India's Growth Prospects: Revisited

        First, the four BIMARU states had low per capita incomes (averaging below Rs. 10,000 per year) in 1999/2000 compared to the five low-fertility leaders in the demographic transition which averaged over Rs. 18000. Second, the BIMARU economies had grown at an average rate of only 4.6 percent over the decade 1992-2002 compared to the 6.3 percent clocked by the low-fertility states. The disparity is greater in terms of per capita income growth since population in BIMARU states has grown faster. Third, precisely because the BIMARU states are laggards in the demographic transition, they will see the highest relative and absolute expansion in population and labour force between now and 2051. Their share of India’s population will rise from 41 percent to 48 percent, since nearly 60 percent of India’s population increment will be concentrated in these four states (undivided). In a nutshell, the demographic dividend of a transitional labour supply bulge will be focussed on four populous, poor, slow-growing northern states, with weak infrastructure, education systems and governance. The chances of translating this potential of additional labour supply into a reality of employment and high growth appear slim. Indeed, if recent experience is a reliable guide, the demographic dividend could transform into a daunting employment deficit.

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Table 2 - Income, Growth and Population: Major States

Sources: Economic Survey 2001/02, Tenth Five Year Plan, and “Long Term Population Projections for Major States, 1991-2101” by Leela Visaria, Pravin Visaria (EPW, 8 Nov. 2003).  Data are for undivided Uttar Pradesh, Madhya Pradesh and Bihar.

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Demographic Dividend: Capital

        Labour is not the only possible component of a demographic dividend. There is also capital, through higher savings. As Kelkar (2004) observes, “Children and old people tend to save less; savings is highest in the working years. So the demographic projections which clearly point out that India will have a bigger fraction of the population in the age group 15 to 64 simultaneously predict a higher savings rate in the future.” RS (2004) boldly claim that the 14 percentage point decline predicted in India’s dependency ratio between 2000 and 2025 will “translate into a roughly equivalent rise in private and aggregate savings, from about 25 percent of GDP to 39 percent”. This will lead to a rapid growth in capital stock and correspondingly higher growth of GDP. They base their highly optimistic claim on some rather dated work on savings behavior by Muhleisen (1997), which is far from definitive.

        If we look at the trends in aggregate savings and investment in India over the past two decades (Table 3), we find only mild support for the views propounded above. This is despite the fact that the demographic trends projected over the next four or five decades have also been at work over the past fifteen years or so. It is true that household savings (including unincorporated enterprises) have risen from around 16 percent of GDP in the late 1980s to about 22 percent in 2000-2003. Private savings have risen even more from 18 percent of GDP to 26 percent over the same period. However, public savings have gone from plus 2.4 of GDP to minus 2.3 percent , reflecting a decline of 4.6 percent of GDP, mostly because of sharply rising revenue deficits of central and state governments. In effect, the large increase in private savings has been substantially offset by the fall in public savings. There has been a modest  increase in gross domestic savings since the late 1980s of about 3.5 percent of GDP, but almost all of it has been neutralized by the decline in foreign savings (current account deficits in the balance of payments) from around 2.5 percent of GDP to nil or marginally negative in recent years. As a result of these trends in savings, the “bottom line” of aggregate investment shows only marginal increase between the late 1980s and early 2000s. And this is the item that matters for the growth accounting exercises of RS and Kelkar.

Table 3 : Savings and Investment

(As percent of GDP at current market prices)

Source: Economic Surveys, 2001/2, 2003/4

Notes:   P :  Provisional Estimates; Q: Quick Estimates

                          GDCF: Gross Domestic Capital Formation

                        GDS: Gross Domestic Saving

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        Looking ahead, much depends on the success (or failure) of efforts at fiscal consolidation at both central and state government levels through fiscal responsibility laws and reforms in revenue and expenditure policies. If the currently high revenue deficits can be reduced in line with fiscal responsibility laws and other guidelines, then the prospects for improvements in aggregate savings and investment could be better than the modest expectations of my earlier paper (Acharya:2002b): “the considerations above suggest a moderate improvement in the rate of gross domestic investment in the medium term, perhaps to the levels attained in the mid-1990s.”

