6. Economics Notes 26

Elaborate Notes

Changes in GDP Calculation

In January 2015, the Central Statistics Office (CSO), under the Ministry of Statistics and Programme Implementation, introduced a new series of National Accounts, revising the base year from 2004-05 to 2011-12. This revision was not merely a mechanical update but involved significant methodological changes to align India’s practices with international standards, primarily the System of National Accounts (SNA) 2008.

• Change in Base Year from 2004-05 to 2011-12:

  • Historical Context: The base year of national accounts is periodically updated to ensure that the estimates reflect the contemporary economic structure and relative prices of goods and services. The previous base years were 1999-2000, 1993-94, and so on. The choice of 2011-12 was based on it being a relatively stable macroeconomic year, free from major shocks or fluctuations, and the availability of comprehensive data from various surveys like the National Sample Survey (NSS) 68th round and the Annual Survey of Industries (ASI).
  • Rationale: Over time, the structure of the economy changes—new sectors emerge, some decline, and the relative importance of different sectors shifts. A recent base year captures these structural transformations, providing a more accurate picture of economic growth. For instance, the contribution of the services sector, particularly in telecommunications and financial services, expanded significantly between 2004 and 2011.

• Change in Data Source for the Corporate Sector:

  • Previous Method: The estimation of manufacturing and services sector output heavily relied on data from the Annual Survey of Industries (ASI), which sampled about two lakh factories. This was an establishment-based approach.
  • New Method: The new series incorporates data from the Ministry of Corporate Affairs’ MCA-21 database. This is a comprehensive, enterprise-level database covering over five lakh companies registered with the ministry. The shift from an establishment-based approach (ASI) to an enterprise-based approach (MCA-21) was intended to provide a more exhaustive and representative coverage of the corporate sector. This change was championed by committees like the one headed by Prof. Ravindra H. Dholakia, which advocated for using more administrative data for national accounting.
  • Implications: This shift was one of the most significant changes, as it captured the activity of a much larger set of companies, including many in the burgeoning services sector that were previously under-represented.

• Shift from GDP at Factor Cost (FC) to GDP at Market Price (MP):

  • Conceptual Shift: The internationally accepted standard for measuring economic output is at market prices, which reflects what consumers actually pay. The SNA 2008 recommends using GDP at Market Price as the headline measure.
    • GDP at Factor Cost (FC): Measures the total value of goods and services produced, calculated from the perspective of the producers. It is the sum of factor incomes (wages, profits, rent, interest). Formula: GDP at FC = GDP at MP - Indirect Taxes + Subsidies.
    • GDP at Market Price (MP): Measures the value of output at market prices, including indirect taxes (like GST, excise duty) and excluding subsidies provided by the government. Formula: GDP at MP = GDP at FC + Indirect Taxes - Subsidies.
  • Introduction of Gross Value Added (GVA) at Basic Prices: Alongside the headline GDP at MP, the new series introduced the concept of GVA at basic prices as the primary measure of sector-wise output.
    • Basic Price: This price includes production taxes (e.g., land revenues, stamp fees) but excludes product taxes (e.g., excise duty, sales tax). Formula: GVA at Basic Prices = GVA at FC + Production Taxes - Production Subsidies. This provides a more accurate measure of the value added by producers before the final product taxes are levied.

• Refinement in Calculation of Labour Income:

  • Previous Method: The old series often treated labour as a homogenous entity, without differentiating between various types of employment roles.
  • New Method: The 2011-12 series introduced the concept of ‘effective labour input’. This methodology assigns different weights to labour based on the nature of employment—distinguishing between owners, hired professionals, and helpers. This differentiation is based on the premise that different categories of labour contribute differently to value addition, aiming for a more nuanced and accurate measurement of labour’s contribution to output.

• Expanded Scope of ‘Agriculture and Allied’ Sector:

  • Previous Method: The calculation of value addition in agriculture was primarily focused on crop production and some allied activities.
  • New Method: The new series widened the scope to better capture the value addition in the entire ‘Agriculture, Forestry, and Fishing’ sector. It incorporates more comprehensive data on livestock, using data from the Integrated Sample Survey and Livestock Census. The value addition from by-products like hides, skins, and manure, which were previously under-reported, is now more systematically included. This reflects the growing importance of the livestock economy to rural incomes.

