This is the draft of an essay I had submitted to ‘Industrial Economist’, a magazine published out of Chennai. The magazine celebrated its Golden Jubilee last week in Chennai. Surely a proud moment. They had requested me to contribute an essay on the above topic to the Golden Jubilee Special issue. Below is the original version I had submitted.
India’s challenge to achieving middle-income status is productivity. Corporate governance is hurdle to higher productivity of labour and capital in the private sector. Government’s control and moralising mindsets are barriers to productivity in the overall economy. Both need to change for India’s potential to be realised, especially since easy growth-pickings such as growth in the global economy and in global trade, that was available to East Asia (first to Japan, then to the Tiger economies and then to china), are not longer available.
India at 2030: of possibilities and pitfalls
On January 31, the Central Statistical Organisation in India released its first revision to India’s Gross Domestic Product Statistics. In the year ending March 2017, it projected that India’s nominal GDP stood at Rupees 152.54 lakh crores (or, Rupees 152.54 trillion). In the year ending March 2017, the average US dollar/Indian rupee exchange rate was 67.05. That translates into a nominal GDP in U.S. dollar terms of around 2.275 trillion. Now, if we simply assume that, over the next thirteen years, the India’s nominal GDP in rupee terms will grow at 10% per annum, then in rupee terms, the Indian economy will be 527 trillion rupees big. If we assume an average exchange rate of 60 rupees to a dollar, then, in dollar terms, the Indian GDP will be around 8.8 trillion. Many assumptions lie behind this estimate. Are they realistic or, are they conservative?
First, we have assumed a nominal GDP growth rate of 10%. Most of us know that nominal growth has two components – a real component and an inflation component. I had assumed a real GDP growth of around 6% per annum and an inflation rate of 4% per annum. The real GDP growth assumption of 6% is conservative if one compared it to the real GDP growth rate that China achieved in its growth years from 1979 for nearly thirty years. Based on official World Bank data, China’s nominal GDP growth averaged 16% per year between 1979 and 2009. Real GDP growth averaged 10%.
The three Ds and the Indian economy
As Ruchir Sharma had noted in an article, for Foreign Affairs last year, global economy is in the grip of three Ds – depopulation, deleveraging and de-globalisation. That is one of the reasons China too has resorted to increasing reliance on debt, especially since the 2008 crisis. It has also launched the ‘Belt and Road initiative’ to put its domestic capacity to use and create growth opportunities for its industries and for the economy. However, getting growth back to levels seen before 2008 will not only be hard but may also be harmful. One needs to recognise and accept the hurdles that have come up before attempting to defy them. Countries, as much as individuals, need to be clear-headed about the factors that they can control or influence and the factors they cannot. They need to work on the former and wait for the right opportunities on the latter. Where does India stand with respect to the three Ds that Ruchir Sharma had identified? Answer to this question has a bearing on India’s economic growth and size potential in 2030.
The developed world’s population and labour force growth is slowing. Even India’s population growth rate has slowed. At around 1.2%, India’s population growth rate was lower by 0.1% than the global population growth rate in 2016. For the world and for India, population growth rate peaked in the Seventies. But, the world growth rate slowed faster than India’s.
De-leveraging is not India’s problem yet. Indian public debt – Union and State governments combined – at 68% of GDP is on the high side. Indian private non-financial sector (includes companies, unincorporated businesses and households excluding banks and other non-banking financial entities) has borrowed heavily from capital markets and form banks in the last fifteen years. This sector’s debt/GDP ratio was around 36.0% in 2002. It had risen to a peak of 62% in 2014. But, in the last four years, de-leveraging has been underway. The debt ratio has come down to 55.9%. India’s households have very low levels of debt by global standards. There is scope for them to catch up. Hence, despite the government’s high debt ratio, India’s overall debt ratio at 124% of GDP is on the lower side. Debt can be harnessed to boost growth.
However, India’s financial sector, dominated as it is by the government, is not in a position to provide debt capital. As long as banks remain under the control of the government, the government’s budget constraint will be binding on banks’ ability to raise capital. Without adequate equity capital, they cannot grow their assets, i.e., expand lending. The current crisis could have been an opportunity to pass the banking system on to private hands with safeguards and regulations for ensuring systemic stability and for ensuring that Indian banks did not repeat the mistake of their counterparts in the West. But, that opportunity has not been grasped yet. Crises are the best times to whittle down political resistance to fundamental changes that affect entrenched interests. Perhaps, in the unique Indian style, we might get there – a banking system that is not dominated by government shareholding – by stealth and in our own opaque and convoluted manner.
