IN 1998, the Gross Domestic Product (GDP) of China stood at $1.84 trillion in terms of 2013 dollars.¹ The country was ranked seventh according to GDP, behind the United States, Japan, Germany, United Kingdom, France and Italy in that order. Fifteen years later, in 2013, China’s GDP had reached $9.2 trillion, making it the second largest economy in the world. Can India perform similar feat in the next fifteen years?

By coincidence, at $1.88 trillion dollars in 2013-14, the current GDP of India happens to be almost identical to that of China in 1998. The country ranks tenth in the worldwide GDP ranking, behind the above seven countries plus Brazil and the Russian Federation. So the challenge of India would be to do in the next fifteen years what China did during 1998-2013.

Most analysts are likely to contend that India cannot accomplish what China has, arguing that democracies simply cannot do what authoritarian regimes can. Yet they would be wrong; not only is such growth feasible in a democracy, the noisy and contentious democracy of India itself has performed at the Chinese level for almost a decade.

During the nine years following 1 April 2003, India grew 8.3% per annum in real rupees. Once we take into account the real appreciation of the rupee against the dollar during this period, this growth translates into a gigantic annual rate of 13.4% in real dollars.² Taking a significantly more conservative figure of 11% annual growth in real dollars, $1.88 trillion in 2013-14 can be transformed into $9 trillion at 2013-14 dollars in fifteen years. This would make India the third largest economy in the world, behind the United States and China.

 

Feasibility, of course, only signifies opportunity. Conversion of this opportunity into reality would require the removal of the ‘cobwebs that come in the way of rapid industrialization’, in the memorable phrase from the landmark 1991 address to the nation by the late Prime Minister Narasimha Rao upon assuming the highest office of the nation. While Prime Minister Rao began the removal of the cobwebs with a bang and Prime Minister Atal Bihari Vajpayee valiantly carried his unfinished task forward, many still remain.

No doubt, some readers will ask, why such preoccupation with growth? So let me state the obvious at the outset: growth is sought not for its own sake but for what it can contribute to the alleviation of poverty and suffering, education, health and prosperity. Those who think that we can get there much faster through appropriate redistribution policies need only consider that allowing 25% of the GDP for government expenditure, an entirely equal distribution of the nation’s current income would give each individual just 150 to 200 rupees per day. This may be good enough for an existence slightly better than subsistence, but not for comfortable living. For example, it will not allow the beneficiary to even pay for a motorcycle over a five year period. And in so far as even small redistributions tend to be contentious and difficult, those already in the top quarter of the population by income levels would do fine even without growth. It is precisely those at the bottom of the population that would suffer the most in the face of a stagnant economy. Even redistribution becomes politically far more feasible if incomes are rising rapidly. Our own experience conclusively demonstrates the validity of these propositions. It is only after the Rao-Vajpayee reforms began delivering accelerated growth that we saw a real break in poverty trends. And the large-scale redistribution programmes such as those under the Mahatma Gandhi National Rural Employment Guarantee Act and the Food Security Act could also be launched only in the context of a rapidly growing economy.

 

Growth helps combat poverty, ill health and illiteracy through two channels. First, it creates gainful employment and raises wages, which directly lowers poverty and equips households with financial resources to access privately available education and health. It also allows entrepreneurs to establish private educational institutions at all levels and hospitals. Second, growth places ever-rising tax revenues in the hands of the government, which can use them to combat poverty and build education and health infrastructure in the public sector.

 

Given the centrality of employment friendly growth, the first question we must ask is what has been holding back such growth in India. While systematic evidence of growth impacting poverty in India is now available, it remains true that growth has done less in India to create good jobs for the masses than in China recently, and prior to that in South Korea and Taiwan in the 1960s and 1970s.³ The issue is particularly relevant in view of the fact that on average 12 million workers are currently entering the workforce each year in India.