• Improved Coverage of the Financial Sector:

  • Previous Method: The coverage was limited and did not fully capture the activities of the rapidly evolving financial landscape.
  • New Method: The new methodology explicitly includes value addition from a wider range of financial institutions. This includes stock exchanges (NSE, BSE), stock brokers, mutual funds, and pension funds. Furthermore, the economic contribution of regulatory bodies like the Securities and Exchange Board of India (SEBI) and the Insurance Regulatory and Development Authority (IRDA) is now accounted for, providing a more complete picture of the financial sector’s role in the economy.

Potential GDP

Potential GDP represents the maximum level of real output that an economy can sustain over the long term without generating inflationary pressures. It is an estimate of productive capacity, determined not by aggregate demand but by the supply-side factors of the economy. It is not the absolute maximum output possible in the short run (which can exceed potential GDP, leading to inflation) but a sustainable ceiling.

• Determinants of Potential GDP:
  • Labour Force: The size, growth rate, and quality of the labour force are primary determinants. A larger, more skilled, and better-educated workforce can produce more goods and services. The demographic dividend in India, for example, is seen as a key factor that can boost its potential GDP, as highlighted in various Economic Surveys.
  • Capital Stock and its Utilization: This includes physical capital like machinery, equipment, and infrastructure. A higher stock of capital and, crucially, a lower Incremental Capital-Output Ratio (ICOR)—which measures the additional unit of capital needed to produce an additional unit of output—leads to a higher potential GDP. Efficient utilization of capital is paramount.
  • Technological Efficiency: As espoused by economists like Robert Solow in his neoclassical growth model (1956), technological progress is a key driver of long-term growth. Advancements in technology, innovation, and R&D enhance productivity (Total Factor Productivity), allowing more output to be produced with the same amount of labour and capital.
  • Natural Resources: The endowment of natural resources like land, minerals, and energy sources can influence an economy’s productive capacity, particularly in primary-sector-dominated economies. However, the “resource curse” theory suggests that reliance on natural resources without institutional strength can be detrimental.
  • Infrastructure: High-quality physical infrastructure (roads, ports, power) and social infrastructure (health, education) reduces transaction costs, improves efficiency, and raises the overall productive capacity of the economy. The National Infrastructure Pipeline (NIP) in India is a policy initiative aimed directly at boosting potential GDP through infrastructure development.
  • Political Stability and Governance: A stable political environment, rule of law, predictable policies, and good governance create a conducive environment for investment and economic activity, thereby enhancing potential output.
  • Economic Structure: An economy with a diversified structure, particularly a robust and competitive manufacturing sector, often has a higher potential for sustained growth compared to one heavily reliant on agriculture, which is subject to climatic vagaries. The “Make in India” initiative aims to strengthen the manufacturing sector to boost India’s potential GDP.
  • Demographic Factors: The age structure of the population is critical. A youthful population (demographic dividend) can expand the labour force, while an aging population can shrink it, potentially lowering potential GDP if not offset by productivity gains.

Unemployment

Unemployment is a state where individuals who are able and willing to work at the prevailing wage rate are unable to find gainful employment. It represents underutilization of a nation’s most crucial resource—human capital. As articulated by economists like Amartya Sen, employment is not just about income but is central to human capabilities and freedom.

• Key Concepts:

  • Labour Force: Comprises all persons in the age group 15-59 years (as per NSSO, though internationally often 15-64) who are either working (employed) or are actively seeking work (unemployed). It excludes students, homemakers, and others not seeking work.
  • Workforce: The subset of the labour force that is actually employed.
  • Labour Force Participation Rate (LFPR): The percentage of the working-age population that is part of the labour force. LFPR = (Labour Force / Total Working-Age Population) * 100. A low female LFPR is a significant challenge for India.
  • Unemployment Rate: The percentage of the labour force that is unemployed. Unemployment Rate = (Number of Unemployed Persons / Total Labour Force) * 100.
  • Employment Elasticity: It measures the responsiveness of employment generation to economic growth. A value of 0.5 means that for every 1% increase in GDP, employment grows by 0.5%. A declining or near-zero elasticity, as observed in India in recent decades, signifies “jobless growth”. The decline from 0.52 (1973-83) to near zero post-2011 is a stark indicator of this phenomenon. The negative elasticity in agriculture (-0.42 in 2011-12) indicates a net outflow of labour or job destruction due to mechanization.

