Preliminary Thoughts on India's Economic Growth

J. Bradford DeLong
delong@econ.berkeley.edu
http://www.j-bradford-delong.net/

April 2001


A (Longer) Paper Draft

The conventional narrative of India's post-World War II economic history begins with a disastrous wrong turn by India's first prime minister, Jawaharlal Nehru, toward Fabian socialism, central planning, and an unbelievable quantity of bureaucratic red tape. This "license raj" strangled the private sector and led to rampant corruption and massive inefficiency. As a result, India stagnated.

As Gurchuran Das (2000) puts it, the desire to make sure that private industrial development conformed to social needs led to:

a nightmare… [a]n untrained army of underpaid engineers… operating… without clear-cut criteria, vetted thousands of applications on an ad-hoc basis… months in… futile microreview…. again lost months reviewing the same data… interministerial licensing committee… equally ignorant of entrepreneurial realities… also operat[ing] upon ad hoc criteria in the absence of well-ordered priorities…. seek approval for the import of machinery from the capital goods licensing committee… foreign agreements committee… state financial institutions. The result was enormous delays… years… with staggering opportunities for corruption…

Moreover, established business houses learned how to game the system with "…parallel bureaucracies in Delhi to follow up on their files, organize bribes, and win licenses…" Established businesses could use the first-come, first-served nature of the licensing process to foreclose competition: apply for your competitor's license before they did, watch their application be rejected because enough capacity had already been licensed in that industry and the government did not want to see overinvestment, and then simply sit on the license without using it to build any capacity.

Thus the consensus view among economists is that of Bhagwati (2000), who describes Indian growth before the reforms of the early 1990s as having been "stuck at a drastically low level" during "nearly three decades of illiberal and autarkic policies." He endorses Lal (1998) who attributes the failures of economic growth to two factors, the first and less important "cultural" and the second and more important "political." As Bhagwati summarzies Lal, India's bane is:

…the profesional 'povertywallas': the politicians who have incessantly mouthed slogans such as 'garibi hathao' … [Indira Gandhi is meant here: that was the major slogan of her 1971 election campaign] and the economists who write continually about 'abysmal poverty'. Both have generally espoused policies, such as defending public sector enterprises at any cost, discounting and even opposing liberal reforms, promoting white-elephant style projects that use capital-intensive techniques on unrealistic grounds such as that they would create profits and savings when in fact they have drained the economy through losses...

The rhetoric seems to suggest that India has suffered a unique series of disasters caused by bad judgment on the part of Jawharlal Nehru in being overimpressed with the Soviet Union's resource mobilization, bad company being kept by Indian colonial elites who listened too much to British Fabian socialists, and malevolent bad judgment exercised by politicians (chief among them Nehru's daughter Indira Gandhi) who saw India's poverty not as a problem to be solved through economic growth but as an interest group to be appeased in an attempt to seize and maintain political power.

Yet if you look at the growth performance of India before 1992 in the context of the general cross-country pattern, India does not appear to be an exceptional country. Its rate of economic growth appears average. Moreover, its values of the proximate determinants of growth appear average as well. Simplistic growth theory tells us that the proximate determinants of growth are (a) the share of investment in GDP (to capture the effort being made to build up the capital stock), (b) the rate of population growth (to capture how much of investment effort has to be devoted to simply equipping a larger population with the infrastructure and other capital needed to maintain the current level of productivity, and (c) the gap between output per worker and the world's best practice (to capture the gap between the country's current status and its steady-state growth path, and also to capture the magnitude of the productivity gains possible through acquisition of the world's best-practice technologies). Neither India's investment share nor its rate of population growth are in any sense unusually poor for an economy in India's relative position as of independence.

Figure 1: Actual and Predicted 1960-1992 Output per Worker Growth

The fact that pre-1990 India appears "normal," at least as far as the typical pattern of post-World War II economic growth is concerned, places limits on the size of the damage done to Indian economic growth since World War II by the Nehru dynasty's attraction to Fabian socialism and central planning. India between independence and 1990 was not East Asia as far as economic growth was concerned, to be sure. But it was not Africa either. It is average--suggesting either that India's poor growth-management policies were not that damaging, or rather that they were par for the course in the post-World War II world.

