Wednesday, October 29, 2008

Feedback: Four inconvenient truths about India's economic growth


Last week (23 Oct '08) Shanta Devarajan, Chief Economist at the World Bank for Africa and the global economy gave a seminar at Wits in which he attempted to debunk some of the popular thinking about India's upward march of economic progress. There are four myths or - to use Al Gore's popular parlance - 'inconvenient truths' about this emerging power that need to be re-evaluated.

Inconvenient Truth #1:
Growth accelerated ten years before the reforms

In 1991, under the stewardship of then finance minister (and now PM) Manmohan Singh import licenses, capital controls, tariffs and quotas were all systematically reduced. In the grand narrative of "India Shining" this was the moment when the theory of trade liberalisation took root and the country was allowed to fulfill its true potential.

However, the not-so-convenient truth for many is that this growth actually took place before the reforms were initiated. The period under Indira Gandhi was one of socialist rhetoric, big state involvement in the economy, exchange controls, etc. But under her son Rajiv Gandhi, there was a change in attitude toward the domestic private sector in the early 1980s.

A key distinction was that the 1980s were pro-business rather than pro-competition as it was later in the 1990s. But ultimately the change in approach was a trend and not a schismatic moment.

However, Devarajan stated that India "got lucky" with the 1991 crisis which forced further reforms. The liberalisation agenda had already begun under Rajiv Gandhi but the crisis galvanised the Congress administration to aggressively reduce trade tariffs and lower regulation. This momentum subsequently carried India to the levels that we see today. Simply, reforms helped accelerate and consolidate a process that had already been under way for years.

IT#2: India grew despite high fiscal deficits

Although the World Bank and the IMF often insist on a 3% fiscal deficit, Devarajan argued that what many people don't know is that the major reforms actually resulted in a huge revenue loss after 1991 in terms of customs, excise and financial repression taxes, etc.

Add this to high interest payments, (and not high expenditures on infrastructure and public works), and you have stratospheric deficits. In this sense, Devarjaan noted, capital expenditures actually fell.

He went on to state that the very factors that contributed to high deficits, plus lower entry barriers have increased competition and hardened budgets for firms and banks. Now you have no more reckless spending.

So another myth is broken. You can have growth with a large fiscal deficit. Said Devarajan: "If some small African country was running at 6% the IMF task teams would have been crawling all over the place!" Not so in India.

IT#3: India is not growing - the Western and Southern states are

It is not the whole country but rather already prosperous states like Punjab, Maharashtra, Tamil Nadu and Gujarat that are enjoying the fruits of prosperity. Other states such as Bihar, West Bengal, Uttar Pradesh are experiencing significantly lower, if any, improvements in their economic standing. "This is no hair-splitting issue. We're talking about five, six hundred million people. That's almost the size of Africa." he said "I mean UP has a population of 160 million. That's a lot of people".

A big drag on these states' growth has been the failure of agriculture. Consider that today the farming sector involves some 100 million people. The much celebrated IT workers of the outsourcing revolution, the ones whom Thomas Friedman argues are making the world 'flat' are a meager 1 million individuals. Both groups contribute the same amount to the gross domestic product.

Why, Shanta asked, has agriculture failed during this period of phenomenal economic growth? Primarily, and ironically, it's because of subsidies. Farm subsidies for electricity and water mean that prices for these resources are not a consideration for farmers who suffer no sanction for inefficient work. For instance, unlimited electricity supply means that farmers run their pumps for too long, stretching the power grid to its limits and also reducing the water table. This is an expensive burden on state revenue, sometimes amounting to over 1% of GDP. The end result is that nobody gets the so-called free power as the infrastructure to provide it is collapsing.

There is also no political will to rectify this as any Chief Minister who tries will invariably get voted out of office. The result is a classic case of unintended consequences where a well meaning policy to help the poor actually results in squandering and waste. Because of this, Indian agriculture is now lagging behind China and even Bangladesh in its production targets.

India also has a highly regulated labour market where it can take many years of severance pay to fire a worker and very harsh punitive measures for non-compliance. In the labour courts of India there are some 533 000 cases pending with 28 000 having been in place for over a decade.

Whilst acknowledging the benefits of trade unions and workers rights, Shanta pleaded with India to create a more elastic labour force as the status quo was leading to a reduction in productivity and entrepreneurial activity. Manufacturing has also suffered under these conditions and India's informal economy is disproportionately high.

IT#4: Despite growth, services are getting worse

Devarajan noted that in several critical areas India's ability to cater to the basic needs of its people was declining: water distribution, adequate standards of education, and simple health provisions such as immunisations. He gave some bleak figures reflecting the state of public welfare in the country and across most indexes (e.g. teacher & doctor absenteeism) the government was mostly doing very badly.

Devarajan explained that this was attributable to a dysfunctional matrix of politics, patronage and poor network services. Those connected to state utilities are paying artificially reduced tariffs (which benefits them in the short term). However, this affects the quality of the service and ends up not helping the poor population who aren't connected to the system and who actually need it the more than the middle-income farmers. The unconnected group have to pay vastly inflated prices for water from private contractors who deliver it in large trucks. Clearly this is far more wasteful. One of Shanta's graphs showed an almost perfect correspondence between a rise in subsidies and a dip in public investment.


This was a wonderful seminar with some passionate contributions from the audience afterward. Thank you to the Centre for India Studies in Africa for organising it and everyone who attended - Dr. Shanta Devarajan most of all.


  1. Interesting.

    But... Africa certainly has more that 160m people (we're at around 800 million if I recall). And, I'm not sure that mainstream economists ever said a country cannot grow if it runs a fiscal deficit. The worry of the IMF and others is that deficit spending is unsustainable (which, of course, it is).

    (P.s. you should enable the new comment system...)

  2. Yeah, I know Africa doesn't have 160 mil. The ambiguity in the language is misleading. I meant that the total accumulation of ppl in the less advantaged states is around the same as in our entire continent (roughly 800 mil). I accidentally swapped the quote around.

    *note to readers I have corrected this error

    The new comment system seems confusing. The benefits aren't immediately apparent to me. What's the deal?

    I'm not advocating running at a deficit in perpetuity, but I think it's a myth nonetheless that India is flush with cash from prudent spending strategies. Agreed though, unsustainable.