Productivity Growth

        All three papers rely fairly strongly on high and improving rates of productivity growth in the Indian economy. RS start with a base rate of  total factor productivity growth (TFPG)  of 2.5 percent (which they believe was the experience of 1980-2000) and then claim that this is less than half the rate that is feasible for India in future from reforms which catalyze “catching up”! Similarly, Kelkar starts with a base rate of 2 percent TFPG (again reflecting two recent decades of experience) and also foresees a possible doubling of this rate in the coming decade as a result of reforms and other factors.

         Before turning to the prospects for reform-induced productivity improvement in future (in the section below on reforms outlook), it would be useful to briefly assess the quality of the base rate assumptions of these authors. The most painstaking and comprehensive work on year-wise national income and productivity trends in India has been recently published in two monographs by Sivasubramonian (2000, 2004). Based on his work, Acharya-Ahluwalia-Krishna-Patnaik (2003) have compiled, for their chosen sub-periods, trends in TFPG over the five decades, 1950-2000 (see Table 4). The TFPG estimates for the 1980s and 1990s are in the same 2-2.5 percent range cited by Kelkar and RS. This is fine as far as it goes. But how far can we rely on such estimates for future assessments of growth prospects?

Table 4 : Growth of GDP, Total Factor Input and Total Factor Productivity

     Source : Acharya, Ahluwalia, Krishna and Patnaik (2003).

     Note : For each sub-period, GDP, TFI and TFP are trend growth rates.        

        It is important to recall the well-known qualifications to such growth accounting exercises. First, there are very serious conceptual and statistical problems in compiling meaningful indices for factor inputs, which cast doubt on the quality of results emerging from such calculations. Second, the TFPG results are basically “residuals”, where productivity is the label attached to the part of output growth which is not readily explained by increases in factor inputs. Above all, the real mystery and challenge lies in explaining changes in TFPG over time. Without a firm understanding of why TFPG has fluctuated in the past it is difficult to confidently project the rates for the future. Put another way, if output growth turns to be high, we are almost certain to find high TFPG rates in the future numbers. And if economic growth is low, so will be the TFPG estimates. Basically, the predictive power of past TFPG estimates may not be impressive for the future.

Institutions

        RS base much of their “upside optimism” about India’s growth prospects “on the quality of institutions, which has been India’s underrated strength.”. They cite cross-country regressions which find India’s per capita income level well below what would be consistent with the country’s institutional achievements in terms of “a stable democratic polity, reasonable rule of law and protection of property rights”. They also feel that India’s institutional quality has contributed to “resilience in handling shocks” and thereby to avoiding large fluctuations in growth, a point also noted by Kelkar.

        Any serious observer of trends in India’s governance and institutions over the past fifty years would find it very difficult to reconcile such optimism with the long continuing erosion of standards and practices in key institutions of elected legislatures, the judiciary, the bureaucracy and the police. Some observers such as Shourie (1983) have documented a particularly sharp decline since 1980. Even RS acknowledge later in their paper that “these meta institutions have been buffeted and weakened over time by the vicissitudes of vested interests, time and politics”.

However, they underestimate seriously the toll such entropy is taking (and is likely to take in future) of effective public policy, productive investment and growth.

On the narrower issue of public administration and its impact on growth potential, the remarks in my earlier paper (Acharya:2002b) may still be appropriate: “There is plenty of anecdotal evidence to suggest that the quality of public administration in India has been declining steadily, if slowly, over the last several decades. Even in the relatively simple matter of implementing development projects, there is growing evidence of falling standards. In part, this is linked to growing politicization of civil services and the rising tide of corruption in the politico-bureaucratic nexus. Even the effectiveness of the basic administration of law and order has deteriorated. Ahluwalia (2002) writes “Tensions associated with economic and caste stratification in parts of the country, especially in rural areas, have created disturbed conditions in some of the slow growing states… There are reports of urban mafias engaged in extortion, various types of protection rackets, and even kidnapping in parts of some States”.   What’s more, the impressionistic evidence suggests that such problems are worst in the poorest and slowest growing States. This, in turn, means that effective implementation of development programmes is weakest where they are most needed.

