Sam eco e

- IInd Floor, Paliwal Market, Gumanpura KOTA (-0744 -2392059 & 3290500

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ECONOMICS ESSAYSAGRICULTURE A COLOSSAL NEGLECT

Now one may find that the same has happened with ouragriculture. The suicides in 2007 and 2008 in AndhraPradesh are just the beginning. Bihar and other easternstates have been facing floods on regular basis. Things maygo further worse. For example, Bihar has no industry, it haslost its minerals and floods are killing agriculture. Underthese conditions only God is helping them.When Then I was a small boy, I was told that one shouldnot neglect those things, which are certain in nature andnot run after uncertain things. If it is done, the uncertainbecomes further uncertain and even the certain becomesuncertain.Agriculture (including allied activities) accounted for 17.8per cent of the Gross Domestic Product (GDP-at constantprices) in 2007-08 as compared to 21.7 per cent in 2003-04. Notwithstanding the fact that the share of this sector inGDP has been declining over the years, its role remainscritical as it accounts for about 52 per cent of the employ-ment in the country. Apart from being the provider of foodand fodder, its importance also stems from the raw materi-als that it provides to industry. The prosperity of the ruraleconomy is also closely linked to agriculture and alliedactivities. Agricultural sector contributed 12.2 per cent ofnational exports in 2007-08. The rural sector (including ag-riculture) is being increasingly seen as a potential sourceof domestic demand; a recognition, that is shaping the mar-keting strategies of entrepreneurs wishing to widen the de-mand for goods and services. Indian agriculture suffers froma mismatch between food crops and cash crops, low yieldsper hectare except for wheat, volatility in production andwide disparities of productivity over regions and crops. Thedomestic production of pulses and oilseeds are still belowthe domestic requirements and India imports pulses andedible oils to satisfy domestic demands. Further, a distinctbias in agricultural price support policies in favour of riceand wheat has distorted cropping pattern and input usage.Food management is inefficient with unsustainable level offood subsidies imposing heaving burden on Government fi-nance. The rural economy and the private sector severelylack the basic infrastructure to build sufficient buffer stocks,and the country remains vulnerable to weather stocks. Therural credit is one of the most concerned areas. The CreditDeposit Ratio (CDR) in rural areas for both public and pri-vate sector banks was substantially low compared to ur-ban and metropolitan areas. The Gross Capital Formation(GCF) in agriculture as a proportion to the total GDP hasshown a decline from 2.9 per cent in 2001-02 to 2.5 percent in 2007-08.The agriculture sector faces challenges on various fronts.On the supply side, the yield of most crops has not im-proved significantly and in some cases fluctuated down-wards. The scope for increase in the net sown area is lim-ited and farm size has been shrinking. In the case of cer-tain crops like sugarcane, extreme variability in the acre-age and production over the years has been a matter ofconcern. On the other hand, in the case of pulses, pro-duction has just not kept pace with the requirement leadingto a rise in prices given that its availability in the interna-tional markets is limited. The ill-treatment of the agricultureappears to be the best way to preserve poverty on whichthe sectarian politics survives. The politics of poverty alle-

viation thrives only when there is persistence of poverty.Indian policy making has suffered from a typical anti-agri-culture bias since 1956, the day Indian policy makersadopted Mahalanobis model, under which agriculture wasgiven a step son treatment. Although, agriculture was al-ways out of the purview of direct taxation, yet, it has beenproved that it is heavily taxed. Protection accorded to in-dustry and over-valued exchange rate constitute an indirectand implicit tax over agriculture.Keeping domestic prices below world prices gave negativeprotection to agriculture and it was another form of taxa-tion. In this way, agriculture and poor agriculturists had tobear the brunt of generating resources for industry, whenthe sector itself was ailing. Indian agriculture and hencerural India has always been betrayed in the past, but, keptalive by occasional injections of technologies, subsidiesand sops. Formation of Commission for Agricultural Costsand Prices (CACP), introduction of seed-fertilizer-water tech-nology, formation of different cooperative societies, market-ing agencies, etc. have created a positive atmosphere foragricultural growth but, all these were short-lived and wereunable to compensate it fully. Over the past few years, lib-eralization has meant the withdrawal of several subsidiesfrom the farming sector, resulting in a sharp increase in thecost of fertilizers and seeds coupled with power hikes. Lib-eralization and globalisation are the process in the processof elimination of unfair treatment at the national and inter-national level. The protection must go. But, a State cannotforget its basic duty to protect a common man. The protec-tion cannot be withdrawn without the creation of proper in-frastructure and investment. The subsidies must be I with-drawn in proportion to the investment. There cannot be onedrug for all the diseases. Liberalisation may be pancea ofone, may not be for all. The rural credit system can bestreamlined by the following measures:(a) Self-Help Groups must be encouraged for banking inthe rural areas;(b) The rural banks must relinquish narrow banking andmust resort to universal banking;(c) Even Narasimham Committee suggested consolidationof rural branches of commercial banks into banking enti-ties;(d) There should be separate prudential norms for the ruralbanking;(e) It should be possible to devise a model in which theresources of commercial banks are available for rural lend-ing, which would be carried out through specialised banksoperating only in rural areas. The main-line commercialbanks can buyout rural loan portfolios of these rural banks;(f) The government must provide incentives in the form ofexemptions to the commercial banks to operate in ruralareas;(g) The banking system should equip itself to identify theeligible clients based on prescribed norms in the govern-ment-sponsored programmes such as IRDP rather than todepend on the government agencies;(h) The operating systems of banks and other rural financ-ing institutions (RFIs) like RRBs and District Credit Coop-erative Banks (DCCBs) in terms of appraisal, supervisionand follow up must be properly reviewed and strengthened.I strongly feel that there is urgent need to reconsider thefollowing measures:(a) India’s agricultural policy should continue to be “grain-


