Everyone now knows at least something about the big problems in the Indian economy: slow or no employment growth and growing youth unemployment; farmers’ distress; increasing inequality. But one significant issue has escaped public attention—the falling investment rate. Since 2011-12, the share of gross fixed capital formation (or investment) to national income has fallen quite significantly, by nearly 6 percentage points of GDP estimated at current prices, and slightly less at constant prices (taking account of inflation).
Why should this matter? After all, the economy seems to be growing quite fast even with a lower investment rate (which is in itself a bit of a surprise). Why should we even expect the investment rate to keep rising, and why should we worry if it falls?
The most obvious reason is that economic growth depends on investment. But in any case, the development project in India is still far from complete—and the kind of structural change and diversification that will be needed to deliver better incomes and employment conditions to the bulk of India’s population will simply not be possible without much more investment. But then the question is how this investment is going to come about and what form it takes. Should it be more public or private? Should it depend mostly on large corporate players or hope for small and medium firms to invest and emerge?
The kind of structural change and diversification that will be needed to deliver better incomes and employment conditions to the bulk of India’s population will simply not be possible without much more investment.
The economic strategy of the past two decades essentially relied on large corporate investment to deliver more investment, and therefore more growth, productivity, and formal sectors jobs. At least, that was the goal. And in pursuit of this goal, it was believed that the large private corporate sector needs to be incentivised in every possible way: through access to relatively cheap credit (much of which has not been repaid), provision of subsidised inputs, amenities, land, natural resources—and of course, cheap labour.
This strategy worked for a while, especially during the boom of the 2000s, when GDP grew rapidly and investment rates picked up, pushing growth up further. But there were many adverse fallouts: terrible environmental damage, growing bad loans with banks, rising inequality and a proliferation of “scams” that were the by-product of all these incentives being offered to big capitalists. But that process has run out of steam, and corporate India (and foreign investors) is no longer showing the same appetite for investment.
There are many reasons for this decline in investment rates, including the weight of the bad loans in the banking system, projects that are held up or delayed because of environmental and legal concerns and so on. But a very big reason is the fact that the domestic market is not growing sufficiently for a range of consumer goods, because wage incomes have been suppressed. It is ironic—but predictable—that the strategy to deliver more profits to corporates by suppressing wages has ended up reducing potential profits by shrinking the potential market. The focus on large companies also left out the small and medium enterprises that provide the bulk of employment in the country, which have also suffered the most due to policies like demonetisation and the poorly implemented GST.
That decline in investment, especially by SMEs, is also a big reason why employment is simply not growing fast enough to meet the needs of the young educated population, and why it is so very hard for them to find jobs that meet their aspirations.
Obviously, to revive investment it is necessary to revive demand, especially by putting incomes in the hands of the poor. Also, it is well known that public investment has a strong positive effect on private investment, through its linkage effects and because it can provide much-needed infrastructure. This is particularly true for SMEs, who would also benefit greatly from a package providing access to credit, input and markets. So the solution to this problem is in the government’s hands, if it could only recognise this.