What is driving the economic boom?

It is the result of the corporate sector's increasing savings and investment, enabled by higher profits which, in turn, are facilitated by government policies.

THERE is no question about it - the Indian economy is in the midst of a boom. According to the Central Statistical Organisation's (CSO) national accounts statistics, between 1999-2000 and 2006-07, the gross domestic product (GDP) in constant prices increased at an average annual rate of nearly 7 per cent. And for the past three years, the economy has been growing at 8 per cent.

This growth is clearly driven by higher investment since investment rates in the economy also appeared to have gone up in this period. This phase really begins from 2002. Until then both savings and investment rates were not on a clear upward trend - indeed, they fluctuated around levels broadly similar to those of most of the 1990s.

But even so, for several years domestic savings rates were higher than domestic investment rates, indicating excess savings that were not finding adequate outlet in investment within the economy. So the bullish animal spirits of entrepreneurs were clearly not so strong as to lead to even higher investment rates that w ere easily feasible given the rising domestic savings. It is only in the very recent past that domestic investment has been higher than domestic savings.

So why did savings increase? The story now is rather different from that of the 1990s when the moderate rise in savings rates was led by household savings in physical assets. Since the turn of the decade, the increase in savings rates has been driven by a reduction in the net dissaving of the government (even excluding public sector enterprises) and significant increases in private corporate savings as a percentage of the GDP.

This very large increase in private corporate savings - a doubling of the rate in around five years - reflects a dramatic increase in corporate profits, which is clear from various data sources. The private corporate sector unquestionably has been the chief beneficiary of the economic boom.

But there is another component of savings that has not been doing so well. Household savings in physical assets covers not only house construction and other building up of physical assets by households but also real investment in agriculture as well as by the small-scale sector in industry and services, which is not part of the private corporate sector. This measure of savings can, therefore, be a useful indicator of investment by the numerical bulk of small enterprises (which also happen to employ the bulk of the work force in the country).

This has actually been declining as a share of the GDP in the recent past. Since a real estate and construction boom has occurred over this period, the decline is unlikely to have been in this area. Rather, this suggests that real investment by agriculturalists and small enterprises has come down as a share of the GDP despite the apparent macroeconomic boom. And this conclusion is confirmed by the evidence on investment by households, which has also come down as a share of total investment.

It is often argued - even by important policymakers and government leaders - that external capital is essential to allow the Indian economy to grow and that therefore it is critical to undertake various measures to encourage the flow of more foreign direct investment (FDI) and portfolio investment into the economy. Yet, net capital flows have been negative for a significant part of the recent period of high aggregate growth. Indeed, they were negative and falling when domestic investment rates were increasing quite sharply.

Only since 2004 have net capital inflows been positive, though they still form a negligible proportion of the investment and certainly a minuscule proportion of the GDP at 1.3 per cent. So they cannot be said to have added significantly to the economic boom since their contribution to total investible resources has been either negative or marginal.

These conclusions are reinforced by an examination of the components of investment. Investment by households (which includes, as mentioned above, all non-corporate investment in agriculture as well as investment by non-corporate small units in industry and services) increased as a proportion of the GDP between 1999 and 2002 but it has been declining subsequently. In fact, in 2005-06 it was actually overtaken in importance by investment of the private corporate sector, which has increased sharply from the same period and now amounts to around 13 per cent of the GDP.

Public sector investment has remained broadly stable as a proportion of the GDP. The relatively new term "valuables" is an attempt to capture the holding of gold and other precious stones and metals. It is a moot point whether this should be included in investment since it is not real productive investment as much as a form of hoarding. Of course, its share of total domestic investment remained small even in 2005-06, at less than 4 per cent. But its share has been increasing from less than 1 per cent two years earlier, and would, therefore, have contributed to the overall increase in aggregate investment rates, even if its actual role is notional.

What all this suggests is that the recent boom has been driven by the private corporate sector's increasing savings and investment, which in turn has been enabled by increasing corporate profits. This increase in corporate profitability, in turn, is not a sui generis phenomenon, arising simply out of the growth process itself. Rather, it is dominantly the outcome of government policies, in particular the combination of the low interest rates and numerous tax concessions and implicit subsidies that have significantly increased retained profits.

According to the national accounts data, the share of the operating surplus of companies (which incidentally includes both private and public enterprises) has increased from around 12 per cent at the start of the decade to nearly 16 per cent in 2004-05, which is a remarkable increase of around 30 per cent in a short time. At the same time, the share of employees' compensation has come down marginally. This includes both workers' wages, which have come down quite sharply, and remuneration of salaried employees, which has gone up.

Meanwhile, the category "mixed income" shows a declining trend in income share, and over the period in question, the share fell by around 8 per cent. This is significant because this includes all the self-employed, who have been growing as a proportion of the employed and who now account for half the workforce in India, according to the latest large National Sample Survey (NSS). So, even while the share of the population dependent upon "mixed income" has increased, the share of income received by this group has fallen.

So this is a profit-led boom, driven by increasing inequality not only between workers and capitalists but also between different categories of producers. The private corporate sector is the greatest beneficiary and now also the greatest contributor to the boom. But the non-corporate producers and small and tiny establishments, as well as petty self-employed producers of goods and services, are clearly not gaining in relative terms, and in some cases may be worse off absolutely.

This allows us to relate the macroeconomic and national accounts data to the evidence from the employment surveys of falling shares and worsening conditions of wage employment over this period. It also allows us to understand why the theme of "two Indias" is unfortunately so persistent and so plausible, at least in economic terms.