2

oriented”, supplemented by pulses and oilseeds;(b) Seed Act must be introduced which lays down strin-gent punishment to those who sell spurious seeds/fertiliz-ers;(c) A more comprehensive and farmer-friendly crop insur-ance policy should be formulated;(d) Food for work programme should be modified. It shouldbe restricted to construction of permanent structures, tostop diversion of grains in the name of short-term fictitiousprojects;(e) The Budget 2004-05 has also admitted that the agricul-ture sector requires massive investments. Such investmentscan be through credit-enabled private investment and en-hanced public investment. For this fiscal instruments toboost investment in agriculture would be needed;(f) The rural credit system must be revamped. The function-ing of Regional Rural Banks (RRBs) and Cooperative Banksmust be streamlined. A comprehensive rural credit deliverysystem should be evolved. The Kishan Credit Cards (KCC)suffers from adhocism. It should further be simplified;(g) Nothing has been done on long-term basis to solve theage-old flood problems in Bihar and other eastern states.The main cause of flood in North Bihar is the heavy rainfallin Nepal. The rainwater enters Bihar through Gandak, Koshi,Adhawara Group of rivers. We must take immediate mea-sures to control the rainwaters;(h) The irrigation facility is only confined to food-grain areasbut it is almost absent in the dry land areas. This avertscrop diversification. The existing Accelerated Irrigation Ben-efit Programme (AIBP) should be restructured and thereshould be a spatial growth of irrigation system. For this,both private and foreign investments should be invited;(i) Even though the horizontal productivity has been in-creased to a very large extent but the vertical productivityhas been thoroughly neglected;(j) The cropping pattern is more or less static not only be-cause of direct neglect of the same by the agricultural policyformulators but also because of the failure of various re-sponsible institutions to change the rigid socio-psycho per-spectives of farmers;(k) Introduction of rational market mechanism is indispens-able for the sustained growth of Indian farmers. For this,the subsidy provisions should be minimized and the samefinancial resource could be utilised to increase the invest-ments;(l) Green revolution produced regional disparity in the coun-try. For minimizing this negative fallout, Indian agricultureneeds area specific programmes, which could bring ever-green revolution in the country. But for this, the policy for-mulation should depend upon ground realities rather thanthey be knit in air conditioned rooms;(m) The biggest problem of Indian Agriculture is that it isstill nature ridden. Till it is brought out of the clutches ofmonsoonal vagaries, it would continue to show skewed re-sults;(n) Capital formation in agricultural sector should be madegovernment’s responsibility;(o) A transparent linkage between field and market shouldbe established so that farmers get remunerative returns androle of intermediaries can be minimized;(p) Agro-processing industries should be installed all overthe country. This would help cater domestic as well as for-eign demand. India contributes just 1 per cent of the agro-

processed products of the world. This is abysmally low;(q) Government should garner some resources by taxingincome of a few big landlords. This would ensure equityand give some money to the exchequer;(r) A shift from minimum support price system and devel-oping alternative product markets are essential for crop di-versification and broad based agricultural development;(s)The Central government must provide financial assistanceto the state Governments for procurement and distributionof food grains at subsidized rates, particularly to the fami-lies below the poverty line. Only an enhanced agriculturalgrowth would provide stimulus to other off-farm activities inrural areas due to its forward and backward linkages. Thiswould generate more employment and income in rural ar-eas, which in turn would cause reduction of poverty in theseareas;(t) APMC Act must be amended and mandi taxes shouldbe abolished. It will allow competitive markets to develop.Suggestion by Economic Survey 2008-09There is clearly a need for a renewed focus on improvingproductivity. At the same time to step up the growth of al-lied activities and non-farm activities that can help improvevalue addition. The current focus on developing rural infra-structure particularly rural roads needs to be maintained asit would go a long way in providing connectivity that is es-sential for movement of agricultural produce. The irrigationsector requires a renewed thrust both in terms of invest-ment as also modem management. There is considerablescope for development of micro-irrigation systems and wa-tersheds and in the use of a participatory approach for achiev-ing the same.There is a need to narrow the gap between producer pricesand consumer prices through proper marketing support. Thedevelopment of marketing infrastructure and storage andwarehousing and cold chains and spot markets that aredriven by modern technology will go a long way in address-ing this need.As per the Report of the Committee on Financial InclusionQanuary 2008), more than 73 per cent of farmer house-holds have no access to formal sources of credit. Innova-tive institutional mechanisms that provide credit and finan-cial products (including insurance products) specificallydesigned to meet the needs of the farm sector keepingtheir risk - bearing ability in view is the need of the hour.The rural economy needs to be viewed as comprising of acontinuum of interrelated economic activities. Farmingneeds to be dovetailed with viable off-farm and non-farmactivities. Farmers need to be facilitated to take up valueaddition such as processing of agricultural produce, horti-culture, pisciculture, poultry, development of non-farm ruralenterprises. On the distribution side, there is need to en-sure that benefits accrue to the targeted population. A mis-sion approach for promotion of smart cards and its crossreference with ration cards and voter ID cards would helpbetter targeting, lesser leakages and easier administration.An area that requires focused attention is the issue ofsustainability of agriculture with due emphasis on environ-mental concerns. Soil erosion, water logging, reduction ingroundwater table and the decline in the surface irrigationare the problems faced by agriculture. The consequencesof climate change on Indian agriculture also need to befactored in the strategy for the development of this sector.On the whole, while the challenges faced by the agriculture


3ECONOMIC GROWTH

HARROD-DOMAR MODEL,INSTABILITY OF EQUILIBRIUM.

