distinguish what is certain from what is probable. For example, a game of roulette is not subject to the Law of Uncertainty, but the prospects of a European war, life expectancy, or weather forecasts are. There is no scientific basis to form any calculable probability.

As a part of his most important contribution, he differentiated between Risk and Uncertainty, where a risk was an uncertainty with a calculable probability. He went on as a part of his Theory of Uncertainty to explore how to manage these circumstances as rational and economic men. He devised for this purpose a variety of techniques. The three most important ones have been outlined as follows:

1. An assumption that the present is a much more serviceable guide to the future than an examination of past experience would show it to have been hitherto. In other words, we largely ignore the prospect of future changes of which we know nothing.

2. An assumption that the existing state of opinions as expressed in prices and character of existing output is based on a correct summing up of future prospects.

3. Endeavour to conform with the behaviour of the majority or the average on an assumption that the psychology of a society of individuals attempting to copy the others leads to a conventional judgement.

A practical theory of the future based on the flimsy foundation of these three principles is subject to sudden and violent changes. Apart from that, there is a threat of instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than on a mathematical expectation. Most probably, of our decisions to do something positive can only be taken as a result ofanimal spirits—of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities. Enterprise only pretends to itself to be mainly actuated by the statements in its own prospectus, however candid and sincere. Thus if the animal spirits are dimmed and the spontaneous optimism falters, leaving us to depend on nothing but a mathematical expectation, enterprise will fade and die;—though fears of loss may have a basis no more reasonable than hopes of profit had before. It is safe to say that enterprise which depends on hopes stretching into the future benefits the community as a whole. But individual initiative will only be adequate when reasonable calculation is supplemented and supported by animal spirits, so that the thought of ultimate loss which often overtakes pioneers, as experience undoubtedly tells us and them, is put aside as a healthy man puts aside the expectation of death. This means but that economic prosperity is excessively dependent on a political and social atmosphere which is congenial to the average business man.

The way Keynes breaks down Say’s Law is by pointing to a motive for holding money that had not yet been understood: the speculative motive, which arises because of uncertainty about the future. The scale on which capital assets are produced depends on the relation between their costs of production and the prices which they are expected to realise in the market. It is not surprising that the volume of investment, thus determined, should fluctuate widely from time to time.

Business men play a mixed game of skill and chance, the average results of which to the players are not known by those who take a hand. Nevertheless, businessmen must make decisions. Since decisions are made under conditions of imperfect knowledge, investment by business can be volatile. Keynesian economics as the economics of disequilibrium is the economics of permanent disequilibrium. Keynes showed that there could be a lack of effective demand that could spiral into a recession and then a depression. Not all income is consumed and not all savings are invested. In the face of uncertainty, there is liquidity preference and liquidity trap when interest rates can fall no further to induce investment. Thus in a multiplier fashion, the economy falls into recession.

Marginal Propensity to Consume:

Multiplier = 1/ 1-MPC = 1/s

When you invest, people get wages, they spend and it leads to a multiplier impact on the economy. Other factories get set up as these earning workers create more demand. This is the multiplier effect. In a depression situation, you look at it in exactly the opposite way. Domino effect sets into fashion. The major factor behind this is the animal spirit. The major discourse is “My good will not sell,” and this leads to what Keynes called involuntary unemployment. If you lower wage to the equilibrium wage, the purchasing power will be curbed. Therefore, the government must step in. Say’s law is all about balanced budget economics. Keynes debunked this myth. In the time of recession, only the government can take the risk because accountability is the power of democracy.

The realisation dawned following the Great Depression and the publication of the General Theory. All nations had, until then, operated under Say’s law. In 1930s, all governments were helpless and therefore democracy rose to power and this is proof that the governments listened

to Keynes. Keynes managed to convince Roosevelt. Bridges and roads etc. were now creating employment.

Is there a natural tendency for inequality to decline under capitalistic circumstances?

The hypothesis that there is a natural tendency for inequality to decline under capitalist circumstances comes from the Kuznets Curve, a fairy-tale of capitalism. The natural progression of development is towards industrialisation and urbanisation, following the Kuznets Curve. Initially, this is theorized to lead to increased inequality in society, as capitalists get richer and the influx of rural labour holds wages down. Inequality increases in the early phases of industrialisation, because only a minority has the capacity and resources to benefit from the new wealth that industrialisation brings. But as employment opportunities grow and the flow of rural labour dries up, wages rise and an equalisation tendency appears, which gets stronger over time, with the spread of education and skills to large parts of the population.

Thus, if we plot inequality against time, we get an inverted-U or bell-shaped curve, the Kuznets Curve. If this hypothesis were true, it would show that the “trickle down” of the benefits of growth to all is a natural and automatic part of capitalist development. In former US president John F. Kennedy’s memorable phrase, “A rising tide lifts all boats.”

The recent work of Thomas Piketty, Capital in the Twenty-First Century, provides the strongest demolition of the Kuznets Curve hypothesis so far. Piketty’s biggest achievement is that he is able to match the monumental statistical structure that Kuznets pioneered.

