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Mystifying India's Economic Growth

 Mystifying India

BOOK REVIEW

1991 which have overwhelmingly targeted

Mystifying India’s Economic Growth

manufacturing. S econdly, the endogenous estimation of growth rates does reveal a GDP break from 1991, but then only if the Pulapre Balakrishnan most recent GDP series, i e, at 1999-2000 =

T
100 prices, is used, for which see his volume is a collection of papers Balakrishnan and Parameswaran (2007b).

Sustaining India’s Growth Miracle by Jagdish Npresented and the transcript of Bhagwati, Charles W Calomiris (New Delhi: Stanza/Rave With services the fastest growing segment

panel discussions held at a confer-in the economy, apart from its preponder-

Media), 2008; pp x+262, Rs 495.

ence at Columbia University, New York, in October 2006. It has been put together by Jagdish Bhagwati and Charles Calomiris, and brought out by Stanza in 2008. The presence of so eminent an economist among the editors would leave a potential reader raring to go. However, this one was disappointed with the limited choice of topics and the exceedingly one-sided presentation of the arguments.

First, a comment on the choice of title – conveying a certain breathlessness with which recent growth in India was likely received at the conference – may be in

o rder. “Miracle” suggests an occurrence that is beyond our understanding. For economists, whose very business it is to deconstruct material outcomes, even the suggestion of a mystery would be unflattering to themselves. But to play along with the editors a bit, perhaps they only had in mind a growth experience so i mpressive, out of the ordinary and unexpected as to be seen as being miraculous. However, does this portray sufficiently accurately the recent developments in India? Actually, what we see today is the continuation of a tendency of the growth rate of the Indian economy to quicken over shortening intervals starting with the acceleration around 1950. To almost wilfully overlook this and suggest that growth first accelerates only after some liberalisation of the trade and industrial-policy regimes was initiated in the 1980s (or is it the 1970s then?) is to fail to read the evidence the way a professional economist ought to.

Since the work of Hatekar and Dongre (2005) we know that the “dominant break” in the time series of GDP taken over the 20th century is around 1950. Recall that this coincides with the initiation of planning for growth, if not exactly development. Having stagnated for close to half a century the economy had responded with alacrity to the expansionary policy and grown at a steady clip till about the

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january 17, 2009

mid-1960s (Sivasubramonian 2000). To now commence with 1950 as the initial point in your study and then to christen all movement in the economy till the next a cceleration of the growth rate as “Hindu growth” (p 11) is akin to setting up a straw man in your bid to establish the superiority of a liberal economic regime over an interventionist one. No one takes this sort of exercise seriously anymore. In any case, India’s quantitative economic performance has not, till now, reached the east Asian proportions, especially the sustained double-digit growth that had first attracted the epithet “miracle”.

Absence of Perspective

There is some absence of perspective when judgment is based on a mere three-year run commencing the year 2003 (see Figure 1.2, p 12). Also, it is by now accepted within the profession that establishing structural breaks in an economic series must use a hands-off procedure. Though this cannot do without some judgment yet, it does constitute a methodological progress. A discussion and reference to the literature is available in Balakrishnan and Parameswaran (2007a).

We have by now a reasonable understanding of the growth process in the I ndian economy over the past three d ecades or so. A sectoral decomposition of GDP growth reveals that it is the accelerated growth of services that contributes overwhelmingly to higher growth rates from the late 1970s. This pattern continues unchanged even after 1991. Evidence for both periods is presented in Bala krishnan and Parameswaran (2007b). Two further points may be noted. Services show a relatively autonomous growth, which is surprising, but that is what econometric investigation reveals. This implies that one cannot argue that this has been driven entirely by the trade and industrial policy reforms since ance in output, it is now moot whether it is the “funda mental transformation” of “ India’s development strategy” (p 1) since 1991 that is responsible for the faster growth in recent years. The sobering fact is that the share of manufacturing in GDP has remained unchanged since 1991 despite “less c ontrols, more markets and greater openness”, all of which together presumably characterising the said transformation.

