Effects of Export Promotion and Import Substitution on Poverty, Inequality and Growth in India: An analysis in "closed loop" Input-Output

framework

DEBDAS BANDYOPADHYAY

DEPARTMENT OF STATISTICS UNIVERSITY OF KALYANI KALYANI 741235 WEST BENGAL INDIA

Effects of Export Promotion and Import Substitution on Poverty, Inequality and Growth in India: An analysis in "closed loop" Input-Output framework
DEBDAS BANDYOPADHYAY DEPARTMENT OF STATISTICS UNIVERSITY OF KALYANI KALYANI 741235 WEST BENGAL INDIA

1.Introduction Choice between export promotion and import substitution as two competing strategies of economic development has been subject matter of discussion among policy makers. For a developing country, this choice is crucial as each of them affect i)foreign exchange reserve, considered to be one of the most important factors limiting growth, and ii)income distribution and poverty through their influence on the level and structure of output and prices. It is often suggested that for developing countries promotion of labour intensive manufacturing exports is a good strategy for reducing poverty1. Import substitution, on the other hand, is generally discouraged on the ground that most of substitution has been capital intensive in nature and contributed relatively little towards reducing poverty and income inequality. It has also been argued that, scope of import substitution being rather limited in agriculture where most of the poor earn their income, capital intensive import substitution will worsen the relative position of the poor in the economy. It has been emphasised that countries pursuing industrialisation through import substitution policy may have unfavourable impact on distribution of income distribution and poverty2.

Comparison between export promotion and import substitution strategies of development should ideally be done in a framework that captures interrelationships among income distribution, poverty and growth. Foreign trade affects growth and income distribution through their impact on level and structure of output and prices. Income distribution affects poverty and growth of an economy because import content of the consumption goods of the poor being less than that of the rich, any redi1

For example, Ranis (1973), with reference to experience in Far- East countries, calls it a conventional wisdom to export labour intensive manufacturing goods for reducing unemployment and poverty in labour surplus developing countries. 2 See, for example, Krueger(1970), Kervis(1973) etc.

3 stribution in favour of the poor will ease foreign exchange constraint of the economy and enhance growth. A number of studies estimate the effects of income redistribution on poverty, growth and other macroeconomic variables using a framework that captures one-way dependence of growth and poverty on income redistribution (see, Pyatt(1972),Paukert, Skolka and Maton(1974), Sinha et al(1979),Mohammed (1981)etc among others.)3. In this framework it is assumed that hypothetical redistribution of household income neither affects nor affected by distribution of personal income within each industry4. Consequently, the alternative level and structure of output leaves the overall inequality in household income distribution unaltered although it changes the level of average income in different fractile groups of households. This is mainly because household income distribution in this methodology is not derived from personal income generated within each industry. These studies also ignore important factors like prices, inequality in wage structure, food grain output constraints etc. that have profound effects on income distribution, poverty and growth of a developing economy like India5. In this paper we estimate and compare, for Indian economy, the effects of export promotion and import substitution strategies of economic development on poverty, income inequality, growth and other important macroeconomic variables using a model that captures two-way dependence between growth and income distribution. The model focuses on i) differential access to employment due to difference in skill characteristics tics among socio-economic groups and resultant inequality in wage earning, ii) different rules of price and output determination in food grain and non-food grain sectors arising out of their different supply conditions6 and iii) differential consumption and savings behaviour across income groups in the economy. Moreover, the model endogenously determines the "poverty group" and their level and share of income as a function of level and structure of output and prices given the distribution of income between wage
3

Mohammed (1981), however, surpassed the scope of this model by using it for studying the impact of foreign trade on income distribution. Thus although he assumes that "trade by bringing about higher level of employment may reduce income inequality" (Mohammed (1981), pp132) , income distribution parameters are kept fixed under alternative export-promotion and import substitution schemes. Export promotion and import substitution strategies may, however, increase income inequality as shown in this paper. 4 A certain mapping between implicit personal income distribution and exogenous household distribution of income under alternative hypothetical redistribution is assumed to exist, although it is not specified. 5 Tendulkar(1971) , the first closed loop model for Indian economy , considered both wage and non-wage income while closing the model with respect to consumption . He, however, did not consider distribution of wage earning as the paper was not concerned with redistributive exercises.
6

This basic dichotomy in output and price behaviour in underdeveloped countries is clearly spelt out in Robinson and Eatwell(1974,pp145-157). Its empirical justification for Indian economy can be found in Chakrabarty(1970), Maity(1975) among others.,

