sectoral interlinkage in india

7/29/2019 Sectoral Interlinkage in India

1/37


2/37

2

2 SECTORAL INTERLINKAGE, INCOME DISTRIBUTION AND UNEMPLOYMENT

A CKNOWLEDGEMENT:

We would like to take this opportunity for thanking all our respected faculty

members of Economics Department, St. Xaviers College (Autonomous),Kolkata. This project would not have been possible without our basic

understanding of what Economics is all about, and towards this end the

indelible effort of Professor Partha Pratim Ghosh, Professor Mallinath

Mukherjee , Professor Dr. Ranjanendra Narayan Nag, Professor Bipra Kumar

Das, Professor Pia Ghoshal, Professor Relina Basu and Professor Neelanjan Sen

needs special mention. We would like to thank all those people who are

associated with the National Economics Festival of St.Stephens College, Delhi

University, that gave us an opportunity, and all our friends who motivated us, topresent this paper, irrespective of any discrimination on any grounds. We are

grateful to Rev. Dr. John Felix Raj S.J. (Principal, St. Xaviers College), Rev.

Fr. Jimmy Keepuram S.J. (Vice-Principal, St. Xaviers College, Arts and

Science Department) who have readily helped us in our endeavour. We have

also benefited from the treasure trove of books on Economics at the British

Council library and the Central Library of St. Xaviers College (Autonomous).

Lastly, we cannot forget to mention the excellent infrastructural support we

received from the College in the form the Central Library and the Cyber Roomand are grateful to Computer Laboratory In-charge Mr. Sujit Chanda.

However, the usual disclaimer applies.


3/37

3


A bstract:

This paper attempts to look at inter-sectoral linkages in context of the Indian

economy, using the more recent data on Indian GDP. It clearly shows that the

most striking feature of Indias high economic growth in the past two decadeswas the boom in the service sector, and even the Reserve Bank of India

acknowledges it as the mainstay of Indias phenomenal GDP growth. An

increase in the final demand of services creates a pull-up effect that results in

the growth of the other sectors as well. Furthermore, if tariff liberalization is

coupled with an expansion of markets for the output of the export-oriented

sectors then it can create the aforesaid pull-up effect. We undertake literature

survey and empirical evidences, and try to formulate the results through an

input-output analysis, and a general equilibrium model. Thence a look into theresultant unemployment and inequality consequences through the Harris-Todaro

model shows that there is an explicit migration from the agricultural to the non-

agricultural sector in hope for a better standard of living. Finally, certain

policies have been prescribed against the aforesaid bane and for the boon of an

even better sectoral interlinkage.

Keywords: sectoral interlinkage, services, input-output analysis, general equilibriummodel, unemployment, inequality.

JEL Classification:O21,L80,C67, C68, J64


4/37

4


SUBJECT Page Numbers

Introduction The Journey Begins

Literature Survey The Path

Traversed

Input Output Analysis

A Simple General Equilibrium

Model

Harris Todaro Revisited

Policy Prescriptions Towards A

New Dawn

Conclusion The Way Ahead

Appendix

06

07 16

17 20

21 25

26 29

30 33

34 35

37


5/37

5


LIST OF TABLES PAGE NO

Table 1: Sectoral share ofGDP at FC (at 1999-2000

prices)

10

Table 2: Sector Wise TrendGrowth Rate of GDP (at 1999-

2000 Prices)

11

Table 3: Sectoral DemandMatrices [(I - A)-1] (Demand

Linkages)

14

LIST OF FIGURES PAGE NO:

Figure 1: Sectoral share ofGDP at FC (at 1999-2000

prices)

10

Figure 2: Sector Wise TrendGrowth Rate of GDP (at 1999-

2000 Prices)

12

Figure- 3: Indian IT SectorExport Trend (1991-92

2007-08)

19


6/37

6


The Journey Begins:

Distinct structural changes give rise to the process of economic development in

a country. With the economic progress, a countrys GDP basket enlarges and a

shift in economic activity occurs from agriculture towards manufacturing andservice sectors, i.e., non-agricultural sector (owing to higher income elasticity of

demand of the latter than that of the former). This, in turn, leads to structural

shifts. This process brings with it marked changes in the production process,

consumption pattern and various other social indicators. Investigations of

structural relationships help one understand not only the evolution and progress

of such relationships but also the inter-sectoral adjustments over time. Hence, a

clear perspective on the inter-sectoral dynamics could be useful in devising a

conducive and appropriate development strategy.

Sharp divergences in growth rates of different sectors are found to have serious

implications for income distribution, inflation and current account deficit of an

economy. A proper comprehension of the characteristics and trend of sectoral

linkages also assumes importance in designing socially-just policies and

effective monetary/credit policies. Thus, for a developing country like India

where socio-economic problems such as poverty, unemployment and inequality

influence policy decisions, it becomes important to study inter-linkages among

the constituent sectors so that positive growth impulses emerging among the

sectors could be identified and fostered to sustain the growth momentum. A

good understanding of the inter-sectoral linkage dynamics is very important for

framing effective monetary and fiscal policies to lead to development through

inclusive growth. The annual real GDP growth of India from 2000-01 to 2002-

03 is 4.7%; its pace accelerated after 2003-04 and the growth rate between

2003-04 and 2005-06 reached 8.3%. A large part of the credit behind the current

phase of phenomenal Indian growth has been attributed to the structural reforms

that got initiated in early 1990's. The changes associated with such reforms are

likely to get captured in the more recent data than those lying further off. It was

in this respect that we thought of exploring the sectoral inter-linkages in Indian

economy using the more recent data on Indian GDP. In this paper we make an

attempt to analyze the recent growth trends of India. We undertake literature

survey and empirical evidences, and try to formulate the results through an

input-output analysis, and a general equilibrium model. Thence we look at the

resultant unemployment and inequality consequences.


7/37

7


The Path Traversed:

After achieving political, as well as economic independence, in 1948,Jawaharlal Nehru, To solve the problems of underdevelopment, unemployment

and poverty, had taken the Soviet-type development strategy where the Indiangovernment played a key role for industrialization and it was reflected in theIndustrial Policy Resolutions of 1948 and 1956 and also in the Industrial(Development and Regulation) Act of 1951 which obliged firms to obtain agovernmental license for entry and expansion with regard to the manufacturingsector. The two-sector growth model (1953) by P.C.Mahalanobis (the founderof the ISI where the I-O tables of India were compiled from the late 1950s to theearly 1970s), gave the theoretical basis for these policies. Therefore, it is highlylikely that the compilation of IO tables in the early years is closely associated

with the economic planning policy adopted by the government.

