For the past three decades, the Indian economy has grown impressively, at an average annual rate of 6.4 per cent. From 2002 to 2011, when the average rate was 7.7 per cent, India seemed to be closing in on China — unstoppable, and engaged in a second “tryst with destiny,” to borrow Jawaharlal Nehru’s phrase. The economic potential of its vast population, expected to be the world’s largest by the middle of the next decade, appeared to be unleashed as India jettisoned the stifling central planning and economic controls bequeathed it by Nehru and the nation’s other socialist founders.
But India’s self-confidence has been shaken. Growth has slowed to 4.4 per cent a year; the rupee is in free fall, resulting in higher prices for imported goods; and the spectre of a potential crisis, brought on by rising inflation and crippling budget deficits, looms.
To some extent, India has been just another victim of the ebb and flow of global finance, which it embraced too enthusiastically. The threat (or promise) of tighter monetary policies at the Federal Reserve and a resurgent American economy threaten to suck capital, and economic dynamism, out of many emerging-market economies.
But India’s problems have deep and stubborn origins of the country’s own making. The United Progressive Alliance government, which took office in 2004, has made two fundamental errors. First, it assumed that growth was on autopilot and failed to address serious structural problems. Second, flush with revenues, it began major redistribution programmes, neglecting their consequences: higher fiscal and trade deficits.
Structural problems were inherent in India’s unusual model of economic development, which relied on a limited pool of skilled labour rather than an abundant supply of cheap, unskilled, semiliterate labour. This meant that India specialised in call centres, writing software for European companies and providing back-office services for American health insurers and law firms and the like, rather than in a manufacturing model. Other economies that have developed successfully — Taiwan, Singapore, South Korea and China — relied in their early years on manufacturing, which provided more jobs for the poor.
Two decades of double-digit growth in pay for skilled labour have caused wages to rise and have chipped away at India’s competitive advantage. Countries like the Philippines have emerged as attractive alternatives for outsourcing. India’s higher-education system is not generating enough talent to meet the demand for higher skills. Worst of all, India is failing to make full use of the estimated one million low-skilled workers who enter the job market every month.
Manufacturing requires transparent rules and reliable infrastructure. India is deficient in both. High-profile scandals over the allocation of mobile broadband spectrum, coal and land have undermined confidence in the government. If land cannot be easily acquired and coal supplies easily guaranteed, the private sector will shy away from investing in the power grid. Irregular electricity holds back investments in factories.
India’s panoply of regulations, including inflexible labour laws, discourages companies from expanding. As they grow, large Indian businesses prefer to substitute machines for unskilled labour. During China’s three-decade boom (1978-2010), manufacturing accounted for about 34 per cent of China’s economy. In India, this number peaked at 17 per cent in 1995 and is now around 14 per cent.
In fairness, poverty has sharply declined over the last three decades, to about 20 per cent from around 50 per cent. But since the greatest beneficiaries were the highly skilled and talented, the Indian public has demanded that growth be more inclusive. Democratic and competitive politics have compelled politicians to address this challenge, and revenues from buoyant growth provided the means to do so.
Thus, India provided guarantees of rural employment and kept up subsidies for food, power, fuel and fertiliser. The subsidies consume as much as 2.7 per cent of gross domestic product, but corruption and inefficient administration have meant that the most needy often don’t reap the benefits.
Meanwhile, rural subsidies have pushed up wages, contributing to double-digit inflation. India's fiscal deficit amounts to about 9 per cent of gross domestic product (compared with structural deficits of around 2.5 per cent in the United States and 1.9 per cent in the European Union). To hedge against inflation and general uncertainty, consumers have furiously acquired gold, rendering the country reliant on foreign capital to finance its trade deficit.
Economic stability can be restored through major reforms to cut inefficient spending and raise taxes, thereby pruning the deficit and taming inflation. The economist Raghuram G Rajan, who just left the University of Chicago to run India's central bank, has his work cut out for him. So do Prime Minister Manmohan Singh, also an economist, and the governing party, the Indian National Congress. These steps need not come at the expense of the poor. For example, India is implementing an ambitious biometric identification scheme that will allow targeted cash transfers to replace inefficient welfare programmes.
India can still become a manufacturing powerhouse, if it makes major upgrades to its roads, ports and power systems and reforms its labour laws and business regulations. But India is in pre-election mode until early next year. Elections increase pressures to spend and delay reform. So the country’s weakness and turbulence may persist for some time yet.
The writer is a senior fellow at both the Peterson Institute for International Economics and the Centre for Global Development
©2013 The New York Times
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