4 and profit and distribution of wage earning. These factors, which have important bearing on the level and share of income of the poor, have not been formally combined together, to the best of our knowledge, in a model for analysing and comparing the effects of inward and outward looking foreign trade policies on income distribution, poverty, and growth of Indian economy. Structural specification of the model is given in section 2. Section 3 describes the database of the study. Empirical results obtained by simulating the model with different export promotion and import substitution polices are analysed in section 4. Major conclusions emerging from the study and limitations of the model used are listed in the final section. 2.The Model The primary objective of the model is to consider the interdependence of output, price and income distribution in an economy for determining poverty, inequality and growth in a segmented economy. This interdependence can be best examined by segmenting the economy in to a number of productive sectors and the population into a number of socio-economic groups. Economy has a number of productive sectors of which the first sector, called food grain sector, uses Cobb-Douglas type production function while the production in rest of the sectors, called non-food grain sectors, are characterised by Leontief technology. These sectors, which are interdependent and differ in supply conditions, play an important role in determining the prices and output economy. We assume that, in the short run, food grain output is supply constrained and there are excess capacities in non-food grain sectors of the economy. Population is divided in two groups viz. "poor" or "target group" and "non-poor" or "non-target group"7. The two socio-economic groups are linked with different productive sectors through income and consumption. The target group is linked with productive sectors through employment" and their income consists of only "wage" income8. The non-target group, on the other hand, is linked with productive sectors via employment as well
7 8

Throughout the paper we shall use the terms poor and target group interchangeably. The employment for the poor include employment both as hired labour and self-employment. Correspondingly the term "wage" include contractual wage payment as well as earning from self -employment.

5 as ownership of assets. Thus income of non-target group consists of wage and profit income. These groups are also implicitly linked with each other through commodity trade. Change in the level and pattern of consumption of one group will change the level and share of income of the other group via its impact on the level and structure of output and prices of the economy. Impact of trade policies on poverty and other economic variables in our model are transmitted mainly through these linkages. Given this segmentation of the economy and its linkages, the model determines level and share of income of the poor, the level and structure of output, prices and growth of the economy. Model Equations are grouped into a number of blocks viz. Income Distribution and Poverty, Output and Employment, Prices, Private Consumption, Import, and Investment and Growth. Unknown variables in a Block are solved taking variables determined in other Blocks as given. The model equations, given in Table-1, form a system of interdependent parts, each part dealing with a particular aspect of the overall problem9. 2.1.1 Income Distribution and Poverty Poverty group consist of households with per capita income is less than or equal to the minimum per capita income (k0) required to meet the poverty line aggregate consumption10. We assume poverty group households i) earn their income only through employment either as hired labour or as self employed ii) have a common dependency ratio (db ) which is a constant (z* ) multiple of the overall dependency ratio of the economy11 and iii) net savings of the poverty group is zero. Under these assumptions, minimum per capita income, k0 ,is the cost of poverty line consumption times the dependency ratio of the poverty group (see eq.1 in Table-1). Given the sectoral output and price (determined in the next section), aggregate income of the poor(Yb), determined from distribution of sectoral employment (Li) over different wage classes as given by wage distribution matrix (eik),is the total wage income up to k0 (eq.2). Number of persons in the target group is equal to the target group employment (i.e. total employment up to wage class ko) times dependency ratio (db). Poverty ratio ( ) and per capita inc9

A schematic presentation of the working of the model is given in Fig.1. This income definition only ensures the ability of the poor to buy the poverty line aggregate consumption but may not guarantee poverty line normative consumption. For one possible treatment of the problem see Panda( 1992). 11 Over all dependency ratio of the economy has been defined as the number of persons , including the earner , per earning member of a household and is equal to total population (P*) divided by total employment ( Li ). Dependency ratio of the poverty group is then a constant (z*) multiple of over all dependency ratio of the economy. ( see eq.3).
10

6 Model Equations

Income (1) (2) (3) (4) (5) (6) (7)

Distributi on
0

and

= d b . p . 0
cb b

poverty : Investment and Growth

Y d

= eik . L i . wk
i =1 k =1

k0

(22 )

U
j

= j + .v j +
j

z .( P . / L )
* * i =1 i n

. v {(1+R j)
j

1} / j , j = 1,2 n , i = 1,2,3,....... n
0

= d b .( eik . Li . wk
i =1 k =1

k0

(23)P * I i = bij.U )/
j =1

y y

y
n

/( . P*)

(24 )
i k

xi = i ( xi xi )
j

, i = 1,2,3,..... n

i =1 k =

e . L . w
k0
+1 ik a

25 ) +y

= (1 t d ). y

26 ) /(1 ). P*

R = {v jc / v 0 } , j = 1 , 2 , 3 n jc R ={ v / v }
0 j j j

Output and (8)

Employment
( a +b ) / c

= D. p
n 1

1 d

w
j

a / c 1

.p

b / c f * i * i

Pr ice (9) (12 ) (10 ) (13 ) (11) (14 ) (15 )

x = a . x + C + I + . x + G + E M , i = 2,3, n p . x ( p , p , w ) x ( p , p ) = 0 = a. .p / + + p = (1L ).(1 x t ).( mw+ l ) , j = 2,3,... n = .x , i = 2,3, n L m = a . p .(1 + t ) + a p (1 + t ) , j = 2,3,..... n

