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Honing our driving skills

The Indian economy has many growth multipliers, one of them being changed social norms, writes Kaushik Basu.

columns Updated: Apr 02, 2008 19:01 IST
Kaushik Basu

For the Indian economy, this is the age of the present continuous. This is evident from a spate of recent books: India Arriving (Rafiq Dossani), Propelling India (Arvind Virmani), India: Emerging Power (Stephen Cohen), India’s Emerging Economy (Kaushik Basu). If India does not arrive, emerge or get propelled, there will be a lot of disappointed authors. What are the chances that these same verbs will apply to India in the not too distant a future, but in the past tense? We must start with the facts.

That the aggregate Indian economy is growing very rapidly is beyond question. Having grown at around 1 per cent per annum from 1900 to 1950, and at a sluggish 3.5 per cent through the 1950s and 1960s, India’s growth rate suddenly picked up in the late 70s. From 1993, the economy was growing even faster. It seemed to be on a growth path of 6 per cent per annum; and over the last four years the growth has been an astonishing 9 per cent. This is a remarkable performance compared to India’s past, but how does it compare with other nations of the world? The answer is very well.

Let us go back to 1975, the time when purchasing power parity (PPP)-corrected international data became available. If we take the 109 nations for which consistent data are available and track India’s movement through this chart, one can immediately see how the Indian economy has performed vis-à-vis other nations. Let me consider the poorest 52 nations among the 109 nations. In 1975, India had a rank of 90 among the 109 nations — the 90th poorest nation. There were only 19 nations behind it. By 1984, it had a rank of 89, a small improvement. By 1994, it had moved up to rank 80, and by 2004 to rank 75. This is good performance but it is sobering to see China climbing from 108th rank to the 58th over the same period.

Indeed, if we take the last decade-and-a-half and do a global cross-country comparison, there turns out to be two nations that had consistently higher growth than India. These are China by a wide margin and Vietnam by a sliver. Pakistan, it is interesting to note, grew faster than India between 1975 to 1984, but after that it fell behind.

Like the superior performance of the aggregate economy, the fact that inequality in India, no matter how one measures it, is growing is beyond question. The outstanding average figures are being achieved largely by a small segment of the well-off population growing at phenomenal rates, the middle-income group growing well but less rapidly and a bottom segment of around 20 per cent of the nation growing at snail’s pace. What this suggests about poverty is true. Poverty, as measured by the percentage of people below the poverty line, is declining but at a rate that is unacceptably low. It is unpardonable that an economy that is doing so well overall has somewhere between 220 and 280 million people living below the poverty line. And it is important to remember that we draw our poverty line really low, which is a useful technique for keeping these numbers low.

To understand the prospects of overall growth, we need to know the sources of India’s rapid growth. Though ideologues will disagree, analysis shows that many factors lie behind this. One indicator of the multiplicity of causes is the fact that the economy has reached this high growth in several steps.

The question of when the first break in growth in independent India occurred has exercised many minds and as research has progressed we have gone further and further back: early 1990s, early 1980s and even late 1970s. I would argue that the first of the growth spurts occurred in the year that most of us Indians block out from our psyche as non-existent: 1975. In that first year of the Emergency, the nation grew at 9 per cent and it was not just a one-year spurt. Barring a severe downturn in 1979-80, when the economy shrank by 5.2 per cent (the worst year in the history of independent India), the economy never looked back after 1975.

What caused this initial breakaway from stagnation is a matter of some debate. But one undeniable factor is that India’s savings and investment rates had risen sharply from the late 60s to the late 70s. What caused this? the nationalisation of banks in 1969, with the State-owned banks then being forced to open branches in remote areas, and the start of Unit Trust of India in 1964, helped boost the savings rate, which in turn was the first impetus for rapid growth. Data on the number of bank branches indeed show a sharp rise after 1969.

The next step occurred in 1993. The reforms of 1991-93, which led to the removal of our licensing system and effected a range of policy initiatives in the international sector, were the most important policy event since 1947, and one can see its impact in the faster growth and the exponential build-up of foreign exchange reserves that happened subsequently. From 1977 to 1990, our forex reserves hovered around $ 5 billion, occasionally dropping to a precarious low level and more occasionally crossing $ 6 billion. From 1993, the reserves started rising, steadily and on a high gradient, and is now well over $ 200 billion. The reforms of the early 90s were concerned with India’s international sector and the success which India saw after that occurred primarily in the nation’s international dealings. Not only did the reserves build up but the precarious situation that we were in in the early 1990s, with large short-term debt and unmanageably high debt-service ratio, rapidly abated. India’s exports picked up and the software boom was firmly on course.

Finally, let me turn to the last and most recent growth spurt that began four years ago and is continuing. Not surprisingly, since the analysts have not had time to catch up with the event, this is the least understood of India’s three growth surges. Among the chief causes are three contenders:

The nation’s savings (and investment) rate, which is the critical driver of economic growth, has seen the most astonishing rise over the last four years, from 24 per cent to 34 per cent of the nation’s GDP, after remaining stagnant since the late 70s. This places India, for the first time, among what was once thought of as an exclusively East Asian phenomenon — the ability to save and invest over 30 per cent of the national income.

The last US presidential election caused a second outsourcing boom, helping our economy greatly. During the election there was a lot of criticism of US firms that were outsourcing backoffice work to developing countries, India being the major destination. This had the unexpected effect of advertising the major cost-savings possible by outsourcing. Advertising on US TV is expensive and Indian firms could never have financed this on their own. The advertisement effect of the debates and subsequent attacks on outsourcing by some conservative commentators turned out to be a boon — someone else paying for your advertisements.

Finally, this is hard for me to prove since it is difficult to measure and quantify, but I believe there is a cultural and social revolution on in India. For a market economy and, for that matter, any modern, industrial economy to function effectively requires a certain culture and a set of enabling social norms. The instinctive urge not to renege on contracts, the ability to restrain oneself from cheating, having a culture of trust, and a multitude of other matters of habit play a vital role in making a market economy possible. It is my belief that nations that have faltered on the path to industrialisation — the sub-Saharan African nations, the South Asian economies, including India till recently, and many Latin American ones — have done so not because of wrong policies as much as because the underlying structure of social norms and culture needed for an industrialised market economy were not in place.

(Kaushik Basu is Professor of Economics and Director, Center for Analytic Economics, Cornell University. This is an edited excerpt from the Sage-Madras School of Economics Lecture delivered on December 14)