Economic Policy Reforms and the Indian Economy / Edition 2 available in Hardcover
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- University of Chicago Press
India is the second most populous country in the world and also one of the poorest. From the late 1940s to 1980, India's per capita income grew at an average annual rate of only two percent. Expansionist economic reforms during the 1980s boosted economic growth but also unfortunately resulted in high inflation and a balance of payments crisis. As a consequence, in 1991 the government announced sweeping new changes in economic policies.
Economic Policy Reforms and the Indian Economy evaluates the effects of those changes and identifies areas of the Indian economy still in urgent need of reform. After an overview of Indian economic policies and development since independence, papers focus on the country's fiscal situation, the environment for private economic activity, education, the reservation of certain activities for small-scale industry, and determinants of differentials in rates of growth across the different Indian states. Contributors include respected academic specialists on India and policy reform, high-level Indian administrators, and present and past policymakers.
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About the Author
Anne O. Krueger is currently the first deputy managing director at the International Monetary Fund. While editing this volume, she was the Herald L. and Carolyn L. Ritch Professor in Humanities and Social Sciences and director of the Center for Research on Economic Development and Policy Reform at Stanford University. She is the author, editor, or coeditor of over a dozen books published by the University of Chicago Press.
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Economic Policy Reforms and the Indian Economy
By Center for Research on Economic Development and Policy Reform Stanford University.
University of Chicago PressCopyright © 2002 Center for Research on Economic Development and Policy Reform Stanford University.
All right reserved.
The Indian Economy in Global Context
Anne O. Krueger and Sajjid Chinoy
Since Indian independence, a great deal of economic progress has taken place. By any measures--life expectancies, infant mortality rates, nutritional standards, literacy and educational attainments, or real per capita incomes--the Indian people are considerably better off than they were a half-century ago. Yet there is a certain impatience and uneasiness: For all of the many achievements, there is a strong sense that more rapid improvements in these and other indicators of well-being are quite possible. Moreover, if they are possible through realignment of existing policies, per capita incomes for many Indians are still so low that more rapid growth is manifestly desirable.
It is the purpose of this chapter to provide an overview of the strengths and weaknesses of Indian economic policy and performance to date, in order to set the stage for an analysis of policies and policy changes that can enable even better performance in the future. Such an assessment necessarily entails an examination of Indian economic policies andperformance in comparative perspective. In-depth analysis of particular policies then follows in later chapters.
The towering international economist of the 1960s and 1970s, Harry G. Johnson, once heard an economist start a comment with the phrase "In a country like India...." He did not let him finish his thought, but interrupted to ask, "What other country is there like India?" He was, of course, right, but while there is no other country like India, it is nonetheless the case that inferences relevant to India can be drawn from experiences, achievements, and effects of reforms in other countries. Thus, with due recognition that growth rates among Indian states and regions differ significantly (see Ahluwalia, chapter 3 in this volume), and that comparisons of growth rates and other indicators economy-wide may be misleading given India's size and diversity, we nonetheless proceed with an assessment of performance to date, of bottlenecks to further improvements in performance, and of the potential for improved performance were these bottlenecks addressed.
Section 1.1 provides a brief survey of the evolution and structure of the economy prior to the 1990s. Section 1.2 then analyzes the reforms of the 1990s and economic performance during the decade. Section 1.3 traces the response of the economy in the 1990s to the reforms. Section 1.4 then analyzes some of the key areas not discussed in depth in later chapters in this volume that still offer great potential for accelerating growth if reforms are carried out. Section 1.5 concludes.
1.1 The Evolution and Structure of the Indian Economy
There are many good economic histories of India's economic evolution since independence, and that economic history is well known (see Ahluwalia 1985, Chakravarty 1987, Joshi and Little 1994, and Srinivasan 2000). Nonetheless, any effort to assess priorities to improve economic performance must be made in light of an understanding of the evolution of policy and the economy at least since independence. Here, we do that with a very broad brush, and the interested reader may consult any of the references above.
The natural starting point is that Indian per capita incomes were very low in the late 1940s and early 1950s, and there had been little improvement in living standards over the previous century. Real income per capita is estimated to have grown at an average annual rate of only 0.7 percent between 1870 and 1913, and of only 0.2 percent over 1913 to 1950 (Morawetz 1977, 14).
