Raghuram Rajan Panel Report on State backwardness - An Analysis

Raghuram Rajan Panel Report on State backwardness

- An Analysis

Recently we all read in the newspapers that the Finance Ministry has tabled the report of the Raghuram Rajan Committee that was formed to suggest ways to identify indicators of the relative “Backwardness of the States” for equitable allocation of Central funds. The Rajan Committee has come up with a Multi-Dimensional Index that will help measure backwardness and aid the Centre in allocating funds to states.

Finance Minister P.Chidamabaram said that, “the demand for funds and special attention of different States will be more than adequately met by the twin recommendations of the basic allocation of 0.3 per cent of overall funds to each State and the categorisation of States as “Least Developed” States.”

The report, released on last Thursday, places Goa on top with regard to development, followed by Kerala. Punjab is a distant third.

The committee, which is likely to become the basis of allocation of funds in the future, shows a paradigm shift in how economic development is measured. Apparently, it rejects evaluation on the basis economic growth indicators only.

 It also states why developed states like Gujarat are performing poorly on human development indicators (HDI), including infant mortality rate and malnutrition. Due to a better HDI, Kerala has been ranked the second best-developed state. Though Tamil Nadu is far behind Kerala, it is third among the “relatively developed” states.

The index proposed by the committee includes 10 sub-components: Monthly per capita consumption expenditure, education, health, household amenities, poverty rate, female literacy, per cent of SC/ST population, urbanisation rate, financial inclusion and connectivity. For devolution of funds to the states, the committee has proposed a formula which takes into account population and area of the states.

At present, there are 11 special category states: Arunachal Pradesh, Assam, Himachal Pradesh, Jammu & Kashmir, Manipur, Meghalaya, Mizoram, Nagaland, Sikkim, Tripura and Uttarakhand.

Read : http://www.deccanherald.com/content/359656/rajan-panel-report-cost-state.html

The Raghuram Rajan Committee’s report on criteria for determining backwardness of states has placed Karnataka among the relatively developed states. It ranks 10th in terms of development. The state will now lose its share in allocations from the Centre.

According to a finance commission formula, the state gets 4.39 per cent of the Centre’s total allocation. Now, it will get only 3.73 per cent. 

Gujarat has been categorized as “less developed state,” just below Tripura.

According to the committee, which was constituted following political pressure from Bihar Chief Minister Nitish Kumar, Odisha is the least developed state, followed by Bihar and Madhya Pradesh.

http://www.deccanherald.com/content/359656/rajan-panel-report-cost-state.html

Now, Let us examine or try to make a humble attempt, as to how meaningful and practical are the findings of the hi-profile report.

(1)                   It is a universally known fact that Global Industrial production and trade are the only two of the biggest engines of wealth creation known to mankind that has reached record highs and is chugging along nicely across the planet for the past three centuries. 

(2)                  Wealth created is not necessarily the wealth spent..!! But if you lag behind in the creation of wealth then how can you spend wealth. It is quite obvious.

(3)                  Ideally speaking Wealth Spent can’t ever be more than the Wealth Created. If you want to lay more stress on the quantum of Wealth spent then you are indirectly not interested in the sources of wealth creation. 

(4)                 The Grand Panel headed by Raghuram Rajan has worked on a Multi-Dimensional Index. The Index categorizes backwardness of states based on

                                                   i.     monthly per capita consumption expenditure,

                                                ii.     education,

                                             iii.     health,

                                              iv.     household amenities,

                                                 v.     poverty rate, and

                                              vi.     female literacy,

                                            vii.     percent of SC-ST population,

                                         viii.     urbanization rate,

                                             ix.     financial inclusion and

                                                x.     Connectivity.

The above parameters only gives a reflection that the so called visionary economists’ were too economic in placing their ideas before the government and their lofty ideas belonged very much to the eighteenth Century. It is surprising to note in this list the logic behind the inclusion of the parameters like:

(1)         The percent of SC-ST population is no criteria of backwardness. There are 100’s of countries in the world who have no SC/ST population does that mean that they are developed

(2)        urbanization rate, have no practical relevance.

(3)        The parameter of Household amenities’ is very much taken care of by monthly per capita consumption expenditure, why doubling up.

(4)       Connectivity: Just because Goa is well connected thru motorcycles so it is one of the most advanced states and so is not qualified to receive central funds for development is very funny logic.

(5)        How does the inclusion of the percentage of SC/ST population effect upon the backwardness of the state –it is really a paradox

(6)        If the above parameters are relevant then It is surprising that how they missed a few more equally meaningful but parameters like:

¨   Rate of Growth of the class of beggars /acre of urban cities

¨   Rate of growth of Suicides by farmers in each state

¨   Rate of growth of Strikes and Dharnas in the state per year

¨   Rate of growth of Communal riots in the state

¨   Rate of Growth of Child marriage

¨   Rate of growth of the Consumption of Ayurvedic Medicines instead of Allopathic medicines.

