Back to the 1950s: State to lead investment and higher taxes to fund it

As the finance ministry starts work on Union Budget 2023, due 96 days from now, it’s useful to ask what key political objectives will drive it. We know the answer from the pronouncements of the prime minister and the RSS: employment, employment, employment. 

And therein lies a problem. This is something that wealthier Indians haven’t realised fully yet: higher taxation is inevitable for financing the effort. So brace for it. 

The reason for higher taxation is the inability of the private sector to invest on the scale required to satisfy the minimum thresholds of political and social needs. We are back to the 1950s. 

And the reason why the private sector will not invest is the high and rising cost of capital. Unlike in the 1950s, it has the non-financial abilities that are needed. But finance is going to be costly. 

Also, given the competition from China, the only way non-Chinese firms can make money is by adopting labour-displacing technologies and by producing services that only require low-wage temporary employees. This means even if the Indian private sector gets some money, it can make money only by avoiding large-scale employment. 

This labour displacement is already happening in a big way in developed countries. The latter, low-wage temporary employment, is happening in less developed ones like India, and the trend will accelerate. 

So what we will get in the next decade is what Marx had predicted in his tome, Das Kapital, namely, the search for profits creating “a vast army of the unemployed”. He also had, therefore, advocated a huge role for governments. 

There’s no getting away from this inevitability for another reason. The world population in 1900 was around 1 billion. Today it is close to 7.5 billion. To generate employment for even 50 per cent of these people — say about 3 billion people — the world requires capital on a mind-boggling scale. Or subsistence wages for 12-14 working days. Or both. 

Neither is going to happen. Such large injections of capital will cause massive inflation, which is politically unacceptable. Subsistence wages will also be politically unacceptable except at the margin. 

That’s why we now have to see how the government will respond. And the answer lies in India’s own economic past between 1957 and 1992. Two features characterised these 35 years. One was the state taking the lead in investing. The other was high taxes to finance that investment. 

Low wages were avoided in the formal sector by rigid labour markets and artificially propped up wages and salaries. The resulting low productivity was financed by high taxes and gradually increasing borrowing, which reached its climax in the crisis of 1991. 

In other words, we are back to the Mahalanobis-TTK model of growth with some variations in detail. That model, thanks to Mahalanobis, emphasised investment in heavy machinery. The thought was good, but like many good thoughts, it didn’t work. 

Its new variant will emphasise infrastructure, both hard and soft. This is what we have been seeing for the last six years. This trend will only accelerate. 

So the million-dollar question: who will bear the brunt of the higher taxation? I think the reduction in corporate taxes to 23 per cent will be and should be gradually eliminated and taken to a level that compensates for the inability to increase either GST base rates or personal income taxes. 

But even this will not be enough. So, in the end, I believe we will turn the clock back to the 1960-90 playbook, wherein government borrowing will gradually rise to perhaps 150 per cent of GDP in five years. 

This has been the global trend as well, so there’s no need to get agitated. It’s just the “Washington Consensus” — more private, less public — being reversed.