1 1s
j =1 1 1 ij i i i i

1d

i =1

ij

i =1

ij

mi

mi

= a j .e jk . wkj
k =1

j = 2,3,....... n

Demand : Consumptio n : (16 ) (17 ) (18 ) (19 ) (20 ) Im port 21)

C = y /P C = (1 s ) y / P P = . P P = (1 ). P
1 1 b 2 h a 1 * 2 *

=[

P {a . p + b .(C
m m m m =1 i i i n m

a j .
m j =1

p )}] ,
j

i = 1,2,3... n

= aij . x j
j =1

+ hi (C i + I i + G i )

, i = 1,2,3,.... n

7 Table-2 Notations
(Superscript 0 refer to base year, superscript m to population group m and subscript i to sector i)

A. Endogenous Variables Percentage of poor PCE for population group m Agg. Private Consumption for sector i Dependency ratio Investment by sector of origin Normative wage rate Sector i employment Sector i unit labour cost Producers price for sector i output Size of population group m CPI for poor Unit material cost for sector i Capacity growth rate of value added Aggregate value-added growth rate Investment by destination Value-added for sector i Sector i output Market supply of sector 1 output Change in- stock Aggregate income of the non-poor Aggregate income of the poor Per capita income of the non-poor Per capita income for the poor yb

B. Parameters Domestic and imported input coefficients aijd , aijm Capital coefficient bij Parameters of LES for population mth gr. aim , bim Parameters of agricultural production fn. D,b,c (i,k)th element of emp. distribution eik Labour-output ratio for sector 'i' i Average import content of domestic demand hi Li Stock-flow conversion factor for sector i i li pi Sector 'i' investment fn. parameters i, i i, Pm Savings rate for the non-poor sh pm Direct tax rate td mi Indirect tax rate ti Ri Mark-up for sector 'i' i R Import duty tmi Ui Average wage rate in kth wage class wk Vi Average wage rate in sector 'i' wi xi Market demand sector 1( base yr. price) x1d xis C. Exogenous Variables x Export of sector i output Ei* ya Government consumption of sector i Ci* yb Population P* ya cm Ci db Ii k0

ome of the poor (Yb ) are then determined in eqns.4&5. Aggregate income of the non-target group (Ya) consists of wage income above k0 and profit income (Yf) from which their per capita income (Ya) is determined eqs.6& 7). 2.1.2 Output, Price and Employment Food grain output is determined from farmers' supply response function taken as a function of food grain price(p1),average wage rate in food grain sector (w1),and fertiliser price (pf)(eq.8)12. Its price is market clearing type and is determined from eq.12 such that excess supply in the food grain market (right hand expression of eqn.12) is zero. Non-food grain sectors output are demand determined and obtained from input- output material balance equation (eqn.9) and their prices are determined by Kaleckian type mark up pricing rule (eqn.13). Unit material cost(mj) and wage cost

12

Food grain supply response function depends upon many other variables. We, however, ignore such variables and absorb their effects via the constant D. Further, fertiliser price, pf , in the supply response function is obtained by applying indirect tax rate on the producers price as determined in the eq.13.

8 SCHEMATIC DIAGRAM OF THE WORKING OF THE MODEL

PL

Wage rate & WDM

Supply Response Fn. for AG

Domestic & Imported Input-Output coeffs. Sectoral labor coeffs. oe Sectoral mark up & tax rates

Income of poor & non-poor % of people below PL

Output for AG

Mkt supply for AG Sectoral private cons. Prices for AG

Prices of NAG ( I-O Model )

Wage rate & WDM

Sectoral prices

Pvt. cons. demand for AG LES parameters

Market demand for AG

Sectoral Exports

Changein -stock Imports Output of NAG ( I-O Model ) Sectoral gross Inv.

Sectoral Govt. cons. Sectoral Output Output of AG Sectoral Inv Functions

Fig.-1 Endogenous Exogenous

AG : Agricultural goods, NAG : Non-agricultural goods, WDM : wage distribution matrix ,PL: Poverty line

(lj) are blown up by mark up rate (

13

)and indirect tax rate(tj) to get the

sect-oral market price (eq.13) . Material unit cost consists of domestic and imported material input cost while wage cost depends upon labour coefficient( j) and distribution of sectoral employment over different wage clas-ses (eqns.14&15). Employment in food grain sector is determined by factor demand equation obtained from the first order condition of constrained profit maximisation problem in agriculture (eqn.10.). Employment in non-food grain sectors are obtained by applying labour output ratio to sectoral output (eq.11).

13

Market supply for food grain, x1s (=x1 (p1, pf, w1) - a11.x1 ), is defined as food grain output net of food grain inputs. Food grain producers own consumption are bought from market.