¨    

¨   E.t.c.

§   

(5)                  Well, Internationally all the leading economists of the west or east have never highlighted the parameters of backwardness to plan for growth and development of their respective economies. In fact, all around the world economists consider that Real GDP, as the one perfect economic indicator that says the most about the health of the economy and the advance release will almost always move the markets. No one considers the criteria of Consumption as a standard Index of Growth. The system of GDP calculation is by far the most followed, discussed and digested indicator out there - useful for economists, analysts, investors and policy makers. The general consensus is that 2.5-3.5% per year growth in real GDP is the range of best overall benefit; enough to provide for corporate profit and jobs growth yet moderate enough to not incite undue inflationary concerns. If the economy is just coming out of recession, it is OK for the GDP figure to jump into the 6-8% range briefly, but investors will look for the long-term rate to stay near the 3% level. Similarly for under-developed nations like India and China a growth of 8-10% is quite normal. The general definition of an economic recession is two consecutive quarters of negative GDP growth.

(6)                  The GDP takes care of all together i.e.

a.    Rate of Growth of Industry

b.   Rate of growth of Agriculture

c.    Rate of growth of the Services Sector

d.   That is why it has been pointed above that only the Real GDP is the one indicator that says the most comprehensively about the health of the economy.

e.    Accordingly the states whose GDP is less they are obviously relatively backward. It is so simple as that.

(7)                  If you consider that in the states like J&K where wealth spent is far more than the wealth created by those states then does that mean they are developed states by this criteria...! How…? Because, the money that is spent in those backward states comes from the various packages that the centre has been feeding them. Naturally the Consumer Purchase Index would correspondingly rise in those states.  Accordingly the very base that RRR committee has considered to fix the parameters of backwardness that is the use of “Monthly Per Capital Expenditure” derived from National Sample Survey Organization reports as a measure of income, rather than “Monthly Per Capita State Domestic Product”. This is where the source of fault in representation of factual indices have to be noticed. This also indicative of the negative pessimistic attitude of Governance.

(8)                  The panel says that as they were interested in measuring the well-being of the State population, on the basis of an ill-conceived methodology ~ “consumption from the household survey seems more appropriate than income from the national accounts”….! It is mind boggling to note that a majority of the committee agreed regarding measurement of backwardness on the consumption pattern of the society at large instead of the more dynamic parameters of GDP that reflect the Constructive Development / relative backwardness, of the economy.

(9)                  In strategic states like the J&K, where a lot of funds are fed by the International terrorist Organizations’, huge doles are funded thru drug mafia, and so on. All these funds do go in directly increasing the degree of consumer spending in those states. Similarly the creation of money thru the parallel economy also helps in improving the Consumption pattern from household sectors, in most states...! There are no criteria to make corrective adjustments’ for such dubious consumer spending.  

(10)              The basic fault in this methodology of measuring relative “Backwardness of the States” on the basis of the Consumer pattern lies in various factors :

a.    Internationally it is well accepted that the biggest engines of wealth creation and Growth in any society/economy known to mankind are Industrial Development and Trade and not personal Consumption.

b.   The parameters of Personal consumption depend on various factors :

                                                   i.     Social standards of the individual families.

                                                ii.     Economic Standards of the Individual families

                                             iii.     Some families belong to HUF category where the consumption patterns may differ from that of the Individual units of families.

                                              iv.     Some have huge ancestral properties that may not allow them to spend more on property.

                                                 v.     Most of the Indian families have a tradition of saving more than consumption on personal things. Obviously the Index of the Degree of Consumption by the common Household, ignores the contribution of the degree of savings to Total Income.

                                              vi.     Many families and individuals have habit of investing in Gold for any occasion and this being a major investment will never be taken care of by the Index of the Degree of Consumption by the common Household.

                                            vii.     Most of the families have a sacred belief, irrespective of any religion they may belong to, that whatever they donate for charity should be in hidden form and not to be exposed to the general public. Naturally this factor again will never be taken care of by the so called and notoriously hyped up concept of the Index of the Degree of Consumption by the common Household.

                                         viii.     Some cities in India have at least one/two members living abroad and naturally huge amounts of funds are repatriated by NRIs back to their families. Kerela is an ideal example. Definitely those families have a very standard of living (with a relatively very high degree of consumer spending in monthly Household goods) as compared to those earning from local sources.

                                             ix.     There are many more such factors/activities which are carried out by different individuals in varying degrees out of their total income generated from various kinds of trade, production and services rendered by them to the society at large.

