Introduction

The aims of this essay are twofold: (i) to understand Ricardo's economics in relation to other classical political economists, especially Smith, Sismondi and Malthus and (ii) to provide an alternative conceptual architecture for better understanding contemporary societies. Thus, it serves as a companion in the above two ways. While the locus of discussion is Ricardo's explanation of relative prices and income distribution (value theory), this shall be complemented by a discussion of his approach to economics and his theory of economic growth.

In Ricardo's index to the Principles, there are five entries on Malthus, one entry on Sismondi, and over 20 entries on Smith. Ricardo writes approvingly of Malthus for presenting ‘to the world … the true doctrine of rent’ and of Smith and Sismondi for having improved the ‘science’ of ‘Political Economy’ but notes that they have not grasped the principles of rent and therefore that of income distribution (Works, I, 5–6).

The essay is organized as follows. Section 2 highlights the role of value theory in Ricardo's political economy and for economics in general. Section 3 provides an overview of Ricardo's method. Section 4 outlines Ricardo's critical engagement with use value and exchange value. Section 5 discusses Ricardo's theory of value and distribution. Section 6 engages with Ricardo's growth theory and the role of demand therein. Section 7 offers a conclusion.

The Raison d’etre of Value Theory

Before stating the raison d’etre of value theory, it is necessary to present the aims or ‘objects’ of political economy as laid out by Smith.

In short, it may be stated that Smith envisioned political economy as a science which has at its core the enrichment of the people. Therefore, the determinants and growth of wages and profits constitute a central part of political economy.

Introduction

In the previous chapters, we discussed the determinants of output and employment (Chapter 4), the link between economic growth and employment growth (Chapter 5) and, very briefly, the informal nature of employment in India (Chapter 6). As Adam Smith had written, the central objective of political economy is “to provide a plentiful revenue or subsistence for the people”. And the pursuit of full employment is one of the ways through which all the people can secure a ‘plentiful revenue’. Additionally, as already stated in Section 4.1, the employment ought to be secure (reliable) and well-paying (gainful). Together, this can contribute to a good life for all and, therefore, full employment is viewed, in this book, as an extremely desirable policy objective.

This chapter summarises the nature of employment in India by measuring its various aspects—drawing upon, primarily, the context. Recollect from the previous chapter that the ‘what to measure?’ question is heavily dependent on concept (used interchangeably with theory) and context. Subsequently, this chapter reiterates relevant aspects of the Keynesian approach to employment and provides broad-based macroeconomic solutions to tackle India's unemployment problem. The chapter concludes by underscoring the need for a comprehensive employment policy, which meaningfully integrates wages policy, growth policy, agricultural policy and education policy, in order to attain full employment as envisioned here.

The nature of employment in India

There are innumerable ways of looking at employment within the macro, meso and micro approaches. Some of the macro questions we hear take the following form. How much employment has the economy added in the past year? What is the quality of the existing state of employment in the economy as a whole? Do gender and/or caste play a role in determining the overall employment rate? The meso questions are of the following kind. How much employment does the services sector generate every year? What is the extent of distress migration from one sector to another? Do gender and/or caste influence sectoral employment? Questions from a micro approach take the following configuration.

Introduction

When the prices of essential commodities like dal (pulses) and onions increase, it makes headlines in newspapers. It is similar with fuel (petrol and diesel) prices too. If we have at our disposal the knowledge regarding the determinants of these prices, then we can formulate policies aimed at reducing the prices. In the preceding chapters, we discussed the macro determinants of aggregate output (Section 4.2), the nature of India's financial architecture (Section 3.2) and the significant presence of informality in the Indian economy (Section 6.4). It will presently be seen (in Section 8.2) that a brief understanding of the aforementioned empowers our attempt to understand the nature of inflation.

This chapter introduces you to the nature of inflation—the rise in aggregate price level over a sustained period of time—by measuring its various aspects and posing several questions for you to ponder over. The measurement of aggregate price level requires the aid of the statistical device of index numbers, which is an average of a special kind. After outlining the problem of high inflation, the chapter provides a range of broad macroeconomic solutions relevant to the Indian context. Before we get into the details of inflation, note that the primary objective of the Reserve Bank of India (RBI), as mentioned on its website, is “to maintain price stability while keeping in mind the objective of growth”.

To reiterate, the primary aim of economics, following Smith, is to ensure “a plentiful revenue or subsistence for the people”. This warrants not only reliable and gainful full employment, but also that the purchasing power of wages witnesses an improvement in line with the evolution of people's social needs. Or, at the very least, the purchasing power of wages ought to remain steady. This chapter focuses on commodity flows and money flows, both of which influence commodity prices. It takes Keynes's assumption of a ‘monetary production economy’ seriously to arrive at an understanding of inflation. The chapter concludes by arguing that the policies to combat inflation warrant the joint forces of fiscal and monetary policies.