But broadly, in the context of the Indian Economy, the dynamics of inter-linkages among the sectors has been examined by the researchers and policymakers in the following three ways:

The Input-Output tables which not only reveal the broad trends instructural shifts but also provide valuable insights into theinterdependence among the sectors,

Purely statistical analysis of causality among the sectors,

Econometric modeling exercises among various sectors of the economy.

For example, Dhawan and Saxena (1992) and Hansda (2001) used the I-0approach. Both causality tests and econometric models have been used byRangarajan, 1982; Ahluwalia and Rangarajan, 1989; Bhattacharya and Mitra,1989, 1990 and 1997; Sastry et al, 2003; Bathla, 2003, etc.

Satyasai and Baidyanathan (1997) found that in the pre and early post-independence period, the industry sector had a close relationship with

agriculture due to the agro-based industrial structure. The output elasticity ofindustry with respect to agriculture was 0.13 during 1950-51 to 1965-66(Satyasai and Viswanathan, 1999).

Rangarajan (1982) has found that addition of one percent growth in theagricultural sector stimulates the industrial sector output to the extent of 0.5 percent, and thus, GDP by 0.7 percent during 1961-1972 .An important finding ofthe study is that the consumption linkages are much more powerful than

production linkages.

However, due to the stunned agricultural growth and favourable agriculturalTerms-of-Trade, among other factors the industrial sector witnessed a slow


8/37

8


growth, followed by stagnation since the mid-1960s (Patnaik, 1972; Nayyar,1978 and Bhatla, 2003). In fact the interdependence between the two sectors hasfound to be weakened during the 1980s and 1990s (Bhattacharya and Mitra,1989; Satyasai and Viswanathan, 1997). For instance, Bhattacharya and Rao

(1986) have found that the partial output elasticity of industry with respect toagriculture has declined from 0.15 during 1951/52 1965/66 to 0.03 during1966/67-1983/84.The deteriorating linkages between agriculture and industry have been primarilycredited to the deficiency in demand for agricultural products, decline in shareof agro-based industries coupled with slow employment growth (Rangarajan,1982; Bhattacharya and Rao, 1986). However, Ahluwalia (1985) denied thewage good constraint argument for the industrial stagnation of the mid sixtiesand contested presence of any relationship between agriculture and industry.Instead he argued for the supply constraints owing to poor infrastructure and

poor productivity performance as the major reasons for stagnant industrialgrowth.

In order to assess the contribution of services sector to the industrial growth,Banga and Goldar (2004)estimated a capital, labour, energy, material andservices (KLEMS) production function for Indian manufacturing sector for the

period 1980-81 to 1999-2000. Empirically, it found that the contribution ofservices to output growth increased substantially to 2.07 per cent per annumduring the 1990s from 0.06 per cent per annum during the 1980s. The relative

contribution of services to output growth was about one per cent in the 1980sand increased significantly to about 25 per cent in the 1990s.

The paper by Sastry et al (2003) asserts that, for the period 1981-82 to 1999-2000, the forward production linkage between agriculture and industry hasdeclined, whereas backward production linkage has increased. They also foundsignificant impact of agricultural output on industrial output, and thatagricultures demand linkage to industry has declined, while that of, fromindustry to agriculture has increased.

Bathla (2003)carried out a comprehensive analysis of the inter-sectoral linkagesin the Indian economy for the period 1950-51 to 2000-01.Under the granger-causality framework, no evidence of relationship was found between primaryand secondary sectors, while primary sector was found to have a unidirectionalcausation with trade, hotels, restaurants, communication services andfinancing, insurance, real estate & business services sectors, the secondarysector was found to have bi-directional causality with them. Under the co-integration framework, strong evidence of existence of long-run equilibrium

relationship was found among the primary, secondary and the specializedservices sectors.


9/37

9


That most of the studies in India (and in many developing countries) havefollowed the traditional two-sector framework in a closed economy, it raisesquestions about the methodological reliability and the comprehensiveness of the

findings. It is reasonable to argue that neither the two-sector model nor theclose economy framework are appropriate to analyze the sectoral linkages inIndia, because India has been becoming more and more open since the reformsof 1990s, and since then (or even before), the growth of the economy has beenled by the services sector. Services-led growth is the most prominent feature inthe post-reform era (Rakshit, 2007), and, thus, any sectoral linkages analysiswhich circumvents the services sector does not provide comprehensiveempirical findings.

Thus, we observe that the process of economic development in Indian economyresults in distinct structural changes since industrial stagnation in the mid 1960s.From a traditional agro-economy till the 1970s, the Indian economy hastransformed into a predominantly services-oriented economy, especially sincethe mid 1980s. Economic reforms initiated in the mid-eighties, and theirexecution from early 90s, has not only brought about the structuraltransformation in the economy to a certain extent but also led to a substantialincrease in the degree of integration with the rest of the world. With thecontinuous rise in the share of services sector in GDP for the Indian economy,there has been a phenomenal growth in distributive, communication, consumer

and financial services, which, in turn, drives from increased demand from thecommodity-producing sectors. This development has added a new dimension tothe inter-sectoral linkages in the Indian economy.

However, after witnessing remarkably high and stable growth during the 1990s,the Indian economy has recently shown the symptoms of recession. Thus, indesigning appropriate long-run strategies to achieve a sustained 8 per centgrowth-rate in real GDP (GDPR) envisaged in the Approach Paper for the TenthFive-Year Plan [Planning Commission, 2001], a proper understanding of the

sectoral linkages was given much importance. This issue has also becomerelevant for the conduct of monetary/credit policy as well. In the recent past, theReserve Bank had reduced the bank rate and the cash reserve ratio (CRR)intermittently in order to stimulate the growth process. These measures,however, have not induced the desired result of increasing demand, bothconsumption and investment, possibly due to the persistence of certain sectoralrigidities in the Indian economy.