To date, well paid jobs in India have been few and far between because growth has been heavily concentrated in the capital- and skilled-labour-intensive industries such as auto parts and automobiles, two wheelers, engineering goods, chemicals and chemical products, petroleum refining, telecommunications, pharmaceuticals and software. Indian entrepreneurs instinctively run away from hiring low-skilled workers, opting to invest instead in capital- and skilled-labour-intensive sectors and technologies.

According to the Economic Survey 2013-14, non-agricultural establishments in the private sector with 10 or more workers, employed just 12 million workers as of 31 March 2012. An additional 17 million workers enjoyed well paid jobs in the public sector. Together, these workers represented approximately 6% of the entire workforce in India. All other workers were self-employed or worked in low productivity and low wage jobs in agriculture or small non-agricultural establishments.

I have for long argued that the creation of good jobs for the low skilled requires policies that would encourage large-scale firms to enter employment intensive sectors such as apparel, footwear and electronic assembly. India’s failure on this front is best illustrated by the apparel industry. According to Hasan and Jandoc, a gigantic 92.4% of apparel workers in India were employed in firms with 50 or less workers in 2004-05.⁴ In sharp contrast, 87.7% of the Chinese apparel workers were employed in firms with 51 or more workers. Unsurprisingly, the Chinese apparel exports have been consistently more than ten times those of India. Prior to China, South Korea and Taiwan also created employment intensive growth by exporting labour-intensive products, including apparel.

 

Critics have offered two counter arguments. First, they suggest that India need not follow the traditional light manufacturing route to transformation and can instead rely on its dynamic services industry. The drawback of this path is that dynamic services such as software create painfully few jobs and those they do are for the highly skilled. A 2009 National Sample Survey Organization report noted that the largest 626 services enterprises accounted for 38% of the total services output but an insignificant 2% of services employment in 2006-07.⁵

The second argument accepts that services cannot be counted on creating good jobs but contends that micro, small and medium enterprises (MSMEs) in manufacturing can. This suggestion too turns out to be without merit. The ongoing research of economists Rana Hasan and Nidhi Kapoor shows that 73% of workers employed in firms with 20 or fewer workers accounted for just 12% of output in 2010-11. These firms could not possibly afford to pay decent wages to their workers. Viewed differently, 95% of MSMEs are micro enterprises investing less than 2.5 million rupees each in plant and machinery. With such small investment, they can hardly generate value necessary to sustain high wages.

The inevitable conclusion is that we create space for the emergence of some large and medium size enterprises in the labour-intensive sectors, which would not only link us better with the world markets but also lend dynamism to smaller firms within the same sector. Large firms must compete against the best in the global economy and must constantly look for cost-cutting technologies and management practices. In turn, they force similar efficiency in small and medium firms that must either compete with them or serve as their ancillaries. Small and medium firms generally flourish in sectors in which large firms flourish. With rising wages rapidly pricing China out of labour-intensive products, time cannot be more opportune for India to take the space it is poised to vacate.

 

Reforms that India needs to become a $9 trillion economy are by now familiar and I will only briefly list the most important ones. Immediately, we must reform the Land Acquisition Act and restore the health of banks. The current Land Acquisition Act is so complex that no new land acquisition has been initiated anywhere since it came into force on 1 January 2014. The Rajasthan Land Acquisition Bill, 2014 offers one possible blueprint for the reform. The health of banks needs to be restored through recapitalization, raising equity from the market, closure of the weakest banks and consolidation of others into larger banks. Without these reforms, credit markets, so essential for formal sector investment, will not function smoothly.

 

In the longer run, labour laws relating to strikes, reassignment of tasks, layoffs, contract labour, apprenticeship, pension and insurance are all in need of modernization. The current labour laws have acted as a huge deterrent to hiring of workers in organized sector industry.⁶ Simultaneously, a modern bankruptcy law, permitting smooth and timely exit of firms with the workers’ interests protected, is required. Existing exit avenues are so complex that it takes decades to wind up a firm with the result that firms avoid entering a market unless they are absolutely sure that changes in market conditions will not render them unprofitable in the foreseeable future.⁷

In the public sector, unprofitable manufacturing enterprises with no hope of revival must be closed down. The Times of India (13 October 2014) recently reported the surreal story of British India Corporation, a textile factory, which shut down production nine years ago, but still has 1800 employees who report to work daily, receive wages and bonus, perform overtime shifts, are subject to job changes and awarded promotions. Such madness needs to end.

