Vijay Joshi: Achilles' heel of economic strategy

India's GDP has grown by nearly 6 per cent per year in the last two decades. This puts the country among the world's top growth performers. But India's high growth has also been highly peculiar. Its character raises doubts about whether it can be maintained at its present rate, let alone raised to attain the target of 8 per cent. It is doubtful also whether it is conducive to fuller employment and a sustainable alleviation of poverty.

Unlike other high-growth economies (HGEs), India's growth has not been accompanied by a rising share of industrial output in GDP. The table shows the relevant facts for India and relevant HGEs.
 

Share of Industry (Manufacturing Sector) in GDP
Country	1960	1980	1990	2002
China	32 (na)	48 (40)	42 (33)	51 (35)
India	19 (13)	24 (16)	28 (17)	27 (16)
Indonesia	15 (9)	42 (13)	39 (12)	44 (25)
Korea	20 (13)	40 (28)	43 (29)	41 (29)
Malaysia	18 (8)	38 (21)	42 (24)	47 (31)
Thailand	18 (12)	29 (22)	37 (27)	43 (34)
Source (basic data): World Development Indicators ( in %)

The share of industry in India's GDP grew from 19 per cent in 1960 to 27 per cent in 2002. In other HGEs over the same period, the share of industry doubled to reach 40 per cent or more of GDP.

The contrast is reinforced if we look more narrowly at manufacturing. (This has the advantage of excluding the oil sector, which is important in Indonesia.)

China's case is rather special. Industry was already 48 per cent of GDP in 1980 but it was highly inefficient. After the Chinese reforms, some of the industrial growth was unwound and the share of industry fell to 42 per cent in 1990.

But since then it has risen, in a more efficient manner, to reach 51 per cent in 2002. India's growth has been very different. In stark contrast to other HGEs, India is yet to have a broad-based industrial revolution.

Another notable feature of India's high growth, and a disturbing one, is that it has been relatively "jobless". In the organised sector, including its manufacturing component, employment barely changed between 1991 and 2002; since 1996, it has actually fallen.

Total employment, as measured by the NSS, has done somewhat better and has grown by about 1 per cent per year in the last decade. But this must be put into perspective by noting that (a) there remains a large amount of unemployment, open and disguised, and (b) the labour force is projected to grow by 2 per cent (8 million people) per year for the next 25 years. It has become commonplace to refer to the "demographic bonus" that India is going to enjoy as a consequence of the forthcoming change in the composition of the population towards working-age adults. But how is the growing labour force to be productively employed?

Other HGEs achieved a rapid growth of output and employment on the back of industrial expansion, powered by exports of labour-intensive manufactured goods.

The reasons for the success of this strategy are straightforward. On the demand side, profitable exports boosted the incentive of firms to save and invest.

Savings also rose rapidly as a consequence of the rising incomes of the new recruits to the industrial sector. On the supply side, export-led industrialisation enabled the shift of surplus labour from agriculture to industry without running into diminishing returns from capital accumulation.

By contrast, India's industrial development has been capital-intensive and India has not had a sustained East Asia-style export boom.

India's share in world exports was 2 per cent in 1950, fell to 0.4 in 1980, and rose marginally to 0.8 in 2002. China's export share rose from 0.8 per cent in 1980 to 5 in 2002. In the last two decades, China's export volume grew at 16 per cent per year, double the Indian rate.

Can India achieve its employment and growth objectives, despite rejecting the tried and tested road travelled by other HGEs? I doubt it. Faster growth in agriculture is necessary, indeed essential, but not sufficient.

The growth rate of agricultural output has been around 2 per cent per year in recent years. It would be unrealistic to expect it to rise much above a trend rate of 3 per cent; and historical experience shows that even high-productivity agriculture cannot absorb more than a small part of the working population.

In the last decade, services have been growing at 8 per cent per year, industry at 6 per cent. Again, history and international experience indicate that this disparity cannot continue at India's stage of development.

