During the First Five Year Plan (FYP-1) period, the Planning Commission began groundwork for the Second Five Year Plan (FYP-2). A series of studies under the guidance of Prof. P.C. Mahalanobis involved Indian and foreign economists and statisticians. These studies contributed to the writing of the Mahalanobis Plan Frame, which was regarded as the most radical plan outside Communist countries and became the foundation of FYP-2 and all future long-term planning.
The strategy aimed at building a self-sufficient economy.
Though adapted from the Feldman model of the 1920s rather than an original creation, the Mahalanobis model introduced the tradition of using theoretical models for practical policy planning—his key contribution was applying relevant knowledge into action.
Mahalanobis divided the economy into two sectors:
Capital goods production sector
Consumption goods production sector
The key policy decision concerned the share of total investment allocated to each sector.
The model assumes that the Incremental Capital Output Ratio (ICOR) is technologically determined for each sector, extending the Harrod-Domar model to two sectors. Growth in output depends on investment and capital productivity in each sector.
The change in output of the capital goods industry is represented by:
It - It-1 = βk T (It-1 - It-2)
where βk is the ICOR of capital goods sector and T is the share of total investment allocated to it.
Similarly, the consumption goods industry's output change is:
It - It-1 = βc (1 - T) (It-1 - It-2)
where βc is the ICOR of the consumption goods sector.
Current production of capital goods relates back to investment in previous periods through the model's equations. Assuming constant technological and policy coefficients, capital goods output relates to base period investment by:
Ik,t = I0 (1 + βk T)t
Consumption goods output depends on prior capital goods production and investment:
Ic,t = I0 [ (1 + βk T)t-1 + ... ]
The total output can be linked to base period output and investment by summing consumption and capital goods output.
The long-run growth of consumption and Gross National Product (GNP) is dominated by (1 + βk · T). As this term is raised to power t, it becomes the asymptotic growth rate in the long run.
Since β values are technologically fixed, the policy directive is to maximize T, the share of investment in capital goods. Sacrificing current consumption by diverting investment from consumption goods to capital goods lowers short-term consumption but results in a higher long-term stream of consumption goods.
Mahalanobis’ underlying viewpoint is clearly ‘structuralist’. The division between capital goods and consumption goods is rigid. Once capital goods are produced, they define the aggregate investment/output ratio. Given the allocation of new capital goods between these two sectors, future output is mechanically determined by the given Incremental Capital Output Ratio (ICOR).
There is no role for demand flexibility; consumers consume only consumption goods, as capital goods cannot be directly consumed. Thus, output of capital goods determines the savings rate.
International trade is not considered; importing capital goods would disrupt the link between consumption and previous investment allocation decisions. Technological and behavioral flexibility are ruled out, and prices play no role as signals influencing economic decisions.
The basic constraint on development was an acute deficiency of material capital, preventing adoption of more productive technologies.
The speed of capital accumulation was limited by the low capacity to save.
Even if domestic savings capacity rose via fiscal and monetary policy, structural limitations prevented conversion of savings into productive investment.
Agriculture was assumed to experience secular diminishing returns, while industrialization would employ surplus labor more productively in industries benefiting from increasing returns to scale.
Granting primacy to market mechanisms would cause excessive consumption by upper-income groups and under-investment in sectors vital for accelerated economic development.
Though unequal income distribution was undesirable, a sudden transformation of ownership of productive assets was viewed as harmful to maximizing production and savings.
The planners pursued a policy of deliberate industrialisation. Even before theorists like Gunder Frank discussed dependent underdevelopment, India implemented policies to become an independent, metropolitan power.
This strategy assumed the state's predominant influence over economic policy and investment decisions, with private sector investment largely dictated by the plan's requirements. The private enterprise had minimal or no role in formulating economic policies.
Experience showed that reducing poverty effectively required improving efficiency in resource use. This would increase the producer’s surplus, which could be deployed for poverty alleviation.
This led to numerous schemes focused on enhancing capital productivity through improved technology and asset generation, especially benefiting the poor.
To balance this strategy with safeguards against overly centralized decision-making, mass participation in the planning process was encouraged.
It was realised that an increase in GDP growth and a high rate of capital accumulation per decade might not be sufficient to improve the standard of living or meet the consumption needs of the people, nor guarantee economic self-sufficiency in fulfilling diverse demands.
Possibly in response, the strategy shifted to selecting the investment mix based on the demand pattern for final consumption. This approach was reflected in modelling through the use of inter-sectoral consistency models, closely related to Leontief’s input-output models. This strategy was prominent during India’s Fourth Five Year Plan.
By the 1970s, it became clear that the benefits of economic growth had not reached the masses. As a corrective, development strategy shifted towards directly providing necessary consumption benefits to the poor.
In modelling, many new economic and non-economic variables were introduced to identify poverty explicitly and incorporate redistribution strategies within the planning framework. This approach was central to the Fifth Plan.
Incorporation of productivity enhancement alongside redistribution became a key element of plan strategy in more recent plans. To ensure this strategy while avoiding centralized decision-making, mass participation in the planning process was deemed essential.
There was a recognized need to improve the quality of human capital at all levels, extending down to blocks and villages.
The almost exclusive reliance on new investment generation as the sole input for accelerating growth.
Excessive emphasis on self-sufficiency, leading to indiscriminate protection of domestic industries, often at the cost of efficiency and incentives.
Addressing poverty mainly through subsidy-oriented compensatory fiscal measures, which frequently resulted in unproductive employment and underutilized capital.