The quality of the human resources of India is well illustrated by one startling fact: according to a recent survey, Indians who have emigrated to the US have an average income higher than that of any other American ethnic group.
Besides its human resources, India has some other advantages from an investor's perspective and from the perspective of economic development. Most importantly, it is stable politically. India has been a multi-party democracy since its independence in 1947, with only a short interruption during the 1970s. In 1996, the voters turned the Congress Party, which had governed India for all but two brief periods since 1947, out of office. There were no talk of annulling the elections and no rumblings from the military.
India also has certain other fundamentals that contribute to political stability and the protection of investors: a free press, reasonably good accounting standards, and an independent judiciary. The judicial system, although slow and archaic, offers meaningful protection to foreign investors from arbitrary action by politicians, as the recent scandals involving the retail outlets of KFC (Kentucky Fried Chicken) has shown. After local officials closed two KFC outlets on blatantly phony health grounds, they were opened again under court injunctions against the local officials. That sort of protection is not something available to investors in Russia, China or most other emerging markets.
Given the human and educational resources of India, given its relative political stability, given its well-developed legal system, all fundamental prerequisites to the building of wealth, why does India remain so poor? And why is there so little venture capital investment? Why has the poverty become worse since independence, at least in comparison to the rest of the world? And why do Indians who emigrate do so much better on the average than those who stay in India?
To get a sense of India’s poverty, the average per capita wealth in the US and Europe during the 50s was 6 times that of the average per capita wealth in India, taking into account purchasing power differences of the currencies; by 1990 it was 12 times. As for the venture capital, according to estimates published a couple of years ago in the Asian Venture Capital Journal, the pool of venture capital in India-specific funds is the lowest in Asia except for Pakistan. It is the lowest on a per-capita basis—which one might expect—but it is also lowest as a percentage of gross domestic product, which one would not.
The answer to all these questions, which are related, is not hard to find. In three words: "the Indian government." This is India’s great weakness. It consumes vast economic resources that could be more profitably employed elsewhere and inhibits the efficient application of resources in the private sector.
There is a saying that the British introduced bureaucracy to India, but the Indians perfected it. As I'm sure many of you know, "red tape" is still in use–literally. It is cloth tape that wraps the files circulating endlessly within the various ministries. In fact, that's where the expression "red tape" comes from; it’s not from sticky tape. Horror stories of foreign investors caught in the tentacles of the Indian bureaucracy and Indian politics are legion and legendary. I saw the consequences first-hand on the Enron project which was delayed and subjected to enormous additional expense—hundreds of millions of dollars—by the government of Maharashtra, essentially for political reasons.
This is frustrating to me personally, but it is the least of the ways in which the government interferes in the Indian economy to its detriment. India's government is a powerful drag on India's economy. In fact, it's more than that. The past policies of the Indian government—Swadeshi socialism—constitute a human tragedy of immense proportions. In the last one hundred years, the economic growth produced by the relatively free markets of Canada, the US, Europe and Japan has brought previously unimaginable wealth to the average citizen. In the last thirty years, more and more countries have participated and generally have grown economically in rough proportion to the extent they have freed their markets. India has largely failed to participate in this process of building wealth since independence, because of the Swadeshi socialist path its government chose. Two generations of Indians—hundreds of millions of people—have been condemned to a life of poverty because of it.
So, as Vladimir Lenin famously said, "What is to be done?"
The best thing that could be done, from the perspective of economic growth in India—and incidentally, the prospects for venture capitalists—would be for the government to get out of the way. That's all that's necessary. Nothing more. Just get out of the way. If it did, India would bloom economically in ways that we cannot even imagine today.
Many people believe that government should do more than get out of the way. They believe it should support certain types of businesses or channel investment into favored sectors through special tax breaks, tariff barriers, special zones of various kinds or direct investment. Some advocate that the government set up its own venture capital investment arms or establish programs like the small business investment company program in the United States. I don’t agree.
The reason I don’t agree is simple: even if their intentions are good, governments all over the world—not just in India—are always a step behind. They lack the instant feedback provided to private enterprises by having to live or die according to their success in the free market. Silicon Valley became what it is today without any significant help from our government in Washington. In fact, many suspect that it would not exist if it hadn’t started in California, three thousand miles away from the politicians in Washington.
