Mahalanobis model
Encyclopedia
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.
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.
, 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.
In the model the growth rate is given by both the share of investment in the capital goods sector, λk, and the share of investment in the consumer goods sector, λc. If we choose to increase the value of λk to be larger than λc, 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.
. 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.
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.
Development economics
Development Economics is a branch of economics which deals with economic aspects of the development process in low-income countries. Its focus is not only on methods of promoting economic growth and structural change but also on improving the potential for the mass of the population, for example,...
, created by Indian statistician
Statistician
A statistician is someone who works with theoretical or applied statistics. The profession exists in both the private and public sectors. The core of that work is to measure, interpret, and describe the world and human activity patterns within it...
Prasanta Chandra Mahalanobis
Prasanta Chandra Mahalanobis
Prasanta Chandra Mahalanobis FRS was an Indian scientist and applied statistician. He is best remembered for the Mahalanobis distance, a statistical measure. He made pioneering studies in anthropometry in India...
in 1953. Mahalanobis became essentially the key economist of India
India
India , officially the Republic of India , is a country in South Asia. It is the seventh-largest country by geographical area, the second-most populous country with over 1.2 billion people, and the most populous democracy in the world...
's Second Five Year Plan
Five-Year Plans of India
The economy of India is based in part on planning through its five-year plans, which are developed, executed and monitored by the Planning Commission. The tenth plan completed its term in March 2007 and the eleventh plan is currently underway...
, 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 investmentInvestment
Investment has different meanings in finance and economics. Finance investment is putting money into something with the expectation of gain, that upon thorough analysis, has a high degree of security for the principal amount, as well as security of return, within an expected period of time...
towards building up a domestic
Domestic policy
Domestic policy, also known as public policy, presents decisions, laws, and programs made by the government which are directly related to all issues and activity within the country....
consumption goods sector. Thus the strategy
Strategy
Strategy, a word of military origin, refers to a plan of action designed to achieve a particular goal. In military usage strategy is distinct from tactics, which are concerned with the conduct of an engagement, while strategy is concerned with how different engagements are linked...
suggests in order to reach a high standard in consumption, investment in building a capacity
Capacity utilization
Capacity utilization is a concept in economics and managerial accounting which refers to the extent to which an enterprise or a nation actually uses its installed productive capacity...
in the production
Production, costs, and pricing
The following outline is provided as an overview of and topical guide to industrial organization:Industrial organization – describes the behavior of firms in the marketplace with regard to production, pricing, employment and other decisions...
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
Karl Marx
Karl Heinrich Marx was a German philosopher, economist, sociologist, historian, journalist, and revolutionary socialist. His ideas played a significant role in the development of social science and the socialist political movement...
ideas in Das Kapital
Das Kapital
Das Kapital, Kritik der politischen Ökonomie , by Karl Marx, is a critical analysis of capitalism as political economy, meant to reveal the economic laws of the capitalist mode of production, and how it was the precursor of the socialist mode of production.- Themes :In Capital: Critique of...
, 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
Gosplan
Gosplan or State Planning Committee was the committee responsible for economic planning in the Soviet Union. The word "Gosplan" is an abbreviation for Gosudarstvenniy Komitet po Planirovaniyu...
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 NehruJawaharlal Nehru
Jawaharlal Nehru , often referred to with the epithet of Panditji, was an Indian statesman who became the first Prime Minister of independent India and became noted for his “neutralist” policies in foreign affairs. He was also one of the principal leaders of India’s independence movement in the...
, 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 economyAutarkyAutarky is the quality of being self-sufficient. Usually the term is applied to political states or their economic policies. Autarky exists whenever an entity can survive or continue its activities without external assistance. Autarky is not necessarily economic. For example, a military autarky...
. - The economyEconomyAn economy consists of the economic system of a country or other area; the labor, capital and land resources; and the manufacturing, trade, distribution, and consumption of goods and services of that area...
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, λk, and the share of investment in the consumer goods sector, λc. If we choose to increase the value of λk to be larger than λc, 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 sectorAgriculture
Agriculture is the cultivation of animals, plants, fungi and other life forms for food, fiber, and other products used to sustain life. Agriculture was the key implement in the rise of sedentary human civilization, whereby farming of domesticated species created food surpluses that nurtured the...
. 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 supplyMoney supply
In economics, the money supply or money stock, is the total amount of money available in an economy at a specific time. There are several ways to define "money," but standard measures usually include currency in circulation and demand deposits .Money supply data are recorded and published, usually...
and growing inflation
Inflation
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...
. The biggest problem was the fall in the foreign exchange reserve due to liberalised import
Import
The term import is derived from the conceptual meaning as to bring in the goods and services into the port of a country. The buyer of such goods and services is referred to an "importer" who is based in the country of import whereas the overseas based seller is referred to as an "exporter". Thus...
policy
Policy
A policy is typically described as a principle or rule to guide decisions and achieve rational outcome. The term is not normally used to denote what is actually done, this is normally referred to as either procedure or protocol...
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 growthEconomic growthIn economics, economic growth is defined as the increasing capacity of the economy to satisfy the wants of goods and services of the members of society. Economic growth is enabled by increases in productivity, which lowers the inputs for a given amount of output. Lowered costs increase demand...
- Development economicsDevelopment economicsDevelopment Economics is a branch of economics which deals with economic aspects of the development process in low-income countries. Its focus is not only on methods of promoting economic growth and structural change but also on improving the potential for the mass of the population, for example,...
- Mahalanobis
- Indian Economy
- Five-year plans of IndiaFive-Year Plans of IndiaThe economy of India is based in part on planning through its five-year plans, which are developed, executed and monitored by the Planning Commission. The tenth plan completed its term in March 2007 and the eleventh plan is currently underway...