India’s slowing economy
THE optimism generated by the glowing performance of the economy with an average rate of growth of gross domestic product exceeding 6% per year during 1992-93 to 2000-01 after the crisis year of 1991-92 has pretty much evaporated. In fact this average growth conceals a very worrisome trend: after reaching a peak of 7.8% in 1996-97, annual growth rates have fluctuated between 4.8% and 6.6%. Most recent official data show that the rate of growth of GDP in 2000-01 plummeted to 5.2% from 6.4% in the previous year. All sectors except a minor one experienced a decline.
In its mid-year review of the economy, the Confederation of Indian Industry projected a growth rate of 5.25% for the current fiscal year. It would seem that the economy is ominously converging to a 5% annual growth which is the early 21st century version of the infamous Hindu rate of growth of 3.5% in the three decades 1950-80.
The slowdown in India’s growth is gloomy enough, given that no significant reduction in poverty is possible without sustained and rapid growth. But what makes it worse is that it is occurring when the global economy is also slowing down, with an unusual simultaneous slowdown in all major industrial economies. The Japanese economy, in a long slump after the collapse of its real estate bubble, is tipping into a recession again.
The global slowdown started considerably before the economic shock, following terrorist attacks on the World Trade Center in New York on 11 September 2001. The economic shock by itself would not have made much of a dent on the $10 trillion economy of the USA. But by sapping the confidence of consumers, producers and investors, and creating great uncertainty about the future in their minds, the attacks have made the possible economic effects far worse and more lasting.
It is cold comfort that India, being relatively insulated from the global economy compared to other countries, will be much less affected by a global slowdown or for that matter by any financial turmoil. This is because the insurance from external shocks that India bought through such insulation has exacted a high price in terms of foregone growth in the past. Greater integration with the world economy will not only help India achieve faster growth in the future, but the gains from such integration will be much greater in a growing world economy than in a crawling one.
The constraints on achieving a more rapid growth are mostly self-inflicted domestic ones, largely of political economy.1 Most of the constraints and their political-economy roots are well known. For example, one of the contributory causes of the macro-economic crisis of 1991 was the combined fiscal deficit of central and state governments, which, at nearly 10% of GDP was unsustainable. If the deficit of non-financial public sector enterprises is included the figure will be even higher. Naturally the first task of reform in 1991 was to reduce the deficit. Indeed there was a downward trend (but for 1993-94) in the deficit from 10% to 6.8% between 1990-91 and 1996-97. Then the trend was reversed and in 2000-01 the deficit was back to around 10%.
The needed actions for reducing the deficit, both on the revenue side (e.g. tax reform, accelerating the adoption of a sensible value added tax system, improving tax compliance) and on the expenditure side (downsizing the government, reduction of subsidies, introduction of user charges for goods and services supplied by the public sector) are no mystery. Without undertaking them, but merely enacting a Fiscal Responsibility Act is unlikely to change the situation.
The fact that there was never any productive or distributive rationale for most of the subsidies, and even those that were meant for the poor (e.g. subsidies of the public distribution system) did not accrue to them in any significant measure is well established. But none of the political parties, be they in power at the centre and states or in opposition, are inclined to tackle the problem.
Insulation from the world economy, enforced through the license permit-raj, was costly in terms of foregone growth and reduction in poverty, apart from infecting the body politic with the cancer of corruption. It is no surprise that the reforms of 1991 dismantled investment and import licensing, removed dysfunctional controls on capital issues and foreign investment. Tariffs were reduced from an average of 87% to 25%.
However, further trade liberalization is running into resistance. Even the trade reforms of 1991 did not go far enough by leaving in place the quantitative restrictions (QRs) on imports of agricultural commodities and consumer goods. Only the pressure from having to fulfil commitments India undertook as a signatory to the Uruguay Round agreement of 1994 forced their removal by 1 April 2001. However, the removed QRs have been replaced by relatively high tariffs. The commerce minister has even promised to use all steps available under the rules of the World Trade Organization to protect the Indian economy from import competition.
In fact, India is the fourth largest user among members of the WTO of antidumping measures. The most recent example is the imposition of antidumping duties against Chinese imports. It is sad but true, that with the recent hikes in tariffs after the abolition of QRs India is one of the most protected economies in Asia. Although the finance minister in his budget speech of February 2001, reiterated his promise (and that of his predecessors) to bring down India’s tariffs to East Asian levels, it is unlikely it will happen anytime soon.
India is not a favourite destination of foreign investors. Total inflows of foreign direct investment (FDI) was around $2.2 billion in 1999, compared to Thailand’s $6 billion and China’s $40 billion. The dispute with Enron, regardless of its merits and how it is eventually resolved, will only deter foreign capital from coming to India.
