Why Growth Matters (30 page)

While our analysis has continually related Indian experience on growth and its impact on poverty to other developing countries, we now return to Indian policy performance and prospects. Recall that by the 1980s, Indian economic performance was widely seen to be abysmal. India's per capita income had grown by a paltry 1.5 percent annually; the country therefore also failed to attack poverty and the (mis)fortunes of the underprivileged. The economic dimension of Prime Minister Jawaharlal Nehru's tryst with destiny remained elusive.

The counterproductive policy framework, most visible in the license-and-permit raj, had made India a laughingstock around the world. Could anyone take seriously a country that would not let companies expand license capacity and would prevent diversification of production? These are only two of the many irrational restrictions that undermined initiatives as if India had suddenly turned into the Soviet Union. These astonishingly foolish policies, and the abysmal growth rate that they entailed, were crying out to be changed, so that India would finally begin to fulfill Nehru's dream of his country's economic destiny.

Having been converted to the view that India could not go on the way it had, Prime Minister Narasimha Rao enlisted Dr. Manmohan Singh (the current prime minister) as his finance minister. Together this team quickly dismantled investment and import licensing, and opened the economy from virtual autarky to significant openness to direct foreign investment. Other reforms followed shortly. Tariff barriers were slashed; direct and indirect taxes were streamlined; private entry into airlines and telecommunications was permitted; private domestic and foreign entry
into banking and finance was increased; and the reservation of a large number of products for exclusive manufacture by small enterprises was largely abolished. These were real, not symbolic, actions with a huge impact.
¹

Growth accelerated and poverty began to fall significantly. And as we have demonstrated (Myth 3.3), the fortunes of the Scheduled Castes and Scheduled Tribes also registered improvement. Increased prosperity went hand in hand, pretty much as it had been hypothesized when the Plans began in India over half a century ago, with the goals of reducing poverty and uplifting the underprivileged. Even on the inequality front, to which the freewheeling critics shifted in retreat, the evidence is mixed, to say the least. Rather than join the bandwagon against reforms, the question now is: How does India broaden and intensify them so that it may improve upon even growth-centric Track I reforms, thereby getting yet better results on all dimensions?

In fact, the increased revenues that have followed the Track I reforms have meant that India can now genuinely expand social spending to finally begin what we have called Track II reforms in earnest. These reforms take the shape of health care, education, and transfers of income directly or via employment in public works. Indian reforms are now Track I reforms, which as our analysis in
Part II
showed require further changes to induce greater growth and still greater impact on poverty, as well as Track II reforms, which we have analyzed in depth in
Part III
. We are confident that if the government implements the reforms we have outlined in
Parts II
and
III
, we can be optimistic about India's medium- and long-term prospects.

Before we consider the medium-and long-term prospects, however, we must address the current pessimism that afflicts the vast majority of commentators on the future course of the Indian economy. Some of this pessimism reflects worries about the short-term consequences of the post-2008 crisis. But the fact is that virtually every economy, certainly China, Japan, the European Union, and even the United States, has
suffered from the crisis. India is not leading the crisis-impacted decline and has indeed gone on to recover faster than most other countries.

Pessimism has also gripped many observers of India in the wake of the approximately 2 percentage-point decline in the growth rate in the financial year 2011–2012, two years after the country had fully recovered from the financial crisis. Many commentators have expressed the view that we are now witnessing the beginning of the end of the Indian growth story. But these commentators greatly overstate their case.

What we have witnessed is a short-term decline originating in two transitory factors: thirteen consecutive hikes in the interest rates by the Reserve Bank of India (RBI), the country's central bank, and policy paralysis in the central government. The interest rate hikes originated in persistent inflation while policy paralysis resulted from every central ministry freezing up prudentially in response to an outbreak of massive corruption scandals.

Both factors have already begun to go into remission. The RBI has begun to ease up, allowing the interest rate to decline. Moreover, the paralysis has yielded to yet more reforms. As Panagariya (2012b) details, Prime Minister Singh has seized the initiative from the Congress Party leadership to reclaim his legacy as a reformer and announced a series of liberalizing steps, including opening multibrand retail to direct foreign investment (DFI) up to 51 percent and substantially reducing the diesel subsidy. He has also opened civil aviation to DFI up to 49 percent and raised the DFI cap in broadcasting from 49 percent to 74 percent. The prime minister has even announced his decision to introduce cash subsidies, as advocated in this book and in Panagariya (2008a, 2012c).

Indeed, pessimists who base their fears on the reforms' having come to a standstill misread both history and current developments. The reforms had come to a standstill as far back as May 2004, when the United Progress Alliance first came to power. But the decline in the growth rate is quite recent. Besides, even prior to the announcements of the measures just noted, we had begun to see slight progress in the reforms. Reversing its 2004 decision, the government recently deregulated gasoline prices, a much-awaited measure to improve efficiency as well as to contain the fiscal deficit. In a similar vein, it had successfully abolished the
51 percent FDI cap on single-brand retail, leading the Swedish retail furniture giant IKEA to announce plans to invest nearly $2 billion in India.

Some commentators argue that coalition politics in India has led to paralysis. But this argument is not borne out by evidence. Whereas Prime Minister Rajiv Gandhi could implement only small reforms despite a three-fourths majority in the Lower House of the Parliament during the second half of the 1980s, Prime Minister Narasimha Rao under a minority government and Prime Minister Vajpayee under a coalition government were able to introduce far-reaching reforms during the 1990s and early 2000s. Besides, with the emerging consensus on the importance of growth as the essential stepping-stone to combating poverty and advancing other social agendas, the road to reform is likely to be smoother instead of rougher.