The nature of inflation in India

Inflation, as noted in the introductory section, is the persistent rise in the aggregate price level (P) over a period of time.

Introduction

Many textbooks of economics provide the reasons and rationale for the study of economic theory in the first chapter itself. Having already introduced you to the various macroeconomic theories—of money and interest rates, of employment and output and of economic growth—in the previous chapters, and by discussing the importance of economic theory in the present chapter, this textbook adopts a different approach. Moreover, note that this is a transition chapter, as the next two chapters deal with economic policy issues relating to unemployment and inflation, respectively. Just like some students in my economics classes, some of you might also wonder why learning economic theory is important. We have already remarked on the nature of theorising in Section 1.4 and the structure of a theory in Section 4.2. This chapter provides four substantive reasons for a close and critical study of economic theory (and their attendant models).

The need for discipline

Economic facts surround us, be it the price we pay for a ride in the autorickshaw, the value of our shopping expenses at the local vegetable market, the number of hours we spend at work, the number of hours of household work or the number of people who look for jobs daily. How do we decide which prices and quantities to focus on? Is it possible to process facts unaided? Or do we require some sort of a disciplining device akin to a sieve to sift through facts or a lens to magnify select facts? It is in such situations that theory plays an important role—by informing its student which of the key economic aspects to focus their attention upon. Often, these aspects are not directly observable, and will need to be measured or computed by the process of estimation or imputation. For instance, aggregate output (Y) is not directly observable, but, as we have noted in Chapters 4 and 5, it provides a useful indicator of the activity levels in an economy. Similarly, although we are able to see that people purchase food items, consumer durables and transportation, the relevant macroeconomic variable is aggregate consumption (C)—a directly non-observable variable.

Introduction

At the very beginning of this book (Section 1.1), some of the motivating factors behind our decision to study economics were listed. One of them was the question: how to improve the per capita availability of goods and services? In other words, how does aggregate output per worker (Y/N) grow over time? The rate of growth of Y/N is an indicator of the health of an economy. For instance, if the Indian economy is growing at a good pace, it means that, on average, the income per person is also witnessing a good growth. However, owing to the effect of extreme values on averages, we can never be certain whether the growth is primarily driven by a tiny group of chief executive officers (CEOs) whose incomes grew substantially or owing to an increase in the agricultural incomes for a vast number of rural workers. And nor can we ascertain whether the agricultural sector as a whole is growing. To learn about the nature of growth (or in the language of statistics, the distribution of growth), we need to adopt a meso approach—this is what we do in Section 5.3. Given these considerations, treat the growth rate of an economy (growth of gross domestic product, or GDP) as you would treat the blurb of a book—as a reasonable guide to the story, but unable to provide the complete picture.

The previous chapter provided the determinants of output and employment levels in both closed and open economy settings. To continue with the analogy of the idli, while the last chapter examined the determinants of its size, the present chapter looks at the growth in its size over time. ‘Economic growth’ is the study of the evolution of the size of output or output per worker over time. Contemplate whether the determinants of output levels and output growth are necessarily the same; or would you expect the determinants of growth to be different from those of output levels?

This chapter relaxes a key assumption made in the previous chapter, that of given productive capacity. A study of economic growth warrants a study of the growth of productive capacity. What is the role of technological progress in economic growth?

Introduction

What do you think are the relevant aspects of a macroeconomy that can be utilised in the first stage of theorising? Should we try to classify households as rich and poor or treat them as if they are a single homogenous unit? Should we distinguish between local governments and the central government? Should we begin with a classification of firms as capital intensive and labour intensive? Or should we distinguish firms that cater primarily to the rest of the world from those that cater to the domestic economy? While all these are indeed important aspects of a macroeconomy, in this chapter you will soon see that these are not treated as relevant in the first stage of theorising.

This chapter takes you through a quick chronological tour of both the past and present of conceptualising the macroeconomy starting with William Petty in England and ending with V. K. R. V. Rao and P. C. Mahalanobis in India. After introducing you to three distinct ways of conceptualising the macroeconomy, the macroeconomy itself is conceptualised as being embedded within the larger domains of society and ecology. Subsequently, the economy is treated as a web of dual flows of commodities and money moving across the following key sectors: households, financial, non-financial and government. The chapter ends by making explicit the nature of abstraction employed in this book. And as with any theory which is necessarily abstract, its application to the actual world must be undertaken with great caution.

