Ex-CEA Arvind Subramanian Has Junked Not Only GDP Data, But Also Monetary And Fiscal Policy Wonks

As is often suggested, you don’t need to shoot the messenger who brings bad news. But there is no harm in asking him a few questions. In this case, the carrier of bad news is none other than former chief economic adviser (CEA), Arvind Subramanian, who, in a recently-released paper, suggested that India’s gross domestic product (GDP) between 2011-12 and 2016-17 was on an average 2.5 per cent lower.

This means, ever since we adopted the new GDP series based on gross value added (GVA), in no year have we crossed even the 6 per cent mark, never mind the 7 or 8 per cent we occasionally reported. The actuals, according to Subramanian’s estimates, would range from 3 per cent to 5.7 per cent, if one were to use the 2.5 per cent cut across the board over these years. Overall, his average GDP number for these years is 4.5 per cent, and not the 7 per cent we tom-tommed to the world.

The first thing to underline is this: a different GDP estimate should not fundamentally cause us concern, just as a higher one based on the new series should not have given us cause to celebrate. Whether 4.5 per cent or 7 per cent, our situation is not today any worse or better than it already is. Our problems – bad loans, slowing growth, weak corporate profitability, poor export performance – remain with us as before, just as our prospects.

But we cannot ignore the message. If there are serious doubts about the new GDP series, we must take pains to have it thoroughly re-examined, by non-partisan experts, so that its limitations are removed. There is no case for dismissing Subramanian’s doubts.

Additionally, it should spur us to fast-forward reforms. Narendra Modi cannot assume that all is well, and that his agenda can be what it was in the last five years. While his agenda of pro-poor policies can pass muster, he has to focus on several important reforms, including factor reforms in land and labour, and in agriculture. He also has to work hard to restore business confidence – something that went missing after he focused on cleaning up cronyism. He does not need to revive cronyism, but he does need to tell India Inc that he is there to unabashedly support the good guys.

But we also need to ask Subramanian some simple questions. The paper he dished out, titled India’s GDP Mis-estimation: Likelihood, Magnitudes, Mechanisms, and Implications, is essentially an extension of the doubts he had expressed when he was CEA in the Modi government, about whether the new GDP series was measuring growth correctly. Similar doubts had been expressed by former Reserve Bank governor Raghuram Rajan, and also many other economists, but few could put a finger on the problem.

The paper (it can be accessed in full here) essentially says that if GDP had indeed grown as fast as the new series indicated, critical sectors of the economy should also show a positive correlation to it. He used production and consumption data from 17 sectors – electricity, two-wheelers, commercial vehicles, tractors, airline passenger traffic, foreign tourist arrivals, railway freight traffic, index of industrial production, index of industrial production (manufacturing), index of industrial production (consumer goods), petroleum consumption, cement, steel, overall real credit, real credit to industry, exports of goods and services, and imports of goods and services – and pointed out that 16 of these 17 data points had a positive correlation to GDP before 2011, but post-2011 only six had positive correlations.

Question one: if Subramanian suspected that the GDP numbers were out of whack with reality, could he not have simply demonstrated this to the Finance Minister and asked for corrective action? Is the job of CEA merely to doubt the data he has and continue as if nothing happened?

Question two: if Subramanian and even Raghuram Rajan knew about this lack of congruence between GDP growth and sectoral indicators, how valid were their fiscal and monetary policy obsessions?

Question three: is there a good reason why tax growth figures, which are real, were not taken into account while working out the correlation to GDP figures? In his paper, Subramanian explained that he did “not use tax indicators because of the major changes in direct and indirect taxes in the post-2011 period, which render the tax-to-GDP relationship different and unstable.” This does not appear to be a strong argument, for he does not mention which changes in taxes made the comparisons unstable. The main changes related to lower indirect taxes after the global financial crisis, some of which continued until 2014.

The key reason cited by Subramanian for the over-estimation of GDP after 2011 was the shift from using production volumes rather than values – which makes price data critical to the estimation of GVA. If the values used to estimate GDP are wrong, your final estimate will, of course, be wrong.

Which brings us to question four: is Subramanian merely saying that we need to go back to the old method of GDP calculation based on volumes, or is he saying that we need to correct the new series with better data on the values used to estimate sectoral contributions to GVA?

Former chief statistician Pronab Sen told The Hindu that since the two GDP measurement methodologies were different, the estimates would also be different. He told the newspaper: “In estimating the growth of the high-frequency indicators pre-2011, he (Subramanian) has in a sense replicated the method in which the GDP growth was calculated during that period, and then said that there is a correlation between these indicators and GDP growth. Post 2011, when we moved to value indicators from volume indicators, the relationship is weaker because the other two drivers would start getting picked up by the values.”

One conclusion we should draw from this discrepancy is simple: whenever a new series is introduced (whether in GDP, CPI or IIP), the old series must not be discontinued till users and researchers accept the new series as a better substitute. Those who are more comfortable with the old series, can continue to use them.

Question five: why ignore the possibility of productivity gains? The average gap of 2.5 per cent between the new GDP series and Subramanian’s estimates cannot be taken as the real gap for one simple reason: it ignores the possibility of higher value growth resulting from productivity, or quality improvements, even without an increase in volumes.

For example, if car buying has levelled off, it could be because of the rise of Ola and Uber, and also higher usage of public transport. The entry of Jio in mobile telephony may have boosted data volumes even without an increase in the actual number of subscribers. And if corporates are deleveraging, what is the chance that they will not flog their existing assets harder to generate more output from the same investment? Upto a point, you can actually have growth without additional investment is spare capacity exists. And spare capacity and credit binge was what UPA-I’s boom-boom years created.

Productivity gains in the software services industry have also doubled between 2009-10 and 2015-16, and continues to go up even now. If it took around 32,000 engineers to generate $1 bn worth of exports in 2009-10, it now takes less than half those numbers to generate the same incomes, says a NASSCOM study. After the introduction of the goods and services tax, truck-owners have reported a near halving of turnaround time. This means demand for new trucks can be weak in the short term.

But the biggest problem with Subramanian’s new GDP estimates is this: if real GDP growth was really substantially lower, and if we assume that our consumer price indices were not totally wrong, then we have got both fiscal and monetary policies absolutely wrong.

A sharply lower GDP means our actual fiscal deficits throughout the 2011-17 period were much higher, and we should have had a stronger fiscal consolidation roadmap. And if growth was really that much lower, our monetary policy was simply way out of whack and interest rates too high, especially after 2014.

In a sense, Subramanian’s post-facto puncturing of our GDP numbers tells us how our sarkari economists, whether in the Finance Ministry or in the central bank, were blind men leading the economy down blind alleys.