9 2.1.3 Demand Demand for private consumption, investment, change-in-stock and importare endogenously determined while Government consumption and exports are exogenous. Per Capita Consumption Expenditure (PCE) for the two groups of population, C1 and C2, are determined from their respective per capita income, Yb and Ya(eqns.16&17). Sectoral breakdown of PCE for the two groups of population obtained through LES for the respective groups are combined to arrive at private consumption vector for the entire population (eqs. 18,19&20). Finally imports for intermediate and final use are determined in eq.21 using input-output import coefficient matrix (amij) and import coefficient of final demand hj. Investment and change-in-stock are related to output in eqns.22, 23 and 24. Investment requirement by sector of destination (Uj), consists of replacement investment, net fixed investment and an intercept term. Replacement investment is taken as a fixed proportion of sectoral value-added. Net investment is obtained through multisectoral version of accelerator principle (eq.21). If
j

is the investment-

output gestation lag in sector j then net investment in sector 'j' is a function of increase in value-added during gestation period. Assuming uniform distribution of investment over gestation period, net investment in sector j is given by the last term of eq.21 where
j

is incremental capital

value-added ratio and Rj is the post base year value-added growth rate (eqn. 25). Thus sectoral investment in our model is demand driven. Investment by origin for sector i is determined from using capital coefficient matrix (bij) (eq.22). Change-in-stock is obtained by applying stock-flow conversion factor to output change (eqn.24). Finally aggregate growth rate is determined by eqn.25. 3.Data Base The model is applied to twenty two sector Indian economy for the year 1996-97(referred as Base Year)14. Operation of the model requires point estimates of different technological, behavioural and policy parameers. Estimates of the parameters relating to consumption and investment functions, coefficients relating to material and labour inputs, imports, change in stock and the sectoral tax rates are taken from Eighth Plan Technical Note, Planning Commission(1995),Government of India (hereafter referred

14

See Appendix for mapping of Tech. Note sector classification into our classification.

10 as Tech. Note). Estimates of sectoral mark-up rates and policy parameters like direct tax rate, household savings rate and corporate tax rate are taken from relevant issues of National Accounts Statistics and Annual Survey of Industries, Government of India. All India poverty line ( 0) has been es-timated from the estimates of rural and urban poverty line as given in Te-ch. Note under the assumption of lognormality of all India PCE (See Appe-ndix A)15. Initial estimate of sectoral employment distribution matrix, taken from Labour Bureau (1973), National Council of Applied Economic Research (1975) and Roy (1979), is first corrected for changes in CPI for agricultural and industrial workers during intervening period and then made consistent to base year i)Mean monthly private consumption of people below poverty line and their percentage and ii) sectoral total wage by an iterative method16 Estimates of parameters of food grain supply response function are taken from Kawagoe et al.(1985)(estimate 4). Intercept term(D) of the supply function is so determined that food grain output obtained from this function is same as that of the base year. The point estimates are made consistent to base year structure of the economy so that given these point estimates and the exogenous variables the model reproduces the observed base year structure the economy17. Base year values of the variables as reproduced by the model, referred as Basic Solution, are taken as historically given benchmark values with which the changes under different policy scenarios are compared18. Selected macroeconomic indicators under Basic Solution are presented in Table-3 4. Empirical Analysis Effects of foreign trade policies on poverty, inequality and other macroeconomic variables may be studied by analyzing the quantitative impact

15 16

All India Poverty Line estimated is Rs .201 at 1996-97 prices. See, Bandyopadhyay(1986) ,for details. 17 Different problems arise in the construction of consistent data base of an economy. See Taylor (1985), Bandyopadhyay (1986) for details. 18 Units of goods are so chosen that sectoral prices are unity at the base year when the economy is assumed to be at equilibrium. Also to maintain scale comparability, estimated changes under different policy scenario over the Basic Solution are expressed per Rs. one million.

11 of volume and structure of different export promotion and import substitution schemes. In our model any change in volume and structure of export and import disturbs the base year equilibrium of the economy and sets on a chain reaction operating through changes in output, price, income distribution and poverty in the economy. The equilibrium is restored when aggregate savings equates with aggregate investment through changes in output, prices income distribution, and poverty19. Table-3 Selected Macroeconomic Indicators for Indian Economy, 1996-97 as reproduced by the Model+ Economic Indicator 1. 2. 3. 4. 5. 6. 7. 8. 9. GDP Private Consumption Government Consumption@ Gross Investment Export@ Import Savings Rate(%) Investment Rate (%) Aggregate Growth (Post 1996-97) 10. Per capita Income* a) Poor b) Non-poor Estimate Economic Indicator 579087 494345 95096 159169 102287 112641 21.03 22.09 4.40 159.20 553.40 11.Per capita Cons8. a) Poor b) Non-poor 12. Poverty a)Ratio(%) b)Sens Index 13. Inequality(L.R.) a) Income b) Consumption c) Wage 14.Dependency Ratio a)Target Group b) Overall Estimate 159.29 482.15 26.34 15.24 0.259 0.225 0.347 4.13 4.89

@ Exogenous + Rs. Crores at 1991-92 prices * Rs. at 1991-92 prices

4.1 Effects of changes in level and structure of export. Effects of volume and structure of exports are studied under six alternatives as described in Table-4. While the first two alternatives study the impact of change in volume of export in absence and presence of food grain supply constraints in the economy the rest mainly analyze impact of changes in structure of exports20. Macroeconomic impact of alternative volume and structure of exports are given in Table-5. It is found that 10 percent increase in volume of exports, keeping the structure same as in the

19

Schematic diagram showing working of the model and an iterative procedure for its solution are given in the Appendix.. 20 For this we have divided the exporting sectors into two groups viz. traditional exports consisting of sectors like agricultural food products, mining and textiles and non-traditional exports consisting of manufacturing sectors. Their impacts are studied both in presence and absence of constraints in the food grain sector of the economy.

