Mahalanobis model

The Mahalanobis model is a model of economic development, created by Indian statistician Prasanta Chandra Mahalanobis in 1953. Mahalanobis became essentially the key economist of India's Second Five Year Plan, becoming subject to much of India's most dramatic economic debates.

The Feldman–Mahalanobis model

The essence of the model is a shift in the pattern of industrial investment towards building up a domestic consumption goods sector. Thus the strategy suggests in order to reach a high standard in consumption, investment in building a capacity in the production of capital goods is firstly needed. A high enough capacity in the capital goods sector in the long-run expands the capacity in the production of consumer goods. The distinction between the two different types of goods was a clearer formulation of Marx’s ideas in Das Kapital, and also helped people to better understand the extent of the trade off between the levels of immediate and future consumption. These ideas were however first introduced in 1928 by G.A. Feldman, a Soviet economist working for the GOSPLAN planning commission; presenting theoretical arguments of a two-department scheme of growth. There is no evidence that Mahalanobis knew of Feldman’s approach, being kept behind the borders of the USSR. Due to the similarity of the two theories, the model is often referred to as the Feldman-Mahalanobis model.

Implementation of the model

The model was created as an analytical framework for India’s Second Five Year Plan in 1955 by appointment of Prime Minister Jawaharlal Nehru, as India felt there was a need to introduce a formal plan model after the First Five Year Plan (1951-1956). The First Five Year Plan stressed investment for capital accumulation in the spirit of the one-sector Harrod–Domar model. It argued that production required capital and that capital can be accumulated through investment; the faster one accumulates, the higher the growth rate will be. The most fundamental criticisms came from Mahalanobis, who himself was working with a variant of it in 1951 and 1952. The criticisms were mostly around the model’s inability to cope with the real constraints of the economy; it’s ignoring of the fundamental choice problems of planning over time; and the lack of connection between the model and the actual selection of projects for governmental expenditure. Subsequently Mahalanobis introduced his celebrated two-sector model, which he later expanded into a four-sector version.

Assumptions

The assumptions under which the Mahalanobis model holds true are as follow:

• We assume a closed economy.
• The economy consists of two sectors: consumption goods sector C and capital goods sector K.
• Capital goods are non-shiftable.
• Full capacity production.
• Investment is determined by supply of capital goods.
• No changes in prices.
• Capital is the only scarce factor.
• Production of capital goods is independent of the production of consumer goods.

Basics of the model

The full capacity output equation is as follows:

In the model the growth rate is given by both the share of investment in the capital goods sector, λ_k, and the share of investment in the consumer goods sector, λ_c. If we choose to increase the value of λ_k to be larger than λ_c, this will initially result in a slower growth in the short-run, but in the long run will exceed the former growth rate choice with a higher growth rate and an ultimately higher level of consumption. In other words, if this method is used, only in the long run will investment into capital goods produce consumer goods, resulting in no short run gains.

Criticisms

One of the most common criticisms of the model is that Mahalanobis pays hardly any attention to the savings constraint, which he assumes comes from the industrial sector. Developing countries however do not have this tendency, as the first stages of saving usually come from the agricultural sector. He also does not mention taxation, an important potential source of capital. A more serious criticism is the limitation of the assumptions under which this model holds, an example being the limitation of foreign trade. This cannot be justifiable to developing countries today. Also another criticism is that a country to use this model would have to be large enough to contain all the raw resources needed to be sustainable, so therefore this would not apply to smaller countries.

Empirical case

Essentially the model was put into practice in 1956 as the theoretical pathway of India's Second Five Year Plan. However after two years the first problems started to emerge. Problems such as unexpected and unavoidable costs contributed to increased money supply and growing inflation. The biggest problem was the fall in the foreign exchange reserve due to liberalised import policy and international tension, leading to modifications in the Second Plan in 1958. It was finally abandoned and replaced by the Third Five Year Plan in 1961.

See also

• Harrod–Domar model
• Economic growth
• Development economics
• Mahalanobis
• Indian Economy
• Five-year plans of India

References

1. Bhagwati, J. and Chakravarty, S. (1969). Contributions to Indian Economic Analysis, American Economic Review, vol. 59: pp.1-73.

2. Dasgupta, A.K. (1993). A History of Indian Economic Thought. United Kingdom: Routledge.

3. Kumar, B. (1962). An Introduction to Planning in India. India: Bookland Private Limited, pp.1-45, 80-145.