Conceptualising the macroeconomy: past and present

Understanding the macroeconomy requires that it be conceptualised. This calls for the identification of its boundaries and the relevant organs/parts. Since this book defines economics as the science of wealth and adopts a macro approach, certain forms of conceptualising the macroeconomy and the measurement of wealth and income are warranted. Henceforth, I shall use ‘the macroeconomy’ and ‘the economy’ interchangeably because the usual way of expressing the idea of a macroeconomy is through the term ‘the economy’. The economy has been and can be conceptualised and understood by focusing on the following relevant aspects: (a) aggregate income and expenditure, (b) inter-sectoral relations and (c) the flow of funds across sectors.

Introduction

A cursory glance at your daily newspaper for an entire week might tell you about: how the Indian farmers are struggling, how the manufacturing sector is not creating enough jobs, the nature of India's economic growth, the changes made by the Reserve Bank of India (RBI) to the interest rates, the stubbornly wide socioeconomic inequalities across caste and gender, how growth in manufacturing is causing ecological damage, and/or how the Bombay Stock Exchange (BSE) reacted with cheer to a recent government notification. All these listed issues are economic in nature because they deal with employment, economic growth, interest rates and economic inequalities, and they affect the livelihood of individuals, entire communities, sectors as well as the nation. But why spend time trying to understand these economic issues? Of course, if you are enrolled for a bachelor's or master's course in economics, you are required to study them. To pose the earlier question slightly differently, what is it that motivates you to enroll for an economics course or to spend time studying them independently?

To an economist, all the above-mentioned issues will appear related. Although Indian farmers are struggling, they are unable to find jobs in the manufacturing sector because it has not been creating adequate jobs and because the farmers do not have access to the skills/education that are required in the manufacturing sector. India's economic growth is mainly driven by the growth of the services sector; here too, not many jobs are being created and nor do the Indian farmers have the requisite skills/education. The fact of unequal access to education is explained mostly by the historical inequalities arising from the ownership of land and capital. Since agricultural output is insufficient (due to which the farmers’ livelihoods are adversely affected), agricultural prices rise. To tackle this price rise (or inflation), the RBI decides to increase the rate of interest to mop up excess money (more accurately, liquidity) from the economy; this is done because it believes that inflation is caused by too much money chasing too few goods.

Introduction

Why is the total value of all goods and services produced in 2019 in India only 170 and not, say, 250 trillion rupees? In the language of economics, 170 trillion rupees is the gross domestic product, or GDP, of India in 2019. More generally, the question we shall answer in this chapter is: what determines the level of aggregate output? And if we know how many workers are required to produce one-rupee worth of output, the knowledge of aggregate output also gives us the employment levels. This is the rationale for the title of this chapter as well as that of the following section. The knowledge of aggregate output (Y) and aggregate employment (N) allows us to estimate the output per worker (Y/N), which gives us an indication of the well-being of workers on average. If the GDP is visualised as a large idli (a steamed rice cake), Y/N is a rough indicator of how much of it ‘belongs’ to an individual worker. But as with any average, if the (wage) inequality is high or income distribution is skewed, the average will not be a very meaningful measure.

It is not enough that everyone is employed; the employment must also be secure (reliable) and well paying (gainful). You might be surprised to read that the number of unemployed people in India increased from 17.1 million in 2011 to 23.3 million in 2015 (State of Working India 2018, p. 37) (the nature of [un]employment in India and a prelude to thinking about macroeconomic policies to increase employment are provided in Chapter 7). The absence of India's employment context in this chapter differentiates it from the previous one, where the financial architecture of India was outlined. However, some contextual elements of the Indian macroeconomy are visible in Sections 4.3 and 4.4.

This chapter addresses the first objective of political economy as proposed by Smith (see Section 1.3): “to provide a plentiful revenue or subsistence for the people, or more properly to enable them to provide such a revenue or subsistence for themselves”. How do we begin to think about the reasons for the differences in output per worker (Y/N) in India, on the one hand, and Australia or Denmark, on the other?

This short chapter, written in lieu of a conclusion, is also intended to serve as a prologue to your further study of economics. First, I outline the approach to macroeconomics adopted in this book by highlighting the key issues addressed in each chapter. Then, I assemble the theories endorsed in this book along with some instances of how the concept (or theory) was employed to make sense of the Indian macroeconomic context. I end by highlighting the importance of pluralism (of theory and method) in the study of economics.