12 base year, increases private consumption, employment and growth respectively by 1.28, 1.32 and 1.40 percent when there is no food grain output constraint in the economy. However, in presence of food grain output constraint, this favorable impact of increase in exports is much reduced as can be seen from the results under alternatives 1 and 2. Increase in volume of ex-ports also pushes up aggregate savings rate of by 1.30 per cent and pushes down the rate of foreign savings by 2.00 per cent. Table 4: Description of Alternative Export Promotion Schemes.

Case No. 1. 2. 3. 4. 5. 6.

Description of alternative cases. Base year exports increased by 10 percent. Case No.1 with food grain output fixed at Basic Solution level. 10 per cent increase in traditional exports Case No.3 with agricultural output fixed at Basic Solution level. 10 percent increase in non-traditional exports. Case 5 with food grain output fixed at Basic solution level.

Analysis of impact of pattern of export, considered under alternatives 3,4,5 and 6, show that export promotion of traditional sectors have more favorable impact on private consumption, employment and growth than that of non-traditional exports. This is because an increase in traditional export(Case no. 3)increase, consumption and growth by 0.49, 0.28 and 0.54 percents respectively. The corresponding increase non-traditional exports are 0.32, 0.20 and 0.49 percents respectively. Moreover, it is seen that increase in traditional export in presence of food grain output constraint has more detrimental effect on the economy than that of non-traditional export. Effects of increase in volume and pattern of export on economic condition of poor and non-poor are given in Table-6. Results show that monthly per capita income and consumption of both poor and non-poor increases due to increase in volume of export but increase for the non-poor is much higher than that of the poor. Thus we see that 10 percent increase in export results in 1.55 per cent increase in income of the non-poor, the co-

13 rresponding increase for the poor being 1.00 per cent. (see case 1.). Moreover, even this positive impact on poor vanishes and the income of the poor falls by 34 per cent in presence of food grain output constraint in the economy (see case 2.). This is because export promotion in presence of output constraint causes demand pull increase in food grain prices which, in turn results in overall price rise in the economy hurting the poor. Economic position of the non-poor, however, slightly improves (income of the non-poor increases by 1.72 per cent) as a part of profit due to price rise accrues Table 5: Change in Macroeconomic aggregates under alternative Export Promotion Schemes21. Case No. 1. 2. 3. 4. 5 6. Agg. Growth 101.43 101.03 100.54 100.34 100.49 100.44 Private Cons. 101.28 100.99 100.49 100.11 100.32 100.26 Employment 101.32 100.95 100.28 100.18 100.20 100.16 Savings Ratio 101.31 100.89 100.56 100.28 100.50 100.42 Import 101.64 101.03 100.72 100.68 100.97 100.94 CPI 101.04 101.93 100.97 100.32 100.01 101.63

to the non-poor. Consequently, distribution of real income shifts against the poor.22 Analysis of impact of pattern of export reveals that favor-able impact of increase in traditional export is more than that of non- traditional export. Comparison of alternatives 3 and 5 show that 10 per cent increase in traditional export increases the income of the poor and non poor by 0.25 and .06 per cent respectively. Comparison of alternatives 4 and 6, however, show that expansion of traditional export in face of food grain output constraint hurts the poor more than the non-poor. Percentage of poor and Sens index of poverty decline as a result of export promotion, provided there is no food grain output constraint in the economy (see Table-6). Thus 10 percent increase in volume of export reduces the percentage of poor by 1.21 percent and Sens index by 0.71 percent. However if there is food grain output constraint in the economy both the percentage of poor and Sens index increase by 1.47 percent and 0.92 percent respectively due to 10.0 percent in volume of exports. Further, it may be seen that expansion of traditional export has more favorable impact on poverty than that of the nontraditional export. This is mainly because traditional exports originate

21 22

Expressed as percentage change, per Rs. million , over the Basic Solution level. Note that increase in CPI for poor under case 3. is 1.14 per cent and the same for the non-poor is 1.08 per cent.