Table 1.1 gives estimates of per capita incomes of selected Asian countries for 1950 and 1974. Indian per capita income was estimated at US$95 (in 1974 prices) in 1950. While some countries probably had lower per capita incomes (such as several African countries and Burma--now Myan-mar--in Asia), India was poor even by standards of developing countries. However, differentials in estimated per capita incomes were generally not high--the Philippines was estimated to have a per capita income about 70 percent higher than India, while Malaysian per capita income was thought to be almost four times as high.
Certainly, achieving higher living standards for the Indian people was seen to be a major goal after independence. A great deal of thought and dis cussion in planning for independence focused on the need for rapid economic growth and rising living standards. Nehru and Gandhi had, indeed, differed on what economic policy should be, but the two leaders agreed on the centrality of economic developmental goals as a top priority after independence.
At independence, India was a predominantly agricultural economy, with more than 70 percent of the population deriving its livelihood from agriculture, and just under 50 percent of gross domestic product (GDP) originating in agriculture. The Nehruvian view--derived predominantly from Fabian Socialism--endorsed the need for rapid development led by state economic activity and planning. The first few years after independence were naturally focused predominantly on establishing institutions. Even then, a First Five Year Plan was formulated, although it did little more than bring together various projects that were already under way or in the advanced planning stage.
Interestingly, the early planning documents regarded the chief barrier to accelerated growth as the then-low Indian savings rate, and set out a twenty-five-year perspective. The Planning Commission documents stated that a major challenge was to raise the Indian savings rate to 20 percent and concluded that, if that could be attained, Indian economic growth could achieve a satisfactory rate of 5 percent annually.
The Second Five Year plan (1957-1962) articulated a philosophy of state responsibility for development, and laid down much of the strategy that was to be followed in Indian economic policy until the 1990s. The goal of increasing savings remained, although the plan itself provided for more expenditures than could be financed by foreseeable revenue sources. The Second Plan recognized the importance of education, infrastructure, and so on, but it focused on a strategy for rapid industrialization through development of heavy industry, especially for production of capital goods.
By that time, it had been decided that certain industries (the "commanding heights" of the economy) were to be reserved to the state, some industries were to be jointly developed by the state and private industry, and some activities were to be reserved to private industry. Within the plan, targets were established for production levels. These were given to state enterprises. For private sector production, targets were to be implemented through investment licensing, under which the authorities would not grant licenses for more additional capacity than was sanctioned under the plan. Indeed, investment licenses specified the permitted output of factories, and owners in the private sector were not permitted to produce more than their licensed amount without amending the license.
The underlying philosophy of the second and subsequent plans was that Indian development would have industrialization as the major "engine of growth" and that import-substitution policies would be used to stimulate growth, especially in the manufacturing industries. Influenced heavily by and preventing imports of goods when domestic producers were deemed able to meet domestic demand.
Although India's monetary and fiscal policies were relatively conservative contrasted with those in a number of developing countries, the upward shift in demand for imports arising from the plan pattern of expenditures and a rate of inflation above that in the rest of the world combined to lead to increasing rupee overvaluation. That overvaluation, plus the pull of resources into import-substitution induced by the high levels of protection (both from tariffs and from the unavailability of import licenses), discouraged export production and exporting. The "export pessimism" of the early years, which was one rationale for adopting import-substitution policies, became a self-fulfilling prophecy.
Consequently, Indian export growth was sluggish during the period when the world economy was expanding rapidly in the 1950s and 1960s, and India's share of world markets fell. Table 1.2 gives some pertinent data. As can be seen, exports grew at an average annual rate of less than 1 percent in the 1950s, and at 4.60 percent in the 1960s (when the average annual rate of growth of world exports was well above 10 percent). Even in the 1970s and 1980s, Indian export growth rates were below world rates, and India's share fell continuously until the end of the 1980s: India's average share of world trade for that decade averaged only one half of one percent. Only in the 1990s--after policy reforms to be discussed later--did India's share of world markets begin to recover, as exports grew more rapidly than world trade as a whole.
This sluggish growth of exports was accompanied by a falling share of exports in GDP during the 1950s and 1960s. For the decade of the 1960s as a whole, India's exports averaged only 4.25 percent of GDP. Reflecting the "foreign exchange shortage," even imports averaged only 5.83 percent of GDP, as their growth rate also plummeted (see column 2 of table 1.2) in response to the strict import licensing regime at that time.