The latest survey of executives of 1000 global companies by the consulting firm A.T. Kearney found that investors, though generally sanguine about India, are still reluctant to invest because of a perception that it has done less than other emerging markets to reduce fundamental obstacles to investment. Of the executives surveyed, the majority of those with existing investments said that they were likely to add to those investments. But an even larger majority of companies without existing investment said that their likelihood of investing in India was low. In their view the major obstacles to investment in India were bureaucratic hurdles and slow pace of reforms.
India’s rigid labour laws have long been identified as obstacles to growth and equity. The late Professor P.C. Mahalanobis had pointed out as far back as 1969 that India’s labour laws were ‘probably the most highly protective of labour interests in the narrowest sense, in the whole world. There is practically no link between output and remuneration; hiring and firing are highly restricted. It is extremely difficult to maintain an economic level of productivity or improve productivity. The present form of protection of organized labour, which constitutes, including their families, about five or six per cent of the whole population, would operate as an obstacle to growth and would also increase inequalities.’2
The tiny labour aristocracy identified by the professor is employed in the public and organized private sectors. They do not represent the interests of the overwhelming majority of India’s workers, who are either self-employed or work as casual labour, and who do not enjoy job protection or any other myriad benefits conferred on the aristocracy by the labour laws. The aristocracy also consists of members of one or the other of the labour unions affiliated with ruling and opposition political parties. The recent one-day strike by this aristocracy against privatization is an egregious example of its political salience. In fact, it is an obstacle to the adoption of policies that reduce poverty by creating more productive jobs for the majority of the growing labour force.
The political clout of the labour unions has been particularly effective in preventing privatization of public sector enterprises (PSEs). In the five decades since Independence, the public sector has appropriated half or more of total investment and embarked on activities for which there was absolutely no social rationale for their being undertaken by the public sector (e.g. running hotels and airlines).
This socially irrational unbridled expansion has come at the expense of expenditures on vital activities for which there is no effective alternative for the public sector. Such activities include provision of health care, sanitation and hygiene, safe drinking water and education of acceptable quality for the poor, particularly the rural poor. Instead of supporting privatization of those PSEs for which there is no compelling social rationale, and ensuring that those remaining as PSEs are run efficiently, privatization of any PSE is being resisted by political parties and their unions. The resistance is sometimes justified on the totally irrelevant ground that the PSE proposed for privatization is making profits!
Resistance to meaningful privatization is one, and not the only reason for the lack of significant progress in assuring an adequate, inexpensive and reliable supply of infrastructural goods and services such as power, transport and telecommunications. This is not to deny that there has been some progress. For example, the private sector is now allowed to construct and operate ports and toll roads. The establishment of state regulatory authorities for power could depoliticise the setting of power tariffs. Still there is a long way to go and without well-functioning infrastructure prospects for rapid growth and for attracting FDI are not good.
Reforms since 1991 have considerably eased the entry of domestic and foreign firms into the industrial sector. However, the legal hurdles continue to hamper the exit of unviable enterprises. The experience with the Bureau of Industrial and Financial Restructuring in ensuring orderly exit of sick enterprises is extremely discouraging. It remains to be seen whether the proposal of the finance minister to exempt firms with less than 1000 workers from having to seek permission from the government for going out of business in return for higher severance payments to retrenched workers will become law.
Let me conclude with a brief remark on India’s continuing reluctance to endorse the start of a new round of multilateral trade negotiations. It is true that serious problems have arisen in the implementation of the commitments undertaken as part of the Uruguay Round agreement. However, by insisting that these be addressed prior to the start on a new round, India is making a serious mistake.
First of all, economic slowdown such as the one afflicting the world now is the breeding ground for protectionists everywhere. A new round that promises further reductions in trade barriers everywhere is an effective way to mobilize exporting interests everywhere against the protectionist threat. India stands to lose a lot if the world trading system becomes less liberal and more protectionist. Second, in the absence of a new round, the drive towards concluding regional free trade agreements will gather further momentum. Such agreements are a threat to India’s trading interests since it is unlikely to be invited to join any of them.
1. The McKinsey Global Institute in its recent report on India asserts that if the 13 policy changes it recommends are implemented, GDP growth of 10% per year is within India’s reach by 2004-05. These policy changes, such as tax reform, removal of dysfunctional restrictions such as small-scale industry reservation and on foreign direct investment, creating a regulatory environment that promotes competition and privatization are on every reformer’s agenda. However, the report dismisses infrastructural bottlenecks and inflexible labour laws as minor constraints and as such, should not become the sole focus of policy attention. I did not have access to the analysis supporting the report’s diagnoses and prescriptions for the ailing Indian economy. I find this dismissal unpersuasive and the claim of feasibility of reaching and sustaining a 10% growth per year in four years not credible.
2. Prasanta Chandra Mahalanobis, ‘Asian Drama: an India view’, Sankhya, The Indian Journal of Statistics, Series B, 31, Parts 3 and 4, p.442, 1969.