• Causes of Unemployment in India:

  • Demographic Pressure: A large and rapidly growing labour force, a consequence of past population growth, which the economy has struggled to absorb.
  • Jobless Growth: The pattern of economic growth has been capital-intensive and concentrated in sectors like IT-enabled services, which have high productivity but low employment generation capacity. The manufacturing sector’s share in GDP has remained stagnant at around 17%, a phenomenon referred to as “premature deindustrialization” by economists like Dani Rodrik.
  • Structural Issues in Agriculture: The agriculture sector suffers from high levels of disguised unemployment, where more people are employed than are actually needed. This results in very low marginal productivity of labour.
  • Inadequate Education and Skill System: The education system has been criticized for its focus on rote learning rather than vocational skills and critical thinking, leading to a mismatch between the skills of the workforce and the demands of the industry. The lack of a robust university-industry interface exacerbates this problem.
  • Muted Manufacturing and MSME Sector: The failure of the manufacturing sector to grow robustly has prevented the absorption of surplus labour from agriculture. The Micro, Small, and Medium Enterprises (MSME) sector, which is labour-intensive, has been plagued by issues like lack of access to credit, competition from cheap imports (especially after globalization), and regulatory hurdles, leading to the problem of “dwarf MSMEs” that do not grow and create jobs.
  • Stringent Labour Laws: It is argued by some economists, such as Jagdish Bhagwati and Arvind Panagariya, that rigid labour laws in the formal sector disincentivize firms from hiring workers on a permanent basis, leading to increased informalization and contractualization of the workforce.
  • Seasonal Nature of Agriculture: A significant portion of Indian agriculture is rain-fed, leading to seasonal employment where labour is required only during sowing and harvesting seasons, leaving workers unemployed for the rest of the year.

Types of Unemployment

• Cyclical Unemployment: Associated with the business cycles of an economy. During a recession or economic downturn, aggregate demand falls, leading firms to cut production and lay off workers. This type of unemployment rises during recessions and falls during economic expansions. The global financial crisis of 2008 led to a spike in cyclical unemployment in many countries.
• Seasonal Unemployment: Occurs because the demand for labour in certain industries varies with the seasons. Examples in India include agriculture, tourism (e.g., in hill stations), and certain agro-based industries like sugar mills.
• Frictional Unemployment: This is transitional unemployment that occurs when people are in the process of moving between jobs. It includes fresh graduates looking for their first job or individuals who have voluntarily left a job to search for a better one. It is considered a natural and often healthy feature of a dynamic labour market.
• Structural Unemployment: Arises from a long-term mismatch between the skills possessed by the workforce and the skills demanded by employers. This can be caused by technological changes (e.g., automation making certain manual jobs obsolete), changes in the structure of the economy (e.g., decline of the textile industry in a region), or geographical immobility of labour. This is a more persistent and difficult form of unemployment to resolve.
• Disguised Unemployment (Underemployment): A situation where more people are employed in a job than are actually required. The marginal productivity of the extra workers is zero or near-zero. If some workers are withdrawn, the total output will not fall. It is most prominent in the Indian agricultural sector and unorganized family businesses.
• Open (or Chronic) Unemployment: A situation where a person is willing and able to work but does not get any work for a prolonged period. The NSSO defines this based on the Usual Status approach, where a person who did not find work for a major part of the preceding year (183 days or more) is considered chronically unemployed.
• Natural Rate of Unemployment: This is the minimum level of unemployment that persists in an economy even at its full potential output. It is the sum of frictional and structural unemployment. According to monetarist economists like Milton Friedman, attempting to push unemployment below this natural rate through demand-side policies will only lead to accelerating inflation.

Measurement of Unemployment in India

The National Statistical Office (NSO, formerly NSSO) uses different time-reference periods to measure employment and unemployment, capturing different facets of the problem.

• Usual Status (US) Approach:

  • Reference Period: 365 days preceding the date of the survey.
  • Methodology: The survey classifies a person based on their major activity over the year. If a person was engaged in any economic activity for 183 days or more, they are considered employed. If they were available for work but could not get work for 183 days or more, they are considered unemployed. This approach is best for measuring chronic or long-term unemployment.
  • Usual Principal and Subsidiary Status (UPSS): This is a refinement that also considers subsidiary economic activity. A person engaged in economic activity for at least 30 days in the year is considered employed under the subsidiary status.

• Current Weekly Status (CWS) Approach:

  • Reference Period: 7 days preceding the date of the survey.
  • Methodology: A person is considered employed if they worked for at least one hour on at least one day during the reference week. They are considered unemployed if they did not work for even one hour but were seeking or available for work. This measure captures more transient and seasonal unemployment.

• Current Daily Status (CDS) Approach:

  • Reference Period: Each of the 7 days preceding the date of the survey.
  • Methodology: It measures employment status for each day of the reference week. A person working for 1 to 4 hours is considered employed for half a day, and for 4 hours or more, for a full day. The CDS measure provides an estimate of the total person-days of unemployment and is considered the most comprehensive measure, as it captures open, seasonal, and partial unemployment (underemployment). The unemployment rates calculated using the CDS approach are typically the highest among the three.