NEOCLASSICAL GROWTHSOLOW’S MODEL,

STEADY STATE GROWTH.MODELS OF GROWTH OF

JOAN ROBINSON ANDKALDOR;

TECHNICAL PROGRESSHICKS,

HARROD ANDLEARNING BY DOING,

SOME GROWTH MODELSTHE HARROD-DOMAR MODELS

The Harrod-Domar models of economic growth are basedon the experiences of advanced economies. They areprimarily addressed to an advanced capitalist economy andattempt to analyse the requirements of steady growth insuch economy.Requirements of Steady GrowthBoth Harrod and Domar are interested in discovering therate of income growth necessary for a smooth anduninterrupted working of the economy. Though their modelsdiffer in details, yet they arrive at similar conclusions.Harrod and Domar assign a key role to investment in theprocess of economic growth. But they lay emphasis on thedual character of investment. Firstly, it creates income, andsecondly, it augments the productive capacity of theeconomy by increasing its capital stock. The former maybe regarded as the ‘demand effect’ and the latter the ‘supplyeffect’ of investment. Hence so long as net investment istaking place, real income and output will continue to expand.However, for maintaining .a full employment equilibrium levelof income from year to year, it is necessary that both realincome and output should expand at the same rate at whichthe productive capacity of the capital stock is expanding.Otherwise, any divergence between the two will lead toexcess or idle capacity, thus forcing entrepreneurs to curtailtheir investment expenditures. Ultimately, it will adverselyaffect the economy by lowering incomes and employment.in the subsequent periods and moving the economy off theequilibrium path of steady growth. Thus, if full employmentis to be maintained in the long run, net investment shouldexpand continuously. This further requires continuous growthin real income at a rate sufficient enough to ensure fullcapacity use of a growing stock of capital. Thus requiredrate of income growth may be called the warranted rate ofgrowth or “the full capacity growth rate.”AssumptionsThe models constructed by Harrod and Domar are basedon the following assumptions.(1) There is an initial full employment equilibrium level ofincome.(2) There is the absence of government interference.(3) These models operate in a closed economy which hasno foreign trade.(4) There are no lags in adjustments between investmentand creation of productive capacity.(5) The average propensity to save is equal to the marginalpropensity to save.(6) The marginal propensity to save remains constant.(7) The capital coefficient, i.e., the ratio of capital stock toincome is assumed to be fixed.

(8) There is no depreciation of capital goods which areassumed to possess infinite life.(9) Saving and investment relate to the income of the sameyear.(10) The general price level is constant, i.e., the moneyincome and he real income are the same.(11) There are no changes in interest rates.(12) There is a fixed proportion of capital and labour in theproductive process.(13) Fixed and circulating capitals are lumped together undercapital.Lastly, there is only one type of product.All these assumptions are not necessary for the final solutionof the problem; nevertheless they serve the purpose ofsimplifying the analysis.

THE DOMAR MODELDomar builds his model around the following question: sinceinvestment generates income on the one hand and increasesproductive capacity on the other, at what rate investmentshould increase in order to make the increase in incomeequal to the increase in productive capacity, so that fullemployment is maintained?He answers this question by forging a link betweenaggregate supply and aggregate demand throughinvestment.Increase in Productive Capacity. Domar explains thesupply side like this. Let the annual rate of investment be /, and the annual productive capacity per dollar of newlycreated capital be equal on the average to s (whichrepresents the ratio of increase in real income or output toan increase in capital or is the reciprocal of the acceleratoror the marginal capital-output ratio). Thus the productivecapacity of /dollar invested will be I.s dollars per year.But some new investment will be at the expense of the old.It will, therefore, compete with the latter for labour marketsand other factors of production. As a result, the output ofold plants will be curtailed and the increase in the annualoutput (productive capacity) of the economy will be somewhatless than I.s. This can be indicated as la; where a (sigma)represents the net potential social average productivity of

investment ( I/YÄ= ). Accordingly la is less than I.s. la

is the total net potential increase in output of the economyand is known as the sigma effect. In Domar’s words this “isthe increase in output which the economy can produce,” itis the “supply side of our system.”Required Increase in Aggregate Demand. The demandside is explained by the Keynesian multiplier. Let the annualincrease in income be denoted by ÄY and the increase ininvestment by A/and the propensity to save by a (alpha)(= Ä S/Ä Y). Then the increase in income will be equal tothe multiplier (I/α) times* the increase in investment.

á

1IÄYÄ =

Equilibrium. To maintain full employment equilibrium levelof income, aggregate demand should be equal to aggregatesupply. Thus we arrive at the fundamental equation of themodel

∆I I1

ασ=

Solving this equation by dividing both sides by /and


4

multiplying by we get :

∆I

I= ασ

This equation shows that to maintain full employment thegrowth rate of net autonomous investment ( I/IÄ ) must beequal to ασ (the MPS times the productivity of capital).This is the rate at which investment must grow to assurethe use of potential capacity in order to maintain a steadygrowth rate of the economy at full employment.Domar gives a numerical example to explain his point: Letσ =25 per cent per year, α=12 percent and Y=150 billiondollars per year. If full employment is to be maintained, anamount equal to 150x12/100=18 billion dollars should beinvested This will raise productive capacity by the amountinvested ‘y times, i.e., by 150x12/100x25/100=4.5 billiondollars, and the natioiial income will have to rise by thesame amount. But the relative rise in income will equal theabsolute increase divided by the income itself, i.e.,

150

12100

25100

150

12

100

25

1003x

xx percent= = =ασ

Thus in order to maintain full employment, income mustgrow at a rate of 3 per cent per annum. This is the equilibriumrate of growth. Any divergence from this ‘golden path’ willlead to cyclical fluctuations. When I/IÄ is greater than

aa, the economy would experience boom and when I/IÄis less than acr, it would suffer from depression.The Harrod ModelProfessor R.F. Harrod tries to show in his model how steady(i.e., equilibrium) growth may occur in the economy. Oncethe steady growth rate is interrupted and the economy fallsinto disequilibrium, cumulative forces tend to perpetuatethis divergence thereby leading to either secular deflationof secular inflation.The Harrod Model is based upon three distinct rates ofgrowth. Firstly, there is the actual growth rate representedby G which is determined by the saving ratio and the capital-output ratio. It shows short-run cyclical variations in therate of growth. Secondly, there is the warranted growth raterepresented by Gw which is the full capacity growth rate ofincome of an economy. Lastly, there is the natural growthrate represented by Gn which is regarded as ‘the welfareoptimum’ by Harrod. It may also be called the potential orthe full employment rate of growth.The Actual Growth Rate. In the Harrodian model the firstfundamental equation is:

GC = s ...(1)where G is the rate of growth of output in a given period oftime and can be expressed as Y/YÄ ; C is the net additionto capital and is defined as the ratio of investment to theincrease in income, i.e., YÄ/I and s is the averagepropensity to save, i.e., S/Y. Substituting these ratios inthe above equation we see

