The Value Of Detail

Few are gifted with an intuitive ability which can substitute analytical rationale. Mr Swaminathan S Anklesaria Aiyar belongs to this select breed. In his column, (Swaminomics, Times of India, October 20) he has argued that public investment is negatively related to private investment. The relation between public and private investment has been a long and unresolved debate in academic circles. Fairly advanced statistical techniques and causality tests have been used on voluminous data to explore the relationship between the two important variables.

Now all this appears to have been unnecessary. And like most academic concerns, it seems to have been an exercise in futility. For in a simple, succinct and sharply focussed article, Mr Aiyar has removed all the analytical cobwebs. He has laid all controversy to rest with the help of a simple two-line graph. He has plotted the rate of gross fixed capital formation in the public sector alongwith the gross domestic fixed capital formation in the private sector. And Eureka! The results are there for every one to see and acknowledge. Not that the author needed to see the evidence. Apparently, he knew all along that public sector, far from inducing or crowding in private investment, actually causes it to decline.

 

The graph brings out quite clearly that in the post-1986 period, as the rate of public investment declined, the rate of private investment increased. It is all so simple that the only reason why nobody else including heavyweights like S Chakravarty thought of it earlier is because it is too simple for their convoluted minds.

The beauty of the article lies in its simplicity. However, since such a major conclusion, which can potentially alter the fundamentals of development policy, has been drawn, we might like to sacrifice the simplicity a little in the interest of some more enlightenment. The first simplification made Mr Aiyar is to include everything which is not public investment as private investment. Thus, private investment in his classification includes two categories private corporate investment and household investment which are probably as different if not more as public and private investment. And the manner in which he treats private investment it would appear as if everything is private corporate investment, which it is not. A substantial part of the investment which is covered under the generic term of private investment is actually household investment. Even though the proportion of household investment is declining, it still accounts for more than half of the total private sector investment.

The two sub-groups of private investment are different not only in terms of the modes of determination (and indeed the method of estimation household investment is a residue) but also in terms of the structure and composition. For instance, 80 per cent of the fixed capital formation in the private corporate sector is in the form of machinery and equipment whereas it accounts for less than 25 per cent in the case of the household sector. If this minor distinction is taken into account a slightly different picture emerges. As the graphs show, fixed capital formation in the household sector declined sharply after 1990-91 and this decline is closely related to the decline in the public investment.

At the same time the decline in public investment is associated with a rise in the corporate sector investment. Without getting into the arguments about lagged structure of the response, let us assume for the moment that the two are indeed negatively co-related. The basic reasons adduced by Mr Aiyar for the negative relation between public and private investment is that public investment is more inefficient and that it pre-empts domestic savings. The link between inefficiency and crowding out is not entirely clear but the basic argument is that with the decline in public investment more savings are available to finance private corporate investment.

Quite apart from the suspect analytics savings dont determine investment at the macroeconomic level the observed divergence in the trends which has been treated as negative co-relation could be explained by more mundane changes that have taken place like a change in the composition of investment.

While all forms of investment are the same, it is important to make a distinction between its composition. The National Accounts Statistics decomposes investment in terms of assets. It provides information on two categories viz. construction and machinery and equipment.

As the graph shows, the proportion of machinery and equipment within private investment has increased secularly. In fact, after 1986, the year in which Mr Aiyar noticed a break in the relationship, the proportion of machinery and equipment shows a sharp increase. This evidence, alongwith the relationship between household investment in construction and public investment, makes it obvious that a decline in the proportion of construction investment has contributed to the changing relationship between public and private investment.

Increased government investment, especially in construction, through its wage and input components stimulates the demand for private sector goods. The wage-goods intensity of this form of investment being much higher than machinery and equipment. However, the net stimuli for private investment and its distribution across industries depends not only on the additional demand created by increased investment but also on the amount of consumption restricted and how the domestic burden of financing is borne.

The other compositional distinction that can be made is across sectors or industries of use. A changing structure of public investment away from, for instance, electricity to agriculture or trade, will weaken or atleast change its relationship with private investment at the aggregate level. This will happen even at the existing levels of inefficiency or resource preemption. An analysis of investment by industry of use bears this out.

While government investment enlarges markets and stimulates private investment, it simultaneously competes with the latter for scarce inputs. Thus the government and private sector have a contradictory relationship; the former stimulates the latter, yet competes with it in a certain sense. And one tendency can prevail over the other during different time periods. But it is important to note that this contradiction at one level should not obscure the basic fact that the private sector has derived great overall benefits from government investment and will continue to do so.

Thus, the effects of government investment on private corporate investment are not only complex but also variable, even if the net result is a fairly simple one which can be represented in a two-line graph. But in interpreting it and generalising on its basis, the complexity has to be borne in mind. Otherwise it may result in trivialisation.