Piketty adopts both Kuznets’s methods and his data, and extends their coverage over time and space. His data shows a U-curve in the trends of inequality since 1980 in the advanced capitalist nations of the world — US, Japan, Germany, France and Great Britain — the exact opposite of the Kuznets Curve. The graphs of emerging economies are similar. Inequality grows sharply after having fallen initially for a few years proving that there is nothing natural or automatic about declining inequality under capitalism. It is the shocks of war, the policies of a Keynesian welfare state and a strong labour movement that led to a decline in inequality in the 40-year period (1934-1974) that Paul Krugman has called “the great compression”.

These were the decades that saw the emergence of what John Kenneth Galbraith termed “countervailing power”. And it is the unravelling of this balancing power and a shift towards free-market fundamentalism that led to the rise in inequality after 1980. So much so that levels of inequality in the US in the first decade of the 21st century were higher than the extreme disparities of the 1920s.

If anything, the unfettered free market tends to increase inequality through the operation of what economists call “increasing returns to scale”. The benefits of scale tend to favour larger units and the very process of competition tends to destroy competition, through what Karl Marx called the “concentration and centralisation of capital,” a process visible in the history of each and every capitalist economy thus far.

Thus, the tendency of unfettered free market capitalism is towards greater inequality.

Piketty clearly recognises that there are powerful forces that can mitigate inequality. He specifically identifies diffusion of knowledge and skill as a key factor. But these too depend on state policies on education, access to training and skill development. Much more worrisome for Piketty is the fact that there are powerful forces of divergence that exacerbate inequality, even when there is sufficient investment in skills and training.

In recent decades, especially in the US and Britain, corporate CEOs appear to be able to raise their own pay (especially via stock options) almost without limit and with no apparent relation to

their own productivity. As Krugman has shown, real wages for most US workers have virtually stagnated since the 1970s, but wages for the top 1 per cent have risen 165 per cent, and for the top 0.1 per cent have risen 362 per cent. At the same time, over the last 40 years, the income tax top marginal tax rate in the US has declined from 70 to 35 per cent. But the biggest tax reductions have come on capital income, including corporate and inheritance taxes.

Thus, the most important engine that drives inequality up, according to Piketty, is the higher rate of return on capital compared to the low overall growth rate of the economy.

If a slice of a cake grows faster than the cake itself, the inequality between the faster growing slice and the slower one is bound to increase. This is actually an arithmetical identity.

This concentration of wealth further tilts policies towards the rich, there is a tendency to cut taxes for the rich (Bush – 3 large tax cuts in 8 years) while also cutting subsidies for the poor, rather than follow redistributive policies that put money in the hands of the poor.

After the implementation of neoliberal policies in the late 1970s, the share of national income of the top 1 per cent of income earners in the US soared, to reach 15 per cent (very close to its pre-Second World War share) by the end of the century. The top 0.1 per cent of income earners in the US increased their share of the national income from 2 per cent in 1978 to over 6 per cent by 1999, while the ratio of the median compensation of workers to the salaries of CEOs increased from just over 30 to 1 in 1970 to nearly 500 to 1 by 2000. The US is not alone in this: the top 1 per cent of income earners in Britain have doubled their share of the national income from 6.5 per cent to 13 per cent since 1982. And when we look further afield we see extraordinary concentrations of wealth and power emerging all over the place. A small and powerful oligarchy arose in Russia after neoliberal ‘shock therapy’ had been administered there in the 1990s. Globally, the countries of Eastern Europe and the CIS have registered some of the largest increases ever in social inequality. Extraordinary surges in income inequalities and wealth have occurred in China as it adopted free-market-oriented practices. The wave of privatization in Mexico after 1992 catapulted a few individuals (such as Carlos Slim) almost overnight into Fortune’s list of the world’s wealthiest people.

Harvey: “We can, therefore, interpret neoliberalization either as a utopian project to realize a theoretical design for the reorganization of international capitalism or as a political project to re-establish the conditions for capital accumulation and to restore the power of economic elites. Neoliberalization has not been very effective in revitalizing global capital accumulation, but it has succeeded remarkably well in restoring, or in some instances (as in Russia and China) creating, the power of an economic elite.

In her recent Richard Dimbleby lecture (February 2014), Christine Lagarde, managing director of the IMF, states that “seven out of 10 people in the world today live in countries where inequality has increased over the past three decades… the richest 85 people in the world own the same amount of wealth as the bottom half of the world’s population… In India, the net worth of the billionaire community increased 12-fold in 15 years, enough to eliminate absolute poverty in this country twice over”.

Global Wealth Databook 2014 from Credit Suisse reveals that the richest 1 per cent of Indians today own nearly half (49 per cent) of India’s personal wealth. The rest of the 99 per cent are left to share the remainder among themselves. And that too is very unequally shared. The top 10 per cent Indians own nearly three-quarters (74 per cent) of the country’s personal wealth. The remaining 90 per cent share a meagre quarter. At the other end of the spectrum, of the world’s poorest 20 per cent people, nearly one in four are Indians.

Even nearly three decades after economic reforms and high growth, inequality continues to rise and wealth has become even more concentrated at the top. The share of India’s richest 10 per cent families has grown from 66 per cent in the year 2000 to 74 per cent today. India’s super-

rich (top 1 per cent) who owned 37 per cent of India’s personal wealth in 2000, have even more rapidly increased their share to 49 per cent.

As is visible from the analysis of the data presented above, there is not natural tendency for inequality to decline under capitalist circumstances. On the contrary, the opposite has turned out to hold true—inequalities are increasingly rising under capitalist regimes.

