India Transformed

by Rakesh Mohan

  Nevertheless, any attempt to reform the labor laws and do no more than restore the status quo ante to pre-1980, is automatically characterized as anti-labor, damned as part of a larger ‘neo-liberal’ scheme, and opposed by the large trade unions that draw their membership mainly from the existing organized sector. No reformist government has had the courage to break this particular egg to make the desired omelette, i.e., rapid growth of productive employment. All of them have been happy to step gingerly around the issue or, as in the case of the Modi government, to pass the buck to state governments, most of which (to no one’s surprise) have focused on other matters.

  Politicians’ Compulsions

  Meanwhile, the political class has its own concerns. Elections cost money, many million rupees to contest a state legislature seat, and hundreds of millions for some parliamentary seats; a typical parliamentary constituency has 1.4 million voters. Almost all of the cash used to fight an election is unaccounted money, contributed either by the political party or garnered by the candidate. The money has to come from somewhere, either extracted from businessmen who pay for favours from the government, or siphoned off in cash from government-spending programmes. That is one reason why about half the grain supplied by the government at subsidized rates does not reach its intended beneficiaries (the poor); why in public-sector oil-marketing companies the adulteration of diesel with lower-priced kerosene is an organized racket; why billions of rupees spent on irrigation projects create no additional irrigation capacity, as corrupt contractors first bribe ministers and then cheat on the work to be done; and why government-owned banks have financed highway projects at (on average) twice the cost assessed by the National Highway Authority of India. Business favours can take many forms: of getting government-owned electricity-generating units to back down so that the power-distribution companies have to turn to higher-priced power that is privately generated; of high tariffs imposed on steel imports so that domestic producers improve profit margins; of radio spectrum sold well below the market price to favoured mobile telephone companies; of government-owned airlines vacating profitable flight routes and time slots, which are quickly allotted to private airlines.

  These are not deals and scandals carefully hidden in cupboards, along with other skeletons; indeed, they are the stuff of political allegations hurled across the floor in Parliament and state legislatures, and of committee reports and inquiry findings. Much of it, therefore, is common knowledge. The colour of political money taints government decisions, puffs up project costs and leads to suboptimal outcomes in every conceivable way. Political money is the canker that infects much of government functioning. It comes in the way of decisions to reduce the role of government, to privatize, to remove counterproductive controls and expand the role of markets, i.e., the very stuff of reforms.

  Naturally, politics is only nominally about ideology or maximizing welfare. While Indian politics has retained the formal structures of Westminster democracy, its substance harks back increasingly to older, more indigenous, traditions and practices. Other than the Bharatiya Janata Party, which is Hindu revivalist, and the communist parties, which are programme-driven, every other party in India’s multihued political spectrum has become the extension of a single politician or political family—starting, of course, with the Congress. Even parties that started out with clear ideologies, such as the socialists, and those that represented subnational identities have tended to become dominated by single families. This is feudalism in Westminster raiment, with some leading political families counting in their fold parliamentarians and state legislators who are into the third or fourth generation—the Congress’s Nehru–Gandhis, the Thackerays of the Shiv Sena, the Dravida Munnetra Kazhagam’s (DMK’s) Karunanidhi–Maran clan, the Scindias and others. Some political dynasties have emerged in surprisingly little time with billions of rupees in private wealth (such as Jaganmohan Reddy, son of a former Congress chief minister). Many politicians have diversified their activities and become wealthy businessmen in their own right—nascent Indian oligarchs, if you will, since their political clout is useful for business. Some, such as the Marans and the aforementioned Jaganmohan Reddy, have become media barons too. Indeed, individual parliamentarians have declared assets that outdo the entire British Cabinet. It is impossible to understand the political economy of India’s reforms, its limited scope and ambitions, without first understanding the reality of Indian party politics, the dynasties at its heart, and how the feudals have made the state their handmaiden. India’s politicians make sure that they extract their pound of flesh from the economy.

  Broad Support for Shallow Reform

  This political feudalism is mated to a modern sector of the economy and a growing middle class that apply counter-pressure points. Industry and trade have to function, and some semblance of law and order has to be maintained. The English-language media, including business publications, call for more market-oriented reforms, while the cleaner elements in the business world look for an end to corruption and cronyism. Civil-society organizations work at the grass roots to expose malfeasance and misfeasance, and the courts are independent. At the same time, urbanization reduces the role of caste- and community-oriented identity politics, because city dwellers tend to be more interested in issues such as clean air and proper water supply and, therefore, are less likely to simply vote according to their caste or community markers. The result of the interplay of these different forces is the stop-go, piecemeal, partial reform that India has seen since 1991.