There are three ways to reconcile the widespread belief that the inefficiencies of the Nehru dynasty's "license raj" were very destructive for pre-1990 India. The first is to argue that the inefficiencies created by the Nehru dynasty were paralleled by similar mistakes of economic management in most of the countries of the world. If true, this would suggest that a different mode of explanation is needed to account for Indian economic policy and its failures in the first post-World War II generation. It is possible to attribute economic policy mistakes to bad ideology or bad judgment if such mistakes are exceptional. But if it is indeed the case that the same growth-retarding policy biases found in India were found throughout most of the world, then a different, more structural mode of explanation is called for. Why were governments attracted to an inward-looking, import-substituting path rather than an outward-looking, export-promoting one? What were the political benefits seen from a massive and monopolistic--and inefficient--publicly-owned enterprise sector? Why the fear of foreign capital and foreign technology?

At the ideological level, I believe we understand very well where the attachment to planning and near-autarky came from. But as an economist I believe that in almost all cases ideologies can become powerful and effective only if they reflect (in distorted fashion, perhaps) the material interests of politically powerful groups. And here I do not think I understand the political strength of the interest groups that supported policies of overregulation and hostility to foreign trade, either in India or elsewhere.

A second possibility is that the failure of economic policies in terms of promoting efficiency was in large part offset by successes in mobilizing resources. For example, India in the first post-World War II decades maintained a relatively high savings rate for a country in its development position. Total private savings as a share of national product were about 6 percent of GDP in the early 1950s, but rapidly rose to 15 percent of GDP in the early 1960s, and by the 1980s averaged 23 percent of income. As Jones (1994) pointed out, however, over most of the post-World War II period India's relatively high savings effort as a share of GDP translated into relatively low increases in the real capital stock because the price of capital goods was relatively high in India. A high price of capital goods means that a given amount of expenditure on investment buys little real capital.

Under this interpretation, the conventional wisdom about Nehru dynasty economic policies is too pessimistic because it sees only the efficiency costs, and does not see the potential gains from resource mobilization, of which a high savings rate would be one. This line of argument would be more convincing, however, if more Indians were literate. The failure of Indian governments to approach universal literacy, and the failures of Indian public health, suggest that the view that Indian central planning and public investment had massive benefits overlooked by economists' current conventional wisdom cannot bear too much weight.

Yet a third possibility is that the "license raj" was very destructive, destructive enough to cripple what would otherwise have been a true growth miracle along the lines of those seen in East Asia over the past two generations. It is plausible to speculate that in the long run India must have powerful growth advantages. For millennia it has had a culture that places a high value on formal education and literacy. One of the legacies of the British Empire is a large chunk of the population literate in what is rapidly becoming the world's lingua franca. People who can process English-language information may well become one of the world's production bottlenecks over the next generation. India is very well-placed to take advantage of high demand for English-readers, -speakers, and -writers. Add to these the likely benefits of democracy in promoting accountability and focusing politicians' attention on their constituents' welfare, and a case can be made that India ought to have been one of the fastest growing economies of the world not just in the 1990s but in previous decades as well.

To my mind, all three of these ways of assessing Indian economic growth in the first post-independence generation are still live possibilities. I do not yet have the information to enable me to think that I can firmly establish that the weight of probability lies on any particular one of them.


If Indian economic growth between 1950 and 1990 appears more or less ordinary, no one believes that post-1990 Indian economic growth is anything like ordinary. In the 1990s India has been one of the fastest growing economies in the world. At the growth pace of the 1990s, Indian average productivity levels double every sixteen years. If the current pace of growth can be maintained, sixty-six years will bring India to the real GDP per capita level of the United States today. The contrast between the pace of growth in the 1990s and the pace of growth before 1980--with a doubling time of fifty years, and an expected approach to America's current GDP per capita level not in 2066 but in 2250--is extraordinary.

Moreover, this acceleration in Indian economic growth has not been "immiserizing." Poverty has not fallen as fast as anyone would wish, and regional and other dimensions of inequality have grown in the 1990s. But it is not the case that India's economic growth miracle is being fueled by the further absolute impoverishment of India's poor.