But even firms in operation, whether profitable or not, must be privatized. In a careful study of privatization under the first National Democratic Alliance government, Gupta shows that compared to firms that were partially privatized, selling a majority stake with transfer of management control to private owners has on average been associated with 23% increase in sales, 28% increase in profits and no decline in employment.⁸ There is no reason why these gains should be sacrificed to keep manufacturing enterprises in the public sector.

 

Where privatization is not feasible in the near term, preparatory steps towards its eventual realization must be taken. For example, Coal India may be broken up into three or four smaller corporations with the intent to eventually privatize some of them for genuine competition in the sector to emerge. The railways are likely to remain in the public sector but certain sub-sectors within them can be opened to the private sector. For example, the private sector can be given access to publicly owned tracks to run private trains. The current organizational structure of the railways remains unwieldy and a strong case exists for their break-up into four or five corporations with each permitted to run trains on the tracks of the others.

The need for a return to building infrastructure is well recognized. Highway construction, expansion of railways to carry passengers and freight, modernization of ports to achieve the international standards in the clearing of incoming and outgoing goods and power sector reform are the crying need of the hour. The government particularly needs to refocus attention to the reform of electricity distribution companies and state regulatory commissions. Without the distribution companies being solvent, they would not be credible long-term buyers of electricity. In turn, with no credible buyers, generation companies will lack the incentive to invest in generation. The state regulatory commissions need to be fully independent to set tariffs at levels at which distribution companies can be solvent and they need to fully empower distribution companies to collect the revenues due. The prospects for privatization and entry of multiple distributors of electricity within the same circle, along the lines of the telecommunications industry, must be carefully studied.

 

Urban development needs to be speeded up since industrialization and modernization are intimately linked to it. Many local regulations related to the conversion of land from one use to another, floor space index, rent control and urban land ceilings act must be reformed to pave the way for the emergence of low rent housing. Rapid transit between periphery and city centre and a dense transportation network in the central business district are essential. The ability of local administrations to provide electricity, water and sewage must be strengthened.

Both quantity and quality of higher education in India are in urgent need of attention. Gross enrolment ratio in higher education in India remains well below those of comparator countries such as China and Brazil and no Indian degree giving institution appears among even the top 200 institutions on any international rankings. There are no quick fixes, but the starting point has to be greater decentralization with universities and colleges given freedom in governance, setting up curriculums and fees and raising funds from other sources. The University Grants Commission and its various councils need to be disbanded with a regulatory body providing broad regulation without intrusion into day-to-day running of educational institutions. Research needs to be brought centrally to universities and college, which would help forge better links between educational institutions and industry. Such links are also crucial to the creation of skills that industry actually needs.

Finally, India needs greater clarity of thinking in its foreign trade and investment policies. On the trade front there has been some tendency lately to roll back protection. We must not only resist such impulses but also return to trade liberalization that has come to a standstill since the year 2007-08 when the last significant tariff cut took place. It is important to remember that it was protectionism that left Indian industry so inefficient and impeded the development of export-oriented industries for so long. As regards foreign investment, we have seen benefits from it accrue during the past two decades and there is no reason to hesitate in opening up the door wider to defence, insurance and multi-brand retail.

 

I have stated that faster growth contributes to social progress through two channels. First, it creates jobs for those at the bottom and, thus, directly empowers them to privately access education and health. Second, growth also yields ever-rising tax revenues that allow higher social spending by the government. But promoting social goals is not just about spending money. Money must be spent judiciously to generate the largest bang for the buck. Sadly, while we have been able to rapidly expand spending in the last ten years – thanks to accelerated growth – the return to such spending has been low.