  Where reform has been more comprehensive, it is because even though the changes faced resistance in political circles where old ways of thinking persisted, such resistance had no political resonance with voters. The sweeping industrial reforms of 1991 that ended most of the curbs on investment were welcomed in the circles that were affected because it had become increasingly obvious that the old controls were counterproductive. Slow change had begun a few years earlier, building up to the comprehensive delicensing of 1991 that became possible in an atmosphere of crisis management. Similarly, the steady dropping of income-tax rates was popular among taxpayers, even as the progressive reform of the indirect tax system (fewer tax rates, then a shift to value-added taxation) made life easier for businesses across the board.

  It is not that there was no resistance to change—many in the ruling Congress party were critical of the deviations from past orthodoxies. But the fact that there was no broader political resistance to the changes became evident when, in the 1996 elections, the reforms did not figure as an issue; they had not yet touched the lives of enough people. Even eight years later, in 2004, when the ruling BJP campaigned on the basis of a ‘Shining India’, it was rejected by voters who found the rival Congress focus on the ‘aam aadmi’ (common man) more convincing. The benefits of reforms were still to percolate deep enough to win votes.

  In economic terms, though, the freeing up of the private sector laid the foundation for faster economic growth. Private corporate profits as a share of GDP doubled to 8 per cent between the 1990s and the first decade of the new century. As a consequence, the ratio of fixed-capital formation to GDP surged from a range-bound 20–23 per cent of GDP in the 1980s and 1990s, to more than 30 per cent in the new century, taking up with it the rate of economic growth.

  Still, the reforms have remained partial, influenced to varying degrees by the existence of different interest groups, leading to the wisecrack that India has a ‘broad consensus for shallow reform’. Domestic businesses do not want a completely open economy that allows unbridled competition from foreign players, and this is one reason why average tariff levels, though much lower than before, remain higher than in most other countries. Upper-caste and middle-class interests speak to greater investment in university rather than government-school education; neglect of the latter affects mostly the poor, since wealthier parents turn to private schools. Organized labor, occupying high-wage islands, does not want the reform of labor laws that will take away some of their protect
ions and privileges. And landed interests want a continuation of the inefficiencies that reside in the electricity and fertilizer subsidies, and state-guaranteed procurement of grain, since they are the primary beneficiaries of the largesse. In poorly administered cities, public transport suffers from relative neglect, while the small minority that commutes in cars occupies the bulk of available road space.

  There remains, even now, plenty of scope for reforms that don’t need to break the egg. Technology presents one set of options: the digitization of land records gives citizens access to them without the mediation of officials who hold out greasy palms; a biometric identity system makes it possible to replace clumsy subsidy programmes with better-targeted cash transfers. The scope for reforms also expands with the proliferation of success stories: no one would have failed to notice how much better the new private airports are than their government-run predecessors, with the ones in Delhi and Mumbai routinely featuring in the lists of the best-run airports around the world. A similar reform may now be attempted at the country’s major railway stations, a more demanding task since these are used by millions every day.

  Then, new institutions of governance are being created, such as the Competition Commission, autonomous regulators who set the rules for different business sectors (such as telecom or insurance), and the National Stock Exchange that has displaced the older, broker-dominated Bombay Stock Exchange, which reformed in the face of competitive pressure. Tax policies have been streamlined and modernized; while change is not complete, the system is unrecognizable from what existed in 1991—as is financial-sector regulation. The greater role played by overseas investors, portfolio as well as direct investment, has created its own pressure points for better governance, including in the corporate sector. The growing roles of international arbitration and of bilateral investment treaties have acted as restraints on arbitrary authority; notable exceptions tend to hit the headlines and create their own pressures.

  Good, but Not Good Enough

  In a way, all this explains the nature, scope and limitations of India’s quarter-century record of incremental reforms. They have seemed slow and inadequate at any particular point of time, but in their totality, they have had a significant cumulative impact. As is said, a photograph of India taken at any moment in time shows a messy picture; but over time, a moving picture shows how much has changed. The lowest-hanging fruit were plucked in 1991–93, but there has been a real, though unspectacular, broadening and deepening of reforms since then: the generation of greater surpluses leading to the slow cranking up of investment in (among other things) physical infrastructure; the steady improvement in health indicators; the expansion of the social-safety net through the employment-guarantee programme and government-provided medical insurance; and the sharp increase in enrolment rates for higher education. All this and more has led to the higher economic growth rates of the last couple of decades, with an annual average of 7 per cent since 1994.

  While creditable, this is short of the 8–10 per cent that was achieved in the rapid-growth phases of East Asian countries such as Japan, South Korea, Taiwan and China, and points to what a less incomplete reform might have achieved by now. If the growth rate had averaged 9 per cent over twenty years, per capita income would have been 45 per cent higher, with a consequential improvement in the employment situation, a sharp reduction in the numbers of the poor and better human-development indicators.