Aside from general quality, there is also the important issue of expertise in public administration. There is widespread agreement that for too long India has relied on a generalist civil service tradition (especially in executive-management levels) inherited from the British colonial legacy. Despite numerous official reports, there has been little reform of civil services, not counting the legally mandated policies of reservations for backward castes. Although modern governance clearly requires more and more technical knowledge in various fields, India’s governance machinery has yet to adapt to this fact. Consequently, the capacity for conceiving, designing and implementing necessary reforms in various dimensions of economic governance (ranging from telecom and power to education and health) is woefully inadequate in most relevant public agencies. This lacuna is likely to exact a growing toll of development performance in the years ahead.”

The Outlook on Reforms

        Both Kelkar and RS are bullish on further reforms spurring growth in productivity and hence output growth. RS claim that “Reforms are thus going from being crisis-driven to success-driven which makes it more likely that they will be sustained and not be subject to major reversals.” Kelkar also foresees major productivity gains to be reaped through continued reforms in “ four big areas: globalization, infrastructure, privatization and the financial sector.” Is such reforms optimism justified? Let us briefly review each of these areas.

        To label India as a “willing globaliser” (as Kelkar does) seems a trifle excessive. The phasing down of quantitative restrictions on imports that occurred in the late 1990s was largely under WTO discipline following unsuccessful resistance to a challenge to such restrictions that had been brought by trading partners led by the United States (see Acharya:2002c). It is true that the tariff reductions since 1991 have mainly reflected unilateral trade liberalization. But the tariff structure remains complex and high by standards of even developing countries. As for foreign direct investment (FDI), after an initial bout of opening up in the early 1990s subsequent liberalization has been hesitant and sporadic. Progress on this front under the new UPA government has been slow and likely to remain so. The fact that India accounts for only 0.8 percent of world exports and about 0.4 percent of the world’s total foreign direct investment flows is more suggestive of timidity than willingness. The services export boom of the last decade is a real success and likely to continue. But it cannot substitute for our policy failures in nurturing a much larger internationally competitive industrial sector. Without much higher levels of labour-intensive industrial production and exports and export-oriented FDI India cannot hope to capture the dynamism of high growth East Asian economies. Yet, the necessary reforms of labour laws, banking, small-scale industry reservations and infrastructure continue to be impeded by politics and vested interests.

        Well-traveled observers have noted that India has the worst economic infrastructure among all significant emerging market economies in the world. Usually, they are referring to electric power, roads, ports and urban services. They used to include telecom but there we have made real progress in the last decade. We may take some justifiable comfort from the progress on the National Highway Development Programme. But the dismal condition of most state highways and rural roads continues to exact an enormous toll of productivity, growth and jobs in agriculture, industry and exports. As for the power sector, the long history of hugely inefficient state electricity boards, massive theft, pervasive under-pricing to agriculture, declining investment, frequent brownouts and blackouts are all well-known problems. Unfortunately, knowledge of the problems has not spawned quick and durable solutions. Progress has been incremental and not commensurate with the needs of a high growth economy. Conversely, without much swifter improvement in power, it is hard to envisage sustained fast growth of industry, especially small and medium units, which cannot afford captive power. The new Electricity Act (2003) has wrought a major improvement in the policy  framework for electricity generation and distribution. But it will require serious follow through to realize the potential. The post-May-2004 reversion to free power for farmers in major states such as Andhra, Tamil Nadu and Maharashtra does not augur well for the future.  If power remains the biggest single infrastructure bottleneck today, water could well be the greatest problem in future.