SIorYS

YI

orYS

YÄI

YYÄ ===×

The equation is simply a re-statement of the truism thatexpost (actual, realized) savings equal expost investment.The above relationship is disclosed by the behaviour of

income. Whereas S depends on Y, I depends on the

increment in income ( )YÄ , the latter '. nothing but the

acceleration principle.The Warranted Rate of Growth. The warranted rate ofgrowth is, according to Harrod, the rate “at which producerswill be content with what they are doing.” It is the“entrepreneurial equilibrium; it is the line of advance which,if achieved, will satisfy profit takers that they have done theright thing.” Thus this growth rate is primarily related to thebehaviour of businessmen. At the warranted rate of growth,demand is high enough for businessmen to sell what theyhave produced and they will continue to produce at the samepercentage rate of growth. Thus, it is the path on which thesupply and demand for goods and services will remain inequilibrium, given the propensity to save. The equation forthe warranted rate is

GwCr=s ...(2)where Gw is the “warranted rate of growth” or the full capacityrate of growth of income which will fully utilize a growingstock of capital that will satisfy the entrepreneurs with theamount of investment actually made. It is the value of

Y/YÄ Cr, the ‘capital requirements’, denotes the amountof capital needed to maintain the warranted rate of growth,i.e., required capital-output ratio.It is the value of YÄ/I orC. s is the same as in the first equation, i.e., S/Y.The equation, therefore, states that if the economy is toadvance at the steady rate of Gw that will fully utilize itscapacity, income must grow at the rate of s/Cr per yeari.e., Gw=s/Cr.If income .grows at the warranted rate, the capital stock ofthe economy will be fully utilised and entrepreneurs will bewilling to continue to invest the amount of saving generatedat full potential income. Gw is therefore a self-sustainingrate of growth and if the economy continues to grow at thisrate it will follow the equilibrium path.Genesis of Long-run Disequilibria. Full employmentgrowth, the-actual growth rate of G must equal Gw, thewarranted rate of growth that would give steady advance tothe economy and C (the actual capital goods) must equalCr (the required capital goods for steady growth). If G andGw are riot equal, the economy will be in disequilibrium.For instance, if G exceeds Gw, then C will be less than Cr.When G>Gw, shortages result. “There will be insufficientgoods in the pipeline and/or insufficient equipment.” Sucha situation leads to, secular inflation because actual incomegrows at a faster rate than that allowed by the growth in theproductive capacity of the economy. It will further lead to adeficiency of capital goods, the actual amount of capitalgoods being less than the required capital gods (C<Cr).Under the circumstances, desired (ex-ante) investmentwould be greater than saving and aggregate production wouldfall short of aggregate demand. There would thus be chronicinflation. This is illustrated where the growth rates of incomeare taken on the vertical axis and time on the horizontalaxis. Starting from the initial full employment level of incomeY

0, the actual growth rate G follows the warranted growth

path Gw upto point E through period t2. But from t

2 onwards,

G deviates from Gw and is higher than the latter. Insubsequent periods, the deviation between the two becomeslarger and larger.


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It, on. the other hand, G is less than Gw, then C is greaterthan Cr. Such a situation leads to secular depressionbecause actual income grows more slowly than what isrequired by the productive capacity of the economy leadingto an excess of capital goods (C>Cr). This means thatdesired investment is less than saving and that theaggregate demand falls short of aggregate supply. The resultis fall in output, employment arid income. There would thusbe chronic depression. This is illustrated when from periodt2 onwards G falls below Gw and the two continue to deviate

further away.Harrod states that once G departs from Gw, it will departfurther and further away from equilibrium. He writes: “Aroundthat line of advance which if adhered to would alone givesatisfaction, centrifugal forces are at work, causing thesystem to depart further and further from the required line ofadvance.” Thus the equilibrium between G and Gw is a knife-edge equilibrium. For once it is disturbed, it is not self-correcting. It follows that one of the major tasks of publicpolicy is io bring G and Gw together in order to maintainlong-run stability. For this purpose, Harrod introduces histhird concept of the natural rate of growth.The Natural Rate of Growth. It “is the rate of advancewhich the increase of population and technologicalimprovements allow.” The natural rate of growth dependson the macro variables like population, technology, naturalresources and capital equipment. In other words, it is therate of increase in output at full employment as determinedby a growing population and the rate of technologicalprogress. The equation for the natural rate of growth is

Gn. Cr = or # sHere Gn is the natural or full employment rate of growth.Divergence of G, Gw and Gn. Now for full employmentequilibrium growth Gn=Gw=G. But this is a knife-edgebalance. For once there is any divergence between natural,warranted and actual rates of growth conditions of secularstagnation or inflation would be generated in the economy.If G>Gw, investment increases faster than saving and incomerises faster than Gw. If G<Gw, saving increases faster thaninvestment and rise of income is less than Gw. Thus Harrodpoints out that if Gw> Gn secular stagnation will develop. Insuch a situation Gw is also greater than G because theupper limit to the actual rate is set by the natural rate.When Gw exceeds Gn, C>Cr and there is an excess ofcapital goods due to a shortage of labour. The shortage oflabour keeps the rate of increase in output to a level lessthan Gw. Machines become idle and there is excesscapacity. This further dampens investment, output,employment and income. Thus the economy will be in thegrip of chronic depression. Under such conditions saving isa vice.If Gw<Gn, Gw is also less than G as shown in the tendency

is for secular inflation to develop in the economy. When Gwis less than Gn,C<Cr. There is a shortage of capital goodsand labour is plentiful. Profits are high since desiredinvestment is greater than realised investment and thebusinessmen have a tendency to increase their capitalstock. This will lead to secular inflation. In such a situationsaving is a virtue for it permits the warranted rate to increase.This instability in Harrod’s model is due to the rigidity of itsbasic assumptions. They are a fixed production function, afixed saving ratio, and a fixed growth rate of labour force,Economists have attempted to relieve this rigidity bypermitting capital and labour substitution in the productionfunction, by making the saving ratio a function of the profitrate and the growth rate of labour force as a variable in thegrowth process.