Trajectory of Manufacturing

Manufacturing has of course grown very fast very recently and has by now moved on to an altogether different rung of the “value chain”. And while some of this is clearly due to the reforms, the sector is yet to expand relative to the economy. This should have been the outcome if all that constrains its growth is the policy regime, which had finally been substantially liberalised. It is also the case that some segments of the services sector, such as communications and “BFI” (Business, Financial Services and Insurance) have benefited from the reforms and these have grown fast. However, these are not the fastest growing of the services sectors, which is “Trade, Hotels and Restaurants”. And though “Financing, Insurance, Real Estate and Business Services” has grown fast a fter 1991 alright its contribution to overall growth has actually slowed compared to the 1980s, for which see Balakrishnan and Parameswaran (2007b).

Overall, the data suggests that it would be more appropriate to say that while the reforms have substantially altered some segments of the economy, it has not had a strong impact on the rate of growth, when a long-term perspective is taken, or the nature of growth, if it is distinguished by the sectoral contribution to output growth. The volume under discussion misses this because its empirical base is weak, even as its policy predilection is strong. Our a ssessment presented at the beginning of

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this paragraph does not imply that we are bereft of an explanation of the developments as witnessed. The problem arises from a viewing of an economy in motion as responding only to policy shocks. This is a somewhat bookish view of the growth process. On the other hand, from Allyn Young to Paul Romer we have cogent a ccounts of growth once set-off accelerating due to increasing returns, though their a rguments, interestingly, flow from different theoretical streams.

For the less orthodox there is also the idea of a “circular and cumulative causation” originally expounded by Myrdal, and extended by Kaldor to allow for an “endogenous technical progress”. This e ngenders growth with a dynamic internal to itself, i e, growth begets growth u ntil shocked adversely. Some of this mechanism may well account for the relative autonomy observed of a billowing services sector. Specifically in the context of India, Basu and Maertens (2007) have suggested an explanation in terms of a rise in the savings rate. Presumably, this would count as “Solow growth” outside of the steady state. As Lewis had seen it, though, savings are likely endogenous with respect to growth. Nevertheless, the point is that we have plausible accounts of a growth dynamic that is not entirely dependent on the liberalisation of the policy regime. This needs further investigation.

Labour Laws

I now proceed to a review of the articles themselves, ignoring the transcript of the panel discussions which with their air of an after-dinner conversation in a gentlemen’s club add little value to the theme of the volume, which is the future of growth in India. There are four essays in this volume. The first is one by Arvind Panagariya on what it will take to bring double-digit growth rates to India. Taking a cue from China it is pointed out that its growth is based on manufacturing exports that rely on large-scale production, which is c orrect of course. India’s economic pro blem is now cast as one of expanding the share of manufacturing industry in the economy. Labour laws are seen as the p rimary i nhibiting factor.

Panagariya is right to argue that manufacturing growth alone can take up the huge employment slack in India, but quite likely overestimates the role of labour laws. In a comparison with China it would appear that India’s infrastructural shortfall is at least as important a factor as its legal framework. Also, the role of the sustained high growth rate of China’s agriculture is perhaps being missed here. Of course, India’s labour laws are likely to have contributed at least a little to the slow growth of manufacturing employment and need seriously to be reformed to explicitly allow for exit while protecting the welfare of all workers, and not just the ones in the “organised sector” as they currently do. However, what of the role of health and education in raising the productivity of labour and making greater use of it more attractive to firms, thus promoting growth in the future? This has been pointed out by Panagariya’s discussant. One learns from the list of p articipants in the conference that Mihir Desai is a professor at the Harvard Business School. Perhaps in some ways economists tend to be more dogmatic than those who are in contact with business.