        During the NDA government (1998-1994) there was significant forward movement in privatization policies and practices, especially in the later years. The medium-term outlook is much less promising. The Common Minimum Programme (CMP) of the UPA government indicates that “generally” profit-making, public sector companies will not be privatized. This seriously stalls the previously ongoing disinvestment/privatization programme. Certainly, the stock market took this view in mid-2004 and substantially reduced stock valuations of most public sector companies. As for loss-making enterprises, the chances of successful sales by government are bleak given that reserve prices are unlikely to be set low enough to allow successful transactions.

        Recent financial sector policies have been less reformist than Kelkar depicts. While there has been real progress in capital market policies, banking sector policies have been much more mixed. The final years of the NDA government saw significant policy reversals in the form of bail-outs of financial intermediaries (UTI,IDBI and IFCI), the resurrection of interest rate subsidies and the expansion of directed credit interventions. The legislative intent to reduce government equity in public sector banks to 33 percent withered in Parliament committees. Judging by its policy pronouncements, the UPA government will not revive this bill, leaving open the question of whether a public sector dominated banking system , vulnerable to political interference and behest lending, can meet the needs of a fast growing economy. The policies of directed credit and interest rate subsidies are likely to expand. Regulatory forbearance by the central bank (presumably at government behest) is on the rise. So the medium term prospects do not bode well for financial sector reform.

        The reform outlook is cloudy in other dimensions as well, especially if the CMP is given credence and weight. Reforms of India’s rigid labour laws, which have for long depressed growth of modern factory employment and output, are likely to be soft-pedaled. But without such reforms it is difficult to envision jobful growth of labour-intensive manufacturing output and exports. The CMP holds out the prospect of caste-based “affirmative action, including reservations, in the private sector.” If such reservations are enacted in private sector employment, they will become huge disincentives against fresh employment in the organised sector and could seriously weaken the international competitiveness of Indian firms. The costs in terms of social conflict would also be substantial. The CMP and subsequent government policy pronouncements have also promised major increases in central government spending on education, health and employment guarantee schemes. It is difficult to reconcile such ambitious expenditure plans with the fiscal consolidation commitments made in these policy documents and the Fiscal Responsibility and Budget Management Act (2003). Interestingly, the CMP and subsequent policy initiatives seem to display stronger interest in areas (such as education, health and agriculture) which are mainly in the domain of state governments. Conversely, there is a decidedly more lukewarm approach to fiscal consolidation, industrial climate, privatization, banking and labour reforms, which are areas where the policy levers are much more in the central government’s ambit.

        To sum up, a sober assessment of the prospects for reform-induced increases in productivity in the Indian economy in the medium term yields a far less rosy picture than the one painted by RS and Kelkar.

III. Other Downside Factors

        Aside from the issues discussed in the above sections, there are a number of other significant factors which may constrain India’s medium-term growth performance. These are briefly considered below.

Agriculture

        It is hard to find a fast-growing developing economy where agriculture is not growing at 4 percent or higher. It may be no accident that during India’s fastest 5-year growth spurt (1992-97), agriculture grew at 4.7 percent. Since then the trend rate seems to have dropped to barely 2 percent a year, even including the 9 percent bonanza of 2003/4. The reasons are many and include declining public investment by cash-strapped states, grossly inadequate maintenance of irrigation assets, falling water tables, decaying rural roads, unresponsive research and extension services, soil damage from excessive urea use (encouraged by high subsidies) and a distorted incentive structure which impedes diversification from foodgrains.

Tackling these problems and revitalising agriculture will take time, money, understanding and political will. It will also require much greater investments in (and maintenance of) rural infrastructure of irrigation, roads, soil conservation, etc. and reinvigoration of the present systems of agricultural research and extension. While the central government can play a significant role in revamping systems, the main responsibility for strengthening rural infrastructure lies with the states. And their finances are under such stress that it is difficult to see how they will find the money, especially if (as in Andhra Pradesh, Maharashtra and Tamil Nadu) hard won gains of partial cost recovery (for power and other services) are squandered away in bursts of post and pre-election populism.