Take, for example, the employment programme under the Mahatma Gandhi National Rural Employment Guarantee Act (MNREGA). While the principal objective of the scheme is to transfer purchasing power to the poor, the vehicle chosen under it is employment. Money for the scheme is largely provided by the Centre and it travels through a long chain from the central government all the way down to the beneficiary. As is well known, there is substantial leakage through bribes along this chain. In addition, a part of the money has to be spent on the purchase of materials necessary to undertake public projects on which workers are employed.

 

Conservatively assuming the leakage through bribes to be 25% of the total expenditure, and material and wage to be 30% and 70% respectively of the remainder, the scheme must devote a total of 248 rupees to provide a wage of 130 rupees per person per day. Of the remaining amount, 62 rupees end up in bribes and 56 rupees go to pay for materials.

By themselves, these numbers say that MNREGA spends 248 rupees to place 130 rupees in the hands of the beneficiary. But the reality is grimmer. For MNREGA takes away the worker’s labour in return for the 130 rupees it pays. Conservatively assuming the market wage to be 80 rupees per day, the net transfer to the worker is just 50 rupees. In other words, it takes MNREGA 248 rupees to transfer just 50 rupees. This works out to five rupees worth of expenditure to deliver one rupee to the beneficiary!⁹

This is a bad deal for both the beneficiaries as well as the country. Today, with Aadhaar poised to assign biometric identity and Jan Dhan Yojna to provide bank accounts to all, it should soon be feasible to affect cash transfers directly from the central government office to the beneficiary bank account. This can deliver transfers with almost no leakage.

 

Other social schemes in India are marred by similarly vast inefficiencies. If the trillions of rupees spent on food procurement and public distribution system (PDS) were used to give direct subsidies to farmers and cash transfers to consumers, much larger benefits could be delivered. The leakages that take place as the grain makes its way from the farmer to public storage to delivery to the final consumer along multiple chains could all be plugged. This system would also overcome the challenges that the current farm subsidy system faces in the World Trade Organization (WTO).¹⁰

Equally, it is important to rethink how we spend our public funds on education and health. For five or more decades, we have invested resources in creating quality education in government schools and quality health care in public health centres and community health centres but without success. The quality of services at these public sector entities is so poor that anyone who can scrape together just enough resources to access private education and private health care does so. The elite, intellectuals and NGOs insist on holding the poor hostage to these institutions, arguing that we can eliminate corruption and improve quality of service by doing this or that while themselves quietly availing of private schools and hospitals for their children and families. It is morally wrong to deny the poor access to better services when the resources for them are available. How long should they be held hostage to the promise of improvements in quality when this has not worked for five long decades?

If we want to truly empower the poor, we should give them the same option that the rich are able to exercise. The money spent on education per child should be given as vouchers to her family so that they too get to send the child to the school of choice. If the public sector can provide quality education, the voucher will flow right back to the government. Likewise, we should provide health insurance for episodic illnesses requiring large expenses and let beneficiaries decide whether they want to opt for private or public hospitals. We should then require government schools and hospital to recover their costs rather than subsidize them. Under such a system, government schools and hospitals will have to compete against their private counterparts on an equal footing. They would then have to either shape up or ship out.

 

Rather than summarize what has been said, let me conclude with a final word of caution in the conduct of policy. We must fight the instinct to superimpose social goals on every policy. Such an approach distracts from and even undermines the original goal of the policy while also generating unintended adverse consequences. I give here two examples to illustrate the point though the phenomenon they capture is pervasive within the Indian polity.