10/37

10


Overall Growth Scenario of Indian Economy:

The review of the changes in the sectoral composition of the GDP in Indianeconomy (for the period 1950- 51 to 2007-08) is presented in figure-1.it can be

seen that over the three decades (from1970-71 to 2000-01), there is a major shiftaway from the agriculture towards services sector and industrial sector. Thedecade-wise analysis reveals that the share of real income primary sector(agriculture and allied activities) has declined from 55.11% in 1950-51 to17.75% in 2007-08 while manufacturings share has accelerated from 10.16% in1950-51 to 20% in 2007-08. Tertiary sector has witnessed a continuousexpansion with a share in total national income rising from 34.27% in 1950-51to 62.87% 2007-08.

Table 1: Sectoral share of GDP at FC (at 1999-2000 prices)

(in percentage)

Year AgricultureAllied

IndustryServices

1950-51 55.11 10.62 34.27

1960-61 50.62 13.13 36.25

1970-71 44.26 15.45 40.3

1980-81 37.92 17.45 44.63

1990-91 31.37 19.8 48.83

2000-01 23.89 19.99 56.122007-08 17.75 19.38 62.87Source: Handbook of Statistics on Indian economy, 2007-08

During the 1990s, however, there was a sharp rise by about 8 percentage pointsin the share of services sector and almost a similar fall in the agricultural sector,with very little change in the share of the industrial sector.

Figure-1: Sectoral share of GDP at FC (at 1999-2000 prices)


11/37

11


Table-2 provides average per annum growth rate in respect of different sectorsof the economy.

Table 2: Sector Wise Trend Growth Rate of GDP (at 1999-2000 Prices)

Note: Trend Growth rate is estimated using equation ln(Y) = a + b (Time) at 1999-2000prices.Source: Handbook of Statistics on Indian economy, 2007-08

The decade-wise annual trend growth rates in each sector reflects that theperformance of all the sectors was reasonably good during the 1980s indicates ashift towards higher growth only from the early eighties (Figure 2). In the 1960sand 1970s primary sector growth rate was below 2.0% compared to a highergrowth rate of 2.74% during the 1950s. A similar picture of high output growthis witnessed in industrial sector in the 1950s (6%) but a comparatively lesserrate (5.15% and 5.07%) is found in the subsequent decades. Thus low growthrate in the industrial sector in the 1970s was also accompanied with low growthin agricultural sector, pointing to a close linkage between the sectors. Industrialgrowth rate has been relatively high during 1980s when agricultural growth wasalso relatively high. In contrast, the tertiary sector has witnessed phenomenalgrowth from 4.40% in the 1950s to 6.35% in the 1980s and 7.32% in the 1990s.

Year GDP at FC Agriculture

& allied

Industry Services

1950/51-1959/60

3.68 2.71 5.99 4.40

1960/61-1969/70

3.29 1.51 5.15 4.74

1970/71-1979/80

3.45 1.74 5.07 4.45

1980/81-1989/90

5.17 2.97 6.41 6.35

1990/91-1999/2000

6.05 3.34 6.63 7.32

2000/01-2007/08

7.76 3.09 7.46 9.55


12/37

12


Figure- 2: Sector Wise Trend Growth Rate of GDP (at 1999-2000 Prices)

Comparing the sectoral shares in GDP since the 1950s, we find that theagriculture and allied activities has followed downward trend overtime, with

industry remaining nearly constant till 1970s and then showing an upward trendsince 1980s, and services sector share rising in the GDP. Since the early 1950s,share of services sector in GDP exceeded that of the industrial sector, but thesame remained smaller than that of the agricultural sector till the 1970s.

At a glance, the declining contribution of agriculture to GDP gives an

indication that the role of agriculture in the national economy has become less

and less important. While the share of agriculture in national income has been

declining, the workforce engaged in agriculture has exhibited only a marginal

decline: whereas 75.9% of the total workforce was engaged in agriculture in1961, the figure declined to 59.9% in 2000-01 and then to 52.0% in 2006-07. In

absolute terms, agriculture provided employment to 237.8 million persons in

2000-01 (Economic Survey, 2007-08). Vogel (1994) and Bhatla (2003) argue

that agriculture continues to be an important sector in terms of absorbing two-

third of the total work force and positively influencing development of

manufacturing and overall economy despite a deceleration in its share in total

income. Bhatla (2003) also remarked that despite of differential growth across

the sectors, agriculture is still seen to stimulate industrial and overall economicgrowth. Further, the existence of forward and backward production linkages


13/37

13


means that the importance of the agricultural sector cannot simply be implied

just from the value of its direct output.

A Review of Demand Linkages:

The demand linkage between agriculture and industry operates throughagricultural income. An increase in agricultural income brings about an increasein the demand for industrial consumer goods and some producer goods, such as

pumps, tractors, fertilizers, pesticides, etc. According to Ahluwalia (1985), thereare certain consumer goods such as clothing, footwear, sugar and edible oils,which accounts for about a fourth of the value added in the consumer goodssectors, for which rural consumption is over three times than the urbanconsumption. Rangarajan (1982) observed that the rural demand in India forindustrial consumer goods account for as much as two-thirds of the totaldemand for them.

The Terms-of-Trade (TOT) (the relative price ratio) between agriculture andindustrial products plays very important role in enhancing the demand linkages

between the two sectors. A favourable TOT for agriculture leads to higherincome of the agricultural sector, and thus, creates more demand for industrialgoods. On the other hand, the same favourable TOT will squeeze industrialgrowth by reducing the profit margins through increase in the product wagerate.

The TOT for agriculture in India has found to be favourable since the mid1960s, except the unfavourable TOT for the period 1977-78 to 1983-84.Chakravarty (1974) examined the implications of agricultural TOT on Indianindustries, based on the linkages through food grain supply. He postulated that

beginning from 1964-65, a favourable agricultural TOT was instrumental insqueezing the profit margins of the industrial sector through an increase in the

product wage rate. Rao and Maiti (1996) also observed that the impact of a risein relative food grain price on the demand for industrial consumer goods was

significantly negative during 1952-90(cited in Deb, 2002).

The demand linkage can be examined by using the Leontief inverse matrices,i.e. the (I A)-1 matrix, where A is the input-output coefficient matrix. Suchinverse matrices are given in Table 3.