Formal vs. Informal Employment and Globalization

The Indian workforce is characterized by a high degree of informalization.

• Classification of Workers:

  • Self-employed: Individuals who operate their own farm or non-farm enterprises.
  • Hired Workers:
    • Regular Salaried/Wage Workers: Workers on the payroll of an enterprise, entitled to social security benefits like provident fund and paid leave.
    • Casual Workers: Workers engaged on a daily wage basis, with no job security or social security benefits.

• Formal vs. Informal Employment:

  • Formal Employment: Typically characterized by a formal contract, regular wages, and social security benefits. It includes all government employees and workers in private sector enterprises with 10 or more employees who are provided with at least one social security benefit (like PF or health insurance).
  • Informal (Unorganized) Employment: Lacks the protections of formal employment. This includes most agricultural labourers, casual workers in construction, and workers in small private enterprises with fewer than 10 employees. Over 90% of India’s workforce is in the informal sector.

• Impact of Globalization on Informalization:

  • The post-1991 economic reforms, driven by globalization, have had a complex impact on the labour market. While they spurred growth, they are also associated with an increase in informalization.
  • Increased Competition: Domestic firms, especially MSMEs, faced intense competition from multinational corporations (MNCs) and cheap imports. To cut costs and remain competitive, many firms resorted to hiring casual or contract labour, bypassing stringent formal labour laws.
  • Subcontracting and Outsourcing: Globalization facilitated global supply chains. Large firms increasingly outsourced non-core activities to smaller, often informal, enterprises to enhance flexibility and reduce labour costs.
  • Muted Manufacturing Growth: The manufacturing sector failed to generate sufficient formal jobs to absorb the surplus labour from agriculture. The growth that did occur was often in capital-intensive industries.
  • Structural Change: While agriculture’s share in GDP declined (to around 18%), its share in employment remains high (over 42%). The surplus labour migrating from rural areas, lacking the skills for high-end service sector jobs, often ends up in low-productivity informal work in urban areas (e.g., construction, street vending).
  • Demand for Flexibility: The globalized economic environment demands flexibility. Firms prefer a flexible workforce that can be adjusted based on demand fluctuations, which promotes contractual and casual employment over permanent, formal jobs.

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Prelims Pointers

• GDP Calculation Changes (Post-2015):

  • New Base Year: 2011-12 (changed from 2004-05).
  • Headline GDP Measure: Gross Domestic Product (GDP) at Market Prices.
  • Previous Headline Measure: GDP at Factor Cost.
  • New Sector-wise Measure: Gross Value Added (GVA) at Basic Prices.
  • Formula: GVA at Basic Prices = GVA at FC + Production Taxes - Production Subsidies.
  • Data Source for Corporate Sector: Shift from Annual Survey of Industries (ASI) to Ministry of Corporate Affairs’ (MCA-21) database.
  • New Concept for Labour Income: ‘Effective labour input’ which assigns weights based on employment type.
  • The financial sector coverage was expanded to include stock exchanges, brokers, and regulatory bodies like SEBI, IRDA.

• Potential GDP:

  • It is the maximum sustainable level of output without causing inflation.
  • It is determined by supply-side factors: labour force, capital stock, technology, etc.
  • A lower Capital-Output Ratio implies higher efficiency and contributes to higher potential GDP.

• Unemployment Concepts:

  • Labour Force Participation Rate (LFPR): (Labour Force / Working-Age Population) x 100.
  • Unemployment Rate: (Unemployed / Labour Force) x 100.
  • Employment Elasticity: Measures the percentage change in employment for every one percent change in GDP.
  • A value of employment elasticity near zero indicates ‘Jobless Growth’.
  • Natural Rate of Unemployment: Sum of Frictional and Structural Unemployment.

• Types of Unemployment:

  • Cyclical: Due to business cycle downturns.
  • Frictional: Temporary, between jobs. Also called ‘search unemployment’.
  • Structural: Mismatch of skills.
  • Disguised: Marginal Productivity of Labour is zero. Common in Indian agriculture.

• Measurement of Unemployment (NSSO/NSO):

  1. Usual Status: Reference period of 365 days. Measures chronic unemployment.
  2. Current Weekly Status (CWS): Reference period of 7 days.
  3. Current Daily Status (CDS): Reference period is each day of the preceding 7 days. Considered the most comprehensive measure.

