Terms of Trade | Unlocking India’s economic fortunes requires shedding ideological blinkers

The ultimate economic wisdom in India is likely being lost in the cacophony of self-righteous arguments which are seeking gratification rather than the truth

India is in a unique predicament as far as its economy is concerned. It has been the world’s fastest-growing economy for the past few years and is expected to retain this position for quite some time. That it has managed this feat without compromising its macroeconomic stability and suspending democratic freedom makes it an outlier among comparable economies in the world.

Deep within, there is a deep sense of frustration and concern among the Indian economy watchers. The simple reason for this is that India’s current growth rate is just not enough to boost mass incomes for its 1.4 billion strong population, the majority of whom continue to face extreme economic precarity if not poverty. (Bloomberg)

And yet, deep within, there is a deep sense of frustration and concern among the Indian economy watchers. The simple reason for this is that India’s current growth rate is just not enough to boost mass incomes for its 1.4 billion strong population, the majority of whom continue to face extreme economic precarity if not poverty. The race to boost growth and mass incomes is increasingly becoming one against time as the demographic dividend window for India will close in the next couple of decades.

What should be done to make sure that India wins or rather does not lose this race? Dominant or at least seemingly dominant economic and political narratives are increasingly sounding more and more cliché. They often talk in terms of binaries of reforms versus welfare or boosting investor sentiment versus protecting political capital. A lot of political and economic voices, when it suits them, also change sides in these debates.

The truth, as is often the case, has been buried somewhere between these shrill conflicts. If India has to boost its economic fortunes, its economic discourse needs to seek truth from the facts rather than relying on one echo chamber or the other. This edition of the column will highlight recently published work by other economists which are doing justice on this cause on issues which are absolutely critical to the Indian economy.

To target or not to target and how to target inflation… 

seems to have become a question which has been resurrected by none other than the chief economic advisor to the finance ministry in India. The first shots were fired in this year’s Economic Survey which argued for targeting core rather than headline inflation. After RBI dismissed the idea, the CEA doubled down on the argument in an opinion piece published in Mint newspaper on September 3.

The article lists seven reasons to question the current inflation targeting framework and concludes by saying that “discussions on the merits of an inflation targeting framework, the metrics chosen and their numerical values are neither settled nor sterile, but salient”. This newspaper, while recognising the advantages of an inflation targeting framework and the merits of the argument argues against tying monetary policy to, say, vegetable prices preferred to remain non-committal and flagged the current debate as one which “underline(s) the real-life pitfalls of trying to marry economic principles with practical concerns and socio-economic realities”.

To be sure, there is more to this debate than worrying about whether or not food should be included in the inflation targeting mandate, as has been shown by an Economic and Political Weekly (EPW) paper published last month. The paper, which has been written by International Food Policy Research Institute (IFPRI) economists Sudha Narayanan, Kalyani Raghunathan and Anita Christopher shows that food inflation as measured by the Consumer Price Index (CPI) is not necessarily aligned with what they call a Cost of a Healthy Diet (CoHD) measure of food inflation. “Our comparative analysis shows that the CoHD and CPI-F are correlated but measure different things and that the rate of change in the CoHD often outstrips that of the CPI-F. Further, CoHD and CPI-F often move in opposite directions. Collectively, these results suggest that the CPI-F is not a good proxy for the CoHD”, the paper says.

The merits of the argument go beyond the inflation-targeting debate. India has done well to expand the coverage of its calorie-based food security programme but it continues to face high levels of malnourishment and import dependence on key crops such as pulses, edible oil etc. The two, unlike what many believe, are related. India’s self-sufficiency and subsequent dominance in the production of rice and wheat was achieved via the Minimum Support Price route which was only sustained by the distribution of the procured crop under the PDS.

Is it not worth exploring a policy intervention, which targets plugging both these gaps and could potentially end up reaping the rewards of a more stable food inflation due to immunity from volatile international prices of key food items and long-term productivity gains due to improvement in nutrition? Any adjustments to inflation targeting, when done in this context, will also have greater credibility rather than appear as an attempt to wriggle out of a self-inflicted policy cul-de-sac where interest rates which determine greenfield investment and growth are held ransom to prices of onions.

The different consequences of ‘ease of doing business’

That the so-called animal spirits in India are being held back because of lack of ease of doing business has become the most cliched refrain today. It is all more bothersome because we have actually had a government for the past 10 years which had committed itself to unleashing the ease of doing business.

There might be some merit in the argument that official red tape continues to exist in India and businesses must reckon with the reality of having to service political finance requirements. The quid pro quo in this case could be the state allowing these firms to act as deviant 'national champions' rather than disciplining them as extremely efficient firms like the Chaebols of South Korea.