Fiscal Stress

        India’s problems of high fiscal deficits and their preemption of  investible resources are well-known (see, for example, Pinto and Zahir: 2004). What is perhaps less appreciated is how seriously fiscal stress has weakened the capacity of central and state governments to provide effective public goods in the form of function systems of education, health, roads and rural infrastructure. The main sources of such fiscal stress have been the long history of high fiscal deficits leading to rising government debt and interest payments (Rangarajan and Srivastava: 2004 and World Bank: 2003), the large increases in government wages and pensions following the Fifth Pay Commission (see Acharya: 2002a, 2003),  weak tax revenue performance, and growing subsidies for food, fertilizer, power, water and other items resulting from deliberate under-pricing and weak cost recovery. The net result, especially at the state level, is that once  “committed expenditures” for debt service, pensions and salaries are met, there is hardly any money left for spending on the complementary inputs necessary to provide effective public services, let alone for fresh public investment.

        This weakened capacity for effective provision of necessary public and quasi-public goods could significantly constrain the economy’s future growth performance.

Inter-regional Disparities

        Both RS and Kelkar recognize the problems stemming form the past record of disparate growth across Indian states, with the richer states of south and west clearly outperforming all others, especially the poor, populous states of north-central and eastern India.  As RS put it,“ Instead of convergence among the states, we see divergence big-time, with peninsular India growing more rapidly than the hinterland BIMARU states.” They also recognize that “this trend could widen as existing advantages are reinforced by new technologies”. The trend may also be reinforced by disparities in governance and fiscal capacity to provide critical social and economic infrastructure. Quite apart from issues of equity, rising disparities could lead to mounting political stress with grave and unpredictable consequences.

        RS and Kelkar take comfort from the possible equalizing forces implicit in free movement of capital and labour within India. They also point to possible demonstration effects  which could improve economic policies in lagging states. These benign forces may well be at work. But it may be unwise to to count on  big improvements in the medium term. The Tenth Plan presents a consistent set of projections for the Indian economy to grow at 8 percent. It expects the states of Bihar, Madhya Pradesh, Rajasthan and Uttar Pradesh to grow at 7 percent or higher (like East Asian “tiger economies”!). The problem is that in the Ninth Plan period, 1997-2002, they managed average growth of only about 4 percent. Thus some skepticism about the medium term dynamism of these poor, populous states is surely justified. This, in turn, reinforces doubts about expectations of 7 percent plus growth of the Indian economy in the medium-run.

Concluding Remarks

        Enough has been said above to seriously question the growth optimism of these recent papers by RS, Kelkar and Goldman Sachs. One other bit of information from the BRICs study by Goldman Sachs may be relevant. Its authors tested their projection model by running it “backwards” for the period 1960-2000 for eleven important industrial and emerging countries. The “predictions” were excellent---except for India, where the model “predicted” annual growth of 7.5 percent but the actual outcome was only 4.5 percent! Is there something in our stars, genes or polity which tends to produce results well short of possibilities?

        What does all this entail for a reassessment of India’s medium-term growth prospects, the principal motivation for this paper? On most dimensions I see no reason to modify the reasoning and expectations outlined in my earlier paper. The one possible exception, noted above, is a somewhat more buoyant expectation regarding aggregate savings and investment performance of the economy in future.

Taking account of this and other factors discussed here, I would slightly raise average growth expectations to the range of 5.5 to 6 percent for the next five years instead of the 5 percent indicated in the earlier paper. However, I would still retain the caveat in the final sentence of that paper: “ And even this 5 (now 5.5 to 6) percent might turn out to be optimistic if there is a serious economic crisis, whether triggered in the financial sector or government finances, or by war or international turbulence.”

        For those who find this medium-term growth expectation unduly pessimistic, it is worth emphasizing that even a 5.5 to 6 percent average growth is quite creditable for such a large and diverse society and it implies quite healthy per capita income growth at around 4 percent a year.

        Finally, after expressing so much difference of opinion with RS, let me close by voicing full agreement with the quote from George Eliot’s Middlemarch with which they begin their paper : “ Among all forms of mistake, prophecy is the most gratuitous.”

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