14 from such sectors which are more labor intensive and whose share of income among poor than the industries from which non-traditional exports originate. However expansion of both traditional and non- traditional export increase poverty in presence of food grain output constraint. Results on impact of inequality due to increase in volume and changes in pattern of export show export promotion accentuates income inequality. Thus we see that 10 percent increase in export results in 0.92 and 0.57 percent of income and consumption inequality. Further it is seen that inequality Table 6: Change in Economic Profile of Target and Non-Target Group under Alternative Export Promotion Schemes

Case No. 1) 2) 3) 4) 5) 6)

Per capita income Poor Non-poor 100.95 100.12 100.25 99.70 100.06 99.91 101.55 101.72 100.85 101.22 100.98 100.15

Poverty Index H. C. Sens 98.79 99.01 99.01 101.34 99.24 99.88 99.29 100.01 99.68 100.40 99.75 100.32

Inequality(L.R) Income Consumption 100.92 102.73 101.65 100.32 100.19 100.25 100.57 102.56 100.17 100.13 100.18 100.18

accentuating effect of non traditional export is more than that of traditional export. 4.2: Effects of changes in volume and structure of Import Substitution. In order to study the effect of import substitution we consider import substitution in both intermediate as well as final use. Further, to compare how structure of import substitution affect poverty, income inequality and growth we consider the major import using sectors viz. petroleum, metal products, machine tools and fertiliser industries. Different import substitution schemes considered for analysis are given in Table-7. Macroeconomic impacts of alternative import substitution schemes are given in Table-8. It is seen that 10 percent import substitution in all sectors (Case no.1) increase consumption, employment and growth by 0.84, 0.94 and 0.98 percent respectively. Aggregate import requirement fall by 4.76 percent whereas aggregate savings rate increase by 2.67 percent. Thus we see that import substitution, in general, have favorable impact on consumption, employment and growth, but this positive impact is much less

15 than that of corresponding increase in export. Comparison of results under Cases 1 and 2, however, show presence of food grain output constraint in the economy further reduces this positive impact. Comparison of results under Cases 4,5,6show varying macro economic impact of sectoral import substitution. Thus it is seen that import substitution in Petroleum sector has maximum positive impact on consumption, employment and growth than the corresponding level of import substitution in other sectors of the economy. Table 7: Description of Alternative Import Substitution Schemes.

Case No. 1. 2. 3. 4. 5. 6.

Description of Alternative Cases. 10 percent import substitution Sectors. Case 1 with output of sector 1 Solution level 10 percent import substitution Sector 10 percent import substitution in all importing fixed at Basic in Machine tools in Petroleum Sector.

10 percent import substitution in Fertilizer sector Sector. 10 percent import substitution in Electronics and Communications.

Economic impact of import substitution, both overall as well as sect-oral, on the poor and non-poor are presented in Table-9. It is seen that due to 10 percent import substitution across the sectors, income of the poor and non-poor increase respectively by 0.32 and 1.00 per cent. Thus positive impact of import substitution on the income of the poor is much less (almost one-third) than that of the non-poor. Moreover, comparison of results under Cases 1 and 2 show that the discriminatory effect of import substitution on income of poor and non-poor increases in presence of food grain output constraint in the economy. At the sectoral level, it is seen that import substitution in Petroleum and communications sector has comparatively larger positive impact on income of the poor than the other sectors of the economy. This favourable impact of import substitution is, however, much less than that of export promotion. Further, it may be seen import substitution reduces poverty provided there is no food grain output constraint in the economy. Finally, it is interesting to note that increase in inequality due to import substitution is more than that of export promotion.

16 4.7 Growth-equity trade-off under export promotion and Import substitution: A Comparison In recent years there have been a number of studies on the link between poverty, inequality and growth23. Kuznets(1955) was first to observe from cross country data that process of development has a tendency to be accompanied by increase in inequality which was subsequently confirmed by Oshima(1962),Adelman and Morris(1973),Adelman(1974),Chenery and Syrquinn(1975) etc.
24

Recent empirical evidences, however, are far from unamb-

iguous . In this section we compare export promotion and import substitution strategies of development in terms of growth-equity trade-off exhibited by them25. Table 8: Change in Macroeconomic aggregates under alternative Import substitution Schemes. Case No. 1. 2. 3. 4. 5. 6. Agg. growth 100.98 100.36 100.14 100.85 100.44 100.61 Private Cons. 100.84 100.20 100.12 100.69 100.35 100.10 Employment 100.94 100.29 100.20 100.97 100.46 100.16 Savings Ratio 102.76 102.98 100.79 101.31 100.89 100.82 Import 95.24 90.61 99.74 100.68 100.97 101.82 CPI 101.24 101.78 100.92 100.92 100.01 100.36

Following Ahluwalia(1974), we combine per capita consumption level of poor and non-poor in to a single utility index using semilogarithmic Social Welfare Function. Per Capita Utility (PCU) under different export promotion and import substitution schemes and their percent change over Basic Solution PCU, calculated under equal weight and poverty weight social welfare function, are given in Table- 1026. It is seen that both export promotion and import substitution show moderate growth-equity tradeoff under equal weight SWF, its magnitude being lees for export promotion than import substitution. However, under poverty weight SWF, magnitude of this trade-off is substantial for both strategies. It is also
23 24

See, Tendulkar and Jain(1955) , Deininger and Square(2000) among others. For example, Mohammed(1981), Tendulkar and Jain(1995) and Deininger and Square(2000) found little support for the so called Kuznets hypothesis. 25 A policy is said to exhibit unambiguous growth-equity trade-off if a positive growth effect of the policy is accompanied with a decline in Per Capita Utility ( PCU) under both equal weight and poverty weight SWF and vice-versa. 26 See Appendix , for details.

