Risk Latte - India’s Unexpected Growth - Is the Feldman-Mahalanobis Model finally paying off?

India’s Unexpected Growth - Is the Feldman-Mahalanobis Model finally paying off?

Rahul Bhattacharya
May 31, 2009

When the whole world is in the throes of negative economic growth and downward spiral of GDP, when even China’s GDP shows signs of slackening, India’s GDP figures keep confounding the experts and proving the economists wrong.

A couple of days ago, Reuters reported that India’s March GDP was up by 5.8% versus a forecast of 5.2% forecast for the quarter ended March 2009. For the fiscal year ended March 31, 2009 Indian economy grew by 6.7% (against a forecast of 6.5%). Today, the Financial Times newspaper brought out a supplement on The New India. Each article in that supplement talks about how the country is bedeviled by myriad problems, from infrastructure to healthcare, and yet the theme is India Shining and India being a Land of Opportunity. In short, a consumer revolution in India is far from over. On the contrary, it is just beginning.

FT is not alone in asserting this theme. For many weeks now, economists, market experts and financial journalists, have been talking about India being an exception and that it has the potential to overcome the financial hurricane that is buffeting the world very quickly by switching on the enormous domestic consumer demand that lies locked within the country.

As I read these headlines, a curious thought crossed my mind. What if India’s growth story has been sixty years in the making? Is it possible that Jawaharlal Nehru, India’s first Prime Minister after all got it right and all those demigods of free market thinking got it wrong? And above all, and much more importantly, is it possible that the Feldman-Mahalanobis model of economic growth, on which India’s five year plans were based since independence was after all the correct one for India; it is just that it took 60 years to pay off?

No sooner had I asked myself that question, I had to trash it.

For one, no mainstream economist, in the academia or industry, would perhaps even consider Feldman-Mahalanobis model as a model of economic growth in the same vein as say, Harrod-Domar model or a Solow model. Despite it mathematical rigor, they would, perhaps, at best treat it as a strategy in development economics. Many young economists, not only on both sides of the Atlantic but even in Asia may have to do a Google search to find out about Prashant Mahalanobis and Gregory Alexandrovich Feldman.

To be fair, both Mahalanobis and Feldman were not mainstream economists. None of them had any formal training in Economist. One was an electrical engineer and the other a physicist turned statistician.

Feldman was an electrical engineer by profession and worked in the Soviet Gosplan from 1923 to 1931. His report titled “On the Theory of the Rates of Growth of the National Income” was published in 1928 and became the basis for Soviet long term planning. His mathematical study of two sector economic growth model was based on concepts formulated by Karl Marx. Prahshant Mahalanobis was educated in Calcutta and Cambridge and was a statistician, even though he initially trained as a Physicist. He founded the Indian Statistical Institute in the 1931 and was the architect of India’s five year plans. He took the basic premise of Feldman’s model and built on it.

The basic premise behind Mahalanobis-Feldman (FM) model is very simple. The model posits that to reach higher standards of consumption and bigger growth in the consumer goods sector one must first stimulate the capital goods sector by channeling more investments in that sector. An economy has to build up capacity in the production of capital goods before concentrating on the consumer goods sector. In the short run, the capital goods sector matter. However, in the long run increased capacity in the capital goods sector expands the capacity in the production of consumer goods.

In the FM model of economic growth, an economy with unlimited supply of labour (such as India or China) has only two sectors, the Investment goods sector and the Consumption goods sector. The total investment is divided into two parts and the growth rate is given by the share of investment in the capital goods section, and the share of the investment in the consumption goods sector,,where . Initially, all efforts are concentrated in the building up capacity in the capital goods sector. The more the investment in this sector the faster would be the growth rate. Eventually, the capacity in the capital goods sector would spill over to the consumer goods sector and in the long run investments would start to flow into the consumption goods sector.

The million dollar question which nobody asked in 1950s was how long would be “long run”?

Milton Friedman was openly critical of this model just as he was vocal in criticizing Nehru’s idea of a socialistic model of industrialization. Not only Milton Friedman, every two bit economist and economic commentator on the other side of Suez Canal wrote off this model and this theory of economic growth. At best it was totally flawed, if it can be called an economic model at all. At worst, it was pipe dream masquerading as economic thinking.

