Did the UPA Destroy the Economy? A Counterfactual Exercise

As the heat and dust of the Indian elections settles down, as the BJP settles into governing and as the Congress gets used to the idea of being out of power, it might be possible to discuss the question asked in the title of this post.  Before I start, I should state clearly what I am not doing: I am not at all going to suggest that the UPA should have been re-elected in the recent general elections. Given its lacklustre performance, especially during the last two years in office, and the various scams that took place, there is no denying that the UPA deserved to be voted out. But the question in the title of the post is important since it was one the major attacks against the previous government (see here). For a robust and general defence against that attack, I invite the reader to look at the careful analysis of the UPA rule by Ghatak, Ghosh and Kotwal. My purpose in this post is far more limited: I want to narrowly focus on the fiscal stimulus that was introduced by the UPA during 2008-09 and 2009-10 and show how this worked to protect India from the ravages of the Great Recession. I am going to discuss this in the context of a branch of economics known as Public Choice.

Public choice tells us that a government often manipulates economic policy for partisan objectives. One of its most important objectives is to remain in office by being re-elected. This is a far more cynical view of governments as compared to the textbook version which supposes that governments relentlessly promote social welfare. Given the loss of innocence over the last few decades, I am quite sure that the cynical view will find greater resonance among the electorate than the standard textbook view.

Governments have tremendous discretionary powers at their disposal, so that policies are often crafted and implemented in such as manner as to enhance re-election prospects of the party in power. Typically, a self-serving government will try and ensure that the economy is doing well around the time of the elections. This is expected to be done by introducing a public expenditure programme around election time so that economic growth is healthy and unemployment is low. Inflation inevitably follows in the wake of such a programme, but by that time elections have already taken place and the ruling party is once again entrenched in power. Policies to control inflation are now implemented and these lead to rising unemployment. But this situation is non-threatening since the next elections are far off. The middle of the electoral term is thus characterised by low growth and high unemployment. As the next elections approach, once more the economy is boosted to improve the chances of re-election. 

Did the performance of the UPA-II match the prediction of the public choice theory? Not at all. It delivered high rates of growth in the two years immediately after re-election: 8.2% and 8.9% in 2009-10 and 2010-11, respectively. Surprisingly, this was higher than the 6.5% rate recorded in 2008-09, the year leading up to the elections of 2009.  Even worse for UPA-II, it delivered its worst economic performance in the two years prior to the elections of 2014. In short, its performance was the exact opposite to that predicted by public choice theory.

The question I address here is the following: if the UPA government were to behave cynically, as proposed by public choice, how would it have behaved differently? I am going to put forward a counterfactual narrative to the events that unfolded from 2008-09 to 2011-12. Counterfactual history (interested readers may check here) is in the form of a “what if” question: what if the fiscal stimulus package were not implemented in 2009-10?

This counterfactual narrative will be compared to the factual narrative, which was that India’s fiscal stimulus packages were activated on 7^th December 2008, 2^nd January 2009 and 24^th February 2009. These actions, which were in keeping with standard prescriptions for tackling recessions, included excise duty cut, additional plan expenditure, increased government borrowings, interest subsidies for export finance among other measures. The increase in public expenditure due to this stimulus amounted to about 3 percent of GDP (see Supriyo De). It should also be remembered that the employment guarantee scheme (MNREGA) was already in place by then which also added to public expenditures.

The steps that I adopt to carry out the counterfactual exercise are given in the appendix. In its essence, my counterfactual experiment seeks to estimate what the GDP growth rate would have been if the fiscal stimulus of 2009-10 and 2010-11 had not taken place.  The chart below gives the actual growth rate of real GDP as compared to the counterfactual GDP growth rate derived from my exercises. 

The figure makes clear that, in the absence of fiscal stimulus, Indian growth rate would have faltered. From a public choice point of view, sacrificing growth during 2009-10 and 2010-11, (with the government behaving as in the counterfactual exercise) would have been the “rational” choice. Then, as the elections of 2014 approached, a policy to stimulate the economy could have been put in place. Of course, the point is moot whether it would have been possible to revive the economy once it had lost its momentum. A very likely possibility is that India would have slipped into a prolonged recession and extricating the economy out of this would have required an even greater fiscal and monetary stimulus with no guarantee of recovery. If that were to happen then, not only would growth have remained low during 2012-13 and 2013-14, but possibly India would have suffered sluggish growth right from 2009-10. This would have been no different from the pattern of growth experienced in a large number of countries which are still struggling to recover from the recession.

Considering the growth performance of many countries around the world during the time period 2008-09 onwards, it seems almost miraculous that India (and China) was able to postpone the slowdown by a few years. See chart below:

The chart shows that, barring China and India, every other country experienced negative growth rates in 2009 and positive but low rates thereafter.

In fact, as the recession spread around the world, a very large number of countries suffered very low rates of growth in 2009. See chart below which has been created using World Bank data.

Out of the 191 countries covered in the chart, 180 performed worse than India. Of these, 90 had negative growth rates. This chart brings out sharply the world-wide devastation wrought by the Great Recession. Of the 11 countries in the top two groups (on the extreme right of the chart), excluding India and China, the remaining 9 are very small countries with a combined population of only 151.1 million which is less than 13% of India’s population. This probably gives a proper perspective of the significance of India’s achievement during 2009-10 to 2011-12.

In conclusion, I would like to propose the following two points:

1. The ferocity of the recession was too great for any country, including India and China, to have escaped completely unscathed. That India was able to stave off its ill effects for three years is an achievement that is perhaps not adequately recognised and appreciated.
2. The UPA-II government acted quite unlike the predictions put forward by public choice theory regarding self-seeking governments. In fact, by formulating and implementing a fiscal stimulus policy at the correct time, it acted sagaciously and unambiguously in the national interest. Far from having “destroyed” the economy, the UPA-II, in fact, protected the economy from the cataclysm that had engulfed the world.

APPENDIX

The steps that I adopt to carry out the counterfactual exercise are the following:

1. I consider two data series: GDP at constant prices and real Total (Centre + State) government expenditures.
2. For the time period under consideration, I compute the expenditure multiplier defined as change in GDP divided by change in expenditure. I get values that are much higher than those reported in the literature (See Bose and Bhanumurthy). However, I continue to use my higher values. It may be noted that had I used the multipliers reported by Bose and Bhanumurthy, the counterfactual growth rate would have been even lower than the ones reported above.
3. For the years 2008-09 to 2011-12, I create a counterfactual path of government expenditures using the average annual growth rate of the three years prior to 2008-09.
4. The counterfactual path of government expenditures allows me to compute the changes in government expenditures which, when multiplied by the multiplier values of 2008-09 to 2011-12 (see step 2 above), gives me annual changes in real GDP.
5. Finally, these changes in real GDP are used to create the counterfactual path of real GDP from which the counterfactual growth rates are extracted.