But to suggest that we can now speak of a Piketty U-curve of growing inequality, a new “natural law of capitalism” would also be a mistake. Rather it may be more pertinent to recall the last line of Kuznets’ 1954 lecture: “Effective work in this field necessarily calls for a shift from market economics to political and social economy.”

Is Free Trade a good policy for all countries under all circumstances?

Free Trade is not a good policy for all countries under all circumstances. Free Trade outcomes may sometimes be sub-optimal, according to Rodrik.

The resources used in international exchanges must be valued at their true social opportunity costs rather than at prevailing market prices. These two accounting schemes coincide only when markets internalize all social costs, distributional considerations can be shunted aside, and other social and political objectives are not at stake.

Free trade advocates will often grant that some people may get hurt in the short run, but will continue to argue that in the long run everyone (or at least most people) will be better off. In fact there is nothing in economics that guarantees this and much that suggests otherwise. In a wealthy country such as the United States, these are likely to be unskilled workers such as high school dropouts. This renders the whole notion of “gains from trade” suspect, since it is not at all clear how we can decide whether a country as a whole is better off when some people gain and others lose.

Are the gains too small relative to the potential losses to low-income or other disadvantaged groups that may have little recourse to safety nets? And does the trade involve actions that would violate widely shared norms or the social contract if carried out at home—such as employing child labour, repressing labour rights, or using environmentally harmful practices? When the answers to both these questions are yes, the legitimacy of trade will be in question, and appropriately so.

When a trade happens, 2 things happen:

1. Losses: Redistribution leading to rise in inequality.

2. Gains: Efficiency

The more open an economy is, the worse the redistribution-to-efficiency ratio gets. The political and social-cost-benefit ratio of trade liberalization looks very different when tariffs are 5% instead of 50%. The more open the economy, the more the share of government expenditure in national expenditure. What opening an economy does is increase the exposure to risk.

The Historical Experience: Who really believes in Free Trade?

Dani Rodrik (2011): “Even though we think of the nineteenth century as an era of free trade, Britain is the only large economy that maintained open trade policies for any length of time. The United States put up very steep tariffs on manufactured imports during the Civil War and kept them high throughout the century. The major Continental powers in Europe were unhesitant converts to free trade only for a short period during the 1860s and 1870s.”

Britain’s move to free trade reflected a unique constellation of class interests

The crucial date in nineteenth-century tariff history is 1846, the year that Britain abolished Napoleonic Wars–era tariffs on imports of grains.” Corn Laws pitted “rural interests against urban interests. Here “corn” was synonymous with grains, and the tariffs in question covered all food and cereal imports. Landlords wanted high tariffs that kept food prices high and raised their incomes. Urban manufacturers, increasingly powerful as the effects of the Industrial Revolution diffused through London, Manchester, and other cities, wanted to abolish the tariffs to reduce the cost of living. That reduction would allow capitalists to pay even lower wages to their workers. In the end, the ascendant manufacturing interests won the day: they had both the intellectual arguments and the forces of the Industrial Revolution on their side.

In the US the constellation of class interests did not lead to free trade

Trade policies fed directly into the most important social and political cleavage in the country, between South and North. The slaveholding South was organized around an export economy based on tobacco and cotton. The free states of the North relied on a nascent manufacturing base that lagged behind Britain in productivity and struggled to compete with cheaper imports. The South depended on international trade for its prosperity. The North wanted protection from imports, at least until it could catch up.

The Civil War of 1861–66 was fought as much over the future of American trade policy as it was fought over slavery. As soon as the war started, Abraham Lincoln raised U.S. tariffs, and trade protection was increased further following the North’s victory. Import tariffs on manufactured goods averaged 45 percent in the decade after 1866 and never fell much below that level until World War I. By any standard, the United States was a highly protectionist country during the late nineteenth century. Whatever its other economic consequences, free trade in nineteenth-century America would have further reinforced and strengthened slavery as a social and political institution

The lesson is clear: depending on where a country stands in the world economy and how trade policies align with its social and political cleavages, free trade can be a progressive or a regressive force. Britain was the industrial powerhouse of the world in the mid-nineteenth century and liberal trade policies favored manufacturing interests and the middle classes. The United States was an industrial laggard with a cost advantage in slavery-based plantation activities, where liberal trade policies would have benefited repressive, agrarian interests. Free trade and “good politics” don’t always go together.

As James Galbraith said, none of the world's most successful trading regions, including Japan, Korea, Taiwan, and now mainland China, reached their current status by adopting neoliberal trading rules.

Galbraith also contends that "For most other commodities, where land or ecology places limits on the expansion of capacity, the opposite condition — diminishing returns — is the rule. In this situation, there can be no guarantee that an advantage of relative cost will persist once specialization and the resultant expansion of production take place

A classic and tragic example, studied by Erik Reinert, is transitional Mongolia, a vast grassland with a tiny population and no industry that could compete on world markets. To the World Bank, Mongolia seemed a classic case of comparative advantage in animal husbandry, which in Mongolia consisted of vast herds of cattle, camels, sheep, and goats. Opening of industrial markets collapsed domestic industry, while privatization of the herds prompted the herders to increase their size. This led, within just a few years in the early 1990s, to overgrazing and permanent desertification of the subarctic steppe and, with a slightly colder than normal winter, a massive famine in the herds.

