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Has India Peaked? (Part 1)

18/08/2015


Has India Peaked? (Part 1)

Has India peaked? This may seem like a strange question given the strong economic growth the country has experienced since it liberalized its economy in 1991. Together with China, India is widely regarded as the greatest global economic success story of the past quarter century, with growth rates typically ranging between 5 and 10 percent.1 Although its growth rate has declined recently to less than 5 percent due in part to the global economic downturn, the landslide victory of the strongly pro-business BJP (for Bharatiya Janata Party, or Indian People’s Party) in the spring 2014 elections has convinced many that it will begin trending up again in the near future.


Compared to China and other successful late-developing countries such as South Korea and Taiwan, however, the Indian economic miracle has been almost completely anomalous. China and others have built their success on rapid industrialization, taking advantage of relatively cheap labor to build factories that make things that rich Westerners want to buy. This labor- intensive growth has provided gainful employment for over a hundred million people in China alone, and spawned a massive service economy, employing tens of millions more, to cater to their needs. As a direct result, the great majority of the populations of these countries have been lifted out of poverty. South Korea and Taiwan have become developed economies, while China has blossomed into a global economic powerhouse that may soon be second to none.

India, by contrast, has taken a different route. The information technology (IT) sector has almost completely led Indian growth, epitomized by software developers and computer call centers that employ relatively few individuals. Although the IT sector has spawned a large service economy of its own to cater to the needs of these fortunate few, the great majority of the rural population—and their urban slum-dwelling counterparts—remain enmeshed in poverty, relatively untouched by the largesse. The primary reason for this state of affairs is the existence of restrictive labor laws that prevent Indian companies from laying off or firing workers in response to changing market conditions. This has discouraged Indian entrepreneurs and potential foreign investors from funneling their money into the development of large-scale labor-intensive industries.

Unless these laws can somehow be done away with, it is difficult to see how India will ever succeed in lifting the majority of its population out of poverty. Yet, for reasons having to do with both history and ideology, there is no groundswell of support in India for changing these laws. As we shall see, the opposition to doing so is spearheaded by those who should be most sympathetic to the plight of the poor. This includes the traditional political left as well as the lower-caste political parties that have sprung up in the Hindi belt over the past three decades and who purport to represent the interests of the traditional “have-nots” of Indian society.

Due to the increasing fragmentation of the Indian political system since the mid-1980s, reflected in the emergence of these lower-caste parties in tandem with small regional parties organized along ethno-linguistic lines, these forces have enjoyed an effective veto over labor law reform. The two major national parties, Congress and the BJP, were unable to command a majority of the Indian electorate in their own right, and were forced to rely on coalition support from these smaller parties, whose political modus operandi is to hold national politics hostage to their parochial self-interests. This not only cast a cloud over prospects for bettering the lot of the Indian poor, but raised questions about how governable India was likely to be in the future, particularly if the centrifugal forces that gave rise to these parties continued to intensify.

The stunning BJP victory in the spring 2014 elections—in which it did even better than expected and captured an absolute majority of seats in the Lok Sabha, or the lower house of the Indian Parliament—has dramatically undercut this trend and opened up a whole new universe of possibilities. True to its pro-business pedigree, the BJP championed labor law reform during its previous stint in power (1998– 2004) but abandoned it in the face of strong left-wing and lower-caste party opposition. Although the issue played no role in the recent electoral campaign, the key question now is whether Modi will decide to take advantage of his unassailable majority in the Lok Sabha to resurrect it. His decision will determine whether the overwhelming majority of his countrymen who were bypassed by the Indian economic miracle will be able to share in the fruits of its renewal or will remain, for the foreseeable future, on the outside looking in.

 

The Hindu Rate of Growth

For the first 40 years of its existence, India was an economic basket case. Jawaharlal Nehru, the first leader of the new nation, was a great admirer of Soviet-style central planning, believing that capitalist economies were inherently exploitative with a rapacious few becoming wealthy at the expense of ordinary people. Having risen to maturity under British colonial masters, he was bound and determined to have India go it alone, free from dependence on foreigners. For Nehru, this meant constructing an economy based on import substitution, where the emphasis would be on producing domestically as many goods and services as possible. He discouraged foreign investment for the same reason. Business activities and entrepreneurship were tightly regulated by what became known as the “License Raj”—an intricate system of permissions and other assorted red tape required to open up businesses in India. And although the Indian government did not guarantee its citizens jobs, the Industrial Disputes Act (IDA) of 1947 made it almost impossible for employers to fire anyone who actually succeeded in landing a job.

