Planning for the capital goods sector
In an economy that cannot count on importing machines, the long-run growth rate is set by how much of today's investment goes into making machines rather than consumer goods, so the plan should hold consumption down and build heavy industry first.
P. C. Mahalanobis, Jawaharlal Nehru · Credits and sources ↓
What it says
Mahalanobis asked a question the growth models of the time were not asking. Not how much a country invests, but what the investment is made of. Divide output into two departments: one that makes capital goods, meaning machines that make other things, and one that makes consumer goods. Now choose how to split this year's investment between them.
Put more into the consumer goods department and people are better off sooner. Put more into the capital goods department and the country's capacity to build capacity grows, so every later year's investment is larger. The share going to capital goods, which the model calls lambda-k, therefore sets the long-run growth rate, and raising it means accepting lower consumption now for a higher path later.
The whole argument depends on one assumption, and Mahalanobis was explicit about it: machines cannot simply be bought abroad. If they could, a country would export what it is good at and import capital goods, and the composition of domestic investment would not matter. India assumed foreign exchange was the binding constraint, and given the export outlook of the 1950s and the Prebisch finding then circulating, that was not an unreasonable thing to assume.
The Second Five Year Plan of 1956 to 1961 is the model turned into policy, and the Industrial Policy Resolution of 1956 is its legal form: seventeen industries reserved to the state, twelve more that the state would progressively enter, and the rest left to private firms under licence.
Drawn one step at a time
The theory as a graph, revealed a layer at a time. Use the buttons, or the left and right arrow keys. Each step adds the boxes that step introduces and the arrows into them.
- Starting condition
- Mechanism
- Outcome or policy
Four placements, and the reason for each
The four scores are editorial. They run from -3 to +3, they were assigned by the ImpactMojo editorial team from the theory's own texts, and each theory page shows the sentence that justifies its placement so the placement can be argued with. They are a way of arranging a shelf, not a measurement.
The allocation between departments is the decision the model exists to make, and a market cannot make it, because the payoff is decades away and appears in nobody's price signal.
Grow first, and be honest that it means consuming less now. The redistribution was meant to arrive through employment in the new sector, which is the part that failed.
Caste appears in the Plan documents as a welfare category and not as an economic mechanism. Who would own the private half, or be hired into the public half, was not asked.
As far towards the expert end as the shelf goes. The instrument is a Planning Commission staffed by statisticians and answerable to the Prime Minister.
The theory against the record
Each entry takes one claim the theory makes and reports what the evidence says about it, with a named source and a year. This section is the reason the library exists; a catalogue of positions without it is a reading list.
The claim Heavy industry can be built by a poor state.
It was. India acquired an integrated steel industry, heavy electrical and machine tool capacity, atomic and space programmes, and the trained engineering workforce to run them, starting from close to nothing in 1947. Whatever else is disputed, this part of the plan did what it said.
Second and Third Five Year Plan reviews, Planning Commission · 1966
The claim Employment would be absorbed by the sectors the new capital equipped.
It was not. Organised sector employment stayed a small fraction of the workforce throughout the plan decades, and the growth that did occur came disproportionately from government rather than from manufacturing. Capital-intensive heavy industry generated output without generating jobs, and the small industry that was supposed to absorb labour was protected by reservation rather than equipped by it.
Directorate General of Employment and Training organised sector series · 1980
The claim Capital goods, not wage goods, were the binding constraint.
C. N. Vakil and P. R. Brahmananda argued at the time that this was the wrong constraint, and that the shortage that would actually stop the plan was food and other wage goods, since workers put to building steel plants have to eat while they build them. The food crisis of 1965 to 1967, the PL-480 imports and the shift of policy towards agriculture that produced the green revolution are the strongest evidence for their side of the argument.
C. N. Vakil and P. R. Brahmananda, Planning for an Expanding Economy · 1956
The claim Foreign exchange would cease to be the binding constraint.
The opposite. Building the capital goods sector required importing capital goods to build it with, so the plan raised the import bill in the short run while doing little for exports. Balance of payments crises followed in 1957–58, in 1966 with a devaluation, and finally in 1991.
Reserve Bank of India balance of payments series · 1991
What this does not settle
Whether the industrial base was worth what it cost cannot be settled by comparing India with Korea, because Korea's state did something different rather than less: it also directed credit and picked sectors, but disciplined the firms it favoured by making support conditional on exports, which supplied a performance test that Indian licensing never had. The live question is not planning against markets but whether a plan can contain a mechanism for withdrawing support from failure. India's did not, and the licensing system outlived the argument that justified it by about twenty years.
How it landed here
This is the Indian theory on the shelf, and it governed the country for three decades and a half. The most useful thing about reading it now is that the assumption it announced at the start, that machines could not be bought, was a factual claim about the world and not an ideological commitment. When it stopped being true the model had no defence left, which is why 1991 arrived as a rupture rather than an argument.
One that agrees, one that does not
Dependency and unequal exchange
The same diagnosis reached independently. If the terms of trade will not hold, exporting commodities to buy machines is a losing strategy, so make the machines.
Stabilise, liberalise, privatise
Point-for-point reversal, and the same country carried it out. Licensing, public ownership and import controls are the three things the 1991 reforms dismantled.
Whose theory this is
P. C. Mahalanobis 1893–1972
Physicist turned statistician, founder of the Indian Statistical Institute and of the sample survey as an instrument of Indian government. The model was written by someone whose first instinct was to measure.
Jawaharlal Nehru 1889–1964
Supplied the politics the model needed: a state willing to own the commanding heights and a public that would wait.
What ImpactMojo added
The causal diagram, the four placements and the notes justifying them, and the evidence section: what each claim predicted and what the record shows, with a named source and year for every entry.
ImpactMojo · content CC BY-NC-ND 4.0 · code MIT
Start with these
- P. C. Mahalanobis, The Approach of Operational Research to Planning in India (1955). Sankhya. The two-sector and four-sector models, in the author's own words.
- Planning Commission, Second Five Year Plan (1956). Chapter 2 on the approach. Notably frank about the consumption it was asking for.
- C. N. Vakil and P. R. Brahmananda, Planning for an Expanding Economy (1956). The wage goods counter-model, published the same year and largely ignored at the time.
Open access, in Development Discourses:
- Misallocation and Manufacturing TFP in China and India — Chang-Tai Hsieh, Peter J. Klenow (2009)