The explosive growth of South Korea, starting only in the very late 1960s, as that nation diversified its economy away from its comparative advantage in agriculture and raw materials and moved into manufacturing industry through its very heavy-handed industrial policy. By comparison, Somalia — being richer that Korea until the mid-1960s — did not, and instead continued to specialize according to its comparative advantage and ended up being very poor.

Real wages in Peru were more than halved when the free trade shock and subsequent de-industrialization hit the country starting in the mid-1970s. The vocabulary now pertaining to the policy of wage destruction was also invented here: in Peru the year 1978 was officially named “The Year of Austerity” Seen from the Washington Institutions the story could be presented as one of success because exports were skyrocketing. In reality the income of the average person was more than halved. Very similar process of de-industrialization and halving of real wages in Mongolia starting in the early 1990s.

Critically assess Nehru’s contribution to Indian Development.

When India gained independence in 1947, a number of issues plagued the country. These were:

1. Agrarian Poverty

2. Aftermath of Partition

3. Lack of Infrastructure

4. Low Manufacturing Rates

5. Poor HDI

6. Weak Institutional Structures (Bank, Legal, etc.)

7. Development of Democracy

8. Weak Capitalist Class

9. Rampant Caste-System

Second FYP – import substitution, labour intensive.

Infant industry argument.

Rise of Capitalist Society.

Need to be self reliant.

Bombay Plan -

Capital goods.

GDP growth.

Public Sector

Eduction Primary. Health. Skill Development. Korea – not spending on human capital.

64 – Nehru Death.

It was in this picture that Nehru assumed the position of the Prime Minister of India, and undertook steps to contribute to Indian Development. The three pillars of development under Nehru were Industrialisation, Urbanisation and Infrastructure Development. The First FYP focused on the Gandhian philosophy of agrarian development. But then it was realised that the rate of disguised unemployment in the agriculture sector was very high. The opportunity cost of removing people from the agrarian sector was zero. This coupled with historical disadvantage of being a colonised country and market failure as evident by the glaring presence of negative externalities, a weak capitalist class leading to lumpiness of investment, widespread poverty, inequality and unemployment, served as the basis for the development of the Second FYP. The Free Market had failed to deliver; the invisible hand was not working, mainly because there was a very weak capitalist class. India was stuck in a low-equilibrium trap and the focus of the Second FYP was to break out of it. It focused on import substitution called the infant industry argument, which is an economic rationale for trade protectionism. The core of the argument is that emerging industries often do not have the economies of scale that their older competitors from other countries may have, and thus need to be protected until they can attain similar economies of scale. Its objective was to raise the level of income through rapid growth by focusing on industrialisation and capital goods, the means chosen to eliminate widespread poverty.

The commanding heights of the Indian economy were therefore placed in the hands of the public sector because there was no one else capable of doing so. Therefore, Government of India took upon itself the job of removing poverty. Nehru’s greatest contribution to Indian development is the development of Indian capital class. Because of widespread failure, all public goods had to be provided by the state, what this led to is now available to us below:

Rates of growth in each sector of the economy before independence:

1900-1947 1947-2000 1950-1965Primary 0.4 2.5 2.6Secondary 1.5 5.5 6.8Tertiary 1.7 5.0 4.5GDP 0.9 4.1 4.0

GDP per capita 0.1 1.9 1.9Population 0.8 2.0 2.0

The rapid expansion of public investment, which was characteristic of this period, induced growth of both industrial as well as private corporate investment. Private corporate gross fixed capital formation (GFCF) increased at the rate of nearly 13% per annum. The economic planning in these few years hoped two serve the two central functions of a rise in incomes facilitated by intensive capital goods producing sector. Both these objectives were met with significant levels of success. The planners envisaged for complete autonomy in heavy industrialization from foreign aid or foreign direct investments. Import substituting Industrialization is the phrase that is often used to refer to the strategy used to meet this end. Central planning helped in channelizing rising public savings into public investment projects. However, unlike similar approaches in Soviet Russia and China, Nehru’s central planning would not come at the cost of democracy or individual liberties.

Industrial growth was not, however, evenly spread across industries. Public investment was heavily concentrated in capital-intensive industries, and had little direct effect on the domestic market for mass consumption goods. The agricultural sector, from which was drawn the livelihood of most of India's populace, grew at rates barely above population growth rates.

Industrial raw materials produced by the agricultural sector, like cotton and jute, were also in short supply. These circumstances were not conducive for the growth of some of the major traditional manufacturing industries that dominated the industrial sector at independence. Industries like textiles and food products experienced both domestic demand and supply constraints. These in turn combined with the relatively low priority accorded to the textile industries in official policy to also render them incapable of meeting the mounting challenge that they faced in export markets from technological changes and new competitors. Traditional industries like textiles and food products were thus unable to participate in a major way in the industrial growth that took place in this period. Food products and textile industries, which saw a dramatic decline in their relative share of the organized sector fixed capital from 44% to less than 15%. The basic metals (primarily steel) and power (electricity, gas and steam), major spheres of public investment, represented the other side of the shift increasing their combined share in industrial fixed capital from less than 20% in 1951 to nearly 55% in 1965.