                                                x.     The paradox to be noted here is if one compares two ideal examples of living standards as envisaged below;

a.    An ordinary civilian with a family of 4 persons and  a salary bracket of Rs.25,000 per month but spending lavishly on his daily consumer needs without taking much care of his D-days as he strongly believes in the manifestation that “We should live in the Present while tomorrow will be taken care of as and when it comes…!”

b.   Another civilian who is a normal businessman with a family of 4 persons and  at least an income of Rs.50,000 per month but he is a very careful in spending on household expenses which don’t exceed more than Rs. 15,000 in any case. Because he has to take care of the D-days thru his savings alone.

c.    According to the current theory of RRR Committee Whether you would consider, the second person as backward because he spends less as compared to the former is a paradox that will be always be a point of contention. In that case the aid that is being given to the so called backward states should ideally be handed over to persons belonging to the second category.

 

(11)                Well if the basic criteria itself doesn’t take care of all the parameters of the source of income, along with spending, investment and savings in various activities then how can the so called hi-fi Economic thinkers conceive of the idea of placing so much importance on the mis-leading concept of the Index of the Degree of Consumption by the common Household.

(12)               One of the most dangerous implication of highlighting the pseudo-actual so called “Degree of Backwardness” of an economy at individual state levels (within the country), would be detrimental for the interests of those member states who are pushing themselves hard in the international market to attract FDI investment without taking the help of the Centre. These states would be hit very hard because the International Economy watchers would also take such parameters into account (published by the Central Government), before plunging into any decision regarding the formulation of an Investment portfolio in favour of a member state. Now the managers of the Central Government will be in fact cutting the branches of the tree on which the flowers and fruits of the national economy are dependent for their growth. Accordingly the Central government should think twice before publishing such plethora of ambiguous Indices of backwardness.

(13)                Empirical findings for a panel of around 100 countries from 1960 to 1990 strongly support the general notion of conditional convergence. For a given starting level of real per capita GDP, the growth rate is enhanced by higher initial schooling and life expectancy, lower fertility, lower government consumption, better maintenance of the rule of law, lower inflation, and improvements in the terms of trade. For given values of these and other variables, growth is negatively related to the initial level of real per capita GDP. Political freedom has only a weak effect on growth but there is some indication of a nonlinear relation. At low levels of political rights, an expansion of these rights stimulates economic growth. However, once a moderate amount of democracy has been attained, a further expansion reduces growth. In contrast to the small effect of democracy on growth, there is a strong positive influence of the standard of living on a country’s propensity to experience democracy.

(14)              Hence the Gross Domestic Product in an economy represents the total aggregate output of the economy. It is important to keep in mind that the GDP figures as reported to investors are already adjusted for inflation. In other words, if the gross GDP was calculated to be 6% higher than the previous year, but inflation measured 2% over the same period, GDP growth would be reported as 4%, or the net growth over the period.

                                                   i.     The relationship between inflation and economic output (GDP) plays out like a very delicate dance. For stock market investors, annual growth in the GDP is vital. Most economists today agree that 2.5-3.5% GDP growth per year is the most that our economy can safely maintain without causing negative side effects. But where do these numbers come from? In order to answer that question, we need to bring a new variable, “Rate of Unemployment “, into play…!

                                                ii.     Studies have shown that over the past 20 years, annual GDP growth over 2.5% in America has caused a 0.5% drop in unemployment for every percentage point over 2.5%. It sounds like the perfect way to kill two birds with one stone - increase overall growth while lowering the unemployment rate, right? Unfortunately, however, this positive relationship starts to break down when employment gets very low, or near full employment. Extremely low unemployment rates have proved to be more costly than valuable, because an economy operating at near full employment will cause two important things to happen.

                                             iii.     Aggregate demand for goods and services will increase faster than supply, causing prices to rise.

                                              iv.     Companies will have to raise wages as a result of the tight labor market. This increase usually is passed on to consumers in the form of higher prices as the company looks to maximize profits.

                                                 v.     But strangely the new Index of the relative degree of Consumption by Household doesn’t take into effect the incidence of inflation on the consumption patterns. 

(Contd…)

(15)               While the value of both exports and imports are included in the GDP report, imports are subtracted from total GDP, meaning that all consumer purchases of imported items are not counted as contributions toward GDP. Because India runs a current account deficit, importing far more than is exported, reported GDP figures have a slight drag on them. A related measure provided by the Gross National Product (GNP), goes one step further by only counting the value of goods and services produced by labor and property within the country.

                                                   i.     Today in India after the so called dependence on the globalization of economy and encouragement of free trade the consumption patterns of an average consumer have changed dramatically. Everyone knows that the consumer market in India is hit by imported goods. Earlier it was only the rich and well to do families who could afford to use imported consumer items but today even the common middle class also spends almost the same amount on the imported products (as they are freely available around at the corner shop), than the domestically manufactured products. Now how has Mr.Rajan taken care of the contribution of expenses on the imported goods into the Index of the Degree of Consumption by the common Household….. NO…!