The policy implications of the model are that saving is avirtue in any inflationary gap economy and vice in adeflationary gap economy. Thus in an advanced economy,s has to be moved up or down as the situation demands..A Comparative Study of the two ModelsPoints of Similarity

THE DOMAR MODEL

áóIIÄ

IYÄ

ó ==

YÄSÄ

IYÄ

IIÄ

YÄSÄ

á ×==

ISÄ

IIÄ =

or SÄIÄ =THE HARROD MODEL

SIorYS

sYS

YI

YÄ

IC

YS

YÄI

YYÄ

or

YYÄ

GsGC

=

===

==×

==

=

Given the capital-output ratio, as long as the averagepropensity to save is equal to the marginal propensity tosave, the equality of saving and investment fulfils theconditions of equilibrium rate of growth.Looked at from another angle the two models are similar.Harrod’s s is Domar’s ∝ . Harrod’s warranted rate of growth


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(Gw) is Domar’s full employment rate of growth ( ó∝ ).

Harrod’s Gw=s/Cr=Domar’s áó .To prove it

)2(.......óIYÄorIYÄ

ó

)1(......YáSorYS

á

==

==

Since S=I and substituting S for I in equation (2) we have

[ ]

==∴

=

=∴=

YYÄ

GwSinceáóGw

)3(......áóYYÄ

or

YáSóYáYÄ

We have proved mathematically that Harrod’s Gw is thesame as Domar’s ó∝ . But, in reality, Domar’s rate of

growth r=αs is Harrod’s Gw, and Domar’s ór ∝= Harrod’s

natural growth rate. In Domar’s model s is the annualproductive capacity of newly created capital which is greaterthan ó which is the net potential social average productivityof investment. It is,the lack of labour and other factors ofproduction which reduces Domar’s growth rate from

órtosr =∝=∝ . Since labour is involved in’ ó therefore

Domar’s potential growth rate resembles Horrod’s naturalrate. We may also say that the excess of s over ó inDomar’s model expresses the excess of Gw over Gn inHarrod’s model.Points of Difference. There are, however, importantdifferences in the two models.:(1) Domar assigns a key role to investment in the processof growth and emphasises on its dual character. But Harrodregards the level of income as the most important factor inthe growth process. Whereas Domar forges a link betweendemand and supply of investment, Harrod, on the other hand,equates demand and supply of saving.

(2) The Domar model is based on one growth rate ór ∝=But Harrod uses three distinct rates of growth: the actualrate (G), the warranted rate (Gw) and the natural rate (Gn).(3) Domar uses the reciprocal of marginal capital-outputratio, while Harrod uses the marginal capital-output ratio. Inthis sense Domar’s ó = 1 / Cr of Harrod.(4) Domar gives expression to the multiplier but Harrod usesthe accelerator about which Domar appears to say nothing.(5) The formal identity of Harrod’s Gw equation and Domar’sequation’s maintained by Domar’s assumption that

Y/YÄI/IÄ = . But Harrod does not make such

assumptions. In Harrod’s equilibrium equation Gw, there isneither any explicit or implicit reference to ∆I or I. It is,however, in his basic equation G=s/C that there is an implicitreference to I, since C is defined as YÄ/I . But there is no

explicit or implicit reference to IÄ ..(6) For Harrod the business cycle is an integral part of thepath of growth and for Domar it is not so, but is,accommodated in his model by allowing ó (average

productivity investment) to fluctuate.(7) While Domar demonstrates the technological relationshipbetween capital accumulation and subsequent full capacitygrowth in output, Harrod shows in addition a behaviouralrelationship between rise in demand and hence in currentoutput on the one hand, and capital accumulation on theother. In other Words, the former does not suggest anybehaviour pattern for entrepreneurs and the proper changein investment comes exogenously, whereas the latterassumes a behaviour pattern for entrepreneurs that inducesthe proper change in investment.Limitations of these ModelsSome of the conclusions depend on the crucial assumptionsmade by Harrod and Domar which make these modelsunrealistic:

(1) The propensity to save ( )sor∝ and the capital-output

ratio ( )ó are assumed to be constant. In actuality, they

are likely to change in the long run and thus modify therequirements for steady growth. A steady rate of growthcan, however, be maintained without this assumption. AsDomar himself writes, “This assumption is not necessaryfor the argument and that the whole problem can be easilyreworked with variable ∝ and ó .”(2) The assumption that labour and capital are used in fixedproportions is untenable. Generally, labour can besubstituted for capital and the economy can move moresmoothly towards a path of steady growth. In fact, unlikeHarrod’s model, this path is not so unstable that theeconomy should experience chronic inflation orunemployment if G does not coincide with Gw.(3) The two models also fail to consider changes in thegeneral price level. Price changes always occur over timeand may stabilize otherwise unstable situations. Accordingto Meier and Baldwin, “If allowance is made for price changesand variable proportions in production, then the system mayhave much stronger stability than the Harrod modelsuggests.”(4) The assumption that there are no changes in interestrates is irrelevant to the analysis.” Interest rates changeand affect investment. A reduction in interest rates duringperiods of overproduction can make capital-intensiveprocesses more profitable by increasing the demand forcapital and thereby reduce excess supplies of goods.(5) The Harrod-Domar models ignore the effect of governmentprogrammes on economic growth. If, for instance, thegovernment undertakes a programme of development, theHarrod-Domar analysis does not provide us with causal(functional) relationship.(6) It also neglects the entrepreneurial behaviour whichactually determines the warranted growth rate in theeconomy. This makes the concept of the warranted growthrate unrealistic.(7) The Harrod-Domar models have been criticised for theirfailure to draw a distinction between capital goods andconsumer goods.(8) According to Professor Rose, the primary source ofinstability in Harrod’s system lies in the effect of excessdemand if supply on production decisions and not in theeffect of growing capital shortage cr redundancy oninvestment decisions.Despite these limitations, “Harrod-Domar growth models


7

are purely laissez-faire ones based on the assumption offiscal neutrality and designed to indicate conditions ofprogressive equilibrium for an advanced economy.” Theyare important because they represent a stimulating attemptto dynamize and secularise Keynes’ static short-term savingand investment theory.