17 seen that growth-equity trade-off is more for traditional than non-traditional export and it increases when there is food grain output constraint in the economy. Table 9: Change in Economic Profile of Target and Non-target Groups under Alternative Import Substitution Schemes.

Case No. 1) 2) 3) 4) 5) 6)

Per capita income Poor Non poor 100.32 99.96 100.11 100.14 100.13 100.09 100.99 101.19 100.45 100.69 100.57 100.40

Poverty Index H. C. Sens 99.39 101.21 99.95 99.43 99.68 99.97 99.60 101.86 99.85 100.00 99.80 99.94

Inequality(L.R) Income Consumption 101.07 101.69 100.16 100.35 100.32 100.48 101.02 101.92 100.15 100.29 100.27 100.34

5. Conclusions and Limitations The paper estimates and compares the effects of outward looking(export promotion) and inward looking (import substitution) strategies of economic development on income distribution, poverty and growth for Indian economy using a model that captures two way dependence between growth and income distribution. Factors typically found in a developing country like India viz. fix-flex mode of output and price determination, high wage inequality in wage earning and food grain output constraint. Endogenous determination of income distribution, poverty and growth considering the mentioned above factors is the novelty of our model which, to the best of our knowledge, have so far not been used for analysing Indian trade policies. Simulation of the model with different export promotion and import substitution policies show i) export promotion, particularly for traditional sectors, reduces poverty provided there is no food grain output constraint in the economy, ii) poverty reducing effect of export promotion is substantially more than that of import substitution, iii) both export promotion and import substitution increases inequality, particularly when there is food grain output constraint in the economy, but inequality accentuating effect of import substitution is more than that of export promotion and iv) both export promotion and import substitution exhibit growthequity trade-off but its magnitude is substantial and more for import substitution than that of export promotion particularly under the poverty weight SWF. Thus our findings indicate that economic development through export promotion is more effective than import substitution for growth

18 with poverty reduction provided there is no food grain output constraint in the economy and one is ready to accept social cost due to higher level of economic inequality. Before concluding it is, however, necessary to point out some of the important limitations of our study some of which may have substantial implications for long run interpretations of our findings. First use of input output technology in non-agricultural sectors of the economy rules out substitution possibilities among inputs in response to price changes under Table-10:Percentage change in Per capita Utility Level alternative Export Promotion and Import Substitution Schemes27. Case No. Per capita utility (PCU) (Export Promotion) Per capita utility (PCU) (Import Substitution) Poverty Weight 102.50 102.87 101.61 101.32 101.14 101.96

Equal Weight Poverty Weight Equal Weight 1) 2) 3) 4) 5) 6) 100.66 100.70 100.45 100.55 100.70 100.72 101.61 101.72 101.05 101.30 102.50 102.78 100.82 100.98 101.36 101.22 101.52 101.62

different policy scenario. Secondly use of LES for estimating private consumption demand has well known limitations in capturing demand changes over a long period. Thirdly endogenous determination of investment on the basis of accelerator type relation ignores the direct effects of variables like profit rate, price tax etc on investment28. Fourthly modelling of supply response on for the food sector as a whole using only three explanatory variables is restrictive. Finally distributional effects of trade policies on choice of technology which may have considerable impact on poverty and growth is not considered in the present study.

27 28

Basic Solution PCU level under equal weight and poverty weight SWF are 1.13 and 2.56 respectively. In so far as investment in our model is demand driven, indirect effects of these variables on investment are captured through demand.

19 APPENDIX A: Determination of All India Poverty Line. Let the all India poverty line to be estimated be x . Also let Fr and Fu be distribution functions of per capita consumption expenditure in rural and urban India. Then proportion of total expenditure, pj, having per capita expend-iture xj or less is given by

= [ P r . F r ( x j ) + Pu . F u ( x j )] /( P r + Pu ) (1)

where Pr and Pu are rural and urban populations. Now,if Fr and Fu are twopara-meter lognormal distribution functions with parameters (xr , r) and (xu , u) then

p
y y p
jr

p .( y
r

jr

)+

.( y ) (2)
ju

where,

= (1 / r ). + log( x j / xr ) + r / 2 (3) = (1 / u ). log( x j / xu ) + u / 2 (4) = Pr /( Pr + Pu ),

ju

= Pu /( P r + Pu ) (5)

and (.) is standard normal C.D.F. Now, let Qj be the aggregate share of per capita consumption up to xj for the country as a whole, then

