An Indian economic miracle?

• Author: Lal, Deepak

In explaining the acceleration in Indian growth, and to judge if an Indian economic miracle is on its way, it is first necessary to establish when this acceleration began, as this is still subject to controversy. Second it is necessary to identify the sources of this acceleration and to see to what extent these are the results of policy. Third, to provide some reading of the tea leaves until 2030, it is necessary to outline the current constraints on growth. But before that, the current change in Indian economic fortunes needs to be put into historical perspective. This is done in the first part of this article, followed by the next three parts, which deal with the other three broad themes outlined above. As this article is in honor of Angus Maddison, I rely wherever possible on the growth accounting method that he has made so much his own.

Repression, Crisis, and Reform

Like many other developing countries, India at its independence in 1947 followed an inward-looking heavy industry biased industrialization strategy. This was in part a reaction to the laissez faire and free trade policies followed by the British Raj in the 19th century, which were erroneously thought to have led to India's continuing stagnation. Though contemporary research has questioned the validity of this nationalist and often Marxist perspective, it still colors the minds of Indian elites. Like elites in many other developing countries, they have been haunted by their helplessness against the Western assault in the Age of Imperialism. They have sought (like the Chinese) a middle way between the modernity promised by Western globalizing capitalism and their own ancient traditions. Unlike the Japanese, who saw that they could modernize while keeping their traditions, there were two alternative Indian responses. The first represented by Gandhi was to hold on to tradition, and to reject modernity. The second by Nehru was to reconcile modernity with tradition by adopting a form of Fabian socialism. This development model represented a compromise between the Enlightenment strand promoting modernization and the Romantic revolt against the Enlightenment, represented by the younger Marx and the English socialists like William Morris (see Lal (2006c).

At Independence in 1947, with Gandhi dead soon thereafter at the hands of an assassin, it was Nehrn's ideas that determined India's economic policies. They entailed massive dirigiste interventions in the form of centralized planning and a draconian set of economic controls on foreign trade, capital flows, and prices. They, however, yielded a higher growth rate than that experienced under the Raj (Table 1). This acceleration of growth was based on three factors.

The first was a rise in public social overhead investment, particularly on irrigation, and from the late 1960s on R & D in agriculture. The British Raj had been hamstrung in raising public investment as it was always wary of a nationalist revolt that might be provoked by any rise in taxes for its finance. With no such constraint faced by independent India, public investment, which had averaged about 2.2 percent in the interwar period, rose to nearly 7 percent of GDP by 1960-61.

The second was a rise in the rate of savings and capital formation in the economy compared with the century of alien rule. Gross domestic savings which were about 8 percent of GDP at Independence rose to 11.6 percent by 1960-61, and by 1999-2000 were 22.3 percent of GDP.

The third was the rise in population from 1921 induced by a declining death rate, which led to a rising labor force in agriculture. It had grown by 12.6 percent between 1901 and 1940, but rose by 25.4 percent between 1950 and 1970 (Lal 2005: Table 7.4). This growth spurt, on Boserupian lines, (Boserup 1965; Lal 2005, 2006) led to an intensification of agriculture in terms of an increase both in the labor and capital input per unit of land, and a rise in the annual growth rate in agriculture from 0.44 percent between 1900 and 1947 to 3.3 percent between 1950 and 1965. The elasticity of agricultural output with respect to rural labor remained constant at about 2.5 in both the pre-Independence period (1900-40) and the post-Independence period (1950-70), while that of capital to labor rose from about 1 to 2.54, as predicted by the Boserup model (Lal 2005: Table 7.4).

The economic repression under the Nehruvian settlement, however, had led by the mid-1960s to a "quiet crisis" in India (Lewis 1962), with the Hindu rate of growth of 3.5 percent and population growing at 2.2 percent until the early 1980s, yielding meager annual rises in per capita income of just over 1.3 percent. This performance failed to make any marked dent on India's ancient poverty.

