Terms of Trade | A new report suggests India needs a new political economy framework

The report predicts an $8-trillion Indian economy by 2032, but clearly states that this “will be hard work” to be achieved. What does this mean?

Some of the best commentary on the Indian economy now comes from who can euphemistically be referred to as private sector economists. They work at banks and other financial institutions and are invested in not just tracking the economy on a regular basis but also reading the tea leaves as far as its immediate, medium-term and even long-term prospects are concerned. These predictions, for investors of various kinds, are not just an academic exercise. They inform and involve billions of dollars in investment bets.

One of the best private sector commentaries on the Indian economy comes from the team at HSBC research headed by Pranjul Bhandari. (Shutterstock)

A new report predicts an eight trillion-dollar Indian economy by 2032.

One of the best private sector commentaries on the Indian economy comes from the team at HSBC research headed by Pranjul Bhandari. In a report released earlier this week, Bhandari and her colleague Aayushi Chaudhary have made predictions about what the Indian economy will look like ten years from now. Their best-case scenario envisages a 7.5% growth which will make India an eight trillion-dollar economy by 2032; third largest in the world behind the US and China. To be sure, the report clearly states that this is not a given and “it will be hard work” to achieve this goal.

A new India…

The bulk of the growth in the 7.5% growth scenario will happen in what the report calls “New India,” which includes high-tech manufacturing and tech start-ups and service providers which leverage new technologies. This “New India”, the report estimates, had a share of 15% in gross value added (GVA) and 5% in employment in 2018 and this is expected to increase to 25% and 7%, respectively, by 2032.

…And an old one

What is even more interesting is that the report does not see a significant reduction in the share of agriculture in total employment in this scenario building exercise. It is expected to come down from 42% (2018) to 36% (2032) and agriculture’s relative share in GVA – share in GVA divided by share in employment – will actually decline from 0.36 in 0.28 during this period. This means that India’s structural transformation crisis, as far as asymmetry between income and employment shares is concerned, will actually become worse.

The report gives another interesting set of statistics in terms of listing out individual contributions of various factors of production and total factor productivity (TFP) to overall growth using a Cobb Douglas production function framework. For those who are uninitiated into elementary microeconomic theory, a brief digression is in order to explain this concept.

A Cobb Douglas production function calculates TFP as a residual by deducting the role of labour and capital – the two factors of production – in overall growth. For example, let us assume a world where the only economic activity is running taxis. In a world before the internet and cab-aggregators using technology like Uber’s, business (irrespective of its distributional aspects) would be smaller with the same number of taxis, drivers and fuel spending as drivers would not know where to go looking for passengers. The gain in business with an Uber-like technology will be attributed to an increase in TFP.

To be sure, as is always the case with economists, the concept of TFP is not a universally accepted idea. Among the most basic and important critiques of the TFP approach is that it is ill-equipped to handle potential changes to growth from the demand side. To come back to our example, a lockdown which would kill demand for taxis would lead to a massive fall in business despite technology/efficiency levels remaining the same. To give a macro example, the Indian economy grows at a much higher rate when it enjoys high export demand, which it is not very difficult to understand, has got more to do with global demand than productivity/efficiency levels in the Indian economy.

Let us for a moment, set aside this theoretical critique of the concept of TFP and come back to the HSBC report. The report gives TFP values and projections from 2003-07 to 2023-32. The following chart reproduces the values given in the report and adds the share of TFP in overall GVA for each period.

The numbers, at least until 2017-19 are anything but counter-intuitive. Almost 80% of the pre-pandemic growth was driven by increase in labour and capital stock. The bulk of this would have come from expansion in India’s white collared workforce in sectors such as IT and a big increase in private investment, which, to be sure, was also responsible for the stress build-up in the banking system. By the eve of the pandemic, tailwinds to growth from both labour and capital had weakened, which once again is not very difficult to explain given the policy-induced shock to the informal economy and the twin balance sheet crisis.

However, what is interesting is the fact that the eve of the pandemic period sees a big increase in TFP’s contribution to growth with its share crossing the 30% mark. Once again, this is not very surprising given the fact that the eve of the pandemic period saw a big jump in digital innovations even as large parts of the real economy was slowing down. The report forecasts that TFP’s share in overall growth will increase to almost 37% in the 2023-32 period in the 7.5% growth scenario. The contribution of labour or human capital to growth, on the other hand, is expected to fall from 44.3% in the 2003-07 period to just 27.6% in the 2023-32 7.5% scenario.

What does this mean?

If one were to stick to the neoclassical theory framework where different factors of production get paid in keeping with their marginal product, then income share of labour can be argued to be determined only by technological factors. But if the wage rate does not rise as fast as productivity, which has otherwise been the case for India in the recent past, a sharp fall in contribution of labour to overall value-added growth also means that labour income growth — at least for the overwhelming majority — will face a sharp deceleration in the next decade. To give a more relatable argument, it makes perfect sense to argue that most of the rewards from the gains in TFP will be cornered by existing or new entrepreneurs in “New India” or their venture capitalist (VC) funders. The relative share of “New India” in GDP is expected to increase from 3 in 2018 to 3.6 by 2032 in the report.

This kind of a development in an economy already mired in very high levels of inequality is not much of a problem as far as the primary mandate of private sector economists – without any prejudice to their academic quality or integrity – in terms of facilitating better informed investment decisions is concerned. However, this has massive implications as far as the nature of India’s political economy bargaining framework is concerned.

If the majority of the people are not going to experience a significant improvement in their standard of living despite the size of the economy and per capita incomes increasing significantly in the next decade, how will it impact politics?

This column has argued on multiple occasions that India’s political economy equilibrium has become more and more dependent on the fiscal policy palliative route to legitimise politics in the face of deep rooted and increasing economic inequalities. This is a reflection of two factors, namely, the increasingly doomed agrarian transformation project and shrinking space for old-school class struggle between capital and labour.

If things are going to get only worse on these two fronts, fiscal policy will become increasingly stretched to fulfill its palliative function of generating democratic legitimacy for what will increasingly become an even more unequal economy. In fact, there is a good case to argue that fiscal policy will face a new kind of constraint as the weight of “New India” increases in the next decade. Given the fact that most start-ups in the new-tech sectors are driven by VC-funding – the HSBC report says this is critical for India’s growth prospects – and still very far from breaking even, their increasing footprint in the economy will lead to a shrinking corporation tax (levied on profits) to GDP ratio. Any attempts to raise taxes on such investments are likely to lead to a premature end to this potential economic boom by scaring such investors. Similarly, a lot of new-age manufacturing is likely to lead to a fiscal strain – thanks to subsidies under the Production Linked Incentive (PLI) scheme – rather than add to revenue collections.

So, what is to be done?

To be sure, this problem is easier stated than solved. No other economy of India’s size has ever faced such entrenched dualism where a small part of the economy is extremely dynamic but unable to generate enough traction for its lacklustre bigger half. What is also true is that India is perhaps the only economy in the Global South which will have achieved the place of world’s third largest economy without a structural suspension of democratic pulls and pressures in its political economy bargain for a significant period.

What can be said for sure is that both politics and economics will have to reinvent its established wisdom to keep the marriage between capitalism and democracy working in India.

Every Friday, HT’s data and political economy editor, Roshan Kishore, combines his commitment to data and passion for qualitative analysis in a column for HT Premium, Terms of Trade. With a focus on one big number and one big issue, he will go behind the headlines to ask a question and address political economy issues and social puzzles facing contemporary India.

The views expressed are personal