First, in opening multi-brand retail to foreign investors, as a condition of entry, we added the requirement that foreign retailers buy 30% of their wares from small and medium Indian firms. Now the objective behind opening multi-brand retail to foreign investors was to create greater competition in retail and develop supply chains linking efficient domestic manufacturers whether large or small to foreign markets and efficient foreign suppliers to domestic consumers. Foreign retailers are not an efficient instrument of protecting and promoting small and medium firms. To promote efficient small and medium enterprises, we must ask what impediments they face and how those impediments can be removed. If certain policies discriminate against them then those policies should be reformed. But if these enterprises are performing poorly in certain sectors because they are fundamentally ill suited to those sectors, there is no reason to aid them at the expense of either the consumer or the taxpayer.

Second, and in a similar vein, the Companies Act 2013, which replaces the Companies Act 1956, requires all corporations to spend 2% of their profits on corporate social responsibility (CSR). Now companies already discharge their social responsibility by paying taxes. If that is not enough despite Indian companies being among the most heavily taxed in the world, we could raise the tax rate. But why force them to undertake social activities in which they have no demonstrated comparative advantage? And why burden the government yet more since it will now have to examine each corporation for whether or not it has responsibly discharged its social responsibility? The fact that no other country in the world forces such CSR on its corporations testifies to its lunacy.

India stands on the brink of a take-off that could bring far greater prosperity to its people in the next fifteen years than in the entire post-independence era to date. The Chinese experience and our own performance between 2003-04 and 2011-12 testify to its feasibility. It will be a pity if we missed the boat yet again, especially when a dynamic prime minister with so much energy and charisma is at the helm.

 

Footnotes:

1. The World Bank reports the Chinese GDP in 1998 in current dollars as $1.02 trillion. Taking into account the change in the exchange rate from 8.28 yuan per dollar in 1998 to 6.20 yuan per dollar converts this figure into $1.36 trillion. The US GDP deflator rose from 85.8 in 1998 to 115.9 in 2013. Adjusting for this rise leads to the final figure of $1.84 trillion.

2. India’s GDP grew annually 15.55% in nominal dollars from 2003-04 to 2011-12. The GDP deflator in the United States rose from 94.3 in 2003 to 114.3 in 2011, which translates into an annual compound growth rate of 2.14%. Taking this into account, growth in the GDP in real dollars is 13.41%.

3. See Jagdish Bhagwati and Arvind Panagariya, India’s Tryst with Destiny: Debunking Myths that Undermine Progress and Addressing New Challenges. Collins Business, New Delhi, 2012; Arvind Panagariya and Megha Mukim, ‘A Comprehensive Analysis of Poverty in India’, Asian Development Review 31(1), 2014, pp. 1-52; Arvind Panagariya and Vishal More, ‘Poverty by Social, Religious and Economic Groups in India and its Largest States: 1993-94 to 2011-12’, Indian Growth and Development Review 7(2), 2014, pp. 202-230.

4. Rana Hasan and Karl Robert L. Jandoc, ‘Labour Regulations and the Firm Size Distribution in Indian Manufacturing’, in Jagdish Bhagwati and Arvind Panagariya, Reforms and Economic Transformation in India. Oxford University Press, New York, 2012, pp. 15-48.

5. National Sample Survey Organization, Services Sector in India (2006-07). Report No. 529, GOI, Delhi, 2009, p. 37.

6. See Chapter 8 in Jagdish Bhagwati and Arvind Panagariya, op. cit., 2012, for details.

7. See Arvind Panagariya, India: The Emerging Giant. Oxford University Press, New York, 2008, pp. 294-99.

8. Nandini Gupta, ‘Selling the Family Silver to Pay Grocer’s Bill? The Case of Privatization in India’, in Jagdish Bhagwati and Arvind Panagariya, Reforms and Economic Transformation in India. op. cit., 2012, pp. 143-67.

9. These numbers will be partially modified by the value of assets created per-day of work. I ignore this modification principally because by all accounts, asset creation under MNREGA has been minimal.

10. I outline how such a system could be designed such that both farmers and consumers can receive subsidy without violating the current WTO rules; see Arvind Panagariya, ‘Unfairly Vilified at WTO’, The Times of India, 23 August 2014.