Getting the Micro-foundations Right

The pedants in the Union Ministry of Finance may deride Keynesian macroeconomics, claim that it is fundamentally flawed because of the lack of a firm micro-foundation, but year after year the Economic Survey that they bring out consciously goes out of its way to boost “investor confidence”. Keynes, of course, emphasised the importance of the state of long-term expectations and the fragility of such beliefs in his explanation of the insufficiency of private investment, and as far as this is concerned, the learned in North Block never fail to do what is required of them – paint as rosy a picture as is possible of the state of the Indian economy. So, in the just released Economic Survey 2010-11 they confidently claim, in one place, that “the economy has moved closer to the pre-crisis levels”, and, soon thereafter, more upbeat, that the economic recovery “is at the robust level that obtained prior to the global crisis”. And, when they talk of the medium to long term, given “the momentum in the savings and investment rates and...that India’s demographic dividend is yet to peak”, the mandarins expect that “India’s pace of economic development will pick up even more”. This is, of course, predicated upon getting the “micro-foundations of macroeconomic development” right, and in accordance with what they prescribe in chapter 2 of the Survey.

The growth of gross domestic product (GDP) at factor cost at 2004-05 prices in the present financial year, according to the advance estimates, is 8.6%, up from the quick estimate of 8.0% for 2009-10, but is not quite at the average GDP growth rate of 9.5% for the years 2005-06 to 2007-08, that is, before the global financial crisis. And, there is no doubt that the step-up in public expenditure in the fourth quarter of 2008-09 and in 2009-10 contributed to this recovery from the dip to a GDP growth rate of 6.8% in 2008-09. Moreover, though the Survey skirts this, the rebound in the agricultural sector in the current financial year – GDP at factor cost in agriculture, forestry and fishing at 2004-05 prices is expected to grow at 5.4% this year compared to (-)0.4% and 0.4% in 2008-09 and 2009-10 respectively – may have itself raised the demand for the output of the industrial and services sectors.