18
Mar
09

Macro Economic Effects of Changes in Public Investment in India – A Simulation Analysis

The paper which tells about the effect of changes in public investment in India, created by A. Soumya and K. N. Murty is attempts to build a four sector aggregative, structural, macro-econometric model for India. Annual time series data for the period 1978-79 to 2002-03 are used for this purpose. A macro econometric model is as a system of simultaneous equations, seeking to explain the behaviour of the key economic variables in the economy at aggregate level, based on the received theories of macroeconomics. Macro econometric modelling, in general, pursues two objectives forecasting and policy analysis. Three-stage least squares method is used to estimate the model. A preliminary trend analysis has shown slowing down of the economy during ‘90s and thereafter. There are also significant structural shifts in production from agriculture to infrastructure and services in the Indian economy. The estimated model indicated significant crowding-in effect between private and public sector investment in all the sectors.

Counter factual policy simulations of sustained increase in public sector investment in infrastructure, financed through borrowing from commercial banks, shows substantial increase in private investment and there by output in this sector. Further, due to increase in absorption, real output in the manufacturing and services sectors also seem to increase, which sets-in motion all other macro economic changes. A 10% sustained increase in public sector investment in infrastructure, which is less than 0.4% of GDP, can accelerate the macro economic growth by nearly 2.5% without causing any inflation. Further, this increase in income will lead to 1% reduction in poverty in India. This shows the potential for achieving the much debated 10% aggregate real GDP growth in the Indian economy.

In developing countries, the economic policies of the government play an important role in the growth of the economy. Government total expenditure consists of current and capital expenditures. This study has analysed the likely macro economic effects of changes in public investment in infrastructure in India. The quantified effects include the allocative and dynamic responses of the chosen policy change on important macro economic variables relating to four broad sectors- real, fiscal, monetary and external sectors of the Indian economy. The real sector further decomposed into four sub-sectors, agriculture, manufacturing, infrastructure and services. The sign and magnitude of the effects vary over time- immediate to long- run.

Briefly, the estimated model indicated significant crowding-in effect between private and public sector investment in all the four sub-sectors of the real economy. This has important consequences for investment/disinvestment policies of the government, in each of these sectors. Sustained increase in public investment in infrastructure was found to stimulate substantial increase in private investment in all the sectors. Such a policy is expected to result in wide spread changes in the fiscal and monetary sectors of the economy. Thus, public sector investment in infrastructure has the potential to provide the much-needed push and accelerate the growth process of the Indian economy.

A 10% sustained increase in public sector investment in infrastructure (about Rs. 3500-3800 crores p.a. at 1993-94 prices) will enable the Indian economy to grow at an additional 2.5% p.a. and achieve the much debated 10% aggregate real GDP growth per annum in the medium- to long-run. Further, such growth is non-inflationary and welfare improving through higher government revenue and 1% reduction in poverty. The additional expenditure is less than 0.4% of the GDP and about 2% of the tax revenue. We believe that such investment is quite feasible and cost effective. An alternative simulation wherein the government utilizes accumulated capital inflows instead of borrowing from commercial banks, gave similar results, with few changes in external and monetary sectors.


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