The second paper, by T N Srinivasan, is on fiscal consolidation as the unfinished business of reforms in India. It tackles two themes, the existing institutional architecture for fiscal policy, especially the respective roles of the centre and the states, and the impact of the fiscal deficit on growth. On the first topic, Srinivasan a rgues for an implementation of the schedule for elimination of the revenue deficit as it appears in the Fiscal Responsibility and Management Act of 2003. He also counters a suggestion emanating from the Planning Commission that the distinction between the revenue and fiscal deficits is arbitrary by insisting that only the creation of assets – physical or human – can be treated as capital expenditure and that consumption expenditure must pay for i tself. This is well taken. However, it is not clear whether his insistence on the imposition of fiscal targets on the states by the centre is in line with the spirit of the Constitution. In this vein, the public statements made by the finance ministers of some non-Congress states that the United Progressive Alliance government is denying the states part of their due share of the national tax revenues (see the report “Central Scheme Notion Is Unconstitutional: Isaac”, The Hindu,

Kochi Edition, 18 December 2008) needs

to be fully clarified in the public interest.

In the second half of his paper, Srini

vasan looks at the impact of the fiscal

d eficit. While on the macroeconomics, he

scrupulously rehearses all arguments,

i ncluding the possibility of deficits arising

out of increased public expenditure

“crowding in” public investment. How

ever, in his empirical analysis he weighs

in on the conclusion that in India in the

1990s rising fiscal deficits actually crowded

out private investment, as may be inferred

from their movement in opposite direc

tions in the second half of the decade. He

is puzzled by the feature that the observed

slowing of private investment is taking

place at a time of declining interest rates.

The clue to fitting together the jigsaw is to

check out the contemporaneous move

ment of the real interest rate. Starting the

mid-1990s the real interest rate was often

in double-digits, reflecting what has been

referred to as “missing monetary policy”

in Balakrishnan (2009). Then, the RBI

had, very likely with the blessing of a

finance ministry apprehending elections,

ham-handedly dealt with a brief spurt in

the inflation rate. The slump in private

i nvestment that had followed is no longer

surprising. Once the very high real interest

rate regime is recognised, there is no need

for Srinivasan’s ingenious resort to a wors

ening of the investment climate (see p 81)

for which no reason is given. We need not

rely on an inward shift in the investment

schedule once we visualise the schedule it

self in real-interest-rate terms.

TFP Growth

Srinivasan also deals with some microeconomic consequences of the deficit. The route envisaged is an adverse effect on t otal factor productivity (TFP) growth. This is somewhat ad hoc. “Ricardian equivalence” constitutes perhaps the most coherent critique of public-debt-inducing deficits, but a counter-critique is to be found in Tobin (1980). As Srinivasan identifies TFP with technical progress, and the latter is believed to be funded by government, we may envisage a growth in the deficit due to greater public spending on R&D. Now a deficit could be self-extinguishing, as rising TFP leads to growth of output. R esource allocation is however a different

january 17, 2009

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Economic & Political Weekly

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matter and fiscal policy in India distorts it on huge scale. Think of the oil, electricity and fertiliser subsidies which leave today the Indian economy haemorraghing. Though Srinivasan does not address these explicitly, he must surely have them in mind, when the resource (mis)allocational consequences of deficits are r eferred to. Finally, however, his argument that a debt profile that is demonstrably sustainable in terms of the Domar-criterion need not be optimal is entirely correct and has relevance in the Indian context. Arguably, the level of the public debt in India is high. Now a contraction of the revenue deficit becomes relevant as we know from fiscal accounting that any reduction of the public debt must commence with a shrinking of the primary deficit. However, the very unusual historical conjuncture today, when we live in the shadow of the financial meltdown in the US and Europe, justifies an expansionary fiscal stance right now. The true Keynesian message is that the budget deficit must be operated counter cyclically. That in India politics invariably trumps economics when it comes to fiscal policy is another matter.

My comments on the two other articles in the volume will be brief, as their bearing on the theme of the volume is significantly less. Frank Wolak’s paper on the I ndian electricity supply industry shows a considerable understanding of the Indian scenario, especially of power supply. In particular, it strongly points to its potential, if not actual, insolvency under the present practices. This must make us refl ect upon the consequences of continuing with them. Electri city after all is not only necessary for growth, but also for our w elfare. For instance, b eing a land-scarce economy, India’s future settlement must perforce be vertical. And right now the lifts run on electricity! However, Wolak’s discussion of the road map for reforms is far too specialised to be of use to the g eneral economist, entailing the loss of the present reader at least. Some poor editorial judgment has crept in here.