De-globalisation is a bigger threat than is understood. India routinely sets out export targets for the economy. Frankly, that is a futile exercise. Exports are determined by global demand and by the competitiveness of the goods and services that India seeks to export. The latter is in India’s control, to a large extent. The former is not. Hence, the government can set targets for improving the quality, indispensability and competitiveness of Indian exports and then hope that global buyers notice that. Unfortunately, one does not see targets in areas where the target-setter has influence. IN any case, despite setting such targets, India’s export performance has been disappointing in recent years. During the global boom era of 2003-2008, India’s exports rose briskly year after year. Since then, they have struggled.
According to World Bank annual data, after the global crisis of 2008, India’s export growth recovered to nearly 20% in 2010. Since then, the growth rate has been declining, contracting 5% in 2015 before posting a modest increase of 4.5% in 2016. This performance mirrors India’s yo-yo export growth record between 1975 and 1990, a period marked by government dominance of the economy, hesitant liberalisation, political uncertainty and fiscal imprudence culminating in the Balance of Payments crisis of 1990. The unimpressive export performance symbolises a much bigger problem with productivity and scale inefficiencies in India. They constitute a big risk for optimism on India’s aspiration to join the Economics Big League by 2030. We will deal with that later.
A reasonably large part of the problem lies with changing attitudes to foreign trade and imports along with changing attitudes to immigration. Nations are becoming more protectionist and protective of their economies. Whether that is the correct attitude or not is a separate issue. The reality of these unfavourable changes globally, at the margin, and their adverse implications for India’s exports must be understood when we try to assess India’s growth prospects for the next twelve years. Even India is not immune to these trends.
Right after the Prime Minister’s speech at the World Economic Forum in Davos in January, the Indian government proceeded to increase import duties on several items in the Budget for 2018-19. U.S Trade representative has called the admission of China into the World Trade Organisation (WTO) in 2001 a mistake. America has imposed stiff duties on washing machines and steel items. Both America and the European Union refused to grant China ‘market economy’ status at the WTO. The American President walked out of the Trans-Pacific Partnership – a comprehensive trade and investment agreement among nations from Chile to Vietnam – soon after he took office in January 2017. There are rumours that he would pull America out of the North American Free Trade Agreement (NAFTA) that President Clinton signed with Canada and Mexico in 1993, coming into effect in 1994.
East Asian countries, led first by Japan and now followed by China, especially since 2000, had improved their economies and reached middle income status mainly due to strong export market performance. Emphasis on exports raises the bar on domestic manufacturers with respect to scale and productivity. Exports can easily add a percentage point or two to economic growth, making up for domestic slack. India, due to a combination of internal and external factors, is likely to miss out on that for several years, if not longer. Boosting export growth is not easy because India is simply not used to sustained high export growth. The culture of export reliance is missing. It takes years to form that habit. China is way ahead of India in this respect and it too is now vigorously competing to retain its market share amidst dwindling global growth and rising protectionism.
Srinivas Thiruvadanthai, Chief Economist at the Levy Forecasting Institute in New York, laid out the challenge that India faces in no uncertain terms:
“India needs to brace itself not just for a flood of cheap imports from China but also a potential reversal in the long trend of globalization. Trump’s message on economic nationalism, hitherto banished from polite conversation, is likely to experience a revivalism across the world in the years ahead. As global trade shrinks, the positive-sum aspects of it will dwindle, making it harder to paper over the negative aspects of trade. A trade war is a distinct possibility. What steps India’s policymakers take to proactively address the challenge posed by China and a potential global trade war will be hugely consequential for its long-term destiny.”
In other words, boosting economic growth and export growth is as much a productivity challenge as it is going to be a political economy challenge for India. Is India’s statecraft up to it? It is beyond the scope of this article to go into the latter but we will examine the former as it is more important and has a direct bearing on domestic growth.
Internal Growth Barriers
The productivity challenge
In January 2018, credit-rating agency, Fitchratings published a report on the growth outlook for developing economies including China. Among the economies it analysed, it placed India’s real economy growth potential at 6.7%. So, our calculations based on a growth rate of 6% is a tad conservative. That is as it should be. In these matters, Indian governments talk before the economy walks. It is better to be modest on matters that are largely outside one’s control. Despite putting India at the top of the pecking order on potential growth (the growth rate that the economy is capable of generating), Fitch analysts noted two big concerns. One is that India’s labour force participation rate is rather low. Far too few women are in the labour force and there is also a problem with skill endowments of youngsters that prevent them from being absorbed into labour force. The second concern is India’s abysmal Total Factor Productivity Growth.
TFP is the extent of economic growth (or, output growth) that is not explained by growth in inputs. If we define output (or, production) growth as a combination of input growth (the more inputs one uses, the more output one generates) and productivity growth. So, TFP growth is the output growth rate that is over and above the growth rate in inputs. India’s TFP growth rate was 0.6% in the last several years. Fitch notes, “Sluggish TFP growth in a low income per capita country such as India (which has the lowest GDP per capita in our sample of countries covered in this report), which has more room to play catch up, is all the more disappointing.”