There were 5 major things that went wrong in the Nehruvian Period. In laying excessive importance on the development of infant industries, appropriate importance was not given to the following arenas. Following is a critique of the Nehruvian Period:

1. Neglect of Articulate: The first shock to Nehruvian Period was the drought of mid-60s, where a massive famine struck India. What went wrong was that Indian Agriculture, as discussed above, was not placed on a strong foundation. In building up nationalization and Import-Industry Substitution, agrarian bas was not strengthened. The consequence was humiliating, as India had to approach the United States for grains, leading to the US dictating India’s Foreign Policy. Gandhi had always seen the future of Indian Development in rural India’s Development—a relationship with nature characterized by an understanding based on balance with nature.

1. Neglect of Primary Education: There was an absence of a serious effort to build human capabilities via education and training. In the east this had taken the form of a spreading of schooling, vocational training and engineering education. In India, on the other hand, public spending on education had turned towards technical education at the tertiary level too early on. The slow spread of schooling ensured that the growth of productivity in the farm and the factory remained far too slow. It is intriguing that the issue of schooling did not figure majorly among India’s planners, especially as it was a

part of Gandhi’s Constructive Programme. This had not gone unnoticed even at that time. B.V. Krishnamurthi, then at Bombay University, had pointed out that the priorities of the Second Five-Year Plan undergirded by the Mahalanobis model were skewed. He castigated it for a bias toward “river-valley projects,” reflected in the paltry sums allocated to education. But it was the argument advanced by him for why spending on schooling matters that was prescient. He argued that education would enable Indians to attend to their livelihood themselves without relying on the government, thus lightening the economic burden of the latter, presumably leaving it to build more capital goods in the long run as envisaged in the Mahalanobis model. But this was not to be, with enormous consequences for not only the economy but also the effectiveness of democracy in India. The failure to initiate a programme of building the capabilities of the overwhelming majority of our people is a moral failure of colossal proportions.

2. Neglect of Health: Lowest percentage of GDP was allocated to health. Every comparable country that did industrialisation etc. placed central emphasis on health and education. In their own wisdom, Indian policy makers have not done this till today. Private initiatives can do something but there is a limit to what they can do in terms of public goods.

3. Neglect of Ecology: Nehruvian Development failed to achieve a harmony with nature. In using nature as a tool, they ignored the Gandhian principle of achieving balance as is evident by the famine of the 1960s.

4. Neglect of Social Infrastructure: Open defection and lack of availability of clean drinking water, ensuring nutritional security for all including pregnant women and children at tender age to ensure their proper physical and mental growth.

“Under Jawaharlal Nehru, the Indian economy had been transformed from a colonial enclave to one with at least some of the prerequisites for sustained long-term growth while at the same time maintaining autonomy from the superpowers vying for influence on a newly independent subcontinent.” – Balakrishnan

What is the theoretical and empirical case for Bank Nationalisation in India?

In 1969, Indira Gandhi nationalized 14 banks in India. Though this was a huge step against capitalism, evidence shows that this was highly necessary seeing the state of affairs of rural credit in 20th century India. This overview of rural credit in 20th century India finds a remarkable continuity in the problems faced by the poor throughout the period. These include dependence on usurious moneylenders and the operation of a deeply exploitative grid of interlocked, imperfect markets. Usurious moneylending practices are very well documented in many official reports from the colonial period. Perhaps the most important is the Central Banking Enquiry Committee (CBEC) report (1929) and its associated provincial reports, of which the Madras Provincial Banking Enquiry Committee (MPBEC) report is regarded as a classic. It explains how the mechanisms of debt typically had a cumulative force. Frequently the debt was not repaid in full and a part of the loan persisted and became a pro-note debt. By the existence of this heavy persisting debt, the creditor takes the bulk of the produce and leaves the ryot unable to repay short-term loans. But equally, the short-term loan has produced long-term debt and there is a vicious circle. The ryot cannot clear his short-term debt because of the mortgage creditor and he cannot cultivate without borrowing because his crop goes largely to the long-term creditor. Thus, repayment of debts was a major compulsion for farmers to sell their crop and the creditor usually insisted on repayment in the immediate post-harvest period. To do this the debtors were forced to borrow once again. Moneylenders’ power was reinforced through the grain loans they made to poor proprietors, tenants and labourers. Rates of interest were generally higher for the poorer cultivators, partly because they made greater resort to grain loans but also reflecting their generally more vulnerable position. Creditors sought to exploit this vulnerability by cheating in various ways, for it was they who kept the accounts (if any), conducted the grain measurements and had a more accurate knowledge of prices. The 1935 report on agricultural