  The truth, therefore, is that the pace of reform has not been fast enough. India’s fundamental challenges are to create the millions of jobs each year that will keep its burgeoning population of working-age youngsters productively engaged, and to hold out for them the promise of a better future. These call for a still higher rate of economic growth, a much better quality of governance, a rapid end to extreme poverty, political decisiveness and a readiness for change that in their entirety are unlikely to materialize in the given circumstances of the country’s political economy. The multiple realities of its political economy mean that India’s reformers will continue to wrestle with the art of the possible, in an environment of suboptimality, even as it probably continues for the foreseeable future to be the world’s fastest-growing large economy.

  5

  India’s Entry into the Global Economy1

  Martin Wolf

  ‘Just as the world accommodated the rejuvenation of Europe in the post-War world, it must now accommodate the rise of new Asian economies in the years that lie ahead.’

  —Manmohan Singh, December 2006.2

  India has re-entered the world economy. The foreign-currency crisis in 1991 created an opportunity for a transformation in India’s economic engagement with the world. By that time, many policymakers had realized that such a transformation was imperative. Nevertheless, someone had to bring it about. Those heroes were Narasimha Rao, the prime minister, and Manmohan Singh, his finance minister. These men launched reforms that began a transformation not only of economic policy, but, more important, of the policy consensus. Since then, India has moved, without reversals, from the plan to the market and from shrinking from the world economy towards embracing it.

  Twenty-five years later, what has changed in India’s role in the world economy? How far has it liberalized its barriers to trade and capital flows? Has the liberalization been a success? Finally, how should India approach the challenges likely to be posed by the world economy to itself—and by it to the world economy—over the next quarter of a century? These are the questions addressed below. India has indeed entered the world economy. Its own economy has also become far more open than ever before. But the challenges it confronts in the international economy are sure to increase, particularly if, as one hopes, its economic growth exceeds those of most other economies. This will be particularly true if many other countries become increasingly protectionist, as seems likely, particularly after the election of Donald Trump as president of the US. Increasingly, India will have to play a leading role in shaping the global economy and economic system.

  A View from the 1970s

  In 1982, The World Bank published my first book, India’s Exports.3 This was the delayed and much-revised product of the work carried out while I served as the senior economist in the Bank’s India Division from the autumn of 1974 to the summer of 1977. At that time, I focused my attention on India’s trade policies. Even considering liberalization of capital flows would have seemed a waste of time. Moreover, the Bank had a long-standing concern over the impact of India’s trade policy on the country’s rate of growth and pattern of development. The oil shock of late 1974 had brought these long-term concerns into sharper focus, since it created an immediate crisis in the balance of payments. Yet the long-term failures of the Indian economy were a still-greater anxiety. India’s decision to pursue an inward-looking development path since Independence had proved costly. The symptoms were inadequate growth and chronic shortages of foreign currency, even during good times. The crisis of the mid-1970s merely re-emphasized these failings.

  The seminal work of Jagdish Bhagwati and Padma Desai, published in 1970, had made clear to open-minded readers how necessary a decisive change in policy had become.4 My modest study was rather in the tradition of another seminal work, an analysis of Indian export performance by Manmohan Singh, subsequently finance minister and prime minister, published in the early 1960s.5 That study had marked the first important attempt to challenge export pessimism, which had ruled policymaking in the early years after Independence. The picture of India I was able to draw was of a country that had withdrawn still further to the margins of the world economy. ‘Thus, in the 1950s’, I noted, ‘India had been the foremost exporter of manufactures among the developing countries. By the middle of the 1960s it was second, by 1970 it was third, and by 1978 seventh. In 1978 the Republic of Korea’s manufactured exports exceeded India’s by 200 per cent.’6 Largely, as a result of this weakness in exports of manufactures, India’s share in world exports had fallen from 2.4 per cent in 1948 to a mere 0.4 per ce
nt in 1979. In 1955, India’s manufacturing sector had been the eighth-largest among all market economies and much the largest among developing countries, with the exception of China. By 1976, its global rank had slipped to fifteenth. By creeping to the margins of the world economy, India had failed to take advantage of the great opportunity to accelerate industrialization through the promotion of exports of labor-intensive manufactures.

  When one raised the costs of this glaring failure with Indian policy intellectuals and policymakers in the mid-1970s, one was told that the progress of South Korea or Taiwan had no implications for such a vast country. Subsequently, China’s sensational rise as an exporter of manufactures destroyed such complacency. So, too, did the collapse of the Soviet Union. By the early 1990s, the inward-looking and notionally planned economy that India had created had become intellectually indefensible. Attachment to an inefficient development model had deprived the country of decades of lost growth. Every cloud has a silver lining: the crisis of 1991—a great shock at the time—was to mark a decisive and welcome change. Policy was transformed: India re-entered the world economy it had left decades before.

  India Joins the World Economy

  So, what has happened? Let us distinguish trade from movements of capital and labor, with the first being the most important.