14/37

14


Table 3: Sectoral Demand Matrices [(I - A)-1] (Demand Linkages)

Year Agriculture Industry Services

1979-80

AgricultureIndustryServices

1.2140.135

0.049

0.2601.601

0.269

0.0830.191

1.139

1989-90


1.220

0.319

0.144

0.104

1.729

0.404

0.074

0.378

1.318

1993-94

Agriculture

IndustryServices

1.187

0.2970.149

0.087

1.7040.457

0.066

0.3301.334

1998-99


1.152

0.420

0.087

0.075

1.831

0.216

0.051

0.457

1.207

2003-04

AgricultureIndustry

Services

1.265

0.466

0.123

0.077

1.958

0.247

0.061

0.501

1.213Source: Data up to 1993-94 are from Sastry et al (2003) and for 1998-99 and 2003-04 are fromKaur(2009)

From the table, we find that a rise in the demand in agriculture by one unit waslikely to raise demand for industrial goods by 0.260 units and demand forservices by 0.083 units in 1979-80. In 1993-94, one unit of rise in theagricultural output was likely to enhance the demand for industrial goods by0.297 units and that of for services by 0.149 units. Agricultures demandlinkages to industry further increased to 0.446 units in 2003-04, while that to

services declined to 0.123 units during the same.

Unlike the agricultures demand linkages to industry, the industrys demandlinkages to agriculture has been weakened during both the pre- and post-reform

period, whereas industrys demand linkages to services became almost doublein 1993-94 and then it returned to the initial position in 2003-04.

The services-sectors demand linkages to the agriculture sector have remainedmore or less same over the pre and post-reform period, barring some marginal

increase during 1979-80. However, recent trend shows an increasing linkagebetween the two. On the other hand, the service-sectors demand linkages to


15/37

15


industry increased by about 44% during 1968-69 to 1993-94 and by about 52%during 1993-94 to 2003-04.

Services led Growth:

The most striking feature of Indias high economic growth in the past twodecades was the boom in the service sector. This service sector is included inthe non-agricultural sector and hence draws our attention from the traditionalagriculture-industry framework to the overall growth through service sectorlinkages. Service-led growth is sustainable because the globalisation of servicesis just the tip of the iceberg (Blinder 2006). Services are the largest sector in theworld, accounting for more than 70% of global output. The service revolutionhas altered the characteristics of services. Services can now be produced and

exported at low cost (Bhagwati 1984). The old idea of services being non-transportable, non-tradable, and non-scalable no longer holds for a range ofmodern impersonal services. Developing countries can sustain service-ledgrowth as there is a huge room for catch up and convergence. A boomingservice sector could upset three long-held tenets of economic development.First, services have long been thought to be driven by domestic demand. Theycould not by themselves drive growth, but instead followed growth.Second, services in developing countries were considered to have lower

productivity growth than industry. As economies became more service oriented,their growth would slow. Third, services jobs in developing countries werethought of as menial, and for the most part poorly paid, especially for low-skilled workers. As such, service jobs could not be an effective pathway out of

poverty.

The core of the argument is that as the services produced and traded across theworld expand with globalization, the possibilities for all countries to develop

based on their comparative advantage expand. That comparative advantage canjust as easily be in services as in manufacturing or indeed agriculture.

Unlike the two-way linkages between agriculture and industry, the linkagesbetween agriculture and services sector is one-way and this linkage is mainlybackward linkage, rather forward linkage. There are considerable evidence thatinvestments in some special services such as transport and communication,storage, building of rural roadways, banking and financial facilities, trade andhotels, social services such as education, hospitals and other infrastructure, etc.increases agricultural productivity.The growth in specialized services can induce higher rates of economic growth,and is also likely to strengthen agriculture-industry linkages. Similarly, with the

rise in per capita income demand for specialized services that act as inputs inagriculture will increase, because the demand for services is highly income


16/37

16


elastic. This, in turn, will induce industrial growth, and stimulates added agro-products.

The services sector has been the mainstay of the Indian growth process in the

1990s. While the share of services has been ruling high ever sinceindependence, it has received a major fillip only in the 1990s. Indeed,contribution of the services sector to the overall GDP growth peaked an all timehigh of 65.1 per cent in the 1990s up from 43.6 per cent in the 1980s. As aresult, the services share in GDP went up by a spectacular 7.9 per cent in asingle decade of the 1990s touching the mark of 48.5 per cent in 2000-01 whilethe sector took about four decades to improve its share by 12.6 per cent to 40.6

per cent in 1990-91 from 28.0 per cent in 1950-51. The ascendancy of serviceshas had a stabilizing effect on the growth process itself. To quote from theReserve Banks Report on Currency and Finance, 2000-01, it is theservices sector which has kept the GDP growth around 6.0 per cent in the 1990swhen industry and agriculture sectors did not perform relatively well (p. iii 44). Thus, the services sector has been the most dynamic sector of the Indianeconomy, especially over the last ten years (National Statistical Commission,2001, art 7.1.2)

The application of input-output analysis has revealed that Indian economy is

quite service intensive and industry is the most service-intensive sector. Banga

and Goldar (2004) found that services input contributed for about 25 percent of

output growth of registered manufacturing during 1990s (as against 1 percent

during 1980s), and that increasing use of services in manufacturing has

significant favorable impact in total factor productivity (TFP) growth of

organized manufacturing sector. These observations, in turn, imply that

excluding the service sector from the analysis understates the agriculture-

industry linkages. Given these linkages and the recent services sector boom,

the apparent question is how to interlink the services sector with agriculture and

industry, and how it is going to impact the agriculture-industry linkages.


17/37

17


Input-Output A nalysis:

With such rapid growth, significant changes occur in the Indias economic

structure and the need for the data and the analytical tools that capture such

changes is also increasing among policy makers, researchers and businesspractitioners. The input-output (I-O) table that describes all the transactions

between the industries of an economy is one of the useful statistics in order to

meet such demands. Here we undertake an input output analyses to delve into

the matters of inter sectoral interlinkage. The input output analysis is

demand driven, whereby the change in final demand of a sector causes a

change in the output of the concerned sector, as well as a change in the output of

the interlinked sector. However, it is assumed that there is no capacity

constraint.

Let Mij denote the inputs into sector j from sector i, & Mj denote the output of

sector j.