The result was a monumentally inefficient economy that produced decades of painfully slow economic growth, averaging approximately 3.5 percent a year, which came to be known derisively as the “Hindu rate of growth.” Given the strong hold of Third World socialism on the Indian imagination, this situation might have persisted indefinitely. But there was a fatal flaw in trying to organize an economy such as India’s around import substitution: India, ironically, remained highly dependent on imports. In addition to food, which was frequently in short supply, it was forced to import raw materials such as petroleum to fuel what economic activity did exist. But because economic policy was single-mindedly geared toward producing for the domestic rather than the export market, India had great difficulty in earning the foreign exchange it needed to pay for its imports. This forced it to borrow money, which over time drove it ever more deeply into debt.

Despite some modest liberalization during the 1980s, which briefly drove up growth rates,2 this unhappy state of affairs finally culminated in the shock of 1991, when shortages stemming from the Gulf War caused petroleum prices to skyrocket. India simply did not have the foreign exchange reserves it needed to pay the higher prices, while at the same time continuing to service its massive and ever growing debt.3

IndiaEconomic Miracle

Faced with imminent default, the Congress government in power at the time felt obliged to seek an emergency loan from the IMF. As part of the quid pro quo, India agreed to liberalize its economy by opening up the country to foreign investment and doing away with the most onerous requirements of the License Raj. The impact was both sudden and substantial. The economy began to pick up, and within three years was expanding at a rate of over 6 percent annually, eventually reaching more than 9 percent by the middle of the last decade, where it has remained until recently. India began to be mentioned in the same breath with China as one of the world’s two most successful late-developing economies and, by some accounts, a budding future superpower. But there was a big difference.

In a country of 1.2 billion people, comparable in population size to China, India has less than 10 million people working in labor-intensive manufacturing industries.4 The number of Chinese working in such enterprises, by contrast, is more than 100 million.5Indian economic growth in the wake of the 1991 liberalization was led not by manufacturing, but almost exclusively by growth in the information technology (IT) sector. Freed from the shackles of the License Raj, Western computer manufacturers and software developers began investing heavily in the Indian computer software industry. They took advantage of a large pool of highly-skilled English-speaking software engineers, whose services could be obtained for only a tiny fraction of the salaries commanded by their Western counterparts. They were available in substantial numbers due to what is arguably the only positive economic innovation that Nehru ever implemented: the creation of the five original Indian Institutes of Technology (IIT), which began turning out skilled engineers during the 1950s.6 Many of them were underemployed during the long decades of the Hindu rate of growth and ended up going abroad to market their skills (more than 25 thousand emigrated to the United States alone).7 But the IIT graduates who remained behind were ready and waiting when the economy finally did open up in 1991.

We are not talking about a lot of people, however. The number of Indians working in the IT sector has never exceeded one million.8 Nonetheless, as was also the case in China, their efforts have produced a ripple effect within the Indian economy as a whole, with retail and other service enterprises emerging to cater to the needs of this IT nouveau riche. This has succeeded in lifting tens of millions of people out of poverty. According to the Asian Development Bank (ADB), an estimated 25 percent of the Indian population now enjoys middle- class status.9

But this performance needs to be put into perspective. Eighty percent of those Indians deemed by the ADB to belong to the middle class fall into its lowest income bracket, earning only between $2 and $4 a day. This is not very far above the $1.25 a day that the World Bank uses as its benchmark for determining who is living in poverty. According to this criterion, almost a third of the Indian population (32.7 percent) can currently be considered poor. World Bank statistics reveal that an additional 36.1 percent only earn between $1.25 and $2 a day. This means that 68.8 percent of the Indian population, or approximately 800 million people, survive on less than $2 a day. Adding in the ADB middle-class statistics cited above reveals that more than one billion Indians, or over 90 percent of the population, continue to live on less than $4 a day.

Contrast this with China, where only 11.8 percent of the population (compared to 32.7 in India) earns less than $1.25 a day, only 27.2 percent (compared to 68.8%) earn under $2 a day, and 58 percent (compared to over 90%) earn less than $4 a day. Although China is hardly a developed economy, it is far better off than India. This is also reflected in their respective per capita GNP levels. Chinese per capita GNP currently stands at just over $6,000. The Indian level, by comparison, is a relatively meager $1,489, only a little over two hundred dollars a year higher than that of Pakistan, its economic basket-case neighbor to the west.10The bottom line here is that, although India has enjoyed significant growth since it liberalized its economy in 1991, and has no doubt lifted tens of millions of Indians out of poverty, it has not come close to matching the Chinese achievement. This should not be surprising given that the efforts of less than one million skilled IT workers have driven Indian growth, rather than the more than 100 million factory workers who have propelled China up the economic ladder.

(Cont.)

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