Wednesday, January 27, 2010

India’s Economic Miracle Turns 60

On Tuesday, the Republic of India celebrated its 60th anniversary. Though India had won its independence on Aug. 15, 1947, it was not until Jan. 26, 1950, that it adopted its permanent Constitution. The republic’s 60th birthday offers an appropriate occasion to take stock of its economic accomplishments.

Although India began by implementing sound institutions — a robust parliamentary democracy, independent judiciary, well-functioning bureaucracy and fiercely independent press — the economic policy framework it adopted was deeply flawed. By imposing licensing restrictions on products to be produced and imported, their quantity, selling prices and allocation among buyers, the government scuttled private initiative. It also reserved economic activity in a number of sectors exclusively for public enterprises.

And, beginning in the late 1960s, the government went on to nationalize the largest banks, insurance sector, oil companies and coal mines. With such straitjacketing, even the sound institutions and India’s talented entrepreneurs could deliver only modest growth. The economy grew at an average annual rate of 3.8 percent from 1951-52 to 1987-88. (India’s fiscal year begins on April 1 and ends on March 31.)
Modest liberalization and fiscal expansion, financed by incurring debt abroad, had begun to improve growth performance in small measures in the 1980s. The growth rate rose to 4.6 percent between 1981-82 and 1987-88 from 3.7 percent over the preceding 15 years.

With liberalization receiving some impetus under Prime Minister Rajiv Gandhi in the mid-1980s, and fiscal expansion continuing apace, a bigger spurt in the growth rate occurred in the late ’80s. But a mounting external debt to finance the fiscal deficits also culminated in a balance-of-payments crisis in June 1991. That crisis paved the way for systematic and systemic reforms beginning in July of that year. Prime Minister Narasimha Rao, from 1991 to 1996, and Prime Minister Atal Bihari Vajpayee, from 1998 to 2004, presided over wholesale economic reforms, which eventually led to an unprecedented economic boom.

Entrepreneurs no longer needed a license for setting up manufacturing units or for importing the necessary machinery and inputs. Opening the way to private telecommunications operators meant consumers could buy phones instantly rather than waiting for years in a queue, a consequence of the Department of Telecommunications’ former monopoly.

Private airlines meant travelers were no longer held hostage by Indian Airlines. Indian and foreign private banks gave clients a considerable range of options, forcing better service even from state-owned banks.

For a long time, skeptics had argued that democracy was a barrier to East Asian-style miracle-level growth. Until the early 2000s, only authoritarian regimes such as those found in South Korea, Taiwan, Singapore and Hong Kong in the 1960s and
1970s and the People’s Republic of China in the 1980s and beyond, had grown at rates exceeding 8 percent on a sustained basis.

But Indian democracy has now cracked the myth of incompatibility of democracy and miracle-level growth. Its growth rate shifted to approximately 6 percent in the 1990s and early 2000s, and then jumped to 8.5 percent between 2003-04 and 2008-09. Poverty has declined as well.

What has been remarkable about years 2003-09 is that the economies of nearly all Indian states, whether rich or poor, have grown faster than in any other period. One other important indicator reinforces these observations: the spread of telephones. As late as the end of March 1999, India had a total of just 23 million phones, translating into 2.3 telephones per hundred individuals. By the end of September, this number had climbed to 509 million. Even in rural India, there is one phone per household on average.

The Indian economy has shown remarkable resilience to the recent global financial crisis. During the crisis year of 2008-09, the country managed 6.7 percent growth. From July to September 2009, growth rose to 7.9 percent compared with the year-earlier period.

In large part, the credit for weathering the economic downturn without much damage goes to Y. V. Reddy, the former governor of the Reserve Bank of India, who resisted pressures from virtually every corner, including the Finance Ministry, to rapidly liberate the investment activity of Indian banks. Thanks to him, Indian banks had virtually no toxic assets and did not require significant infusion of capital to survive.

Increased incomes made possible by accelerated growth have placed ever-increasing amounts of tax revenues in the hands of the government. The United Progressive Alliance government has chosen to take advantage of these inflows to expand the social safety net. The central plank of these initiatives has been the National Rural Employment Guarantee Scheme, which guarantees one member of each rural household 100 days of employment (per financial year) at the minimum wage.
While this acceleration of social programs is to be applauded, the downside is that economic reforms have come to a standstill under the UPA government. Indeed, there are signs of a creeping return to the past interventionism.

For example, a decision was recently made to require all ultra-mega power projects to buy their equipment domestically. Likewise, a move is under way to extend minimum wage legislation to 340 million workers in the informal sector, bringing inspectors to the doorstep of even the tiniest enterprises and to households employing domestic servants.

Resorting to indirect and distortionary instruments such as this, rather than targeted instruments such as direct transfers to help the poor, is a source of worry if India is to sustain and accelerate its pace of growth and poverty alleviation. By Arvind Panagariya nonresident senior fellow on global economy and development at The Brookings Institution.

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