We define aij = Mij/Mj, where aij denotes the amount of purchases from each

sector to support one unit of output of sector j. In specifying the final demands

for each sector, one obtains the following set of relations for each sector:

Mi = + Ci; i=1(1) n

=>Mi = Ci; i=1(1)n .(1)

Where Ci is the total final demand, Mi is the output of sector i, & aijMj is the

sum of intermediate demand.

Let us consider 3 sectors. Let, X denote the formal sector (which can be taken as

the service sector), Y denote the import competing sector (which can be said

to be the manufacturing sector), & Z denote the export-oriented agriculturalsector. Thus, now i = {X, Y, Z}; j = {X,Y,Z}. Thus, equation (1) can be written

as follows:

MX - aXXMX aXYMY aXZMZ = CX

MY - aYXMX aYYMY aYZMZ = CY

MZ - aZXMX aZYMY aZZMZ = CZ

In matrix form this can be written as


18/37

18


=

=> =

=> M= C,

Where I = , A = , M = , C =

=> M =-1

C

If (I A), known as the Leontief matrix, is non-singular, & I is the identity

matrix. The matrix (I A)-1

is known as the Leontief inverse matrix, which

represents the direct & indirect requirements of gross output in each line of

activity to support one unit of final demand in each line of activity. The sum of

the elements of the ith

row of the total requirement matrix (I A)-1

is normally

taken to be the measure of forward linkage. It is denoted by b i0 = , &

it shows the increase in output of the ith

sector used as inputs for producing an

additional unit of the final sector output. Similarly, sum of the elements of the jth

column of the total requirement matrix (I A)

-1is normally taken to be the

measure of forward linkage. It is denoted by b0j = , & it shows the

input requirements for a unit increase in output of the jth

sector, given each

sectors share in total final demand. Thus, an index of the backward linkage is

derived in the following way:

The existence of the solution the above problem requires

> 0, where =

Assuming that the above holds, the solution are as follows

MX = BXXCX + BXYCY + BXZCZ .(2)


19/37

19


MY = BYXCX + BYYCY + BYZCZ .(3)

MZ = BZXCX + BZYCY + BZZCZ .(4)

Where, BXX = , BXY = , BXZ =

BYX = , BYY = , BYZ=

BZX = , BZY = , BZZ =

Bij > 0, for all i,j ={X,Y,Z}.

Now let us suppose there has been a rise in the final demand of X. i.e., CX has

risen. This might be due a number of factors. Let us assume that there has been

a rise in the external demand of X (the figure below shows the rising value of

exports of IT and ITES of India, in US billion $, over the years. This can be

attributed to a rise in the external demand of the same. This forms the empirical

base of this analysis).

Figure- 3: Indian IT Sector Export Trend (1991-92 2007-08)


20/37

20


Total differentiating (2), we get,

Clearly if CX rises, denoted by CX, there is a rise in the output of the X

sector, since is positive, given the Hawkins Simons condition.

Now, total differentiating (4), we get,

Thus, an increase in the final demand of the X-sector induces a rise in the output

of the Z-sector, since is positive, given the Hawkins Simons condition.

This clearly shows the positive interlinkage between the X and the Z sectors.

Thus, an increase in the output of the formal sector (here X), induced by a rise

in the final demand of its output, pulls-up the output of the agricultural sector

(here Z).


21/37

21


A Simple General Equilibrium Model:

Now we construct a general equilibrium model to have a look into sectoral

interlinkage, and its consequent effect on inequality and unemployment. We

make the following formalization:

We take a 3 sector small open economy.

Let X is the output produced in formal service sector, where X is

produced with skilled labour and capital. Skilled labour is specific to

sector X. Moreover, X uses capital-intensive production techniques.

Let Y be the output produced in import-competing manufacturing sector,

where Y is produced with unskilled labour and capital, and, is tariff -

protected. We assume an ad-valorem tariff rate t. Moreover, Y useslabour-intensive production techniques.

Let Z be the output produced in export-oriented agricultural sector, where

Z is produced with unskilled labour and land. Land is specific to sector Z.

Moreover, Z uses land-intensive production techniques.

is fixed unionized skilled-labour wage-rate; is unskilled-labour

wage-rate.

Assuming unskilled labour-mobility, the wage-rate of unskilled-labour is

same in sectors Y & Z.r is return to capital.

R is return to land.

L is the total fixed stock of labour, i.e., = , where denotes the

total skilled labour available in the economy, & Lu denotes the total

unskilled labour available in the economy.

K is total stock of capital, &

is total fixed stock of land.

s are the commodity prices, where i=x, y, z.

is the per unit requirement of ith

factor of production for the unit

output of the jth

product, which is fixed.

Therefore the price equations are:

.. (5)

. (6)


22/37

22


.. (7)

. (8)

(9)

.. (10)

(11)

Now, differentiating (5) totally,

. (5a)

.. (5b)

.. (5c)

Similarly from (6) and (7),

.. (6c)

... (7c)

where,

and is the income share of the ith factor in the jth sector.

Now representing (5c), (6c) and (7c) in matrix forms,

So for the solution to exist,


23/37

23


, which holds true since the factor income shares arealways positive.

We undertake the following Comparative statics:

1) Trade Liberalization :

Let there be a trade liberalization that is, fall in the tariff rate t. This

means that py (=py*(1+t)) falls.

Given Rybczynskis theorem, from

equation (4), we conclude that there

will be a fall in the unskilled wage

wu, given the factor intensity

assumption.

From the figure we see that there is a

fall in the output of Y from Y0 to Y1.

This would shift the labour demand

curve downwards, resulting in a fall

in wage wu in the Y-sector, and a

resultant fall in employment.

However, the unemployed labour would not move to the export oriented

agriculture sector Z. this is so, because a further increase in the labour

supply in sector Z would cause the wage rate to fall even in the sector Z.


24/37

24


However, the skilled wage is fixed. Thus, there is a clear rise in inequality

between the factor incomes of the two types of labour. One interesting thing to

note here is that sector Y being labour-intensive, the fall in output in the Y-

sector will lead to a greater displacement of labour than sector Z can absorb, it

being land-intensive.