In fact, they all had a point. For forty years from early 1950s until 1991 Indian economy went nowhere. Huge investments were made by the government in heavy machinery and capital goods sector via the five year plans. Capital goods sector was given the top priority. But what happened? The public sector became huge – railways, steel mills, heavy machinery, oil drilling, etc. – and sucked up enormous amount of investment. The output of all this economic activity was at best mediocre, at worst junk. But the process went on and on for fifty years.

And did this gigantic capital goods sector boost the consumer goods sector? Did all this investment in the capital goods sector increase the disposable income – on an average – of the masses, at least the middle and lower middle class Indians? The answer is a resounding “no”. In these fifty years did the lives of ordinary Indians improve by improved quality and availability of goods such as television sets (actually, TV didn’t arrive in India until the early 1980s), refrigerators, cars, two wheelers, stereo players, or even good quality soaps, detergents, shampoo? The answer again is a resounding “no”. For fifty years, from 1947 until around 1992 the consumer goods sector in India was dominated by a cartel – a handful of inept, inefficient and morally corrupt business families (a notable exception to this being the House of the Tatas) – which had a vested interest in India’s underdevelopment.

Therefore, it has been universally acknowledged that the Feldman-Mahalanobis model had miserably failed and it was only the economic crisis of 1991 that forced the Indian government’s hand and made it open its doors to foreign direct investments and the rest is history.

However, I suspect that there was something else at play here. The enormous investment by the Government of India in all those factories, plant and machinery, the railways, airlines, etc. was spilling over elsewhere. Satellite townships grew around these factories and industries, making middle class families nuclear and inducing ambition in them, the demand for home grown engineers and doctors grew thereby prompting growth in schools, colleges and most importantly engineering institutions and medical colleges. And the government went ahead and made investments in these educational institutions; Indian Institutes of Technologies (IITs) were born, Regional Engineering Colleges (RECs) were born, Medical Colleagues were born as more engineers and doctors were needed across the vast expanse of the country where industrialization was taking shape.

The Feldman-Mahalanobis plan may have been based on a Soviet style economic model, but unlike the Soviet Union, and all those criticisms from the Western thinkers notwithstanding, India was not a socialist or a communist country. It was a democracy and free country. People were free. So what if they could not get TVs, cars or refrigerators. Never mind the fact that they didn’t see the skyscrapers going up around them or supermarkets springing up to supply them groceries. They were free to dream. Dream of a bright future for their children, dream of a nation filled with able and qualified doctors and engineers, scientists and University professors. If the father was a foreman in a factory, he wanted his son to be the engineer. In the most bizarre way imaginable, science and technology became the true religion of the people of India.

India became industrialized in a different way. It was the industrialization of the brain and the mind. How else could the software revolution of the 1990s have happened? The spillover effect took time, but it had to happen. All that investment in the capital goods sector, directly or indirectly, over time, had to show up in the consumer goods sector. The opening of the markets to foreign goods and investment in 1992 certainly helped and expedited the process. That was the catalyst. But the consumer revolution was 50 years in the making.

In retrospect, the big investments in the capital goods sector and its importance in economic decision making appear as the correct. The basic premise of the Feldman-Mahalanobis model is correct as it is applied to a totally underdeveloped economy. The implementation may have been wrong and misguided, and perhaps it was. Misallocation of resources did happen because of corrupt bureaucrats and politicians. But the model – the theory, the set of ideas, whatever you choose to call it – is correct. There was no other way India – a multi-lingual, multi-cultural country divided along ethnic lines and with a runaway population even then – could have started off in 1947. Private sector in the country was non-existent. Japan was ravaged by World War II and was beginning its own industrialization process. The conglomerates and the big corporations of the West could hardly care less about India.

And in many ways, China has been following its own version of Feldman-Mahalanobis model. Therefore, Dear Mr Krugman, before you trash Asian economic miracles and talk about economic problems and theories as if economics is purely as a Western vocation, spare a thought for G A Feldman and Prashant Mahalanobis.

Reference:   http://www.reuters.com/article/marketsNews/idAFDEL39673120090529?rpc=44>

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