indebtedness provides instances of moneylenders who kept accounts but never revealed them to debtors, to whom they never provided receipts either. They recorded higher rates of interest on the pro-notes than they actually charged. The amount repaid was generally not deducted while calculating future interest dues, nor were the principal and interest separately accounted. If repayment was not made in installments previously agreed to, a higher “penal” interest rate was charged. Another oppressive nexus involved the purchaser of crops, who in several cases was also a moneylender. In such cases, the debtor had to sell his produce at a pre-arranged time, usually the immediate post-harvest period, at a price, which was lowered to take account of the interest on the loan. Such producers, who lacked the requisite storage and transport facilities to take advantage of price variations, both inter-spatial and inter-temporal, were forced to sell off the ground, as it were, immediately after the harvest. Finally, the fact that they had to buy back grain in the peak price period made them even more inextricably trapped in debt for they had to borrow in order to buy. Tenants, who formed a very significant proportion of the working population in the colonial period, were the worst affected because for them an extra source of exploitation was added – the rent-relationship. Rent payments were generally fixed for the immediately post-harvest period. This was particularly tough on tenants who paid rent in cash. Tenants were not allowed to lift the crop off the ground until the rent had been paid. The moneylender was not merely a source of credit; he often combined the roles of crop buyer, labour employer and land lessor. “Real” rates of interest were then not just the “rate” charged. They were also hidden in the lower price paid for produce sold, exploitative wage rates and rents charged for land leased. This interlocked grid worked in tandem with the oppressive caste system as a powerful nexus of exploitation, which became the basis for the pauperization of the peasantry in the colonial period. The balance of power was terribly skewed against the poorer, “lower” caste farmers, who faced a cumulative and cascading spiral of expropriation. In such a situation, productive investments were virtually impossible to visualise for the vast majority of India’s peasants. Worse, even basic consumption needs were hard to meet, with an external ecological crisis such as a drought being enough to tilt the balance and endanger survival itself, especially when the state provided little or no social security.

In trying to understand the case for nationalisation, it is useful to remember that government control over banking was the norm in most low-income countries in the four decades after the First World War. Similar state-led rural finance programmes were spread across the developing world in the post-colonial period. State control over banking to act as an engine of structural change and the attack on poverty was part of the orthodoxy of development economics at that time. Perhaps the first intellectual case for nationalisation of commercial banks in India was made in a public lecture delivered by K N Raj in 1965. Raj felt that “there are important reasons why banking enterprises seeking to maximise their profits would not venture out into areas and sectors of activity to which high priority needs to be attached from a larger social and economic point of view.” Thus, rural credit was not merely a commodity that needed to reach the poor to free them from usurious moneylenders, it could also be seen as a public good critical to the development of a backward agrarian economy like India, especially as Indian agriculture moved decisively into the green revolution phase, where private investments by richer farmers needed massive credit support. Private Banks operating in an imperfect credit market would only aggravate already existing imperfections. Keynes had already provided the theoretical foundations of this view in the 1930s. Applying the insights of Keynes to a deeply unequal agrarian economy like India, Raj argues that “the very basis of profit-making in banking activity sets limits in underdeveloped economies to the enterprise it can display.” There are high information and transaction costs of dealing with many small borrowers that act as a major disincentive

The historic all India rural credit survey (AIRCS) carried out in 1954 confirmed that formal credit institutions provided less than 9 per cent of rural credit needs in India. Moneylenders, traders and rich landlords accounted for more than 75 per cent of rural credit. Cooperative credit societies had already been in existence for 50 years but their share in rural credit was still less than 5 per cent. In 1951, the AIRCS found that the share of banks in rural credit was less than 1 per cent. Up until 1961, no village in India even had a bank, and only 50% of Indian towns had bank branch. In 1961, only 1% of Indian villages had a bank. The theoretical explanation for this was simple—a profit maximisation bank will only go where profits lay, and

they saw no profits in Indian agriculture leading to a scenario wherein a sector contributing almost 50% to the GDP got negligible to no credit at all! Note that while industry accounted for a mere 15 per cent of national income, its share in commercial bank credit was nearly 67 per cent.

Nationalisation was aimed at redressing these inequities. The idea was to reduce the average population served by a bank branch and to reduce disparities in this across states. After nationalisation, branch expansion was deliberately skewed towards previously unbanked or under-banked rural and semi-urban areas. The RBI created a comprehensive list of unbanked locations in India that it circulated every few years to all banks. In 1970, the RBI formulated its first “socially coercive” licensing criterion-based on this data. For every new branch in an already banked area (with one or more branches), each bank would have to open at least three branches in unbanked rural or semi-urban areas. The RBI directed that all semi-urban locations would have to be covered by the end of 1970. In 1977, the RBI further upped the wager – the banked-unbanked license ratio was raised to 1:4. In 1976, the regional rural banks (RRBs) were created. The RRB act states that RRBs were set up to develop the rural economy by providing “credit and other facilities, particularly to small and marginal farmers, agricultural labourers, artisans and small entrepreneurs.” Other than directing credit to hitherto unbanked geographical regions, the RBI also sought to influence the sectorial orientation of bank lending. In 1972, the definition of certain “priority” sectors was formalised. These included agriculture and allied activities and small-scale and cottage industries. A target of 33 per cent lending to the priority sector was set in 1975 (to be achieved by March 1979). In 1979, the target was raised to 40 per cent (to be achieved by 1985). In 1980, sub-targets were set: 16 per cent of lending was to go to agriculture and 10 per cent had to be targeted at “weaker sections.”

Something fairly dramatic happened in the 20 years following bank nationalisation. The share of rural money lenders was as high as 91% before 1961. This went down to 84% in 1961 and 68% in 1971 due to co-operatives. However, post nationalisation, this number dramatically fell down to 37% in 1981! This led to agricultural development through great income rise. This was the kind of change brought about by nationalisation.

What was the Green Revolution? What were its elements? State merits and demerits.

The famine of the 1960s in India served as major predicament to what was known as the Green Revolution. To counter similar food crisis in the future, and to achieve food security in India, a number of reforms were introduced to the Agriculture Sector. Green Revolution in India was a period during which agriculture in India increased its yields due to improved agronomic technology. It allowed India to overcome chronic food defects.

