The Indian economy has grown at about 6.8 per cent in 1996-97. The achievement is impressive but needs to be tempered with a caveat. Much of this growth has come about because of growth in the service or tertiary sector of the economy. The share of services in gross domestic product has risen steadily from around 29.1 per cent in 1960-61 to around 42.0 per cent in 1996-97.
But why is this a cause for concern? The Indian economy, after all, seems to have behaved in conformity with the Kaldor Law, which states that the share of services in the national income increases as the economy progresses. This holds good in the case of mature economies such as the USA, UK or Japan. But the question is: does the Indian economy display signs of a mature economy just because its gross domestic product has a large service component?
Fault!
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The question assumes importance because the Indian service sector has risen rather disproportinately to either agriculture or industry. In other words, the base of the real goods produced by agriculture and industry has not expanded in proportion to the rise in spendable income as reflected in the growth of the service sector. And this hiatus between the two may create a large potential for inflation.
Says Dilip Nachane, an economist: Some components of growth in the service sector are complementary to the growth in agriculture and industry. Banking and insurance are examples of this. But a large part of the growth in services could be purely illusory, accruing as it does from inflated salaries and wages in the financial sector, legal fees and other such activities. I am afraid such illusory growth can only fuel demand for consumer durables, especially imported consumer durables. The high growth evidenced in the last three years needs to be corrected for this component of growth. The correction factor could be as high as 1.5 per cent, and the actual GDP growth would be lower by this factor.
Nachanes fears are not misplaced. The shift in the shares of these sectors in the total national income highlight the point. The share of agricultural sector including forestry, logging, fishing, mining and quarrying fell from 52.1 per cent in 1960-61 to 32.9 per cent in 1990-91. In 1995-96 it fell to 28.8 per cent and is estimated to fall further to 27.9 per cent in 1996-97.
The share of manufacturing to national income grew, but not at the commendable rate. The manufacturing sector including construction, electricity, gas and water supply constituted 18.7 per cent of national income in 1960-61 and 28.0 per cent in 1990-91. In 1991-92 the share fell to 27.3 per cent but rose to 29.2 per cent in 1995-96. In 1996-97 the share is expected to be around 29.8 per cent.
The share of tertiary sector including transport, communication, trade, banking, insurance, public administration, defence etc. rose significantly from 29.1 per cent in 1960-61 to 39.1 per cent in 1990-91. In 1995-96 it rose to 42 per cent and is estimated to be around 42.3 per cent in 1996-97.
On the face of it, there should be nothing worrisome about the growth of service sector if it supplements either agriculture or industry. But it is a matter of concern if a large part of the service sector is not aligned to industry, and hence contributes little to the growth of goods within the economy. In as much as it does not, the consequent latent demand is a potential cause for future inflation. Says Nachane: Demand for a large part of services in India is much ahead of the state of the economy. This is because of globalisation. Much of advertising, fashion designing, broadcasting etc would fall in this category.
Double fault!
The classical model of economic development accords priority to agriculture and its allied activities in the early stage of development. Thereafter, at the second stage, manufacturing and related activities should get preferential allocations. And, in the third stage, the tertiary or the service sector gets a boost. The last stage conforms to W W Rostows final phase of high mass consumption. The relative emphasis on these three activity groups should keep on shifting through time.
However, severe distortions have developed in the growth pattern of these sectors of the Indian economy since Independence. The crucial point is that even before the first stage of development was completed, the economy shifted its focus to the industrial sector. In the second five-year plan itself, capital intensive heavy industries were given priority. As a result, public investment in agriculture was neglected. This sectoral imbalance was accentuated further by concentrating on the tertiary sector before attaining full growth in the manufacturing sector. Distortions in the form of inflation and unemployment have arisen as a result. Besides, inter-sectoral forward and backward linkages have not been strong.
However, the percentage of population dependent on these sectors has not changed in the same way. This is a pointer to the fact that economic development is benefiting only a few sections of the population. For instance, while the share of agricultural sector in national income fell by 44 per cent in the last 50 years, the percentage of workforce in agriculture has declined only by about 6 per cent. High incidence of disguised unemployment in the agriculture sector has led to low wages. Moreover, migration of agricultural labour to the urban informal sector has depressed wages in that sector too. In contrast to this situation, the faster growing tertiary sector has led to higher wages and salaries, particularly in the organised service sector. It is this factor which is distorting the demand pattern. Demand for imported or indigenous consumer durables arising from this affluent service class has resulted in a skewed market. Unequal income distribution has worsened the situation.
The income growth rate of all three sectors saw wide fluctuations over the years. The growth rate of agricultural sector in 1991-92 declined by 2.0 per cent. During 1992-93 to 1994-95, the sector witnessed a growth rate ranging between 3.5 per cent to 6.0 per cent. This fell by 0.1 per cent in 1995-96 and is estimated to rise by 3.7 per cent in 1996-97.
The manufacturing sectors growth rate fell by 1.7 per cent in 1991-92. In 1994-95 it rose by 9.5 per cent, and then soared to an all-time high of 11.6 per cent in 1995-96. It is estimated to grow by 8.7 per cent in 1996-97. The slowing down of industrial production is clearly attributable to the dramatic fall in the rate of growth of electricity production a non tradable service and a slowdown of growth in the mining sector (mainly because of the 10 per cent decline in the crude oil production). Another noteworthy aspect of industrial growth is the acceleration in the rate of growth of capital goods production to 16.6 per cent in the first seven months of this year from 15 per cent in the seven months of last year. This has offset the decline in the rate of growth of consumer goods and basic goods but falied to prop up industrial growth as a whole.
In the tertiary sector, transport, communication and trade have shown remarkable growth since Independence. In 1960-61, the share of these industry segments was 12.6 per cent, which rose to 20 per cent in 1995-96. On the other hand, the rate of growth of banking, insurance, real estate and ownership of dwellings fluctuated throughout the reform period. The growth rate in 1991-92 rose by 10.5 per cent only to fall to 4.6 per cent in 1992-93. It again rose by 10.5 per cent in 1993-94. The growth rate is estimated at 6.3 per cent in 1996-97.
Although inflation is at its lowest level at present, these fundamental distortions in the economic structure are liable to exert themselves in the long run. Unless due efforts are made to correct these sectoral imbalances, the country could get caught in a structural inflation spiral in the future.
A large part of the growth in services could be purely illusory, accruing as it does from inflated salaries and wages in the financial sector, legal fees and other such activities.