Ashoka Mody: Inclusive growth: Elusive quest

India's most defining characteristic is its diversity. Other countries are large and populous; many are poorer. But in the complexity of its social arrangements, the variety of its major languages, and the range of ethnicities and religions, India is surely unmatched.

The news from the academic literature is not good: diversity can hurt growth and, more seriously, is a threat to the integrity of a nation. The challenge, then, is to turn diversity into a productive asset.

This challenge has been recognised in India, making inclusive growth the central theme for legitimising economic and social policies.

Ultimately, whether inclusion is used creatively to build a better economy and a stronger nation"or is hijacked through populist measures to weaken the state"is the outcome of a political process, which continues to unfold.

Almost 40 years ago, Professor K N Raj, who recently turned 80, proposed, in a provocative contribution, the analysis of Indian policymaking through the lens of "intermediate regimes."

Intermediate classes are an amorphous set and include small businesses, large and middle peasantry, and the public sector labour force. They are distinguished more by who they are not"big business and the disenfranchised"rather than by who they are.

Politically, inclusion has been promoted through a claim on fiscal resources for the "intermediate" classes. These groups were to have generated economic activity and employment for the larger number of the poor to whom direct assistance was much harder to accomplish.

In practice, they displayed limited leadership, with the important recent exception of the surge in information technology activity.

As such, the continued tension in Indian policymaking has been to achieve a desirable inclusion without succumbing to symbolism and, ultimately, a dysfunctional populism to gain the political backing of those who felt excluded.

One beneficial economic implication of the amorphous Indian politics is an abhorrence of inflation, a contrast, for example, to several Latin American countries where political elites dominated and were able to protect themselves from severe inflationary bouts.

Between 1960 and 2000, the Indian annual inflation rate averaged 7.5 per cent a year, compared to 23.9 per cent in Latin America, and was even modestly lower than East Asian inflation at 8.5 per cent a year.

The lens of an intermediate regime also helps explain the paradox of Indian education policy.

While India fares dismally in an international comparison of average years of schooling, Indian entrepreneurs in the software business are renowned for their technical skills.

Thus, the education system was geared to the middle classes, with a range, in particular, of successful engineering and medical schools. These provided livelihood to children of middle class families, while also putting India on the international hi-tech map.

Primary education languished, Jean Dreze and Amartya Sen argue, not because funds were lacking (budgeted resources often went unused) but because politicians and bureaucrats were under only weak pressure to deliver.

Thomas Weisskopf has concluded that recent efforts to integrate socially disadvantaged groups into the educational system continue to focus on preferential entry into the colleges and universities, attempting to incorporate the now disadvantaged into the middle class and, thereby, maintaining the political framework of the intermediate regime.

The politics of intermediate regimes also helps understand Montek Ahluwalia's observation that there exists "a strong consensus for weak reforms."

The consensus for "weak" reforms (euphemistically, reforms with a "human face") reflects the pressures of populism, using the metaphors of inclusion.

Thus, though reservation for small-scale firms is evidently outdated, only limited progress has been achieved in undoing these boundaries. Well after centrally planned economies of Eastern Europe have dismantled state ownership, "disinvestment" (the polite Indian synonym for privatisation) continues to be contentious.

Debate over the proper role of foreign investment resurfaces in new guises.

But were these outcomes inevitable? Could India have achieved its modest progress towards inclusion and economic stability while also growing more rapidly? The answer depends on whether economic reforms were politically feasible earlier.

The answer is "yes" because the reforms were not antithetical to inclusion. In practice, policies straddled the divide between inclusion and populism rather than between socialism (symbolic of inclusion but often populist in outcome) and "liberalisation" (the coy antonym of socialism).

The divide lay not along the fault line of ideas but in the thicket of petty interest group politics.

In the mid-1960s, India's policy stance could have evolved quite differently than it did.

I G Patel has suggested that the elimination of multiple exchange rates that had proliferated to accommodate various interest groups and greater uniformity in import tariffs were possible"reforms that would have opened up the Indian economy to the discipline of international trade.

When reforms did not occur, it became increasingly more painful to acknowledge that the emperor had no clothes, as Rakesh Mohan and Vandana Aggarwal conclude, and populism became more entrenched. It was only the balance of payments crisis of 1991 that forced recognition of endemic inefficiencies.

In recent years, the scope and composition of the intermediate classes and their influence on state policy have evolved. Whether this new fluidity will be constructively channelled depends on how four long-standing challenges are tackled.

First, creating an effective decentralisation is an ongoing enterprise. The 73rd and 74th amendments to the Constitution, though haltingly implemented, have appropriately decentralised development functions and have, moreover, changed the political landscape.

However, decentralisation brings its own risks of fiscal indiscipline.

Second, education reforms remain elusive. Most hopeful is the increase in demand for primary and secondary education as aspirations rise. However, the scale of needs is so massive that the goal of universal education cannot be fulfilled without active state involvement and investment.

The risks with respect to higher education are equally serious. India's reputation for technical education cannot be maintained by the current infrastructure.

Third, stemming a slide into populism will be helped by the implementation of fiscal rules. India has avoided the debilitating macroeconomic instability that populism generated in other developing nations, but large budget deficits have their own corrosive effects: they suck away private savings from productive private investments.

The passage of the 2003 Fiscal Responsibility and Budget Management (FRBM) Act represents important progress. However, the Vijay Kelkar committee concludes that, at the current pace, the targets will be missed by a wide margin.

Finally, commitment to the forces of globalisation can complement domestic initiatives for inclusive growth. The best results emerge when domestic capabilities interact creatively with foreign competition.

Greater competition increases the likelihood of larger investments in productivity enhancements and also reduces the oppressive hold of domestic hierarchies.

This is a moment of high expectation for India. Indian businesses have shown themselves capable of competing successfully in a high-skill international environment.

The challenge to their growth could come from deficiencies in infrastructure and human capital and from regulatory bottlenecks, which could generate a war of attrition of the type that has stymied Indian business in the past.

If they do succeed and visible inequalities of class and region are the result, will the political process accept that success?

(The author is a former student of Professor K N Raj. He lives and works in Washington D.C. and writes here in his personal capacity)