APPLICATION OF HARROD-DOMAR MODELS TOUNDERDEVELOPED COUNTRIES

Growth theory in advanced economies has been associatedwith three principal concepts: the saving function,autonomous vs. induced investment, and the productivityof capital. The Harrod-Domar models are based on theseconcepts and were primarily developed in order-to illuminatesecular stagnation that was threatening the advancedeconomies in the post-war period. The application of thesemodels has now been extended to the development-problems of underdeveloped economies. As Hirschmanwrites: “The Domar model, in particular, has proved to beremarkably versatile, it permits us to show not only the rateat which the economy must grow if it is to make full use ofthe capacity created by new investment but inversely, therequired savings and the capital-output ratios if income isto attain a certain target growth rate. In such exercises, thecapital-output ratio is usually assumed at some valuebetween 2.5 and 5; sometimes several alternative projectionsare undertaken; with given growth rates, overall or per capita,and with given population projections, in the latter case,total capital requirements for five- or ten-year plans are theneasily derived. Let us see how these models can be usedfor planning in underdeveloped countries.Suppose the capital-output ratio is assumed to be 4:1 andthe full capacity growth rate or the warranted growth rate isestimated at 3 per cent per annum for the economy. Byapplying either the Harrod or the Domar formula, the plannerscan find out the saving income ratio required to sustain thegrowth rate of 3 per cent per annum.In Harrod’s model:Gw.Cr=s and by applying the assumed rates we get,3/100x4/1=12/100 or 12 per cent which is the saving-incomeratio. Similarly, in Domar’s model :

∝= áY/YÄ=3/100x4/1=12/100 or 12 per cent (a being the reciprocalof Harrod’s Cr),Thus, if the capital-output ratio is assumed as 4:1 in aneconomy, the community will have to save 12 per cent ofits annual income, if its annual growth rate of output is tobe 3 per cent. Let us work it out in practice. Given thesaving ratio and the capital-output ratio, the Harrod formulafor calculating the growth rate isGw=s/Cr, If s is 12 per cent and the value of Cr 4, thenGw=12/4=3 per cent.Sir Roy Harrod in the Second Essay an Dynamic Theoryhas tried to make his model more applicable tounderdeveloped countries. He has elaborated the supplyside of his fundamental equation by introducing the role ofinterest rate in determining the supply of savings and thedemand for savings. The natural rate of interest in is definedas the ratio of the natural growth rate of per capita outputPc and the natural growth rate of income Gn to the elasticityof diminishing utility of income e. Thus

r nPc Gn

e= .

Taking the values of Pc and Gn- as given, the natural rate ofinterest depends on the value of e which is assumed to beless than unity, rn and e are inversely related to each other.When e is small, rn is high and vice versa.The capital requirements, Cr, depend on the rate of interest,Cr =f(rn). Rather, Cr is a decreasing function of rn. The higherthe rate of interest, the lower the capital requirements, andvice versa.The savings Requirements Sr, like Cr, are.also-of muchimportance in underdeveloped countries. But the averagepropensity to save s is not necessarily equal to socialrequirements of savings, Sr, The actual savings S may begreater or less than Sr, i.e., S ≠ Sr. If S>Sr then’ Gw>Gnwhich means that actual savings being larger in thecommunity, entrepreneurs would desire to invest more? Inthe long run however Gw cannot continue to be greater thanGn which is the highest growth rate that can be attained. Insuch a situation, the actual growth rate would attain fullemployment and will be less than Gw, i.e., G<Gw. This willlead to depression in the economy. On the contrary, if S<Sr,then Gw<Gn. It implies that actual savings being less thanthe required savings in the community, there would be fallin investment. In the long run, it would lead to a fall in thewarranted growth rate below the actual growth rate, i.e.,Gw<G and the level of investment would increase. Ultimatelythere will be chronic inflation.Since low savings, high level of investment and chronic in-flation are some of the features of underdeveloped coun-tries, Harrod suggests the financing of large investmentsthrough the expansion of bank credit and automatic invest-ment of inflationary profits in the capital markets. But thereare no organised capital markets in such economies, there-fore, expansion of bank credit is the only way to financeinvestments and generate economic growth. Low savingsin an underdeveloped country are responsible for its lowrate of growth and the existence of mass unemploymentand underemployment. Thus the actual level of saving shouldbe raised to the level of required rate of savings by a com-pulsory levy or a surplus budget to that S=Sr Besides,Harrod also emphasizes the need for changes in socialand institutional factors in such economies. For social andinstitutional obstacles may be the cause of a low growthrate rather than the lack of savings -in underdeveloped coun-tries, Under the circumstances, Sr will also be low and Smay approximate to it.LIMITATIONS OF THESE MODELS FROM THE STAND-

POINT OF UNDERDEVELOPED COUNTRIESThe Harrod-Domar models are not applicable to underde-veloped countries for the following reasons:1. Different Conditions. The Harrod-Domar analysis wasevolved under different set of conditions. It was meant toprevent an advanced economy from the possible effects ofsecular stagnation. It was never intended to guide industri-alization programmes in underdeveloped economies. Thelimitations of these growth models, as applied to sucheconomies, therefore, stem from this fact.2.Saving Ratio. These growth models are characterized,by a high saving ratio and a high capital-output ratio. In anunderdeveloped economy, however, decisions to save andinvest are generally undertaken by the same group of per-