The first signs of crisis appeared in agriculture, as the Boserupian process, with an unchanged agricultural technology, soon faced diminishing returns. The food crisis of the 1960s forced the government to reverse its previous neglect of agriculture, based on the faulty prescriptions of the Arthur Lewis model that the route to growth in a labor surplus economy was through massive industrialization, with agriculture being left alone until the surplus labor had been worked off. India then adopted the new technology embodied in high-yielding seeds and large inputs of fertilizers and water that led to the Green Revolution. The average annual agricultural growth rate had slowed to only 1.8 percent from 1960 to 1973. The Green Revolution of the 1970s, which was by and large a wheat revolution, raised the growth rate of agriculture to about 2.9 percent from 1973 to 1999. Thereafter, it has slowed as the area under high-yielding varieties has reached its limits, with the potential irrigable area having been utilized and diminishing returns setting in on the new Green Revolution technology.

Industrial growth, which had been 6.8 percent between 1950 and 1965 slowed to 4.3 percent between 1976 and 1980, as the limits of import substitution were reached. There was a foreign exchange crisis in the mid-1960s that led Indian economists to question the dirigiste, inward-looking path India had taken. This reaction was strengthened by the neoclassical resurgence in the 1970s, which questioned the intellectual basis of postwar development economics (Lal 1985, Little 1982). But it was the switch made by Deng Xiaoping from the plan to the market in China, in 1978, that probably most concentrated Indian minds.

With its tradition of Gladstonian public finance, India had avoided the chronic macroeconomic imbalances associated with dirigisme. However, the creation of a rent-seeking society, through the microeconomic distortions introduced by public policy in the planning era, gradually led to a fiscal crisis (Lal 1987).

The first sign was the growth of the underground economy, variously estimated to be 18 to 45 percent of GDP. Second, government revenue, which had risen from about 11 percent of GDP in 1960 to about 20 percent in 1986, stagnated thereafter. Public expenditures rose from about 19 percent of GDP in 1960 to more than 32 percent by 1986. Thus, the public sector borrowing requirement (PSBR) rose from about 8 percent of GDP in the 1960s and 1970s to more than 11.5 percent in 1990, the year preceding the crisis and reform (Lal 2005: Table 12.1). Third, the growing fiscal crisis was met by internal and external borrowing and, finally, by levying the inflation tax. Inflation, which had hovered around 4-5 percent except for years of drought, rose steadily from 1988 to reach a peak of nearly 14 percent in 1991, a year with a bumper harvest. The internal pubic debt rose from 42 percent of GDP in the early 1980s to nearly 58 percent in 1991, as the government tried to meet its fiscal bind through promoting large inflows of short-term capital from the Indian diaspora after 1985 (Lal 9005: Table 12.1b). When they took fright at the deteriorating fiscal and inflation position and moved their money out of India, a Latin American style crisis was finally triggered.

In the dash for growth, a halfhearted liberalization effort began with Rajiv Gandhi's election, after his mother's assassination in 1984. It raised the growth rate, but this liberalizing impetus soon petered out, as his government was caught in a web of corruption charges. The dash for growth did generate an unsustainable boom, with GDP growing at 7 percent in 1989. A weak coalition eame to power in 1989 and was unable to deal with the impending crisis. When it collapsed and a minority Congress government with Dr. Manmohan Singh as the finance minister came to power in 1991, the country was essentially bankrupt, with foreign exchange reserves barely sufficient to finance 10 days of imports, galloping inflation (by Indian standards) of 14 percent, a PSBR of nearly 12 percent, and an impending growth collapse.

The new finance minister began the reversal of nearly a century's creeping--and under Mrs. Gandhi, galloping--dirigisme. The PSBR was squeezed by about 2 percent of GDP with little pain. The Permit Raj began to be dismantled with the virtual ending of industrial licensing, and with the removal of import controls (except on consumer goods, which were only removed in 2001 when they were declared illegal by the World Trade Organization). The import-weighted tariff was cut from an average of 87 percent in 1991 to 27 percent in 1996. The rupee was devalued initially by about 20 percent. Direct foreign investment was once again welcomed, though it was still controlled and restricted to 51 percent foreign ownership.

Even these papal reforms lifted the growth rate, exports, foreign reserves, and inflows of foreign capital. The savings and investment rates rose and the incremental capital-output ratio fell from a pre-reform average of 4.5 to 3.8 in the post-reform period, as the reforms increased economic efficiency. Poverty rates, after rising during the short period of stabilization, came down substantially.

With...