An introduction to macroeconomics

I had strongly remarked in the preface to this book that no textbook, including this, ought to substitute for the reading and studying of classic books and articles in economics. As a consequence, this book can only, and should always, remain an introduction to macroeconomics. The approach followed here has been unconventional insofar as it has critically engaged with two major schools of thought found in economics. Although textbooks usually communicate a settled body of knowledge, in this book, I have adopted an ‘unsettling approach’, as it were. Moreover, as stated in the preface, my preference has been to adopt a problem-setting approach than a problem-solving one, as is commonplace among contemporary economics textbooks.

Chapter 1 took you through a very swift tour of the history of economic thought. A sample of key definitions of economics by Smith, Ricardo, Jevons, Marshall and Robbins was then provided, and we adopted the ‘science of wealth’ definition. In the epilogue to The Science of Wealth: Adam Smith and the Framing of Political Economy (2009), Tony Aspromourgos offers the following judgement of Smith's political economy: “The classical political economy which Smith first fashioned into a satisfying general system of inquiry or science remains in broad terms a sound approach to the analysis of mixed capitalistic economies, centred on the dynamics of economic development” (p. 270; emphasis added). Indeed, it is precisely this approach that has been adopted in this book. Subsequently, the relationship between politics and economic phenomena was highlighted. In the last section, the approach adopted in the book was made explicit: a ‘macro’ level analysis of a competitive economy.

At the very outset I must confess that I did not want to write a textbook. This is because all economics textbooks, except for a few, are essentially the same in their core content and presentation. In particular, there is no recognition of pluralism in theoretical approaches. My engagement with economics in varying capacities—as a student, a teacher, a researcher, a blogger and a commentator—has mostly dealt with a critical appraisal of mainstream economics and the strengthening of an alternative approach inspired by Adam Smith, David Ricardo, Karl Marx, John Maynard Keynes and Piero Sraffa. Both my interest in this alternative approach and the need to present the same to a wider audience persuaded me to organise and document my approach to macroeconomics in a written form.

Besides my desire for documentation, another motivation for writing this book arises from the need to provide good texts (even in the form of a short extract) to students studying in Indian colleges and universities where libraries are not well stocked. I vividly remember, as an M.Phil student at the University of Hyderabad (which has a reasonably well-stocked library), how I had struggled to obtain the materials I required for my research on the economics before Adam Smith. Fortunately, I received help from friends who were in other Indian universities and from historians of economic thought based in foreign universities. I hope that the short extracts, book suggestions in the chapters and the suggestions for further reading at the end of each chapter will provide an impetus to the readers not only to read original texts, but also to demand well-stocked libraries.

I strongly recommend and encourage the use of various texts (books, journal articles, government reports, fiction, newspaper articles and textbooks) in the teaching of any course in economics. This stems from my rather modest experience of just over 15 years as a student and teacher of economics. While the use of varied texts is challenging for both the teacher and the student, I firmly believe that the long-term benefits far outweigh the short-term costs, and that it truly contributes to good learning as it enables the students to become better arbiters of knowledge.

Introduction

This is the first of the three chapters in this book dealing with macroeconomic theory (the others being Chapters 4 and 5). But, given that one of the approaches adopted in this book is to combine both concept (or theory) and context, this chapter begins with an overview of India's financial architecture. Of the three ways of conceptualising the macroeconomy outlined in the previous chapter, the one pioneered by Copeland focuses on the flow of funds across sectors. Copeland's conceptualisation is complemented by the formulation in Section 2.4, where both the commodity and money flows in the macroeconomy are outlined (especially, see Figure 2.2). This chapter is an exposition of the money flows in a monetary production economy, carried out with specific reference to the Indian macroeconomy.

Revisit Figure 2.2 in the previous chapter and try to find answers to the following questions: What is the precise form in which money flows happen between the different sectors in the economy? What kinds of financial products or instruments connect you (as a member of a household) with non-financial firms? Similarly, what kind of financial instruments connect the non-financial firms with the financial firms? In what forms do the households receive wages and salaries in return for their labour? Is it in the form of cash (denominated in Indian rupee), bank deposit, company shares, foreign exchange or something else?

After answering the above-mentioned questions in Section 3.2, we move on to discuss ‘what is money’ and interest rates. Subsequently, the role of the central bank is explained with the spotlight on the Reserve Bank of India (RBI), India's central bank. The chapter ends with a section focusing on the money flows between India and the rest of the world.

The financial architecture of India

Many people rightly associate economics with the study of money and related variables like interest rates and inflation. As previously noted, the approach in this book is to understand the economic workings of a monetary production economy that is characterised by the free mobility of labour and capital. In a monetary production economy, it is imperative that the study of economics examines both money as well as commodity flows.