India – how gigantic is the new giant?

June 10, 2008

This book is the result of a fatherly injunction to “write a definite book on India”. Prof Arvind Panagariya’s “India, the Emerging Giant”, definitely is such a book. It will probably be an authoritative reference book for the next few years to come on India’s economy. The talk is of a giant, but India still only represents 1% of world merchandise trade, and 2.7% of its services trade. Yet the book is a very important contribution to the understanding of economic development and the policies that can lead to it – or not. The book traces India’s economic history since its independence and in particular links its growth performance with the policies undertaken by its successive governments. The author identifies four main phases:

1951-1965 – “Takeoff under a liberal regime” – Despite Prime Minister Jawaharlal Nehru’s socialist ideology centered on import-substitution, trade and investment policy was relatively pragmatic and open, especially to foreign investment and technology. The economy took off progressively, not least as a result of its simple liberation from stifling British rule.

1965-1981 – “Socialism strikes with a vengeance”. In that period, against a backdrop of external shocks (war with Pakistan, among others) and a macroeconomic crisis, the country was closed to foreign trade and investment. Tight controls and restrictions on foreign investment were introduced. Controls on foreign exchange and trade were systematized. The government nationalized banks, put restrictions on the expansion of big companies and introduced a “scheduling” of “small-scale-industries”. The green revolution was pushed forward, and attempts at agrarian reform continued. In all these policies the focus was on equity and reduction of inequality. In fact it stifled growth, with no effect on reducing poverty. There are arduous pages in this chapter describing the mind-boggling and legendary “license-raj” .

1981-1988 – “Liberalization by stealth” – The governments lift progressively various restriction on business expansion and trade. Growth starts to pick up more seriously.

1988-2006 – “Triumph of liberalization”. The macroeconomic crisis of 1991 was the trigger for a systematic approach to economic reform. “Phase IV began with an unprecedented growth spurt that ended in a balance of payment crisis. The response to the crisis was a major liberalisation on both the domestic and external fromnts. The economy was successfully stabilized, and growth at the higher rate resumed within a short period (..). Though the necessity to borrow from the International Monetary Fund and World Bank has subjected the initial liberalization package to the conditionality of these institutions, the proposed reforms were essentially domestic in origin (…)” . India has done away with the infamous “license raj” and opened up its economy. Panagariya says that formally, India’s economy is now as open China’s.

So, is there still anything wrong with India? Panagariya’s main message is that India has missed the transition to manufacturing. It should “walk on two legs” – continue developing services, but not neglect the factories. Despite its successes in services and IT, India must put its rural paupers to work in factories that will process light manufactures, electronics, toys asf – India should fully embrace its comparative advantage in low-skilled labour. The problem is that India has maintained a highly restrictive labour legislation that has stifled investment into large-scale manufacturing.

Despite this fact, India’s growth has already lifted millions out of poverty. According to official poverty estimates, the proportion of Indians living under the poverty line has declined from 38.2% in 1988 to 26.1% in 2000 (latest available figures in the book). He dismisses many claims made that liberalizing reforms have not reduced poverty, and that such assertions, reflected in the 2004 vote reinstating Congress in government, rather reflect rising expectations. Has inequality risen? Panagariya: “According to the available evidence, rural inequality has remained unchanged and has declined marginally while urban inequality has at worst increased by 10 to 12 percent. Evidence on the rise in the urban-rural inequality and regional equality is more compelling”.

The book ends with chapters on where India still has work to do: from further liberalizing trade to reforming education, health and agriculture. On health and education he starkly underlines the states’ failure to provide those services. The sectos should therefore be opened to private providers. When it comes to pro-poor policies and especially to rendering both health and education affordable to the poor he proposes, in health, direct transfers to female household leaders, and, in education, vouchers. All these should be targeted at the lower 30% of the income-bracket. Agriculture also needs to be deeply reformed, made more competitive, opened up and liberated from subsidies, the public grain procurement and storage system, and tenancy and property rights reformed such as to create the right incentives to produce more and better.

In the financial and macroeconomic sphere Panagariya calls for privatization of the big banks that are still under government control. But he says that on the international front, capital account liberalization should move slowly (but not be ruled out). He defends the general consensus reached after the Asian crisis of 1997 that too speedy capital account liberalization can wreak havoc on domestic economies. Despite a few crises, India has benefited from remarkably stable macroeconomic conditions, and he partly attributes it to its shielding it from faced-paced speculative international flows.

This book is sober, factual, clear and very didactic. Even a non-economist can read it – although with a lot of concentration. Most of the analysis is compelling and hard to dismiss. It is full of detailed and well-summarized analyses of almost every aspect of Indian economic life. At the same time it probably is only a beginning. Panagariya himself stresses that he looks at policies at the central level. In fact many changes occur at the federal state level. And many blocages occur there as well. That story needs to be told in-depth. His proposal to simply move to direct cash transfers to the poor to help them directly without distorting the machine that spurs growth and prosperity is very seductive. The issue is the one of political, and sometimes technical feasability. Caste can complicate matters as well.

Generally, this books feeds into the current positive and optimistic mood surrounding India:

“India grew 6.3 percent per annum during 1988-2006. During 2003-2007, the annual growth rate was 8.6 percent”. [According to the IMF, in 2006 it was 9.7, in 2007, 9.2%.] The possibility that the long-run growth rate of India may have shifted to the levels achieved by the East Asian tigers in the 1960s and 1970s can no longer be ruled out”.

But it does send a very strong warning:

“Yet, even as the economy picks up pace and poverty continued to decrease, there remain doubts about the transformation of India from a primarily agricultural and rural economy to a modern one in the foreseeable future.” Bottom line,again: “unskilled-labor-intensive manufacturing has done poorly in India”; “future reform must focus on removing impediments facing its rapid growth”.

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