The fact that India's growth performance seemed to ordinary in world context for the first three post-independence decades makes India's acceleration of economic growth since that much more exciting. With other countries that have experienced growth miracles, it is very difficult to imagine how to translate their experience into lessons for other developing countries. How is a country that seeks to emulate the Italian growth miracle to reproduce the close transport and trade links with the northwest European core? How is a country that seeks to repeat the growth miracle of Taiwan to attain the initial condition of an astonishingly equal distribution of land? How is a country that seeks to follow the Japanese model to assemble--more than one hundred years ago--the national elite consensus for structural transformation and economic development that developed among those who ruled in the name of the Emperor Meiji?

It cannot be done. That is why the Indian case is so interesting, because it shows an example of an economy that was relatively stagnant, and did suffer from mammoth growth blockages, but that managed to turn all that around, and to turn all that around in a short period of time.

What are the sources of India's recent acceleration in economic growth? Conventional wisdom traces them to policy reforms at the start of the 1990s. In the words of Das (2000), the miracle began with a bang:

…in July 1991… with the announcement of sweeping liberalization by the minority government of P.V. Narasimha Rao… opened the economy… dismantled import controls, lowered customs duties, and devalued the currency… virtually abolished licensing controls on private investment, dropped tax rates, and broke public sector monopolies…. [W]e felt as though our second independence had arrived: we were going to be free from a rapacious and domineering state…"

Yet the aggregate growth data tells us that the acceleration of economic growth began earlier, in the early or mid-1980s, long before the exchange crisis of 1991 and the shift of the government of Narasimha Rao and Manmohan Singh toward neoliberal economic reforms. To the extent that we trust aggregate national-level income accounts, it is clear that by 1985 Indian aggregate economic growth had undergone a structural break.

Whether that means that we should look for key causes of India's growth acceleration in the years immediately before 1985 depends on how we conceptualize that structural break. Was it the result of a once-and-for-all change that put the economy on a new, different path? Or when we say "structural change" are we referring to an ongoing process of waves of reform, each of which requires that the political coalition behind reform be reassembled, each of which could fail, and the failure of any wave of reform could return Indian growth to its pre-1980 pace?

Depending on how you answer this question, you focus on one of two time periods. If you look for a single structural break, you look at the last years of Indira Gandhi's rule and at Rajiv Gandhi's administration, the years when economic reform and economic liberalization became ideologically respectable within the Indian government and policies that a development-seeking government ought to pursue to some degree.

If you look for ongoing waves of reform, each of them debated and debatable, then you are more likely to focus on the early 1990s--when the exchange crisis served as a trigger for larger-scale reforms by the government of Narasimha Rao than had been previously contemplated--and today, when one key item on the table is reform of India's budget so that claims on social resources in excess of production do not lead to an inflation crisis.

Figure 2: Indian Real GDP per Capita Level and 1962-1980 Trend

Source: IMF.

 

In the 1980s Rajiv Gandhi's Congress party won 77 percent of the seats in the Lok Sabha in the election that followed his mother's assassination by her bodyguards. During Rajiv Gandhi's administration India came as close to an elected dictatorship as it has ever been. And as the visible representative of a new Indian generation--uncorrupt, interested in reform, focused on applying modern managerial techniques--this last Nehru-Gandhi government ought to have had the power to carry out whatever plans of reform its leader could decide on.

Yet paradoxically this proved not to be the case. Factions within the Congress Party seemed not to believe that their interests were bound up with the success of their leader and his policies. So the reform plans carried out under Rajiv Gandhi were hesitant, and less bold than one would have expected.

The economic reform program that Rajiv Gandhi's government decided upon focused on (a) encouraging capital imports and commodity exports, (b) a modest degree of industrial deregulation, and (c) a modest degree of tax system rationalization. In the government's first year it eliminated quantitative controls on imports of industrial machinery, and cut tariffs on imports of capital goods by 60%. (I know: it is hard to think of a reason for a country like India to have any tariffs or restrictions on imports of capital goods whatsoever. But you have to crawl before you can walk.) Taxes on profits from exports were halved as well. The Rajiv Gandhi administration reduced the number of industries subject to government capacity licensing from 77 to 27 in 1988. And in its last days the government began to end price controls on industrial materials like cement and aluminum.