Note also that growth in services has been as "jobless" as industrial growth. It follows that industry (including agro-industry) has to be the main driver of employment-intensive growth. But it is hard to see how it could do that without an export boom in labour-intensive manufactured goods.

Some people think that information technology could be India's saviour. This is a dangerous illusion. While the IT sector is very important in the long term, its quantitative significance in the near term is limited.

The output of this sector is currently less than 1 per cent of GDP. Employment in the sector is less than a million. This could increase by another million by 2010.

While undoubtedly helpful, it pales into insignificance when one considers that India's labour force will rise by 40 million over the same period (and much of the rise will occur in backward states).

We must remember also that the growth of the IT sector will be constrained by the rate at which the supply of educated labour can be increased. (Note that only 5 per cent of India's relevant age-group receives college education.)

The IT sector does not answer the needs of millions of uneducated people. They require industrial blue-collar employment where most training is received on the job.

I am not arguing that labour-intensive manufacturing is all that matters. Agriculture and services are indeed extremely important for balanced growth.

There is also no reason why India's capital-intensive and hi-tech industries and firms should not continue to grow fast, provided they are efficient and internationally competitive, as many of them now are.

But India needs, in addition, a source of labour-demanding growth, which can only plausibly come through labour-intensive exports. An export boom could provide additionality in growth, provided infrastructure shortages are overcome, because labour supply is elastic and tradable goods could be imported as necessary.

Export demand would stimulate private investment, domestic and foreign. As in other HGEs, extra domestic savings would come from the rise in profits in export activities and the rise in incomes of the newly employed.

The enabling policies that are required to make export-oriented, labour-demanding growth possible are as follows:

Small-scale industry reservations must be phased out. Exports of labour-intensive mass consumer goods (shoes, fabric, garments, toys, sports goods) require production in factories employing large numbers of workers.

India's antiquated labour laws should be reformed. Currently, they make retrenchment or even productive rearrangement of labour difficult. They also impede the smooth exit of firms from failed ventures. This discourages hiring labour and investment in labour-intensive activities.

Direct foreign investment should be promoted and welcomed in export-oriented, labour-intensive industries.

India's creaking facilities in power and transport must be improved. At present, they are a serious constraint on international competitiveness.

Trade liberalisation must be extended. India still has high protection relative to other developing countries. It is still not understood that import protection is nothing but a tax on exports.

The policy of keeping the exchange rate competitive should be continued. If there are balance-of-payments surpluses, adjustment should take the form of fiscal consolidation and import liberalisation, not exchange rate appreciation.

As in China and East Asia, some special measures (for example, special economic zones free of taxes and labour regulations) should be put in place to kickstart the process of dynamic export growth.

Adjustment assistance and safety nets should be devised to cushion the impact of short-term losers from the above policies. The task would be made easier by the fact that the overall demand for labour would be rising rapidly.

Recent experience indicates that the Indian economy responds to good policies. Many of the East Asian countries now face higher labour costs and are moving up the ladder of technical sophistication.

That provides India the opportunity to capture their export markets, just as China captured those of the erstwhile Gang of Four. The abolition of textile quotas in 2005 provides an opportunity to move ahead. In the days of foreign exchange shortages, labour-intensive exports were a focus of policy attention. They must regain that status, this time for somewhat different reasons.

India currently enjoys a new economic leadership of very high quality. It is to be hoped that their new development plan will include concrete measures to phase in and implement the above strategy.

The test of the new leaders will be to convince their party and allies that the strategy would be in the interest of an overwhelming majority of the labour force. And if that proves difficult, let us hope that they can call another election fairly soon and be returned to power with a workable majority.

The bottom line is that in addition to thriving agriculture, services, and capital-intensive industry, India urgently needs labour-demanding, export-led industrial (including agro-industrial) growth. Without it, India's "demographic bonus" could become an economic, political and social curse.

vijay.joshi@merton.ox.ac.uk

(The author is a Fellow of Merton College, Oxford)