Many efforts by governments to intervene in the economy at least purport to foster development. Usually these involve a subsidy of some sort, direct or indirect. Every business likes a subsidy, such as a tax advantage or facilities provided at below-market rates. In general, we encourage our portfolio companies to take advantage of them. But such subsidies never make the difference between success and failure of a business. The marketplace determines that. The subsidies are just arbitrary gifts from the taxpayers to shareholders.
I should add that I include lowering taxes to the extent possible in the general concept of "getting out of the way." There is a Marxist aphorism that "Property is Theft." In my view, it's more accurate to say that "Taxation is Theft." So I'm always in favor of lowering taxes. However, special tax breaks for specific types of business—such as infrastructure or software or export businesses—is, to my mind, bad policy. It distorts decisions regarding allocations of resources away from what is efficient. Obviously, I love it when it favors a company in which we invest. But I think it’s a bad idea from the perspective of India’s development.
I should also elaborate a bit on the subject of government-provided venture capital. I actually think there is no such thing. There is quite bit of money provided to entrepreneurs by their governments, both here and elsewhere, but it’s not venture capital. It’s not venture capital because the people who dispense it aren’t venturing anything themselves. What’s more, it leads to what economists call a moral hazard, i.e., the degradation of prudential standards that occurs when the people who dispense the money don’t bear the risk of its loss. Part of the money that my fund invests is my personal money. Although I am prepared to take risks with that money, I am only prepared to take what I regard as prudent risks, and I have a very personal stake in trying to insure the success of each company in which we invest.
No employee of a government-funded firm, or for that matter, no employee of a large private financial institution, has the same personal risk. This is why in the US, the most successful and prominent venture capital firms, such as Greylock Partners, Kleiner Perkins or Sequoia Capital, are relatively small independent entities. The partners may have much capital to invest, but a significant portion of it is their own. And they don’t have conflicting agendas: They apply all their knowledge and resources to contributing to the success of their investee companies and the consequent return to themselves and their investors. They don’t have to struggle with people in their organizations who may have different agendas. They aren’t worried about how what they are doing will be viewed by the corporate or political superiors. They don’t have the prospect of moving on to another position in their institution or the next Indian Administrative Service posting to dull their commitment.
The Indian government announced recently that it is going to establish a venture capital fund for investment in technology companies with taxpayer dollars. This has already acquired the sobriquet the "Nephews and Nieces Fund," since most people in India expect that it will be used mainly to fund companies owned by relatives of the bureaucrats involved and the politicians with which they wish to curry favor.
Similar government-funded efforts in India in the past have, for the most part, produced bad results. Historically, the "soft money" available from the Indian financial institutions and their affiliated investment arms have resulted in companies being funded that shouldn’t have been funded and deals being done that shouldn’t have been done. The result has been bad for the Indian taxpayers, who have shouldered the loss when the deals turned sour, and bad for the entrepreneurs, whose ventures have not been disciplined by competition for capital in the free markets. The entrepreneurs also have not been given the other things that a good venture capitalist can bring to an entrepreneur, such as access to technology and customers. They are also subject to political influences and politically-motivated demands from the bureaucrats who sit on their boards of directors. I firmly believe that free markets do the best job of allocating resources, including capital, and that most of those who take money from the government will live to regret it.
The experience with a similar effort in Israel is, I think, instructive. Joel Bainerman, the author of a recent article on government-funded technology incubators there, concludes that "Israel's experience with [government-funded] technological incubators has been a waste of public resources without allowing for the most creative ideas of Jewish immigrants from Russia to come to fruition." This program has been in existence for several years and has invested approximately $100 million. Yet, Bainerman says that the official in charge of the program admits that "not even one profitable project has yet come out of the incubators."
Businesses do need governments to provide what only governments can, such as monetary stability and a legal system that provides an effective means to enforce private contracts and redress corporate wrong-doing. Other than that, their citizens are best served if the government just gets out of the way.