= [ p .
r r

p .x d F ( x)] /( P.x ) (6) = [ p x .( y ) + p . x .( y )] / P.x (7)

0

xj
r

x.d F r ( x) +
rj r

ju

where x is average per capita consumption expenditure for the country as a who-le and P is the total population. Now if we assume that all India per capita consumption expenditure follows two-parameter log normal distribution with parameters x and then we know the Lorentz ratio for the per capita consumpt-ion expenditure is given by
L = 2. / ( 2 ) 1 (8)

Now L can be estimated from observed distribution of per capita consumption expenditure and one such formula based upon Simpsons 1/3rd rule is given by

L = 1 ( p +
j= 1 j

j 1

).( Q + Q
j

j 1

) (9)

where n is the number of expenditure class limits considered. Now, an estimate of L as determined from (9) can be used in (8) to determine uniquely. The all India poverty line x can then be determined from the eqs. (10) and (11).

= ( ) (10)

y = (1 / ). log( x / x ) + / 2 (11)

20 B: SOLUTION PROCEDURE FOR THE MODEL In order to solve the Model we adopt an iterative procedure which directly follows from the logical structure of the model. We may note that any change in policy parameter and/or exogenous variable disturbs the model equilibrium and initiates an adjustment mechanism that works through changes in different endogenous variables in the model. The equilibrium is re established when aggregate savings equals aggregate investment. The iterative procedure starts with some initial guess values of sectoral output and prices and consists of the following steps: i) ii) iii) Estimate sectoral gross value added and calculate their rates of growth(Rj )by eqn.26 Estimate sectoral employment(Li) by eqns.10 for sector 1 and by eqn.11 for i=2,3,...n. Estimate per capita income and consumption of the poor and nonpoor (Yb, Ya ,C1, C2) by eqns. 5,7,16,17 after determining K0 ,db ,yb and ya by eqns.1,3,4,2 and 6 respectively. Estimate sectoral private consumption (Ci ) by eqn.20 Estimate investment by origin ( Ui ) as well as destination(Ii) and change in stock( Si) by eqns.22,23 and 24 Estimate terminal year sectoral import(Mi) by eqn.24 Estimate sectoral output(Xi) by eqns.8 for i=1 (or replace it by exogenously given output if there is supply constraint) and by eqn.9 for i=2,..n. Repeat step i) through vii) until the output vector converges. Then proceed to step ix). Using this output vector estimate sector 1 prices (pj) by eqn.12 and use it for determining prices for rest of the sectors by eqn.13. Repeat step ix) till price vector converges. Stop iteration when successive levels of output and price vectors differ by less than a given tolerance level.

iv) v) vi) vii)

viii) ix) x) xi)

Simultaneous convergence of output and price vectors ensures savings-investment identity. This is checked under each policy scenario to confirm validity of the solution procedure. C: Welfare Evaluation of Alternative Policies Welfare evaluation of alternative policies has been done using a social welfare function of semilogarithmic type where utility is written as a function of per capita consumption of the poor and non-poor (See Ahluwalia(1974)). Thus if Cb and Ca denote per capita consumption of the poor and non-poor then social utility function is given by,

U = N1.

21 log Cb + N2.

log Ca

where N1 and N2 are the number of the poor and the non-poor and 1 and 2are weights. Using social utility function defined above we define two alternative measures of per capita social utility, Ue and Up from a)equal weights and b) poverty weights form of social utility function. The equal weights social utility index can be shown to be a measure of increase in welfare if we assume that the utility function is symmetric. The poverty weights social utility index, on the other hand, provides a measure of welfare improvement when weights are different for different classes. Thus Ue Up = {N1.log Cb + N2.log Ca } /N = {N1. 1. log Cb + N2. 2.log Ca } /N

where N is the total population29. D: Mapping of Tech. Note Sectors into 22 Sectors Sector Name 1. Food grain 2. Non-food grain agriculture 3. Allied Agriculture 4. Food Manufacturing 5. Coal and Lignite 6. Crude petroleum and Natural gas 7. Other minerals 8. Textiles 9. Wood and Wood products 10. Paper and Paper Products 11. Leather and Leather products Tech. Note Sector No.. 1 to 4 5 to 11 12 to 14 20 to 23 15 16 17 to 19 24 to 28 29 30 31 Sector Name 12. Rubber and .Plastic products 13. Petroleum and Coal products 14. Chemical Fertilizer 15. Other chemicals 16. Metal & Metal Products 17. Machine & Machine Tools 18. Electronic Equipment 19. Transport Equipment 20. Other Manufacturing 21. Construction & Electricity 22. Services Tech Note Sector No. 32,33 34,35 36 37 to 39 42,43 44 to 47 48,49 50 to 52 53 54,55 56 to 60

29

See Ahluwalia (1974) for method of deriving weights for equal weights and poverty weights form of utility indices. In our study weights are determined in such a way that they yield poverty weights 0.6 and 0.4 for the target and non-target groups of population.

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