Disappointing export and productivity performances signal the formidable underlying challenges that India faces or has failed to tackle adequately in the last few decades. The factors that have led to this sluggish TFP growth are many. Not only labour laws and regulations and hiring practices but poor education and inadequate skilling hold back labour productivity. Corporate governance as much as government approvals and clearances holds back capital productivity. The private sector is diffuse and it is difficult to offer a template to all of it. I will confine myself to what policy can achieve to overcome India’s productivity barrier to economic growth.
The psychological challenge
Clearly, India has come a long way since the 1990s. Economic growth rate had picked up. Per capita income growth had picked up. Literacy rate has climbed. Infant mortality rates have declined. Life expectancy has improved and the poverty rate has declined. Nominal per capita income is around Rupees 10,000.00 now. All these have been accomplished without taking recourse to too much of debt (unlike China) and within a noisy, often disruptive and dysfunctional, democratic political setup. That is the good part. The not-so-good part is the fact that GDP growth rates and per capita income growth rates have slowed in recent years. Savings and investment rates have declined.
Some of this slowdown is due to global factors and slowing population growth, etc. But, throughout this essay, we had emphasised that individuals, institutions and governments must focus on their spheres of control and work on improving outcomes within those spheres. The Indian government embarked on economic liberalisation in the 1990s. But, their commitment to liberalisation has not been steadfast. Since 2004, it may even have reversed. Control instincts usually triumph over the instinct to let go. There is an atmosphere of distrust and mistrust between the governing and the governed. Governments have not delivered to the degree promised or is possible on health, education and infrastructure. That is a breach of contract.
The Comptroller and Auditor General of India in its report on the finances of the Union Government (Report No. 44 of 2016-17) noted that over the last ten years, the Indian government had collected around 840 billion rupees of education cess. But, this amount has not been earmarked in the Public Accounts of India and nor has any appropriate scheme notified to make use of the amount collected for education. Essentially, it is backdoor taxation or cheating of the public. To offset that, the government exempts the vocal classes from certain taxes or raises the tax threshold. The tax base shrinks. Others feel persuaded to evade. It is a downward spiral.
The government has to take the initiative to break this spiral of lack of trust in the society and in the economy. It has the instruments and the authority to verify. So, it can trust. The public does not have the tools – beyond the democratic elections once in five years – to hold the government accountable for its promises. Hence, the onus is on the government to trust and let go. It is the control mindset, blended with a moralistic attitude towards economic activity that obstruct creation of capacity and scale in the private sector. I may be accused, legitimately, of oversimplifying. But, the important role of government and regulatory attitudes towards size in keeping India’s potential economic growth and productivity improvement down cannot be understated. In listing the ‘Six Big Economic Mistakes’ of the present government, I had identified ‘anti-big’ bias as one of them. The second chapter of the Economic Survey 2012-13 has a detailed analysis of how India’s laws and regulations constrain economic growth. The Economic Survey of 2017-18 also refers to the anti-capital bias that has crept into the Indian public and political discourse constraining policymaking.
A more vivid demonstration of that occurred recently when the Government defended the re-introduction of the Long-Term Capital Gains tax in India for gains in the stock market in the budget for 2018-19. The bureaucrat defended the tax saying that the stock market gains did not need any effort. In an era of abundant liquidity and herd-like investing, that might be true but policymaking cannot be guided by such intrinsically dismissive attitude towards such an important part of the modern economy (whether we like it or not).
It is not feasible to go into the depth of these arguments given the space constraints in this essay. The short point is that limits on India’s growth placed by low productivity could be a manifestation of psychological limitations. It is neither easy nor correct to draw a one-to-one correspondence between personal and public morality. The more the Indian policymakers are freed of their inherited, acquired and cultivated psychological shackles, the more the Indian economy will be able to break free of its growth shackles. If that happens, a USD9.0 trillion economy by 2030 will be a floor and not a ceiling for India.
 ‘The boom was a blip’, Foreign Affairs, May/June 2017 (https://www.foreignaffairs.com/articles/world/2017-04-17/boom-was-blip)
 ‘Trump’s Trade War On China And Lessons For India’, Swarajya, January 23, 2018 (https://swarajyamag.com/world/trumps-trade-war-on-china-and-lessons-for-india)
 ‘Investment and Demographics Key to EM Growth Potential – Medium-Term Growth Potential in Emerging Economies’ Fitchratings, January 2018
 ‘The government’s six big economic mistakes’ MINT, September 25, 2017 (http://www.livemint.com/Opinion/sprAUVoQWpbQaSiMCxjMOL/The-six-big-economic-mistakes.html)
 ‘Seizing the Demographic Dividend’, Chapter 2, Economic Survey 2012-13, Government of India
 See paragraphs 1.27-1.29, Chapter 1, Economic Survey 2017-18, Government of India