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sons. The vast majority of the people live on the margin ofsubsistence and thus very few are in a position to save.3.Capital-Output Ratio. Similarly, it is difficult to have acorrect estimate of the capital-output ratio where normalproductivity is often inhibited by shortages and bottlenecks.When they are removed, there is considerable increase inthe productivity of already invested capital. Such aneconomy, therefore, would have either to increase its savingratio or capital-output ratio by improving methods ofproduction arid removing the various obstacles to investment.Prof. Hirschman is of the view that the ‘predictive andoperational value’ of a model based on the propensity tosave and on the capital-output ratio is low and is bound tobe far less useful ‘in underdeveloped than in advancedeconomies.4.Structural Unemployment. According to ProfessorKurihara, the Harrod-Domar growth rate of investment failsto solve the problem of structural unemployment to be foundin underdeveloped countries. It can tackle the problem of‘Keynesian unemployment’ arising out of deficiency ofeffective demand or due to under-utilization of capital. Butwhen population grows faster than accumulation of capitalin an underdeveloped country, structural unemployment willarise due to lack of capital equipment.5.Disguised Unemployment. These models start with thefull employment level of income but such a level is not foundin underdeveloped countries. There exists disguisedunemployment in such countries which cannot be removedby the methods suggested by Harrod-Domar. Thus the mainassumption of the Harrod-Domar models being absent inunderdeveloped Countries, these models are not applicableto them.6.Government Intervention. The Harrod-Domar modelsare based on the assumption that there is no governmentintervention in economic activities. This assumption in notapplicable to underdeveloped countries because they cannotdevelop without government help. In such countries the \roleof the state as a ‘pioneer entrepreneur’ in starting largeindustries and in regulating and directing private enterprisehas been increasingly recognised.7. Foreign Trade and Aid. The Harrod-Domar models arebased on ‘ the assumption of a closed economy. Butunderdeveloped countries are open rather than closedeconomies where foreign trade and aid play very crucialroles in their economic development. Both these factorsare the bases of their economic progress.8. Price Changes. These models are based on theunrealistic assumption of a constant price level. But inunderdeveloped countries price changes are inevitable withdevelopment .9.Institutional Changes. Institutional factors have beenassumed to be given in these models. But the reality isthat economic development is not possible withoutinstitutional changes in such countries. Therefore, thesemodels fail to apply in underdeveloped countries.Conclusion. Thus is appears from the above discussionthat the Harrod-Domar models, based as they are onunrealistic assumptions, have little practical application inunderdeveloped countries, Hirschman, therefore, suggeststhat “economics of development, like the underdevelopedcountries themselves, must learn to walk on its own feet,-that is, it must work out its own abstractions.But Professor Kurihara is of the view that though “their policy

implications are very opposite of what one might expect ofan underdeveloped economy,” yet “the growth models havethis positive lesson for underdeveloped economies, that thestate should be allowed to play not Only a stabilizing rolebut also a development role, if these economies are toindustrialize more effectively and rapidly than the nowindustrialized economies did in conditions of laissez-faire.”He further opines that because of the universal character ofsaving-income ratio and capital-output ratio (or its reciprocal)as measurable strategic variables, the growth mechanismdiscussed by Harrod and Domar is applicable to alleconomic systems, albeit with due modification. That iswhy, these growth models are applicable to theseunderdeveloped countries in Which the technique of planningwith ‘balanced growth’ is adopted because under thistechnique, saving-income ratio and capital-output ratioremain constant during the plan period.


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IMPORTANT POINTS

INDIAN ECONOMICS

ANCIENT & MEDIEVAL INDIAN ECONOMY• Basic features of an economy- Unlimited wants, limitedresources have alternative uses.• Basic problems of an economy- What to produce, how toproduce, whom to produce, and growthof resources.• Kautilya Artha sastra gives details of political, social, eco-nomic, and military organisation of the Mauryan empire• Subsistence agriculture - Production of crops for the sakeof self consumption by the farmer and the family and not forsale in the market.• In urban areas, the group of handcrafters having commoninterests is called as guilds• Sher Shaw Suri first introduced rupee coins in India in1809.• Kautilya Arthasastra has been considered as the mostauthoritative work on ancient Indian economic thought.• Kautilya Arthasastra deals with state craft.• Arthasastra and Neeti sastra deals with the productionand exchange.• Arthasastra felt material wealth is not an end in itself butas an important means to achieve the objectives of life.• In ancient India Vartha means the branch of knowledgedealing with agriculture, commerce, cattle breeding, moneylending and artisanship.• Arthasastra is broader than Varta, because Arthasastradeals with jurisprudence, politics, and economics.• During Sher Sha tenure, lands were surveyed and landtax were determined scientifically based on productivity.• Jagir system was abolished by Akbar.• Akbar introduced land tax based on last ten years aver-age land price.• Laissez-fair (freeness) principle was followed duringancient India.• In ancient Indian economy agriculture and animal hus-bandry was occupies important place as occupations.• Kharaj- Fax on cultivation• Charat Tax on milch cattle• Ghari- Tax on houses.• The first Portuguese explorer ,Vascoda Gama openedsea route to India in 1498.• Grand trunk road was constructed by - Sher Shaw Suri• Main cereals grown during ancient period were Wheatand Barley.• Jizia is a tax imposed on Hindus , who failed to preachIslam .• Muhammed bin Tuglak introduced token currency.• Jajirs means the group of villages.• Begar means land less labour• Jajimani system- It is the system prevails in rural Indiabetween farmers and the village artisans. Generally rewardfor service is paid in the form of kind as per contract• According to Dharmasastras consumption should bebased on dharma. Artha, Kama, Moksha• Dharma sastra deal with consumption and distribution.• Role ol state is limited in economic decision making inancient India.• The three distinct classes in villages in ancient India are -The agriculturists, village artisans. Menials and village offi-cials.

• Slier Sha surveyed and graded lands for the imposition ofland taxes based on productivity.• Akbar fixed land taxes based on the average price ofland.• The founders of modem Indian economic thought areDadabai Nauroji, Ranade, and RC. Dutt and Ghokale.• Ancient literature recognized 4 factors of production.• Commercialization of agriculture—Production of cropsfor sale rather than for family consumption.• Cash crops Cotton, Jute, Sugar cane. Ground nuts andRubber.