Rise in the external demand of the formal service sector :

Let there be a rise in the external

demand of X (as shown in our input-

output analysis). This raises , thus by

Stolper-Samuelson result rate of interest

r also rises. Taking capital (K), being

an increasing function of r, there is anincrease in capital. X being a capital

intensive sector, by Rybczynskis

theorem, production of X must also rise,

as evident from equation (5)

.

The increase in the production of X pushes the labour demand curve (which is

of skilled labour) outwards. However, wage being fixed at , an outward shift

of the labour demand curve results in the fall in unemployment from an initial

level U1 (L1L2) to a new level U0 (L3L2).


25/37

25


Rise in the external demand of the export-oriented agricultural

sector:

Let there be a rise in the externaldemand of the export-oriented

agricultural sector Z. the demand

curve for the output of sector Z shifts

outwards. As a result, Pz* rises, and

the output also rises. However since

land is fixed in supply, it would result

in greater demand of the other factor

of production, unskilled labour. Thus,the labour demand curve will shift

outwards, resulting in a rise in wage in

the Z-sector.

However, labour being mobile

between Y & Z sectors, this would

bring in labour from the Y sector,

shifting the labour supply curve

outwards, thereby reducing wage to

the previous level, but absorbing the

displaced labour from the Y-sector.


26/37

26


Harris-Todaro Revisited:

After having constructed a general equilibrium model to look at the different

facets of sectoral-interlinkage, let us now look into the matter of unemployment

in a different way, using the marginal productivity of labour analysis, a laHarris Todaro (1970).

Suppose there are L workers in the economy with LX in the export-oriented

service sector, LY in the import-competing sector, and LZ in the agricultural

sector, where LX contain skilled labour LS, and LY & LZ contain unskilled

labour LU. Wage in the formal sector is fixed at the unionized level of . In the

agricultural sector, wage is wuz, and the import-competing sector wage wu

y

coincides with agricultural sector wage wuz

as per assumption. We assume thatthe number of jobs in the formal sector, i.e., LX is fixed (unless there is any

parametric change).

We further assume that is greater than wuz this can be attributed to the

following reasons:

(i)The service sector X employs skilled labour, & the agricultural sector Zemploys unskilled labour. Naturally the former wage will be more

than the latter.(ii)In the formal service sector the presence of labour-unions & pro-labour

customs ensure that the wage in the service sector is higher than the

agricultural sector, where the aforesaid conditions do not hold.

(iii) The government usually sets a wage-flooring to protect the interests ofthe labourers. However, this is usually followed in the formal sector

which is organized & supervised, & generally employs skilled

workers. However, in the agricultural sector, these policies go for a

toss.(iv) Workers in the service sector face the threat of being fired. Then they

have to either be employed in the informal sector, or go back the

agricultural sector to work. Thus, this entails a higher wage in the

formal sector.

(v)In the agricultural sector, there are incentives for workers to expend effortwhen labour cannot be directly supervised without incurring

tremendous costs.


27/37

27


(vi) If there is an increase in world demand for goods produced in theservice sector (as mentioned earlier) then the price of the good will

rise, & the benefits will pull-up the wage rate in the service sector.

As is exogenously fixed, there is a fixed amount of labour employed in theservice sector (unless some parametric changes occur). Thus, if there are more

workers than LX in the non-agricultural sector then some would have to find job

in the import-competing sector, and the rest remain unemployed. The crucial

assumption of this model is that workers base their migration decisions on their

expected incomes. The wage-differential created between the agricultural & the

non-agricultural sector leads to individual migrating from the agricultural sector

to the non-agricultural sector. Moreover, we assume that people migrate in hope

of getting a job in the formal service sector which gives a much higher wage.But this migration incurs a cost, which is denoted by C, C > 0.

The problem of obtaining jobs in the service sector depends on the ratio of

vacancies to job seekers. We denote this by p. Moreover, there is the import-

competing sector, in which a migrant can get absorbed in the event that he gets

no job in the service sector.

Thus, the expected wage in the non-agricultural sector is

p. + (1 - p). wuy (12)

Over-crowding in the non-agricultural sector due to high rates of migration

from the agricultural areas results in unemployment in the formal service sector

a part of which gets absorbed in the import-competing sector. If employment

in the service sector is increased by 1 unit, then rural employment falls by /

wuz

units.

Thus, = - ( / wuz) < 0

This induces / wuz

people to migrate from the agricultural to the non-

agricultural sector.

Now, let us denote the probability of an unemployed migrant to be absorbed by

the import-competing sector by q, albeit at a lower wage wuy (= wu

z ). or he

remains openly unemployed with a probability (1 q). thus, the expected value

of this set of possibilities is q. wuy

+ (1 q).0 = q. wuy

(being openly unemployed means that he gets zero wage).


28/37

28


Now, the probability of getting a job in the service sector is given by LX / (LX +

LY). the number LX denotes the numberof jobs there are in the service sector,

while, the number (LX + LY) gives us the total number of potential job-seekers.

The ratio of the two, thus, gives, the chances that a migrant will get a job in the

formal service sector or the import-competing sector.

Thus, the expected income from the service sector is .[LX / (LX + LY)]

Similarly, the expected income from the import-competing sector is wuy.[LY /

(LX + LY)]

Thus, migration continues as long as

.[LX / (LX + LY)] + wuy

.[LY / (LX + LY)] C +

wuz

, (13)

Since the weighted expected income from non-agricultural sector happens to be

greater than the wage in the agricultural sector, plus migration cost. We denote

the right-hand side of the above expression as .

When equality holds, migration equilibrium occurs, i.e., ex-ante people are

indifferent between migrating and not migrating.


29/37

29


The figure in the previous page shows the results of our model. MPLZ

is the

marginal productivity of labour in the agricultural sector, & MPL*

is the

marginal productivity of labour in the non-agricultural sector. OO denotes the

total labour endowment in the economy, i.e., . LZ is the employment in the

agricultural sector. LX is the employment in the formal service sector. LY is the

employment in the import-competing sector. The remaining U ( - LZ - LX - LY)

is the level of unemployment in the economy. The aforesaid results are clear

from the figure.

However, some points are to be noted here:

(i)Ex post, the situation may be different those who landed a job in theformal sector would be satisfied; but those who had to be contend withan informal sector job would regret that they made the move.

(ii)The equilibrium concept implies a particular allocation of labour betweenthe three sectors of the economy. This is because it is the allocation of

labour that affects the perceived probabilities of getting a job.

