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Wednesday, February 27, 2013

Why GDP growth might endanger the economy of India: A commonsense POV

I’m not an economist. I’m not a financial maverick either. So whatever I say and write about economics and finance might not be right, essentially. At the same time, that is not wrong, automatically. “For, the opposite of right is not always wrong.” Just like the opposite of light is not always darkness, as darkness is nothing but a huge scarcity of light and the huge scarcity of light is not opposite to light.

Exactly in the same way, GDP (Gross Domestic Product) growth doesn’t necessarily mean the growth of an economy unless and until the income (real and relative) of people gets increased in a country.

There are many arguments that can be put forth to prove the ineptness of GDP for an economic growth. However, in my humble opinion, SUBSTITUTION EFFECT is a much better way to do that – since, it’s very easy to comprehend.

But easy comprehension doesn’t guarantee that something is unquestionable or doubtless; hence, no such claim or presumption should be made that SUBSTITUTION EFFECT is a full-proof mechanism.

Let’s take for granted:
a)      q1 = superior goods’ price and q2 = inferior goods’ price
b)      One’s income (p1) is fixed, thinking it’s only his real income minus any relative component attached to that

Now, assume one consumes 11-unit of goods at q1 and 8-unit of goods at q2 per month – which is shown with the point (A) on the indifference curve. The tangent onto this curve is the initial budget line for the consumer.

[See the graph below]

In case, there is an increase at q1 as against q2, q3, q4, etc., a change occurs in the consumption pattern due to which the point (A) becomes the point (E).

In that situation, the consumer consumes 4-unit of superior goods and 10-unit of inferior goods and his budget line gets shifted drastically adjusting to the price change happened along q1, as well as to his income change, since, the moment he was compelled to use inferior products he turned worse off than before.

However, that is not considered given the assumption that his real income (p1) is fixed. The shifted and subsequent budget line is the tangent onto the indifference curve on which (E) is established.

But, as the real income is fixed, the consumer tries to further adjust to the situation by balancing between the initial budget line and the subsequent budget line with his disposable income, because, in an economy, everyone always tries to get better off i.e. to use superior goods.

So, the consumer pushes his consumption of superiors goods close to 8-unit along q1 from 4 that consequently increases the consumption of inferior goods close to 15-unit from 10 along q2.

That is shown with the point (G) on the same indifference curve which holds the point (A) because the real income is fixed. The tangent drawn onto the curve touching the point (G) and parallel to the subsequent budget line becomes the ‘ideal budget line’ in the changing or testing condition while a price rise (of superior goods only by default) takes place.

The difference between the point (E) and the point (G) is the ‘substitution effect’, consumers often indulge in, even during inflation, that eventually helps the GDP growth. Whereas such growth doesn’t mean any increase in the real income thereby hardly helps one’s savings. And if savings is not possible, one cannot invest in Education because scholarships are not available at every standard and to everyone. Once investment is not done in Education, Human Capital tends to become non-productive and in the process, a nation’s overall productivity and intelligence hampers so does the Economy.  

This boils down to the fact that if without increasing the real income options i.e. employments, if only GDP growth is targeted through consumerism, the economy of a nation can never grow. Instead, that economy turns brittle and obscure, and always remains developing being perpetually underdeveloped.

Make no mistake that is THE danger, Indian Economy is exposed to. Unless, of course, India seriously thinks to increase its employment elasticity by patronising manufacturing sector more and more that will eventually help the service industries like IT, Telecom, Banking, et al.

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