• Surveys:

  • The Employment-Unemployment Survey (EUS) was conducted quinquennially (every 5 years) by the NSSO.
  • It has been replaced by the Periodic Labour Force Survey (PLFS), launched in 2017 by the NSO, which provides more frequent data (annual and quarterly).

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Mains Insights

GDP Calculation Methodology Debate

• Credibility and Perception: The 2015 change in GDP calculation methodology led to a significant upward revision of growth rates. This created a debate among economists and policymakers. Critics, including former Chief Economic Adviser Arvind Subramanian in a 2019 research paper, argued that the new series might have overestimated GDP growth. The divergence between the high official GDP figures and other macroeconomic indicators like credit growth, industrial production, and export performance fueled this skepticism.
• Cause-Effect Analysis:
  • Cause: Need to align with international standards (SNA 2008) and capture the economy’s structural changes. Use of a more comprehensive corporate database (MCA-21).
  • Effect: Higher growth estimates, but also a controversy that questioned the credibility of official data. This can impact investor confidence and the effectiveness of policy-making, which relies on accurate data.
• Way Forward: The issue highlights the need for greater transparency in statistical methods and cross-verification of data using multiple high-frequency indicators. Strengthening the institutional autonomy and capacity of the National Statistical Commission (NSC) is crucial for ensuring the integrity of official statistics.

The Challenge of Jobless Growth and Inclusive Development

• Core Issue: The phenomenon of ‘jobless growth’, evidenced by declining employment elasticity, is a central challenge to inclusive growth in India (GS Paper III). Economic growth is not translating into adequate employment opportunities, leading to the exclusion of a large segment of the labour force from the benefits of growth. This exacerbates inequality and can lead to social unrest (GS Paper I).
• Analytical Perspectives:
  1. Economic Perspective: The growth has been service-led and capital-intensive. The failure to boost labour-intensive manufacturing, as was done by East Asian economies, is a key reason. Policies have inadvertently favoured capital over labour.
  2. Social Perspective: Jobless growth disproportionately affects the youth, leading to frustration and potential radicalization. It hinders social mobility and perpetuates poverty cycles. The challenge of a “careless and useless manpower” refers to a workforce that is neither skilled (careless in its development) nor productively employed (useless from an economic standpoint).
  • Measures to Address the Challenge:
    • Supply-Side: Overhauling the education system to focus on skills and vocational training (linking to Skill India Mission). Promoting a robust university-industry interface.
    • Demand-Side: A concerted push for labour-intensive manufacturing (Make in India), especially in sectors like textiles, food processing, and leather.
    • Entrepreneurship: Fostering a culture of job creation, not just job seeking, through initiatives like Startup India and MUDRA Yojana.
    • MSME Sector: Resolving the structural issues plaguing MSMEs (credit, market access, technology) to help them scale up and create jobs.

Globalization, Informalization, and Worker Vulnerability

• Historiographical Viewpoint: The impact of globalization on labour is a debated topic.
  • Pro-Globalization View (e.g., Jagdish Bhagwati): Argues that globalization, by promoting efficiency and growth, ultimately creates better opportunities, and the problem lies with rigid domestic labour laws, not globalization itself.
  • Critical View (e.g., scholars like Guy Standing): Argues that globalization has created a global “precariat”—a class of workers in precarious, insecure employment. The push for competitiveness in a global market has led to a “race to the bottom” in labour standards, leading to widespread informalization.
• Cause-Effect Relationship (Globalization → Informalization):
  • Cause: Increased foreign competition and the need for cost-cutting and flexibility.
  • Effect: Firms shift from formal, permanent employment to informal, contract-based work. This reduces their wage bill and social security obligations but increases worker vulnerability.
• Policy Implications (GS Paper II - Welfare): The high degree of informalization poses a significant challenge for social security and welfare delivery.
  • Vulnerabilities: Informal workers lack job security, regular income, paid leave, health benefits, and old-age pensions. They are often outside the ambit of labour laws and are more susceptible to exploitation. The COVID-19 pandemic starkly exposed the precarity of informal migrant workers.
  • Policy Measures:
    1. Social Security Net: Creating a universal social security system, as envisioned in the Code on Social Security, 2020, which aims to cover gig and platform workers.
    2. Skill Development: Up-skilling and re-skilling informal workers to improve their employability in the formal sector.
    3. Formalization Incentives: Simplifying regulations and providing incentives (e.g., tax breaks, subsidies on social security contributions) for informal enterprises to formalize.
    4. Financial Inclusion: Enhancing access to formal credit for small businesses and self-employed individuals to help them grow and potentially formalize.