(iii) The equilibrium concept can be extended to more than two sub-sectorsin the non-agricultural sector or in several sectors in agriculture.


30/37

30


Policy prescriptions - Towards A New Dawn:

Migration from the agricultural to the non-agricultural sector, usually taken to

be rural-urban migration, reduces population pressure in the rural areas and,

thereby, should improve economic conditions and reduce rural poverty.However, disparities between urban and rural areas in terms of income and

employment and the availability of basic infrastructure and services persist. A

major effort is required to ensure that the urban areas can absorb the growing

urban population and that urbanization will not result in an urbanization of

poverty. During the 1950s and 1960s, most governments recognized the need

for simultaneous development of agriculture and industry, of rural and urban

areas, but this was impossible in view of the scarcity of the available resources.

An exclusive focus on rural areas would result in an under-investment in urbanareas and this would limit the growth of the urban sector and its ability to

absorb the rural labour surplus.

An exclusive focus on urban development would produce similar results,

because it would accelerate rural-urban migration and reduce food production

per-capita. Industrialization would pertain to import machinery and other

capital-intensive industrial inputs from developed countries and the cost of

importing capital goods would nullify the gains made by import-substitution.

The import-substituting industries need protection against foreign imports of

similar goods through import tariffs, but this makes the industries less efficient

and competitive.

Under a sustainable development programme the following targets are listed;

Empowerment of communities and development of livable cities,

Alleviation of rural and urban poverty through participation,

Establishment of linkages between agricultural and non-agricultural

development,

Management of integrated area-function-participation development.

Impact of government policies:

Since it has been seen that urban development through creating urban formal

sector jobs leads to migration more and consequent urban unemployment it

would be more efficient to portray on rural development programmes for the


31/37

31


government. The impact of government agricultural policies is a serious matter

of concern that has not been given due attention in our country. The Terms-of-

Trade may be affected, either through demand or supply side, due to significant

effect of price policies undertaken by the government .According to Bhadhuri

,By ignoring the factors like ., and perhaps the most importantly, the

agricultural minimum support price system of the government we cannot even

hope to present a comprehensive and realistic empirical analysis of the evolving

pattern of agriculture- industry interactions.

Examining the impact of government interventions in agriculture (e.g. input

subsidy, minimum support price, etc.) on agricultural growth are required as

most dual economies are starkly differentiated between the traditional

agricultural sector and the modern sector having little connections. Neverthelessthe impact of globalization and liberalization and the subsequent movement

towards free trade has opened up a new dimension for the agricultural sector.

We need to examine the policies of World Trade Agreement of Agriculture and

the impact of external forces on sectoral interlinkage. As Vyas (2004) observed

such move will undoubtedly affect the product mix and the input composition in

agriculture sector in a significant way, and thereby, the sectoral linkages.

The results that have cropped up in this paper give rise to the following policyprescriptions:

Inter-sectoral resource transfer:

An important aspect of linkage between the two sectors is the transfer of surplus

resources such as labour and raw from agricultural to non-agricultural sector.

However, the estimation of inter-sectoral resource flows between agriculture

and non-agricultural sector in a country like India is impossible as the

agricultural activities are informal in nature and more than 80 percent farmersare small and marginal farmers (who are not able to produce any marketable

surplus). Technological change should also be welcomes by the agricultural

sector in order to usher in higher productivity, profitability and more marketable

surplus. The government should take necessary policies in order to boost up

sectoral linkage through resource transfer.


32/37

32


Subsidy in the non-agriculturalsector (with migrationrestrictions):

One way to deal with the

unemployment problem is to

provide wage subsidy in the formal

service sector. As such the firms in

that sector have to bear a lesser

wage cost, and thus, would employ

more labour, thereby, reducing

unemployment in that sector, asshown in the adjacent diagram.

But this actually worsens the

situation by enlarging the

unorganized sector since more andmore people migrate from

agricultural sector with expectations

of a higher wage (since the

propensity to migrate from the

agricultural to the non-agricultural

sector is / wuz > 1, as > wu

z).

This shifts the labour supply curve

in that sector outwards and

unemployment rises.

Hence a mixed policy that combines urban wage subsidies with migration

restrictions would serve the purpose. Interestingly an alternative policy

for shrinking the informal sector excluding the migration restriction

would be subsidization of employment in agriculture. Thus the policy

recommendation regarding employment also suggests a fine link between

agricultural and urban sector.


33/37

33


A n eye for the international market:

The government should encourage the production of goods and services

those produce in line of the international market. As such there would be

an increase in world demand for these commodities which would yield

positive results as shown in our analysis in the paper.

Development of human capital:

The service sector employs skilled labour. Thus to accommodate the

unskilled labour of the remaining two sectors in the booming service

sector the government must take measures to develop human capital such

as health and education. Education would help the people of the country

to acquire skills which would make them eligible for a job in the booming

sector. Efforts must be taken by the government to minimize the time-lag

of skill acquisition. Vocational training can be of help. Moreover, a sector

that is booming would require workers who can work without falling

sick. Thus health is an important aspect.

Efforts must also be taken for developing the rural sector which would

automatically prevent people from migrating to the non-agricultural

sector, thereby, creating multiplier effects along with the wage-subsidy

policy there must also be a labour market regime that protects the

interests of the labourers, but at the same time it shouldnt be too strict so

as to put the entrepreneurs at a loss.

The structural reforms after the BOP crisis, so far, have been perceived to be

more successful in increasing the efficiency and competitiveness of Indian

industry. Exogenous shocks to economy through agriculture as a fall-out of

adverse weather conditions remains a reality even today. In such an event, the

presence of bi-directional sectoral linkages between industry and services (inthe absence of directional causality running from agriculture to non-agriculture

growth) can still help sustaining the growth momentum through appropriate

policy initiatives favoring these sectors. Policy initiatives favouring industry

and services in such a set up would be effective in neutralizing some of the

negatives of adverse shocks from agriculture. In the same spirit adverse shocks

either to industrial and/or services growths are likely to get magnified and

policy initiatives directed towards agriculture alone to counter this need not be

effective in yielding the desired result.


