Reclaiming the Lost Glory

Until 1820, India accounted for one-sixth or more of world output. But under British rule and in the wake of the Industrial Revolution, its economy was eclipsed. Today, though, India stands on the cusp of reclaiming its lost glory. During the fifteen years ending in 2017/18, India’s economy grew 7.7 percent in real rupees and 9.9 percent in real dollars. Today its GDP stands at $2.6 trillion. Even if it were to grow at only 8 percent in real dollars in the coming decade, GDP would reach $7.2 trillion by 2030/31, placing the country in third place in the global GDP rankings. But, as the experiences of all successful developing countries show, sustained growth at a rate of 8 percent or higher requires a policy framework that leads to greater outward orientation, urbanization, and expansion of labor-intensive manufacturing. With concerted policy reform, such transformation is within India’s grasp.

Nuggets: A Miscellany of Reforms

This chapter considers reforms in a few selected areas. On macroeconomy, the key recommendation is an upward revision of the inflation target. It suggests that when public sector enterprises incur losses and serve no public purpose, the government should sell them if possible and close them if there are no potential buyers. It recommends consolidation of subsidies to farmers and conversion to a single cash transfer via the universal Aadhaar biometric identity. It also suggests scaling down the Food Corporation of India, splitting electricity distribution companies into network and supply businesses and opening entry into the latter, and amending the Right to Education Act to improve learning outcomes.

Investing Productively: The Banking Sector

Banks collect savings by households via deposits and channel them to the most productive investors in the form of credit. What happens to bank credit has a determining impact on growth, especially in the formal economy. A key feature of Indian banks has been repeated episodes of accumulation of non-performing assets followed by their recapitalization by the government using public money. These episodes have been concentrated in public sector banks (PSBs), which continue to account for two-thirds of banking assets. This chapter offers a detailed analysis of these episodes and argues that it is time for the government to give serious thought to privatization of PSBs. PSBs are subject to regulation by both the government and the Reserve Bank of India (RBI), but RBI has limited powers over them. On average, private banks outdo PSBs along nearly all dimensions in terms of efficiency.

Investing Productively: The Securities Market

Relative to labor, capital is India’s scarce factor of production. Therefore, it is particularly important that it is allocated to the most productive activities. Well-functioning financial markets are critical to achieving this objective. Accordingly, this chapter focuses on the securities markets in India. In terms of new issues, private placements have dominated securities markets in India, both in equity and in debt. When it comes to public placements, while there is a bit of liquidity in equities, the same is not the case in the debt market. The market in publicly traded corporate bonds is thin, with limited liquidity. This chapter offers a number of ideas to deepen this market. For instance, rules governing investment in these bonds by pension, provident, and insurance funds may be liberalized. The government may also partially de-risk long-term bonds for infrastructure projects through provision of collateral.

Walking on Two Legs

This chapter asks whether India can rely on an export-led, manufacturing-fed growth model. The question stems in part from suggestions that, given its success in the software industry, India can jump the manufacturing stage and go straight to specializing in services. It is argued that India has no escape from manufacturing, though it should also continue to exploit its strength in certain services. The argument for manufacturing is that only it can create good jobs for the vast majority of the workforce, which has limited or no skills. Tradable services such as software cannot employ these workers, and demand for non-traded services depends on domestic income. Manufacturing, being tradable, can expand by exploiting the vast global market. Moreover, as well-paid workers in manufacturing spend their incomes, demand for non-traded services rises as well. The chapter also explains why rising protectionism and the threat of automation do not make an export- and manufacturing-led model unviable.

