COMMENTARY
Virtuous Cycle and
Economic Growth in India
M Parameswaran
A critique is offered after
examining the claims in the
Economic Survey that the concept
of virtuous cycle is of recent
origin and that during the
planning period, the planners
were unaware of such a way of
imagining economic progress.
The evidences provided to support
the presence of the virtuous cycle
in China and the East Asian
countries are also questioned.
M Parameswaran (mpeswaran@gmail.com)
teaches at the Centre for Development Studies,
Thiruvananthapuram, Kerala.
16
C
hapter 1 of the Economic Survey
2018–19, Vol 1, presents a blue
print of the economy for the next
five years in terms of economic growth,
job creation and exports. It restates the
vision, articulated by the Prime Minister,
that India aims to grow into a $5 trillion
economy by 2024–25, which would
make India the third largest economy in
the world. To attain the targeted gross
domestic product (GDP) level, the Eco-
nomic Survey notes, the real GDP has to
record an annual growth rate of 8% for
the next five years. This chapter is im-
portant as it presents the overall frame-
work based on which policy measures
are suggested for realising the target.
On the basis of the recent growth ex-
periences of countries across the world,
particularly of China and the East Asian
countries, the Economic Survey presents
a growth model for India.
[A] growth model views the economy as being
in constant disequilibrium—a virtuous cycle or
vicious cycle. When the economy is in a virtu-
ous cycle, investment, productivity growth,
job creation, demand and exports feed into
each other and enable the animal spirits in the
economy to thrive. (p 5, emphasis is original)
By generating a virtuous cycle process,
the economy is expected to move to
the targeted level of GDP. The Economic
OCTOBER 12, 2019
Survey postulates investment as the
“key driver” capable of generating a self-
sustaining virtuous cycle. Though invest-
ment can be both public and private, the
Economic Survey stresses investment by
the private sector and elaborates on its
virtues. Apart from private investment,
the Economic Survey also prescribes other
measures that can generate and sustain
a virtuous cycle in the economy. To quote,
By presenting data as a public good, empha-
sizing legal reform, ensuring policy consist-
ency, and encouraging behaviour changes
using principles of behavioural economics,
the Survey aims to enable a self-sustaining
virtuous cycle. (p 1)
The Economic Survey claims that this
new way of viewing economic progress
in terms of the virtuous cycle is of very
recent origin, emerging from the eco-
nomic literature following the global fi-
nancial crisis, and that it is a departure
from the traditional Anglo-Saxon view
of the economy. In more than one place,
the Economic Survey highlights the merits
of this “new” way of imagining economic
progress over the earlier strategy of five-
year plans. To quote,
An economy that is in a constant state of dis-
equilibrium needs a new approach to navi-
gate. The earlier attempt to create five-year
plans, largely using the equilibrium frame-
work, failed because it was too prescriptive
for an inherently unpredictable world. (p 12)
This article examines the claims made
in the Economic Survey regarding the
characterisation of economic progress in
terms of virtuous cycle, that (i) it is of very
recent origin and is a departure from the
traditional way of thinking in economics;
vol lIV no 41 EPW Economic & Political Weekly