INDIAN ECONOMY DURING BRITISH RULE• Dadabai Nauroji first estimated national income of Indiaunofficially.• During pre British period, Textiles and Handicrafts wereenjoyed world wide reputation.• First jute mill was started in Calcutta in 1855.• First iron and steel company was started by Jamshed jiTata in 1907 in Jamshedpur.• The first modern industry stated in India is- Iron and Steel• Indian Handicrafts are badly affected due to industrial revo-lution in Britain• Poverty and Un British rule in India was written by DadabaiNauroji. In this book, he analyzed how Britishers are re-sponsible for drain of wealth and to increase poverty in In-dia.• The triangular trade system prevails during British ruleamong three nations i.e. India, China and Britain.• Indigo (useful for coloring textiles) cultivation during Brit-ish rule prevails under two systems (1) Ryot system (2) Nijsystem• Absentee land lordism - Zamindars sublet their zamindariright to some body on commission basis to collect landrevenue from peasants.• Most of the sugar factories are set up by Europeans inIndia were shut down, following the fall in prices of sugar.• East India company is a joint stock company.• Home charges in the form of salaries, pension, intereston debt, expenditure, for the maintenance of Army and Navy.• Essay on Indian political economy was written by M.G.Ranade.• The word political economy first used by Ranade. He statedthat economic laws are not universal and economic growthnot an isolated phenomenon it depends up on social, politi-cal and religious factors.• Ranade is the first Indian economist criticized classicaleconomic model.• GK.Ghokale stated that Swadeshi is the only means toinitiate industrial growth in the country.• Mahatma Gandhi’s economic thought was influenced byRuskin• Colonial economy - Country is treated as a colony of rul-ing foreign country to serve their own interests (rulers).• British used colonial economies as suppliers of raw ma-terials and market for finished goods.• Britishers invested their capital in India through ManagingAgency system• Two major forms of British investment in India are — Pri-vate foreign direct investment in mines, mills and plantation(2) sterling loans for infrastructure projects.• Managing agency system can be defined as partnershipof companies formed by group of persons having huge fi-nancial resources and business experience.


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• During colonial period the large a’mount of British capitalwas invested in infrastructure• The chief industry spread over the whole nation is Textilesand handicrafts.• The industry first hit during the British rule are Textilesand handicrafts.• The opening of Sue/ Canal reduced transport costs andmade the exploitation of Indian markets easier.• Progressive Ruralization means during British period be-cause of loses occurred from the production and sale ofindustrial goods and closures of industrial units, un em-ployed craft men returned to agriculture.During British rule major crops in India are — Rice andWheat.• Main agricultural exports during British rule - Jute andCotton raw materials.• During British period, India is the main exporter of pri-mary goods.• During major period of British rule, India’s foreign tradewas in positive balance.• During British period 75% of the trade confined with Brit-ain.• The most important function of managing agency systemis to provide finance to set up Jute mills and Tea planta-tions.• Features of Indian economy during British rule - Stagnantand weakened economy, low levels of living, predominanceof agriculture as’an occupation.• On the eve of independence the nature of Indian economyUnder developed economy, stagnant economy, semi feu-dal economy, depreciated economy, disintegrated economy.• Causes of stagnation of Indian economy during Britishrule- Backward and age old techniques of production, cus-toms, traditions, colonial policy of British, and economicdrain.• Semi feudal economy- It is an economy in which themeans of production are in the hands of rich people, wholease their lands to tenents by charging exploitative rent.East India company was established in AD 1600.• During British period India’s foreign trade is protectiveand discriminatory.• Britishers mainly interested in production of plantationcrops.• Subsistence farming prevails during British rule. Mainpower used for agricultural operations are human and Bul-lock power.• Depreciated economy- During II world war Indian economywas depreciated due to excessive use of machinery by in-crease in production, to meet war needs but the brokenmachinery was not replaced by new.• Disintegrated economy- During British rule India was di-vided into small states and units. It is anti for the adoptionof uniform and integrated economic policy for the wholenation.• Nature of Indian economy as an underdeveloped economyon the eve of independence- Backward agriculture, short-age of basic industries, industrial backwardness, low capi-tal formation and low standards of living.• Features of Indian economy as an underdevelopedeconomy- Agriculture dominance, shortage of capital, preva-lence of unemployment and underemployment, shortage ofinfrastructure, backward and low techniques.• Stagnant economy- GDP growth rate is very low or nega-

tive because of political, social and economic reasons.• Features of Indian economy as a mixed economy- Exist-ence of public and private sectors, joint sector, licensingand controls, economic planning.• Features of Indian economy as a developing economy-Saving, capital accumulation, national income. Percapitaincome is increasing, development is occurring in infra-structure and all the three sectors i.e primary, secondaryand tertiary sectors.• Economic history of India was written by R.C.Dutt.• Poverty and un British rule in India was written by DadabaiNauroji.• The only journal in the subject of economics during Brit-ish rule The Indian economist.• The founders of modern Indian economic thought wereDadabai Nauroji. Ranade. R.C. Das, and Ghokale• Drain theory was advocated by Dadabai Nauroji.• National income of India was written by V.K.R.V.Rao in1939. to In 1793. permanent settlement act was enactedin Bengal presidency.• First Railway line was constructed from Bombay to Flume.In 1853.• The trade monopoly of East India Company was abol-ished in 1853 by the British parliament. to Between 1 829to 1838, India had positive trade balance with Britain andChina.• During British rule greater degree of monetization of theeconomy was occurred due to inflow of silver.• First Cotton mill in Bombay was started in 1854. to FirstJute mill was started in 1855 in Calcutta.• Bombay plan was prepared by industrialists for the periodof 15 years for India.• The aim of devaluation is to increase exports and de-crease imports.• Economic history of India was written by R.C. Dutt. toThe first country was established trade relations with India-Portugal.• The main aim of east India company is - To earn profitsthrough trade• Permanent settlement implies The amount of land rev-enue the xamindari is supposed to pay is fixed for 30 or 35years, but the rate of land tax and the amount of land rev-enue is to be colleted from the farmers was not specified.• Mugalzari settlement means -It combines the features ofboth the permanent zamindari and Ryotwari systems.• East India company and traders enjoyed monopoly overthe forced cultivation of the cash crops i.e. Indigo and Poppy.• Dadabai Nauroji calculated Percapita income per annumRs 20, during the three years from 1867 to 1870.• The burden of tax on Indian people was about 2.5 timesgreater than on the people of England.• During British rule tax revenue is 22% of GDP now it isnot more than 15%.• The champion of historical method to study Indian economyis Ranade• The idea of economic nationalism was advocated byRanade.• The book famines in India were written in 1900 by R.CDutt.• Tax and expenditure system prevails during British rule isregressive.• Mahatma Gandhi’s economic thought was influenced byRuskin’s book Un to the last.

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