The consequence of this first wave of economic reform was an economic boom. Real GDP growth averaged 5.6 percent per year over the Rajiv Gandhi administration, while real rupee exports grew at 15 percent per year. The country's net capital import bill rose to three percent of GDP by the end of the 1980s. This growing foreign indebtedness--more than a quarter of exports were going to pay international debt service by the end of the 1980s--set the stage for the exchange crisis of 1991. Nevertheless, it is hard to argue that India would have been better off in the 1980s had it not borrowed from abroad. (It is easy to argue that it would have been better off had it followed a more realistic exchange rate policy in 1989 and 1990.) With limited exports, foreign borrowing is an extremely valuable way to finance capital goods imports. If Lee (1994) is correct in arguing that such capital goods imports are extraordinarily productive sources of technology transfer, then even extreme vulnerability to international financial crises as a result of foreign borrowing is a cost that weighs lightly in the balance relative to the benefits of one's firms being able to buy more foreign-made capital on the world market.

By contrast, Narasimha Rao's Congress Party won only 43% of the seats in the Lok Sabha in the 1991 election. For five years, however, he maintained his hold on the Prime Ministership and a narrow working majority. Varshney (2000) points out that in some respects the failure of the Congress Party to achieve a majority in the Lok Sabha in 1991 is deceptive, and understates the strength of his government. By 1991 the Hindu nationalist BJP had come to prominence in Indian national politics (see Hansen (1999)). It was the second largest party in the Lok Sabha after the 1991 election. All of the other minor parties--the Janata Dal, the CPI(M), and so forth--had to reckon that upsetting the Rao government and the Congress Party might well lead to the coming to power of the BJP, which was not to any of their taste. Challenging any of the decisions of the Rao government might bring it down. Hence, as Echeverri-Gent (1998) puts it, because it was so weak--because it was a minority government--the Rao government could be very strong.

Under the Rao government, tariffs were reduced from an average of 85 percent to 25 percent of import value. The rupee became convertible. By the mid-1990s total foreign trade--imports plus exports--amounted to more than 20 percent of GDP. Foreign direct investment was encouraged, and grew from effectively zero in the 1980s to $5 billion a year by the mid-1990s. The government walked rapidly down the path of reform that Rajiv Gandhi's government had tiptoed cautiously onto.

And after the Rao government, reform had become politically popular--indeed, inescapable for governments that wanted to take their share of credit for India's relatively rapid economic growth.


What comes next for India? The governments that followed the Rao government--first the United Front and now the BJP-led coalition--have continued reform and liberalization, albeit not as rapidly as one might have hoped given the pace of economic reform in the first half of the 1990s. But the governments of the second half of the 1990s have failed to make progress in bringing social claims on output into balance with productivity. The total deficits of the public sector--state and local governments, national government, and state-owned enterprises together--now amount to more than 10 percent of GDP. Unless this budget deficit is reduced and the rate of growth of the debt-to-GDP ratio brought under control, an inflation crisis at some point in the future seems likely once potential lenders to the Indian government decide that its debt-to-GDP ratio has risen too high for comfort.

Whether Indian real economic growth continues at the rapid pace of the past decade even if reform slows down and government budget deficits continue will tell us much about the resiliency of the growth process. If Indian real economic growth does continue to be rapid even in the face of erratic public-sector performance, that will suggest to us that the most important factor that changed in India over the 1980s had more to do with entrepreneurial attitudes and a belief that the rules of the economic game had changed than with individual policy moves. If Indian real growth slows, that will suggest to us that the potential benefits in terms of higher growth from each act of policy liberalization are quickly taken up and exhausted, and that successful reform requires not just that reformers be strong at one moment but that they institutionalize the reform and liberalization process over generations.

In either case, the world's economists now have an example of an economy that did not have remarkably favorable initial conditions but that has sustained rapid economic growth over two decades. To those for whom the East Asian miracle seemed out of reach--for whom the advice to emulate South Korea seemed so unattainable as to lead to despair--advice to emulate India may well prove more useful.


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