The Govt Can’t Keep Driving GDP Growth

On March 1, 2017, I wrote a piece titled, Believe in Indian GDP Growth at Your Own Peril. I got many responses to the piece. Some readers, as always, accused me of being a Congressi To them I suggest please read my writing before May 2014. Also, life is not binary at the end of the day. There is a little more to it than just that.

Some others asked if I was suggesting that the government is fudging the Gross Domestic Product(GDP) data. Not at all. I have no evidence of the same. All I was saying was that there are multiple data points which show that the Indian GDP growth just did not feel right and pass the basic smell test.

During the course of last one week, the chief statistician of India, TCA Anant, has given several interviews to explain the deficiencies in the way the Indian GDP is measured. And these deficiencies I feel have led to the GDP being overreported. (I suggest that readers looking for greater detail Google up and read Anant’s interviews).

In fact, there is another point that needs to be made here. One way of measuring the GDP is through the expenditure method. This involves the summing up of private consumption expenditure, government consumption expenditure, investments and finally net exports (i.e. imports minus exports).

Now what happens if we subtract the government expenditure from the GDP number measured through the expenditure method. How much does the remaining GDP grow by? Look at Figure 1.

Figure 1 

As per Figure 1, the GDP growth without taking the government expenditure into account during the period October to December 2016 was 5.6 per cent. This was 140 basis points lower than the overall GDP growth of 7 per cent. Why has this happened?

Take a look at Figure 2. It makes for a very interesting reading. It essentially shows what portion of the increase in GDP between years comes from an increase in government expenditure.

Figure 2 

What does Figure 2 tell us? From forming next to nothing as a part of the increase in GDP between the years, for the period October to December 2016, an increase in government expenditure made up for 26.64 per cent of the increase in GDP.

Hence, for every Rs 100 increase in GDP, increase in government expenditure made up for Rs 26.64 on an average. As we can see during the course of this financial year, an increase in government expenditure has been responsible for a greater proportion of the increase in GDP.

The government spending more to get an economy out of trouble is standard operating procedure. They need to be seen to be doing something and this all they can do.

Nevertheless, there are problems with this approach. The trouble is that this way of creating economic growth by the government spending its way out of trouble, cannot continue indefinitely. At the end of the day the government has a limited amount of money at its disposal. Further, its expenditure tends to be terribly leaky and does not reach a major portion of those it is intended for. Also, the multiplier effect of private expenditure is better.

If India has to continue growing at greater than 7 per cent, then investment needs to pick up and that doesn’t seem to be happening currently due to various reasons. Given that I keep discussing these reasons, I will give them a skip here.

Take a look at Figure 3. It shows the portion of the GDP formed by gross fixed capital formation, a measurement of investment.

Figure 3 

The gross fixed capital formation as a percentage of GDP has been falling over the last few years. This figure needs to start going up, if a genuine economic recovery which creates both jobs and prosperity, needs to take place. And increased government expenditure cannot do anything about this.

The column originally appeared on Equitymaster on March 7, 2017