- Understanding the relationship
between economy, Consumption & Investments
Nowadays NEWSPAPER headlines have been screaming from the roof tops about:-
1) The GDP is slowing down
2) The consumption is dwindling
3) The investment rates are falling
4) The policy paralysis is troubling the economy
All these things do appear– COMPLEX
Is it possible then to SIMPLIFY and understand what these mean and how are they inter-related?
At least we could make an attempt.
To begin with, it is vital to understand that GDP or the ECONOMY stands for the SUM TOTAL OF GOODS AND SERVICES PRODUCED BY THE ECONOMY.
We've felt that by drawing the analogy of a CAR to explain how the ECONOMY would be fairly pertinent route to simplify the explanation.
So let's say the CAR = the ECONOMY
What is it that a CAR loves?
Perhaps the CAR loves good roads which help it produce a smooth uninterrupted drive.
So if CAR=ECONOMY, let's say SMOOTH ROAD = GOOD CONSUMPTION DEMAND.
So Just as a good road gives the car an opportunity to go fast, so also good CONSUMPTION DEMAND would give the ECONOMY the opportunity to grow faster.
But while smooth and good roads are a necessity for a smooth and fast drive, it is not sufficient.
This is because the car also loves FUEL.
So if CAR=ECONOMY, let's say FUEL = INVESTMENT
As long as the CAR has FUEL it can move ahead. Likewise as long as the ECONOMY gets INVESTMENT it can grow and move ahead.
So a CAR needs both FUEL as well as GOOD ROADS for a smooth and fast drive and likewise the ECONOMY too needs both GOOD CONSUMPTION DEMAND as well as INVESTMENTS to grow well and move ahead.
Thus if CAR=ECONOMY; let's say A SMOOTH AND FAST DRIVE = A SMOOTH AND FAST GROWTH OF ECONOMY.
Hope our journey of explaining the complex linkages has been SIMPLE so far.
Now let's see the impediments that can break the car's smooth journey.
Clearly, if we follow the logic that we have established so far,
1) BAD ROADS / TRAFFIC on one hand and
2) FUEL SCARCITY on the other hand
can slow down the progress of the car.
In the same way a FALL IN CONSUMPTION and LACK OF INVESTMENT slows down the economy.
So what does one do to get the car going all over again??
For the car to get going, we will need PEOPLE to PAVE the roads and build INFRASTRUCTURE like FLYOVERS and EXPRESSWAYS
In a sense these are reforms and the PEOPLE responsible for this are the POLICY MAKERS.
In the case of the ECONOMY, we need similar things to be done.
For CONSUMPTION DEMAND to pick up we need REFORMS that help in
1) Creating better products at competitive prices
2) Easier and cheaper credit through lower interest rates so people have easy money to buy
3) Better infrastructure so that goods are made available more efficiently
These are some of the actions among many that would induce CONSUMPTION DEMAND.
For INVESTMENTS to pick up, the government needs to improve the SENTIMENTS of the people from NEGATIVE to POSITIVE.
If people believe that the economy is well poised to grow and the future looks bright, they will be more inclined to take money out of their pockets and invest the same in the economy by way of either
1) Buying shares or
2) Buying debt (Depositing money with banks / companies)
Now the moot question is what will make people believe in the India growth story?
This may happen if the government starts implementing REFORMS and signals to the people that it is determined to remove all the impediments that are slowing the economy so that the economy has a smooth road to drive along.
When people start seeing this happen, they start believing that the economy is back on its rails.
As the sentiments improve based on REAL ACTION OR REFORMS to eliminate hurdles, the positive feeling starts to spread like a contagion.
This encourages other investors including investors from overseas to augment their investments.
This is akin to a good and healthy supply of fuel for the CAR.
So as the roads get paved and highways & bridges get built, the car resumes its journey and gathers speed.
Because the car is moving fast and consuming fuel at a faster rate, the suppliers are encouraged to increase their supply for they believe that a fast moving car would be well poised to pay for the fuel.
Likewise, when the ECONOMY GAINS MOMENTUM, INVESTORS are encouraged to INVEST MORE because they believe that a fast growing economy would be well poised to give healthy returns.
WE HOPE THROUGH THE ANALOGY OF THE CAR WE HAVE BEEN ABLE TO ESTABLISH THE RELATIONSHIP BETWEEN
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