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Author: Nilanjan Ghosh and Soumya Bhowmick, Observer Research Foundation

The Indian economy is yet again at a crossroads. The country’s second wave of COVID-19 had repercussions across the economy and on people’s personal lives and mental spaces, and it laid bare the widening gap between rich and poor. The figures now reveal that such inequalities are impacting the medium and long-term growth prospects of the economy.

After a growth rate of -7.3 per cent in 2020–21, the economy showed signs of revival in the first two quarters of 2021–22 with growth rates of 20.1 per cent and 8.4 per cent. While this revival is largely due to to a lowered GDP base created by the lockdown of the economy, the drivers of growth have largely been the industrial revival with mining and metallic minerals showing double digit growth rates.

The nation-wide lockdown in 2020 — which was tantamount to locking down market forces — exacerbated the anguishes of migrant labour, micro and small enterprises, and the poor. This implies that in the absence of social security in a developing nation like India, social cushioning is provided by market forces — a situation suggestive of policy failure. The failure of distribution and equity became all too apparent.

The Indian growth story has largely been consumption-driven over the last three decades since economic liberalisation, marking the emergence of a new Indian economy that transitioned from a supply-constrained to a demand-constrained one. Comparing growth rates for GDP and its components — private final consumption expenditure and gross fixed capital formation over the last three fiscal years — there has been a systemic decline in trend growth rates.

Even as the government resorted to the introduction of several fiscal stimulus packages over the last two years, there was an actual decline in the growth rates of government final consumption expenditure, in real terms, from 7.9 per cent in 2019–20 to 2.9 per cent in 2020–21.

Growth over the first two quarters of 2021–22 has largely been driven by the private consumption that constitutes more than 55 per cent of GDP. Likewise, negative growth rates in 2020–21 were associated with a decline in private final consumption. Compared to a -24.7 per cent and -8.24 per cent change respectively in private consumption figures in the first two quarters of 2020–21, the first two quarters of 2021–22 witnessed consumption growth of 29.2 per cent and 16.9 per cent respectively. Even government consumption expenditure and gross fixed capital formation have revealed enormous growth in 2021–22, but its proportional contribution to GDP is low.

This is clear testimony to the fact that the remedial measures for reviving the Indian economy should be focussed on policies aimed at demand factors — especially private consumption demand — rather than the supply-side interventions attempted so far. The Union Budget of February 2021 announced multiple small and midsize packages to ameliorate supply chain issues without incentivising consumption demand by reducing direct taxes. The present consumption-led-growth, which would essentially drive an increase in productive capacity in the domestic economy, can be viewed as an unfolding of ‘latent demand’ that could not find an outlet during the pandemic-driven lockdown of 2020.

There is another important connotation of supporting the consumption base of the Indian economy. Income inequality in India has risen through the years and has been further aggravated by the pandemic, with vulnerable groups being largely affected. Going by the economic fundamentals, lower income groups tend to have a higher propensity to consume, while higher income groups are more likely to save or put income towards assets. This implies that a rise of income among lower income groups has a higher chance of boosting the consumption channel of the economy than an increase in income for higher income groups.

This also means the increasing income inequality in India is leading to a faster increase in wealth inequality. According to data from the World Inequality Database, the possession of wealth of the top 1 per cent of India increased from 16.1 per cent in 1991 to 31.7 per cent in 2020. On the other hand, the proportion of wealth of the bottom 50 per cent of the population declined from 8.8 per cent in 1991 to 6 per cent in 2020.

The divergence of income and wealth inequality will have dire implications on the long-term health of the economy, directly affecting growth prospects in recovery periods. It not only impedes skill enhancement for a large section of the population, but it also traps the labour force in cycles of low productivity and ‘low-return occupations’ due to the unavailability of resources.

In an economy where growth is largely consumption-driven, it is important that income reaches the hands of the lower and the middle-income groups. This extra money in the hands of the lower and middle incomes groups will reach into the consumption channel, spurring consumption-driven growth. India’s policy response needs to be ‘Keynesian’ — greater wealth taxation to channel resources towards social goals. This needs to be complemented by economic empowerment at the grassroots level by revitalising social security schemes targeted at income generation for lower income groups.

Nilanjan Ghosh is Director of the Centre for New Economic Diplomacy and ORF Kolkata Centre at the Observer Research Foundation.

Soumya Bhowmick is Associate Fellow at the Observer Research Foundation.

This article is part of an EAF special feature series on 2021 in review and the year ahead.

The post Boosting consumption to lift growth in India first appeared on News JU.

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