Unfortunately, the Indian government won't get out of the way, at least not to the extent it should, because that's not the nature of bureaucracy. A cartoon by Laxman, everyone’s favorite Indian newspaper cartoonist, shows a Babu sitting in his office in North Block with a group of his subordinates reading a newspaper, and saying: "Cut red tape?? Free the economy?? Why, they're trying to eliminate my ministry!" Too true, and he'll resist it with all his strength.
Fortunately, one weakness of the Indian bureaucracy is that it reacts very slowly to changes in the economy. In fact, in a sense, it is still trying to tax and regulate the economy of 1947. That can be seen as a positive thing in the sense that it has woven its web of tax and regulation around what has historically been the most obvious target: manufacturing in general and especially the physical movement of goods. Most of the government’s revenue is still raised from import duties and similar taxes. It has largely failed to fasten its claws onto the real source of value in our times, knowledge and knowledge-based services. And that gives an opening for the transformative economic phenomenon of the end of the twentieth century to work its magic: the Internet. This is India’s great hope. Through the Internet, the great strengths of India—the intellectual skills and knowledge of its people—for the first time can be brought to where they have the most value. This has happened in minor ways before, through emigration. This can now happen—and is happening—on a vastly greater scale.
Many are already aware that software development services have become the largest source of foreign exchange earnings for India. A more recent development is businesses that use software to provide remote services rather than writing software. General Electric Capital services its US mortgages from an office near Delhi. British Airways handles many back-office jobs for itself and other airlines, such as dealing with errors that pop up in automatic reservation systems from two facilities in India. There are many other such businesses. In fact, as of last year, approximately 25,000 Indians were employed in remote services other than software development, according to estimates of the National Association of Software and Service Companies, an Indian trade group. I suspect that number is too low. McKinsey, the consulting company, estimates that number will rise to as much as three million within the next ten years. I suspect that number also is too low. All these people will work in businesses that, if not Internet-based already, will be soon.
I will add that our investments in India are focused to a substantial extent on such businesses, although not exclusively. Among other things, we have invested in a company called Tracmail. Tracmail provides responses from facilities in India to the flood of e-mails now coming into American companies through the Internet. The companies cannot respond in any satisfactory manner, because the flood vastly exceeds their human resources and it would be too expensive to build up the necessary resources. This leads to the common experience of bad service on the Internet. However, the flood doesn't exceed the human resources of India, which now can be applied anywhere on earth instantaneously and at a cost much lower than comparable resources in the US or other developed countries. Tracmail also offers to US corporate clients the ability to offer live web-based interaction with their customers, again by using its access to the enormous human resources of India. For example, one of its largest customers is a new Internet service called Webhelp.com, which offers real-time help to customers wanting to find information on the web. It does so by using trained "web wizards," as it calls them, located at Tracmail’s facilities in India. The customers of Webhelp don’t know and don’t care where the Web Wizards are; this is the power of the Internet to make geography irrelevant.
The next wave is likely to be businesses that make the potential of the Internet a reality, such as vertical portals for business-to-business e-commerce. So far, most such portals are based in the US. But that won’t be the case much longer. There And this is the essential point: I believe that in the future, not only will they be done in India, but they will be done better in India, at least to the extent that they have a strong service component that requires the human touch, because of the vast human resources available there. These business-to-business (or B2B, in Internet jargon) portals are in fact the current focus of our efforts at VIEW Group. We are investing in several of them that have started recently and are providing entrepreneurs with the capital and other resources to create several more.
Through such uses of the Internet, India's intellectual exports need no longer be in the form of the dribble of expatriates and emigrants but in form of the work product of the world's largest mass of educated, intelligent, and English-speaking human beings. This is how India's great resource will be liberated from its great weakness.