34/37

34


The Way A head:

The present paper focuses on the service-led growth of the Indian economy,supporting the recent trend. The paper leads to the following points:

(i) An upward surging trend in final demand of services (which can beattributed to a rise in external demand) increases the output of the saidsector, and creates a pull-up effect that results in the growth of theother sectors as well. This pull-up effect helps in reduction ofunemployment, and a better standard of living for the labour employedin the different sectors.

(ii) An increase in the final demand of the export-oriented agriculturalsector also creates the aforesaid pull-up effects and a favourablestandard of living for the employed labour.

(iii) Tariff -liberalization leads to a fall in output of the import-competingsector, resulting in a fall in the standard of living of the factorsemployed in that sector (in our paper its the unskilled workers).However, if tariff liberalization is coupled with an expansion ofmarkets for the output of the export-oriented sectors, then it might leadto an increase in output of the import-competing sector due to greaterpull-up effect. But this also depends on the ability of the firms in thesaid sector to shed its infancy.

(iv) There is an explicit migration from the agricultural to the non-agricultural sector in hope for a better standard of living. To tackle this

problem more job creation, along with restrictions on migration &rural development is needed.

It has been found that deficiency of demand in one sector is the main constrainton other sectors growth. Suppose, a particular allocation of investment betweenagriculture and non-agricultural sector results in such increases in outputs of thetwo sectors that there is an excess supply of (demand for) non-agricultural(agricultural) output. If the deficiency in demand for non-agricultural outputcannot be eliminated by increasing agricultures share in total investment

because constraints restrict the expansion of agricultural output, then the growthpotential of agricultural sector is the limiting factor for growth. Agriculturalstagnation, by limiting food and intermediate good supplies, markets, sources ofsavings and labour, could constrain industry, while non-agricultural stagnation

by limiting supplies of capital and intermediate goods and markets could restrictagricultural development. While substitutes through foreign trade may beavailable, difficulties of export expansion and consequent foreign exchangeshortages may not allow such routes to be taken.However, for greater social up-liftment, there should be an increased emphasis on human capital and a greater

participation of the people in the growth process. The recent initiative of


35/37

35


inclusive growth is a step in the right direction. Further studies can be takenin the following fields:

Firstly, it has been implicitly assumed in our paper that exchange rate remainsfixed. If the Central Bank intervenes in the foreign exchange market & there is adevaluation or evaluation of the domestic currency, it would entail someinteresting results. The results would change in case of a flexible-exchange ratesystem, as is followed nowadays by most countries. This issue needs a furtherinvestigation in a macro-economic framework.

Secondly, as a country slowly transforms from following an Import-Substitutionpolicy to an Export-Promoting one, the role of the import-competing sectorchanges, provided it grows up. Then the whole framework would show differentresults. However, this particular field can be captured in a framework with at

least four sectors.

Thirdly, the informal sector plays a vital role in the Indian economy. Theinformal sector contributes to employment in India significantly during the

period 1977-78 from 92.2 per cent to 93.6 per cent in 2004-05. On the otherhand the share of contribution of GDP in informal sector was 68.1 per centduring the period from 1977-78 and about 57.6 per cent in 2004-05. Contrary tothe western development model of Lewis which suggests that the surplus labourfrom the subsistence sector would be absorbed in the industrial sector as

development takes place, no such shift of labour from agriculture to modernindustrial sector has taken place in India. Rather the shift has been fromagricultural sector to the informal service sector which is quite sizeable incontributing to the economys output. Moreover, there also exists dualism andcontract-farming in the agricultural sector. This suggests that existence ofinformal sector is likely to have a huge effect on the income distribution andemployment of an economy and it needs further research in future.

Fourthly, Environmental Sustainability is an essential global pursuit, because

environmental degradation is inextricably and logically linked to the problemsof poverty, hunger, gender inequality, and health. Livelihood strategies and foodsecurity of the poor often depend directly on functioning ecosystems and thediversity of goods and ecological services they provide. Insecure rights of the

poor to environmental resources, as well as inadequate access to environmentalinformation, markets, and decision-making, limit their capacity to protect theenvironment and improve their livelihoods and well-being. Thus, protecting andmanaging the natural resource base of economic and social development andchanging consumption and production patterns are fundamental requirements.


36/37

36


References:

Bhattacharya Kaushik, Sastry D V S, Singh Balwant and UnnikrishnnanN K: - Sectoral Linkages and Growth Prospects: Reflections on the

Indian Economy , pp. 2391-2393.

Bhattacharya Rudrani: - Agro-industry, Inequality and Sectoral growth, pp. 3-9.

Bleek Schmidt Friedrich, Malley Jurgen, Spangenberg H.Joachim: -"Towards a Set of Proactive Interlinkage Indicators as a Compass on theRoad towards Sustainability.

Jones R.W.: - The Structure of Simple General Equilibrium Models.

Lanjouw O Jean, Lanjouw Peter: - The Rural non-farm sector: issuesand evidence from developing countries , pp. 12-20.

Marjit Sugata: -Agro-based Industry and Rural Urban Migration.

Marjit Sugata: -International Trade and Economic Development,Oxford collected essays, Trade & Wage Gap in Developing Countries,

pp. 86-105.

Marjit Sugata: -International Trade and Economic Development,Oxford collected essays, Trade & Wage Inequality in DevelopingCountries, pp. 106-121.

Saikia, Dilip: - Agriculture-Industry Interlinkages: Some Theoretical andMethodological Issues in the Indian Context, pp. 15-23.

Saikia, Dilip: - Trends in Agriculture-Industry Interlinkages in India: Preand Post-Reform Scenario", pp. 12-16.

www.indiastat.com

www.mospi.nic.in

www.rbi.org.in


37/37

37SECTORAL INTERLINKAGE, INCOME DISTRIBUTION AND UNEMPLOYMENT

A PPENDIX:

Relevant data to figure 3 (page-18):

INDIAN IT SECTOR EXPORT TRENDYEAR VALUE( US BILLION $)

1991-92 0.194

1992-93 0.305

1993-94 0.447

1994-95 0.631

1995-96 0.794

1996-97 1.31

1997-98 1.92

1998-99 2.55

1999-00 3.71

2000-01 6.54

2001-02 7.93

2002-03 9.86

2003-04 12.97

2004-05 18.05

2005-06 25.69

2006-07 33.22

2007-08 47.02

2008-09 50.41

sectoral interlinkage in india

Documents