Green revolution refers to the quantum jump in food grain production following the use of high yielding varieties, fertilizers and pesticides coupled with expansion of irrigation facility, multiple cropping and use of modern mechanized implements like tractors, threshers, harvesters etc. The Green revolution came on the scene around the middle of the sixties, beginning with Kharif crop of 1966. It happened because of certain circumstances like drought conditions, which prevailed during 1965-66 and 1966-67. These were also the years when the seeds of high yielding variety became available. It led to enhanced agricultural production providing security to India in food grain production. Prior to Green revolution the problem of hunger and malnutrition prevailed in the country and the demand of food was fulfilled through imported food grains from abroad.

The "revolution" began in the 1960s through the introduction of high-yield crop varieties and application of modern agricultural techniques, and led to an increase in food production in India. The HYVs need multiplied amount of fertilisers to sustain themselves. This in turn means that the soil needs an excess of irrigation. Because of the rise in the water-level, the number of pests also rises. To counter the damage to the crops because of the presence of these pests, synthetic pesticides are used. The process leads to a massive increase in agricultural output. The main elements of the Green Revolution are thus:

1. Hybrid/High-Yielding Varieties of Seeds

2. Chemical Fertilisers

3. Irrigation

4. Synthetic Pesticides and Insecticides

The Green revolution triggered by high yielding varieties brought a complete change in production technology, marketing, storage and extension. The production of food grains by 1977 grew so much that imports were stopped, old debts were paid and the country became self-sufficient. The production of food grains rose from less than 61 million tonnes in 1949-50 to 131 million tonnes in 1978. The production of cereals (rice, wheat, maize and barley) rose from less than 51 million tonnes to about 120 million tonnes during the same period. By the end of 20th century the food grain production rose to 209 million tonnes with a buffer stock at around 6o million tonnes. In 2013 the food grain production in the country has reached to about 259 million tonnes.

The merits of the Green Revolution were thus as follows:

1. Increase in Agricultural Production: As mentioned above.

2. Prosperity of Farmers: With the increase in the agricultural production, the earnings of the famers also increased and they become relatively prosperous. This, however, was limited only to the farmers who were already better off and could afford the cost of the Green Revolution technologies. However, this has given rise to the trend of capitalistic farming.

3. Reduction in Import of Food Grains: Closer to achieving self-sufficiency in food-grains. There is sufficient stock in the central pool. The per capita net availability of food grains also increased from 395 grams/day in the 1950s to 463 grams/day on 2003.

4. Industrial Growth: It brought about large-scale farm mechanisation which created demand for different types of machines like tractors, harvesters, threshers, motors, pumps, etc. Consequently, agro based industries producing these goods have progressed massively.

5. Price Control

6. Rural Employment in Punjab: Due to trends of multiple cropping and use of fertilizers, rural employment in Punjab also saw an appreciable rise.

Despite the early benefits, it became apparent that there were many negative impacts of the Green Revolution. The Green revolution initiated with motive to achieve self-sufficiency in food grain production fulfilled the desired goal. However, its several harmful effects are evident now. The burgeoning problems of land degradation, deforestation, environmental pollution, depletion of biodiversity, increased incidence of mosquito borne diseases, pest resurgence, lowering of ground water table are the results of Green revolution in India. The harmful effects of Green revolution on ecology and environment, human health and agriculture are as follows:

1. Inter-crop Imbalances: It was only a wheat and rice revolution. It has wrested areas from coarse cereals, pulses and oilseeds. The HYV seeds in latter crops have either not been developed so far at all, or they are not good enough for farmers to risk their adoption. Consequently, their cultivation is fast becoming uneconomic and they are often given up in favour of wheat or even rice. The result is that an excess of production in two main food-grains (wheat and rice) and shortages in most others today prevail side by side.

2. Regional Disparities: Green Revolution technology has given birth to growing disparities in economic development at interred and intra-regional levels. It has so far affected only 40 per cent of the total cropped area and 60 per cent is still untouched by it. The most affected areas are Punjab, Haryana and western Uttar Pradesh in the north and Andhra Pradesh and Tamil Nadu in the south. It has hardly touched the Eastern region, including Assam, Bihar, West Bengal and Orissa and arid and semi-arid areas of Western and Southern India. In short, Green Revolution affected only those areas which were already better placed from agricultural point of view. Thus the problem of regional disparities has further aggravated as a result of Green Revolution.

3. Increase in Inter-Personal Inequalities: It has been observed that it is the big farmer having 10 hectares or more land, who is benefited the most from Green Revolution because he has the financial resources to purchase farm implements, better seeds, fertilizers and can arrange for regular supply of irrigation water to the crops. As against this, the small and marginal farmers do not have the financial resources to purchase these farm inputs and are deprived of the benefits of Green Revolution Technology. There were about 1,053 lakh holdings in India in 1990-91 out of which only 1.6 per cent exceeded 10 hectares in size.

4. Unemployment: Except in Punjab, and to some extent in Haryana, farm mechanization under Green Revolution has created widespread unemployment among agricultural labourers in the rural areas. The worst hit are the poor and the landless people.

