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IB.ECONOMICS
collection of Internal Assessment works for Economics in
International Baccalaureate programme
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Commentary number 2. The problem which was faced by the India’s economy in recent months is the constantly growing distance between the actual and potential growth1. The importance of the problem comes from the fact that this potential growth originates from the number of qualified labour, for which the market would not provide the chance to increase the welfare of the state. Unemployment which rose as a result of such situation would be the reason for the series of sociological as well as economical problems beginning with the lack of motivation to study (what would result in the lower potential growth in long-run; this does not solve the problem since this decrease would originate from the lowering of qualification – not the number of labour) ending with the higher criminal rate and lower GDP per capita2 (the growth of population would be higher than growth of GDP). The distance between the actual and potential growth is the consequence of the law of diminishing return: if there is a lack of one of factors of production (e.g. the capital) even significant growth of the other would not result in the serious growth of output. In India the growth of population was not followed by the growth of foreign capital and improvement of infrastructure. The shortages in infrastructure are the menace for the development of India’s firms (they could not effectively transport their goods and communicate with their clients or suppliers). The improvement of infrastructure would increase the profitability of investment what would in turn attract foreign capital. Finally this would result in the increase of the factors of production whose lack now hold back India’s economy. Thus the government should make every effort to increase the physical capital in its state. There is also another argument which indicates the need for investments. This time it is linked with the circular flow3. The potential of this state and the popularity of outsourcing4 in Europe and United States attracted many investments which became the significant injection into India’s economy. The new course of China generated however the serious competition between these two states and lowering of India’s injection. On the other hand the former boom in 1994, 1996 created the demand for the goods that still could not be supplied by the domestic market. Hence India has to import a lot (see histogram5) increasing its withdrawals. As the result the equilibrium level of national income6 was placed far below the full employment level of national income7, which additionally rose as a consequence of growth of population. The deflationary gap8 which arose (presented on diagram 1.) reflects the appearance of demand deficient unemployment9. The government investment into infrastructure would be the significant injection into circular flow what would reduce the gap (see diagram 2) Another essential step mentioned in the article is to encourage people to save more. This would enable the capital formation, what would increase the productivity of factors of production – namely financial capital. In this case the growth of withdrawals will not increase the deflationary gap since banks and other financial institution will reinvest the capital gathered through savings, what will act as an injection. This time however the cumulated capital would be dedicated to most profitable investments what would bring greater advantage to India’s economy than if it was spent by individuals on consumption. The problem which arise here is the risk of high inflation10. In the ideal situation, until the full employment level of national income is reached (the deflationary gap is liquidated), the prices should not rise significantly, since the market simply uses its free capacities. However the problem is that in India not only the high growth is needed but rather the acceleration of this growth. In short-run producers are not able to immediately meet so drastically increased demand for their products. The demand would exceed the supply and the prices will grow. This is presented on diagram 3 picturing the relation between average price and income. Thus in the light of to proposed changes in India, the high inflation could be suspected, which in turn could cause worse climate for investments. The scope of the problem is serious, since even existing inflation is too high. In my opinion however, the change of the policy is necessary. The consequences of the growing unemployment would be serious. Hence the radical actions should be undertaken. Two mentioned propositions: encouraging people to save more and improvement of infrastructure could be the key to development. 1 actual growth – the percentage increase of the output produced in the economy of a given country recorded in one year; potential growth – the percentage increase of the output the economy is able to produce providing the full employment of resources (the percentage increase of the production capacity of the economy in one year) 2 Gross Domestic Product – the sum of the value of the final goods and services produced in the given country in one year; GDP per capita – GDP divided by the number of citizens. 3 The flow of the factor payment, goods, services, withdrawals (taxes, savings and import expenditure) and injections (e.g. investment, government expenditure and export expenditure) within the economy 5 data in RS crorer; Source: http://www.iif.edu/data/fi/fd/FD4-2.pdf (from http://www.financeindia.org/fdatabase.htm) 6 Equilibrium level of national income – the level of national income at which injections equal withdrawals; the national income always tends to reach this level. 7 Full-employment level of national income – the level of national income at which there is no deficiency of demand 8 deflationary gap – the difference between national income and national expenditure (if the first exceeds the second one) at the full-employment level of national income. |
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