This article has been republished, with permission, from EcoTalker, HERE.
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As articulated by the Indian Prime Minister, Shri Narendra Modi, India aims to grow into a USD 5 trillion economy by 2024-25, thus making India the third-largest economy in the world. Given 4% inflation, as MPC specified by the Government for the RBI , this requires real annual growth rate in GDP of 8 per cent.
In this article, we will talk about two major ideas proposed in the economic survey to achieve this goal and at the same time, solve major pressing problems in India. The Survey suggests a shift from the Anglo-Saxon view of the economy and towards a structure better suited for the present times. The second idea encouraged is the incorporation of behavioural economics into public policy making.
Departure from Traditional Anglo-Saxon view of the Economy
Let’s start by understanding what exactly the Anglo-Saxon model or Anglo-Saxon capitalism is. The Anglo-Saxon model is a capitalist model that emerged in the 1970s based on the Chicago School of Economics. In economies with Anglo-Saxon Capitalism, levels of taxes and regulations are low compared to other capitalism models. Additionally, it has stronger property rights and contract enforcement, there are lower barriers to free trade and many companies claim that doing business is easier. It also has fewer regulations, especially regarding labor markets i.e. less red tape. It dates back to the ideas of classical economist Adam Smith and exists in the rich advanced economies such as the US, UK, Canada, Australia, Ireland, and New Zealand.
So why the shift?
Critics of this model claim that it neglects the interests of stakeholders, leads to inequality and higher levels of poverty as compared to other models.
My personal understanding of this suggestion in the Economic Survey was basically to move away from the traditional approach and towards the contemporary ‘Modinomics’, which somewhat involves the incorporation of Behavioural Economics into policymaking (Daniel Kahnemann and Amos Tversky termed ‘prospect theory’ in 1979) and looking at the economy as being in a state of constant disequilibrium, imbibing new learning from the economic literature following the Global Financial Crisis.
Viewing the economy as being in a constant state of disequilibrium – a virtuous/ vicious cycle.
First, the core premise of the traditional economic theory is that people choose by optimizing, they make unbiased choices and have ‘rational expectations’. Another major warehouse of the economic theory is that of equilibrium. In competitive markets where prices are free to move up and down, they fluctuate in a way that makes supply equal demand. In contrast, the survey suggests viewing the economy as being in a constant state of disequilibrium as captured by a virtuous or vicious cycle.
Second, the traditional view often attempts to solve job creation, demand, exports, and economic growth as separate problems. In disparity, the survey suggests that these macroeconomic phenomena exhibit significant complementarities. Therefore, understanding the ‘key driver’ and enhancing the same enables simultaneous growth in these macro phenomena and enables the economy to thrive.
When viewed in this manner, the triggering macro-economic ‘key driver’ that catalyzes the economy into a virtuous cycle becomes critical. This Survey makes the case for investment, both public and private, as the ‘key driver’ that can create a self-sustaining virtuous cycle in India.
Investment, especially private investment, is the ‘key driver’ that drives demand, creates capacity, increases labor productivity, introduces new technology, allows creative destruction, and generates jobs.
By providing evidence from across the globe, especially from China and East Asia in recent times, it is suggested that high growth rates have been sustained only by a growth model driven by a virtuous cycle of savings, investment and exports catalyzed and supported by a favorable demographic phase.
Emphasis is made on the importance of savings ( ‘-Horioka Puzzle’ 1980 ) pointing out the positive correlation between savings and growth, the importance of precautionary savings and how high investment must be backed by domestic savings in order to support the economy.
The Survey also talks about an ‘aggressive export strategy’ like reducing India’s overall tariffs, which could be beneficial for India in the midst of the ongoing trade war between the US and China.
There is a need to embrace learning from other fields such as psychology, natural sciences, engineering et cetera. The economic survey propagates the philosophy that economies are intricately interwoven systems and may rarely be in a state of equilibrium. By stating the case of Lucas(1990) and the over-reliance on DSGE models- the survey highlights the need for evolving macroeconomic thinking that fits the institutional differences in a country like India vis-à-vis the Anglo-Saxon economies. It is very important to develop theories according to the real world and not the other way round, which brings us to the second idea that is presented in the economic survey.
Leveraging the Behavioural Economics of ‘Nudge’
This basically draws on the psychology of human behavioral insights to ‘nudge’ people towards the desired behavior. Referring to Adam Smith’s Theory of Moral Sentiments’ (1759), the survey shows that a wide range of human choices is driven by our mental resources- cognitive ability, attention, and motivation.
Since my time as a senior in school, I have been perplexed by stories about the myriad ways in which people depart from the fictional characters that populate economic models. It is crucial to understand that normal people do not behave like robots or in the words of Thaler, they are not ‘homo economicus’ and are most certainly not always rational.
A case can be presented of the use of Behavioural insights in the SBM (Swachh Bharat Mission) which is a nationwide cleanliness drive launched on 2ndOctober ’14 , the birthday of India’s most revered ‘role model’ Mahatma Gandhi, thereby leveraging the values propagated by him and thus, creating a mass movement on the lines of ‘Satyagraha’ for a cleaner India. As each village has at least one swachagrahi, who is a local, they were able to leverage their social ties within their villages to effect change. People are more likely to listen to and emulate someone they know, which is why local ambassadors of change are more effective in getting through to people than mass media campaigns. Another behavioral insight that was used here is that of appealing to people’s emotions, for example, attaching a sense of disgust to open defecation has a better chance of moving people to change. Most people want to behave or be seen to behave in congruence with these norms.
The survey dives into many other such successful application of behavioral insights into policymaking in India- Aadhar, JDY, Beti Bachao Beti Padhao, taxes on tobacco -to name a few.
Here’s what I think
While it is true that an enriched approach towards econ, one that acknowledges the relevance of humans, is necessary, we cannot just throw away everything we know about economics and how markets operate. These theories remain useful as starting points for more realistic models. The primary reason for including humans in economic theories is to improve the accuracy of predictions made with those theories and needless to say, behavioural economics is definitely more interesting than regular economics.
Understanding certain principles of behavioural economics can bridge the gap between people’s preferences and the choices they make, and thereby enable informed policymaking. If we talk about India in particular, social and religious norms play a dominant role in influencing behaviour, behavioural economics can provide a valuable instrument for this change. For instance, combining behavioural economics with spiritual and religious norms can help reduce tax evasion and wilful default- drawing references from Hinduism, Islam and the Bible wherein the non-payment of debt is condemned- and encourage a move towards tax compliance.
Talking about the emphasis of the Survey on investment as the central driver for a $5 trillion economy is something that is easier said than done, especially against the scrim of a notable decline in savings/GDP ratio . Even if we look at the alternative of relying on foreign savings for investment boost, it could expose the economy to widening CAD which would have its own consequences.
Needless to say, if implemented in letter and spirit, the overall recommendations proposed in the economic survey will go a long way in boosting growth and generating employment. However, one is inclined to think that a key issue is missing: there is very little emphasis on reforms in the survey and this lack of emphasis on reforms in the survey can end up affecting the aforementioned boost in growth and employment.
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2. Misbehaving, The Making of Behavioural Economics(Richard Thaler, 2015)
Photo by Narendra Modi on Flickr.