                                                ii.     If we take into account the cascading effect of the contribution of the degree of increase in basic prices of Oil and Gas (which are basically imported products and contribute very heavily to the balance of payments position of the country) on the pricing of all consumer driven commodities then the effect will be found to be more enormous. Definitely the spending of the consumer on all those items that are directly or indirectly related to oil & gas will only be providing us with hollow index of status of economic backwardness on the parameter of consumer spending.

                                             iii.     Similarly, it is quite evident that the measure of the Index of the Degree of Consumption by the common Household would never have taken care of reducing the total expenses done by common household on the imported items. Thus leading the Government of India to false figures of backwardness. 

                                              iv.     Mr. Gupta is emphatically and logically correct when he expresses that he significantly disagrees with the decision to use monthly per capital expenditure derived from National Sample Survey Organization reports as a measure of income, rather than per capita State domestic product, which he said substantially, altered State rankings. However, the panel continued to defend its choice of indicator because they were paid to change the parameters only to show the development of Gujarat in poor light as per the instructions of their bosses in the Congress. .  

                                                 v.     Isn’t it pathetic on the part of the professionals of international repute included in the Economic panel to have compromised so easily with their principals and beliefs just to keep their political bosses happy…!

(16)               What is the relevance of GDP or Gross Domestic Product: The gross domestic product is an important economic indicator and is usually inflation adjusted. This is an important tool for measuring the rate of inflation. The important segments, which are hampered include:

a.    Investment

b.   Interest rates

c.    Exchange rates

d.   Unemployment

e.    Stocks

f.     Various monetary policies

g.    Various fiscal policies

h.    

2.    The effect of inflation and economic growth is manifested in the following cases:

a.    Investment:

b.   Interest rates:

c.    Exchange rates:

d.   Unemployment:

e.    Stocks:

(17)               Hence the utility of GDP in measurement of the development of an Economy is the most comprehensive tool that is used by all economists’, thinkers, International Market Analysts and so on. Where was the need then of introducing a new hollow concept which by itself would only go on to hit us back as envisaged above.

(18)               In my opinion yes, the expertise of the RRR Committee could have been used to discuss the more important issues of

                                                   i.     Curbing the rapid growth of the parallel economy in our country.

                                                ii.     How to curb the flight Indian money to other economies without being accounted for.

                                             iii.     How to curb high rate of corruption in our economy.

                                              iv.     How to reduce the power of cartels in controlling the prices at hyper-inflationary levels, only to make a mockery of the FREE MARKET ECONOMY.

                                                 v.     How to make Effective use of MRTP Act in controlling the cartels and role of mediators.

                                              vi.      How to control the Real Estate prices at realistic levels so that un-necessary funds are not blocked in un-sold inventories that could harmful for the economy in general in the long run. China has done it in the past three years by taking very strong measures, but we are sleeping.

                                            vii.     How to control the prices in the pharmaceutical industry. Because this is one Industry which is not market driven. The consumer has no role to play in the fixing of their prices and the common is really hit hard by these kind of absurd pricing.

                                         viii.     How to introduce the concept of CPI taking care of the prices at the retail level instead of the wholesale level.

                                             ix.     How to rationalize and simplify the system of red-tapism in the bureaucracy in order to attract more foreign direct investment in the country.

                                                x.     How to simplify the procedures’ of exports.

                                             xi.      How to increase the degree of employment in the economy so that it will be more attractive source of investment

                                           xii.      

Hence if these experts were awarded the job of taking a call on the issue of Funding from the Centre to the states based on a state’s development needs as well as its development performance.  But surprisingly enough they have taken an oft-beat criteria of backwardness instead of real Economic development into consideration.

According to them only :

(a)        Ten states that score above 0.6 (out of 1) on the composite index have been classified as “Least Developed,”

(b)       the 11 states that scored from 0.4 to 0.6 are “Less Developed” and

(c)        the seven states that scored less than 0.4 are “Relatively Developed.”

Well we would like to ask only one question that if they say that from now on they would like to utilize the above index for allotment of funds then the seven states that are clubbed as the “Relatively Developed” must be having the highest ratio of GDP which in fact is not so. Let the so called experts check and verify their figures.  

Accordingly if the basic criterion of categorization of the Index is questionable then the whole system is erroneous.

Accordingly, point to be noted here is that this report seems to be politically motivated and not conceptually correct. The Raghu Ram Rajan Committee has submitted the report just days after Raghu Ram Rajan was appointed the Governor of RBI, is sufficient to make any fool understand that he has been awarded the great post as a reward for changing the statiscal interpretation of the yardsticks of growth instantly only to embarrass Modi who has vandalized all forts of the UPA single handedly without any problems.