Underemployment in Agriculture

The chapter begins with a history of agricultural policy in India. It goes on to argue that policies aimed at improving outcomes within agriculture alone cannot bring prosperity to those engaged in it. Today, agriculture employs 44 percent of India’s workforce but produces at most 17 percent of GDP. With the overall GDP per capita itself low, agricultural output per worker is extremely low, indicating gross underemployment of labor. Therefore, marketing reforms that shift prices in favor of the farmer and against intermediaries cannot go very far. With self-sufficiency in agriculture, increases in productivity will likely result in lower prices rather than higher revenues. Besides, agricultural growth rarely exceeds 4.5 percent over even a decade-long period. Scope for increased incomes through diversification within agriculture into horticulture, fisheries, and animal husbandry is also limited. The upshot is that the only avenue to increasing agricultural incomes rapidly is to pave the way for half or more of the farm workforce to migrate into industry and services.

In Conclusion: Revisiting the Past, Looking to the Future

This chapter looks back at post-independence economic history to understand the stranglehold that socialism acquired on the Indian economy in the early years, the launch of reforms in 1991 under Prime Ministers Narasimha Rao and Atal Bihari Vajpayee, partial reversals under Prime Minister Manmohan Singh, and a return to reforms under Prime Minister Narendra Modi. It particularly emphasizes the role that a socialistically inclined bureaucracy plays in continuing to hold back reforms. The chapter concludes by making the case that despite a slowdown in growth at the present time, India’s future is bright—but only if the leadership stays the course on economic reforms. The chapter concludes with a number of cautionary notes relating to policy. These relate to policy stability, the necessity of migrating half or more of the agricultural workforce to industry and services, creating an ecosystem that would help firms to grow larger, the centrality of success in export markets, and the need for investment in labor-intensive sectors of the economy.

Governance

This chapter covers three areas of governance: consolidation of ministries, reform of bureaucracy, and some selected aspects of economic administration. On ministries, it argues that India needs to eliminate some ministries while consolidating others. This will minimize inter-ministerial turf battles and speed up decision-making. On bureaucracy, the chapter calls for opening senior positions to competition, as talent must be brought into the government from wherever it exists. Other recommendations for bureaucracy include allowing officials to take short-term positions in non-government sectors, greater use of young professionals, reining in vigilance agencies, reforming training institutions for officials, and ending colonial-era practices. On economic administration, the chapter recommends creating missions for speedy reforms, a focused strategy for the expansion of exports, creation of a separate office for trade negotiations directly under the prime minister, numerous improvements in tax administration, a sunset clause on all centrally sponsored schemes, and transparency in fiscal accounting.

Reforms for Export-Led and Manufacturing-Fed Growth

The near absence of large enterprises in the manufacture of labor-intensive products and consequent failure of such products in export markets is the reason for the paucity of good jobs for those with limited skills in India. To change this, India needs a clear focus on export expansion. It must avoid falling into the import-substitution trap that kept the country poor for decades. The rupee must depreciate sufficiently to eliminate its current overvaluation. Tariffs must be lowered and rationalized. Particularly important is to eliminate duties on synthetic fabrics and fibers. All indirect taxes must be reimbursed to exporters. Free trade agreements must be forged with countries that have potentially large markets. Trade facilitation must allow rapid movement of goods within the country and at ports. Finally, markets for labor and land must be liberalized. It will be worthwhile, though politically challenging, to experiment with autonomous employment zones that provide flexible land and labor markets within large areas.

Underemployment in Industry and Services

This chapter shows that even industry and services in India are characterized by gross underemployment. The bulk of the workforce in industry and services is concentrated in informal unincorporated enterprises, where self-employment and casual employment dominate. The average value added by a worker in these enterprises is no higher than that in agriculture. Most enterprises have no hired workers, and when they do, annual wages are under 100,000 rupees. Whereas 75 percent of China’s manufacturing workforce is in medium and large enterprises, only 16 percent of India’s workforce is. The near absence of medium and large enterprises translates into very low productivity, not just overall but also in small enterprises. This is because medium and large firms produce greater competition and innovation in products, processes, and management. Medium and large firms also benefit from exposure to global markets. Creation of high-quality jobs requires an ecosystem conducive to the emergence of medium and large firms.