5. Ecological Effects: The worst effect of Green revolution has been witnessed on the ecology and environment of the country. Green revolution has caused marked decline in the forest cover of India. Use of modern mechanical instruments has led to large scale deforestation for the agricultural practices.  Deforestation has led to the problem of drought, siltation of rivers and dams, flood, loss of biodiversity, global warming, lowering of ground water table etc. Indiscriminate use of fertilizers and pesticides for enhanced crop yield has caused the problem of air, water and soil pollution. The inorganic fertilizers containing high levels of uranium applied to the field are drained by rain water to rivers and lakes causing water pollution. Ground water is also being depleted. Soil erosion which is the removal of the top soil cover is the result of Green revolution. The nutrients, organic matter and microbial population are mostly concentrated in the top layer of the soil. Thus the top soil is core of soil fertility. The intensive cultivation practices under Green revolution without fallowing have put severe pressure on land resources leading to the problem of soil erosion. Excessive use and mismanagement of water resources has resulted into the problem of soil salinity, alkalinity and water logging. The increased use of pesticides has enabled the pests to develop resistance against the pesticides. This has led to the problem of pest resurgence and multiplication.

6. Human Health: The construction of canals to boost the agricultural production under Green revolution package technology has led to spread and outbreak of mosquito borne diseases. A commonly used pesticide for the control of pests in rice crop is highly hazardous as it causes serious eye, kidney and liver disorders. The harmful effects on human health have been reported from the state of Kerala. Pesticides like DDT are non-biodegradable and are fat-soluble which enter the food chain and reach the human body where they are deposited in adipose tissue. When oxidation of the fat takes place in body the pesticides are released in the system causing harmful effect to human health. One of the most dramatic and harmful effects of the Green Revolution can perhaps be seen in Punjab, where the rise of uranium has contaminated water to such an extent, that the state has witnessed an unprecedented increase in the number of cancer cases. In fact, there’s a train that runs from Punjab to the countries medical hubs called The Cancer Express.

Green revolution in India has led to substantial increase in food grain production but has created threatening problems of deforestation, soil erosion, soil salinity, environmental

degradation, loss of crop diversity, pest resurgence, increased incidence of mosquito borne diseases etc. Therefore, the advantages of the Green revolution have been masked by the problems posed by it. Therefore it is the need of the hour to shift from fertilizer and pesticides based conventional agriculture practices to natural and renewable resource based sustainable agriculture, which is cheap, environment friendly and emphasizes on the conservation of natural resources.

What is the logic for government intervention in the market for food?

. Producers didn’t know if their produce will sell. Applying Keynes’ Theory of Uncertainty, the producers in the food market can’t know if their expectations will be realised in the food economy, i.e., the future of their produce is uncertain. The scale on which production needs to be undertaken depends on the costs of production and the prices which are expected to be realised in the market. Lack of an effective demand that is met to this production can severely hamper a farmer’s livelihood in an agrarian market. For poor to medium farmers, this threat of non-realisation of the expected demand very often came true, pushing them into severe debt.

The FCI was set up to curb this problem of realisation for the farmers. With the introduction of the MSP, the farmers were guaranteed a minimum price for their produce by the government, thus causing the government to intervene in the food economy and make it hand visible. This was done to ensure the farmers that they were at the centre of food security. The cost structure and optimal profit margin for the farmers was taken into consideration before deciding the MSP.

The produce was procured by the FCI from the farmers at a MSP. Allocation at Central Issue Price happened here, before the produce was transferred to the state governments. From here, the produce was distributed to the various Fair-Price Shops known as PDS or Public Distribution Systems or Ration Shops from where they are sold at the central issue price to the beneficiaries.

India’s Public Distribution System (PDS) is the largest distribution network of its kind in the world. PDS was introduced around World War II as a war-time rationing measure. Before the 1960s, distribution through PDS was generally dependant on imports of food grains. It was expanded in the 1960s as a response to the severe food shortages of the time; subsequently, the government set up the Agriculture Prices Commission and the Food Corporation of India to improve domestic procurement and storage of food grains for PDS. By the 1970s, PDS had evolved into a universal scheme for the distribution of subsidised food. In the 1990s, the scheme was revamped to improve access of food grains to people in hilly and inaccessible areas, and to target the poor. Subsequently, in 1997, the government launched the Targeted Public Distribution System (TPDS), with a focus on the poor. TPDS aims to provide subsidised food and fuel to the poor through a network of ration shops. Food grains such as rice and wheat that are provided under TPDS are procured from farmers, allocated to states and delivered to the ration shop where the beneficiary buys his entitlement. The centre and states share the responsibilities of identifying the poor, procuring grains and delivering food grains to beneficiaries.

Government intervened in the Food Economy mainly because the free capitalist economy failed to deliver. As mentioned above, the producers faced the challenge of realisation. Say’s Law didn’t operate. Supply did not create its own demand. Rural Credit was at a high, and produce was going to waste as it was not effectively distributed. India faced a major famine in the 1960s because of the way agrarian development was ignored hitherto. The free food market had miserably failed to deliver. Because of the problem of distribution, the produce didn’t reach the beneficiaries. Sometimes the cost was so high that the poor could not afford the necessary goods. Price control as promised by a capitalist economy was not realised. Government intervention provided a corrective to both these problems. The problem of uncertainty was curbed by offering a MSP to the farmers, and the problem of access was curbed by providing food grains and other essential items to vulnerable sections of the society at reasonable (subsidised) prices.