Promising as this theory sounds, it does not tell us why India does well in capital-intensive manufacturing rather than labour-intensive sectors which is what a textbook theory of comparative advantage would tell us. Many commentators, the government and international institutions included, have been pointing out this problem, but there seem to be no easy answers.

Another recent EPW paper by Chinju Johny and Jayan Jose Thomas, economists at IIT Mumbai and Delhi respectively, suggests that the reason one has not been able to find an answer is that there is no single answer to this question. The paper builds on fieldwork in the garment clusters of north (Delhi) and south (Bengaluru) India and finds that the former was based on small units employing a flexible workforce while the latter has built large factories employing a large and permanent workforce.

“It appears that the small, fragmented and rather traditional nature of the garment industry in many clusters across the country, including Delhi–NCR, Ludhiana and Ahmedabad, is partly on account of the reluctance of the capitalists to modernise the firms. Here, the Indian manufacturers seem to be facing a dilemma. Modernisation requires making investments in machinery and buildings and also providing higher wages and more regular employment to the workers. However, there are limitations to growth even after the firms transform themselves into large, export-oriented enterprises of the kind in the Bengaluru cluster. The firms which supply garment products to the global production networks have been squeezed by the global brands, which fuel competition among the suppliers—mostly from developing countries—to cut costs. Given the difficult choices involved, many Indian capitalists seem to be content with the status quo in the industry. For them, the advantages arising from the availability of cheap labour are, in themselves, sufficient to provide some measure of success in the domestic markets as well as in niche segments of the export markets”, the paper argues, adding that the future of labour-intensive manufacturing is better secured by looking at the domestic market rather than seeking to serve MNCs which are always looking to squeeze their suppliers.

Has India’s industrial policy sincerely engaged with these challenges? Is it even aware of their existence and possible diversity across sectors? Trying to answer these questions might be more useful than running after the mirage of so-called ease-of-doing-business which, as the paper shows, might be nudging capital in the wrong direction from the perspective of India's larger economic interests.

The case for differentiated fiscal federalism

All politicians complain about the weakening of fiscal federalism in India until they grab power at the centre. Both the centre and the states have been peddling their convenient versions of half-truths vis-à-vis fiscal federalism in India. The former likes to cite a much higher constitutionally mandated share of tax devolution to the states without mentioning that it has been shifting growing proportions of the tax collections outside the divisible pool of resources.

The states rightly criticise this dilution of their rightful share but do not like to talk about the fact that the centre (for its own political interests) has been increasing the amount it spends in states outside what it has to devote to the states. This point was made clearly in a Carnegie India working paper by Suyash Rai and Milan Vaishnav which was covered in an earlier edition of this column.

But are all states the same when it comes to the practice of fiscal policy? A recent research note by JP Morgan’s Chief India Economist Sajjid Chinoy – one version of it has also appeared in the Business Standard – has done a fantastic comparative study of state finances which shows that they are very different when it comes to imbibing fiscal prudence not just in terms of fiscal deficit (there is very little leeway there because of FRBM rules) but also their debt-GSDP ratio.

“There is a lot of heterogeneity (in debt and deficit levels) across states. Going forward the objective must be to ensure debt levels are inter-temporally sustainable for every state and eventually converging across states. To achieve this, however, state fiscal rules may need to be risk-based and therefore differentiated reflecting state fundamentals”, Chinoy argues underlining a principle which could be a game-changer in India’s fiscal federalism.

While Chinoy is careful to underline that adequate provisions should be made to ensure that poorer states with high debt and low growth levels do not get unduly penalised under such a framework without pitting equity against sustainability, there could be deeper political economic factors which could prevent such a pursuit. For example, this year’s Economic Survey found that many states with higher poverty did worse than their richer counterparts in generating employment under the rural employment guarantee scheme. Is it because of the fact that poor workers in poorer states are more interested in migration rather than working at home? Is it a result of greater corruption and subversion of such schemes?

Would the growing chorus against the equity principle in tax devolution – it takes more from richer states and gives more to the poorer ones; the former being from the south and west and the latter from the north and east – change if the demographically older southern states were appraised about their current and future dependence on labour from their poorer, more populous and also younger peers?

These are all important questions, and they are far from exhaustive, which need more and more engagement outside the typical echo chambers if India’s economic policy discourse has to make it more useful in boosting its economic fortunes. The ultimate economic wisdom in India is not to be found in extreme positions, it is more likely to be lost in the cacophony of self-righteous arguments which are seeking gratification rather than the truth. We should be grateful to economists, young and old, who continue to work on the truth despite the polarised discourse and associated intellectual and other rewards.

Roshan Kishore, HT's Data and Political Economy Editor, writes a weekly column on the state of the country's economy and its political fall out, and vice-versa