Indeed, overall economic growth was sharply reduced during the balance-of-payments crisis of 1966-67. The crisis, which was manifest in the foreign exchange position of the government, was greatly intensified by poor harvests. The devaluation of 1966, however, was a failure in several regards: (a) the poor harvest itself resulted in worsened economic conditions; (b) the additional foreign exchange that had been committed by foreign governments and multilateral institutions (to support the devaluation and accompanying policy measures) was not forthcoming; and (c) the devaluation raised the rupee reward for exporting very little, if at all, as export subsidies were simultaneously removed. In some instances, the rupee subsidy per dollar had been greater than the increase in the rupees per dollar accompanying devaluation.
Despite initial liberalization moves accompanying devaluation, including shifts of some commodities to open general licenses, the overall trade regime was probably more restrictive by the early 1970s than it had been in 1964-65. Moreover, other measures (such as the restrictions on large industrial houses with gross assets exceeding rupees (Rs) 20 crores under the Monopoly and Restrictive Trade Practices Act that came into effect in 1970) also increased the degree of detailed regulation by the government of the Indian economy.
It should also be noted that an increasing number of economic activities took place in the public sector. State-owned enterprises had been built in industries such as steel, fertilizer, heavy chemicals, machine tools, and so on. Even hotels were owned by the public sector. In some of these cases, state-owned enterprises operated alongside private sector firms, whereas in others the state enterprise was a monopoly. Public corporations were established and given monopoly positions in activities as diverse as insurance, importation of bulk consumer goods (canalization) under which only the government entity could import items such as petroleum and export goods such as sugar. Naturally, telecommunications, (telecoms), railroads, and other infrastructure activities were also in public hands. In the late 1960s, the banks were all nationalized. Hence, in addition to the government's controls over the private sector, publicly owned entities themselves undertook a great deal of economic activity.
By the late 1970s and early 1980s, it was obvious to many that the pervasive regulation and controls over private economic activity by the government had had effects opposite to those intended and had inhibited economic efficiency and economic growth. Indeed, when Rajiv Gandhi became prime minister, he declared that his primary objective was to "rationalize" controls. The intent was clearly to reduce the number of overlapping and sometimes even inconsistent regulations.
Despite that campaign, which raised the ceiling below which licenses were not needed and simplified procedures in some instances, most analysts did not regard the results as having significantly reduced the regulatory burden. Joshi and Little (1996, 4) concluded that "Rajiv Gandhi had embarked upon some liberalization in 1985. Although he seems to have quickly lost interest, this helped to put such reform on the political agenda."
Meanwhile, by the 1980s, other structural problems were becoming more and more evident and acute. Two in particular deserve mention. First, India's infrastructure--which was widely recognized to be of inadequate quality and quantity even during the 1960s and 1970s--became increasingly stretched, as economic activity (despite the low rate of growth) led to increased demands on infrastructure at a rate greater than that at which supply was increasing. Second, it became increasingly apparent that public sector enterprises, which had been established in order to accelerate economic growth, were not achieving this goal. Rates of return were low or even negative, and, instead of fostering economic growth, these enterprises became a drain on public resources (and one of the factors therefore accounting for the inability to increase infrastructure availability at the same pace as increases in real GDP).
However, during that same period, the government's fiscal stance became significantly more expansionary. Table 1.3 gives an indication of this behavior over the 1980s. As can be seen, the share of government spending in GDP (including "lending"--much of which is not repaid--to the states) rose rapidly during the decade, while revenues grew much more slowly. By the end of the decade, India's fiscal deficit (financed primarily from domestic borrowing) was averaging well above 8 percent of GDP--an unsustainable number. In addition, the current account deficit had risen significantly and was above 2 percent of GDP in each year in the second half of the 1980s.
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Table of Contents
Foreword: George P. Shultz
List of Abbreviations
Chronology of Important Events
Introduction: Anne O. Krueger
Part One: Current State of the Economy
1. The Indian Global Economy in Global Context
Anne O. Krueger and Sajjid Chinoy
2. Indias Fiscal Situation: Is a Crisis Ahead?
T. N. Srinivasan
Comments: Shankar Acharya, Kenneth Kletzer, N. K. Singh
3. State-level Performance under Economic Reforms in India
Montek S. Ahluwalia
Comment: Shankar Acharya
Part Two: Private Economic Activity
4. Doing Business in India: What has Liberalization Changed?
5. Bangalore: The Silicon Valley of Asia?
Round Table on Business in India
Part Three: Government Activity
6. Small-scale Industry Policy in India: A Critical Evaluation
Comment: Roger Noll
7. Emerging Challenges for Education Policy
8. Does Economic Growth Increase the Demand for Schools?
Andrew D. Foster and Mark R. Rosenzweig
9. Priorities for Further Reforms
Anne O. Krueger