and (ii) this way of imagining economic
progress was absent when India was for-
mulating its planned economic develop-
ment in 1950s. It also comments on two
other related issues.
Modelling economic progress in terms
of the virtuous cycle is not of recent
origin and it dates back at least to Young
(1928). The literature also uses the term
cumulative causation in place of virtuous
cycle, as the mechanism essentially
implies that each state of the economy
drives itself to the next higher level.
Hence, in this article, we use the terms
virtuous cycle and cumulative causation
interchangeably. Young (1928) imagines
a process of cumulative causation in
industrialisation due to increasing re-
turns arising from division of labour.
Hirschman’s (1958) unbalanced growth
strategy is also based on the generation
of a virtuous cycle in a poor economy,
by creating a disequilibrium through
investment in some selected sectors.
Similarly, Myrdal’s (1957) idea of growth
as an endogenous cumulative change is
also a reflection of the idea that eco-
nomic growth proceeds on a path of
cumulative causation.
The sources of cumulative causation
in modern industrial economies include
division of labour, knowledge spillovers
and learning by doing (Kaldor 1972). In
real life, these three sources work
together and reinforce each other, creat-
ing strong increasing returns at the
aggregate level, which would result in
the increasing growth rate of the economy
over time (Romer 1986; Balakrishnan
et al 2017). In modern industrial econo-
mies, division of labour is nothing but
the adoption of roundabout methods of
production in which a variety of special-
ised inputs are used to produce final
goods (Rodríguez-Clare 1996). The litera-
ture modelling economic progress based
on these ideas suggests that there would
be multiple equilibria, an equilibrium at
a lower level of income characterised by
a shallow division of labour and weak or
absence of knowledge spillovers, and an
equilibrium at a higher level of income
featured by deeper division of labour
and extensive knowledge spillovers.
Cumulative causation models are not
devoid of the equilibrium concept, as
Economic & Political Weekly EPW OCTOBER 12, 2019
COMMENTARY
claimed by the Economic Survey. The A steady increase of β may be, therefore, a
models generate equilibrium growth rates, characteristics of harmonious development.
(p 311)
that is, variables would grow maintain-
ing the balance among them. As increas- Here one point needs to be clarified.
ing returns to scale technologies need a Five-year plans in India were the instances
certain scale of operation to break even, of the state’s direct action to accelerate
in these multiple equilibria models, the economic growth in an underdeveloped
process of cumulative causation works economy. On the other hand, virtuous
only after the economy crosses a thresh- cycle represents the internal dynamic of
old size (Balakrishnan et al 2017). There- a growing market economy. Of course,
fore, for an underdeveloped economy to to be more effective, state action in the
move out of the lower level equilibrium form economic planning must recognise
trap, it needs to be positively shocked by and utilise this internal dynamic. As evi-
investing in sectors having greatest link- dent from the following statement of
ages and spillover effects. Once it is Mahalanobis (1955), made while elaborat-
shocked and crosses a threshold size, the ing the context and logical and statistical
economy would be able to move up basis of the plan-frame of the Second Five
through a virtuous cycle path. The under- Year Plan, it is clear that planning in India
lying driver of this process is the ever- recognised this internal dynamic.
increasing productivity owing to reali- I shall now consider the proportion of invest-
sation of increasing returns. However, ment that should be allocated to industries
this process is not automatic; it needs to producing investment goods (λk) through
planning. We found from available data that
be lubricated by providing productivity-
βk is usually much smaller than βc (that is,
enhancing environments like improve- the marginal increase of income per unit of
ment in the quality of institutions and investment is much less in basic industries
governance, better provisioning of public producing capital goods than in industries
producing consumer goods). This being so, the
goods and so on.
larger the value of λk, the smaller is the in-
A reading of writings on economic crease in income in the short run; but, after a
planning in India in 1950s convince one critical period of several years, income begins
that Indian planners were aware of the to rise steeply. (Mahalanobis 1955: 28–29)
presence of a virtuous cycle mechanism Balakrishnan et al (2017), while explain-
in the economic growth process. For in- ing the growth acceleration of the Indian
stance, on the possible path of the ratio economy since the end of 1970s, provides
of increment in income to investment empirical evidence for the presence of
(β), Mahalanobis (1953) concludes that, the virtuous cycle that emanates from
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vol lIV no 41 17
COMMENTARY

the positive feedback relationship between
manufacturing and services sectors,
which can increase the growth rate of
economy over time. The paper dates the
beginning of this mechanism to 1965–66,
15 years after the commencement of
planned economic development in the
country. As anticipated by Mahalanobis
(1955), public investment during the first
15 years of planning must have provided
life to this mechanism. Public invest-
ment in capital goods industries is the
strategy adopted by the Indian planners
to take the economy to an accelerated
growth path. In comparison to this, the
Economic Survey does not have a clear
and convincing strategy to harness the
cumulative causation mechanism.
There are also problems in the empirical
evidence provided to support the presence
of virtuous cycle in the growth process of
China and East Asian countries. By plot-
ting saving and investment rates against
per capita GDP and GDP growth of these
countries, the Economic Survey concludes,
the evidence in this section suggests that
savings and investment and GDP growth
grown in virtuous cycle in the high growth
economies. (p 8)
This conclusion is very tenuous as the
positive correlation between two varia-
bles does not imply the presence of a vir-
tuous cycle. It requires two-way causa-
tion, that is, each variable is feeding the
other, which cannot be inferred from
the simple correlation between them.
After setting the target and strategy,
the Economic Survey suggests continu-
ous recalibration of policies based on
real world evidence derived from obser-
vations (data analysis). Here, the recom-
mendation is made for making data a
public good within the legal framework
of data privacy. The chapter also argues
for adapting economic theories to Indian
realities and makes a case for theory
building on the basis of observations (data
analysis) instead of testing theories
derived axiomatically using data. Here,
the issue is in abstract subjects like eco-
nomics and other social sciences, as
concepts and variables are framework
dependent. Therefore, the choice of
which variables are to be selected and
what kind of relationships among them
are to be tested depends on the theoreti-
cal framework one holds. Hence, pro-
ceeding to the data analysis without a
framework is meaningless. As the follow-
ing quote from Albert Einstein reveals,
this is the case even in natural sciences
where concepts can be concrete:
It is the theory which decides what we can
observe.
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Balakrishnan, Pulapre, Mausumi Das and M Para-
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Economic Growth and its Distribution in India

Edited by
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