Software Industry

Finally, we have Ashis Arora’s paper on the Indian software industry and its p rospects. Arora is a long-time student of the industry and his domain knowledge, so to speak, is impressive. However, in this

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article he has spent far too much time trying to establish the factors underlying the rise of the Indian software industry. Recall that the volume itself is on sustaining the growth of the economy. While commenting on accounts of the origins of the software industry Arora misreads my own p osition, suggesting that in Balakrishnan (2006) I have argued that “public policy is the cause” (p 186) of the growth of software in India. Actually, what I had done was to contest the assertion made by Arora et al that the software industry had prospered due to the “benign neglect” (see p 182 for the reference) of the Indian government, presumably, otherwise hell bent on stifling all industry. Nowhere do I recall stating that the government had intervened with “strategic intent”, as claimed by Arora (p 183), in the sense of “picking winners” a la east Asia. My paper had been titled “Benign Neglect or Strategic Intent? The Contested Lineage of the Indian Software Industry” only to hypothesise two extreme scenarios. However, I certainly had argued that India software had been the beneficiary of state intervention both indirect – in the form of investment in s cience and technology and engineering e ducation – and subsequently direct – via dedicated infrastructural facilities and zero taxes for 100% e xport-oriented p roduction.

It is a simple-minded reading of my a rgument that public policy caused the I ndian IT industry. At the same time, it surely was “a factor” in its rise. This is testified to even in the reports of NASSCOM cited in my paper. In the second half of his article Arora evaluates the Indian software industry’s prospects of moving up the value chain, identi fying likely impediments to such progress. This is quite original material, and a highly readable section too. As I see it, Arora sees the challenge to the Indian industry stemming from two sources, namely, organisational culture and domain knowledge. On the former, Indian firms are viewed as working with a legacy of cutting corners and b eing risk averse. On the latter, it is pointed out that organisations geared towards fulfilling r equirements laid down by clients are unlikely to be able to divine the needs and tastes of “the as yet unknown buyers” of IT products. To successfully engineer g lobally competitive products Indian firms would need far greater knowledge of b usiness practices and would have to better imagine products of the future. These are valuable insights.

So how do I conclude? I am unable to enthuse over this volume of essays. It overlooks far too much of the Indian economy. Where are agriculture, health and education, money and finance, governance, and, yes, foreign trade itself? While a singleauthor study of growth in India cannot be expected to cover all these aspects, surely we may expect of an entire conference devoted to the subject to get a little plural. And what the editors do include is mostly approached at an angle. I guess you need first to explain growth before you extol it as a “miracle”. Had not Keynes said something to the e ffect that if economists could be got to think of themselves on a par with carpenters that would be altogether a good thing? As for “Hindu growth”, we would require a Franz Fanon to decipher how a shibboleth that obscures more than it illuminates serves as so potent an attractor for some economists!

Email: pbkrishnan@yahoo.com

References

Balakrishnan, P (2006): “Benign Neglect or Strategic Intent? The Contested Lineage of the Indian Software Industry”, Economic & Political Weekly, 9 September.

– (2009): “Macroeconomic Policy, Structural Reforms and Economic Growth” in Macroeconomic Management and Government Finances (New D elhi: Oxford University Press for the Asian D evelopment Bank) forthcoming.

Balakrishnan, P and M Parameswaran (2007a): “ Understanding Economic Growth in India: A Prerequisite”, Economic & Political Weekly, 14 July.

– (2007b): “‘Understanding Economic Growth in India’, Further Observations”, Economic & Political Weekly, 3 November.

Basu, K and A Maertens (2007): “The Pattern and Causes of Economic Growth in India”, Oxford Review of Economic Policy, 23, 143-67.

Hatekar, N and A Dongre (2005): “Structural Breaks in India’s Growth: Revisiting the Debate with Longer Perspective”, Economic & Political Weekly, 2 April.

Sivasubramonian, S (2000): The National Income of India in the Twentieth Century (Delhi: OUP).

Tobin, J (1980): Asset Accumulation and Economic Activity: Reflections on Contemporary Macroecono mic Theory (Chicago: University of Chicago Press).

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