Therefore, we are not shaken in our optimism for India's prospects for the medium and long term. Perhaps we are biased in our optimism: we were economic theorists and later turned to policy analysis that would help transform India and the world. If we were pessimists, this shift would be irrational: Unless we expected that we could change the world, why turn to policy analysis? But bias aside, we can provide objective reasons why we believe that good days lie ahead for India.

      
1.
  
There is little doubt that Indian reforms are irreversible and can only go forward. A large number of young Indians are conscious of the benefits that reforms have brought to them and to the country. There is no politically important constituency that can thrive on anti-reform rhetoric in the years to come. It is telling that so many political parties tried to organize protests against the September 2012 package of reforms that included the opening of multibrand retail to foreign investment and cut the diesel subsidy but failed to mobilize public support.

      
2.
  
Many have also noticed that the anticorruption mass movement, led by activist Anna Hazare and several social activists, is far bigger than the Occupy Wall Street demonstrations. But what sets it apart is that it is against corruption,
not
against reforms. In fact, more reforms (extended to new areas, such as mining rights) rather than less are what the demonstrators have called for.

      
3.
  
Besides, as we have argued at length when dissecting the numerous anti-reform myths that the critics repeat ad nauseam, the critiques rarely go beyond assertions, and increasingly, the refutation that we and others provide are being read and the old anti-reformers are now losing the iconic status that in the past was accorded readily to our prominent intellectuals.

But if public opinion will not sabotage the reform process, what do “objective” factors tell us about India's growth prospects? Here, too, three fundamental facts work to India's advantage.

      
1.
  
Growth depends on two underlying factors: savings (or investment) and the productivity of the investment. The Soviet Union had phenomenal savings rates but little productivity, so it went steadily downhill despite its “blood, sweat, and tears.” The East Asian economies had phenomenal savings rates but also high productivity, so they grew at “miraculous” rates. Fortunately, India's savings rate has steadily risen. It is already 32 percent to 33 percent of GDP and is expected to rise further.

      
2.
  
As for productivity, India has profited, and will continue to profit, from two factors. First, India has steadily opened up to the world economy. There is ample evidence that openness pays dividends. The second factor is India's diaspora, which brings dividends through a variety of channels. Working in senior positions in numerous large companies in the United States, the diaspora bring these companies to the shores of India, linking the country to the latest technologies. There are also synergies
between Bangalore and Silicon Valley. Indian entrepreneurs are also a source of vast remittances that now amount to more than $50 billion annually. The presence of the highly professional and successful diaspora in the developed world has also promoted a friendly image of India, translating, for example, in the Indo–US nuclear cooperation deal. Finally, with their analysis and advocacy, the diaspora have kept pressure in favor of continued reforms.

      
4.
  
Ironically, the recent slowdown in the economy has suddenly refocused the attention of one and all on growth. From the times when 5.5 percent growth was viewed as an impressive achievement, India has arrived to the point where the drop to this rate in the first two quarters of 2012 was seen as a disaster. Even many traditional skeptics who argue that higher growth does not help the poor have begun to complain that the declining growth is hurting them. In turn, Prime Minister Singh has been able to successfully use the occasion to convince Congress President Sonia Gandhi that there is no alternative to Track I reforms for the revival of growth, which alone can yield the steadily rising stream of revenues necessary to finance the Track II reforms that have been her sole focus in recent years. The return of Track I reforms is, of course, a major source of optimism for us.

Finally, how will Indian growth fare compared to China's? Amartya Sen thinks this is a “stupid” question.
²
We reject this view. China's huge growth rate has produced for China dividends in international politics. It gives China an advantage over India in influencing economic outcomes in its favor. So, where does India stand vis-à-vis China?
³

      
1.
  
China has been rapidly increasing its defense spending. It is trying to match its “hard power” to the “soft power” that its phe
nomenal growth rates have earned it. But this has gone with its increasingly aggressive behavior in the East China Sea, in the South China Sea, and in its activities in the regions surrounding India. India is thus constrained to react by spending more on its defenses. Which country will be damaged more by this developing rivalry and defense spending remains to be seen.

      
2.
  
China has been growing very fast, so its demand for labor in Guangdong and nearby provinces on the east coast has been rising rapidly as well. But its labor supply is not rising anywhere as fast because of its one-child policy and the restraints on rural migration to the urban areas including export processing zones. So, wages have been rising, with China transitioning from a Marxian reserve army of labor available at a constant real wage to a situation of rising wages with growth. This slows down growth as well. By contrast, India is behind the curve and its demographics imply that it will have an ample supply of young labor, which can place India on the growth trajectory of the earlier China with abundant labor.

      
3.
  
China's authoritarian regime, compared to India's democracy, leads to two important consequences that militate in India's favor. First, China is fearful of
samizdat
:
⁴
it cannot afford to have software develop to a point where the people can communicate freely and even dare to undermine political control. The result is that the PC (the personal computer, and all that it implies today) is incompatible with the CP (the Communist Party). But much technical progress comes through software developments. So, India, which is a freewheeling democracy like the United States, has an enormous advantage over China.

      
4.
  
The other implication of China's authoritarianism is that as the bourgeoisie develops and seeks political rights, China faces a real dilemma. Will the country respond to these demands in the fashion of the suppression at Tiananmen Square, or will the authorities be accommodating? In the former case, China will surely implode at some stage. The Chinese future therefore has
a big question mark on it. By contrast, India will continue to move along, albeit at a slightly less hectic pace, with its “agitation and response” model, whereby grievances are aired and government responds. Slower but surer. And after all, democracy must be judged not just instrumentally, in terms of its economic consequences, but also as an end in itself.