Is all this really going to happen? Is the Internet going to allow India at last to participate in the benefits of the unprecedented growth in the world's economy in the 20th century? I think so. There is only one thing that could stop it: the Indian government. But I don't believe it will. I believe so for a one reason: the secret is out. Hundreds of millions of ordinary Indians now watch television, both Indian and foreign, which they did not do in 1947 or indeed until the last few years, and they see what they are missing. Many millions have also worked abroad or have relatives who work abroad. And approximately one million are now connected in one way or another to the Internet, the most powerful tool of all for disseminating information. Many of these people may not be able to articulate the economic policies that will be necessary for them to share in the abundance they see abroad. But they see clearly enough who has it and who does not, and eventually will support those who will allow the economy to grow so they can have it also. Even though the impulse of the government to control the economy undoubtedly lives on and progress will be fitful, as the benefits of a free economy become more and more obvious, the extent of its control will decline. And it is unlikely that the government will attempt, as it has in China, to control the uncontrollable, that is, the Internet.
To put it differently, no group of politicians will, in the long run, be able to stand between hundreds of millions of ordinary Indians and their aspirations for the better way of life they can see before them. The ability of the Nehruvian socialist bureaucracy to continue the policies that give its members power and relative affluence at the cost of the continued impoverishment of the vast majority of Indians depends on the ignorance of that majority, ignorance that will not continue in the face of the flood of information now washing into every village in India
3. An assessment of the impact of India's structural adjustment
3.1 Growth rates
The first notable consequence of structural adjustment has been a slowdown in the average rate of growth of the economy relative to the preceding quinquennium, as evident from Table 1.
Table 1: Average annual growth rates (1980-81 prices)
Source: Calculated from the Economic Survey 1998-99, GOI.
It has been argued that Fund-Bank style reforms are inevitably associated with deflation in the short-run, and it is only after a while that the economy is expected to pick up on the basis of stimuli other than those which prevailed under the earlier regime. In short, a transitional period of stagnation is expected, and should not cause undue worry, since growth would subsequently pick up on a new and supposedly more secure basis. In the case of India too, until recently it appeared that there were two distinct phases of growth in the post-reform period, a phase of deflation during which the economy was being sought to be stabilised, and a subsequent phase of recovery, starting from 1993-4.
It is now clear, however, that this recovery was a result of transient phenomena. These included the stepping up of the fiscal deficit in 1993-94, and, even after the fiscal deficit had been lowered in the subsequent years, the satisfaction of pent-up demand for a variety of hitherto-not-available luxury consumer goods. Since the rate of growth of the demand for such goods, as opposed to the once-for-all splurge that the satisfaction of pent-up demand entails, is much lower, the stimulus which such demand imparts to industrial production evaporates quickly; and this is exactly what has happened.
Industrial performance has been dismal in 1997-98 and 1998-99 (Table 2). As a result, compared to an average annual growth rate of 8.4 percent in the index of industrial production (which is distinct from real value added in industry) during the quinquennium 1985-86 to 1990-91, the rate for the eight years 1991-92 to 1998-99 (on the assumption that the growth rate observed during April-December of 1998-99 holds for the year as a whole) comes to 5.7 per cent.
This slowing down clearly is a secular phenomenon, not just a short-term consequence of stabilization. It is an expression of the loss of expansionary stimulus that a 'liberalised' economy entails, through the decline of public investment, through higher interest rates, and through the shrinkage of demand owing to import liberalization.
Table 2: Industrial growth rate (percentages)
Note: New series with base 1993-94 = 100.
Source: Economic Survey, 1998-99.
A slowdown is also evident in the agricultural sector, where the growth rate in the production of foodgrain in particular has declined sharply. For a long time now the Indian economy has experienced a secular growth rate of foodgrain production of around 2.5 percent per annum which was a little higher than the population growth rate. Even during the 12 year period 1978-9 to 1990-1 (both being good agricultural years are comparable), the rate of growth of foodgrain production was 2.4 percent which was above the population growth rate.
However, over the period 1990-1 to 1997-8 (again both good agricultural years), the growth rate of foodgrain production dropped to 1.2 percent which was distinctly lower than the population growth rate. This is the lowest average rate since the mid-1950s, and a very dramatic drop compared to the earlier decades. In such a context, increased volumes of exports (both foodgrain and cash crop) along with higher rupee prices of such exports because of rupee devaluation, have also meant rapidly rising prices of food in the domestic market. Further, the period of the 1990s, besides exhibiting the usual fluctuating pattern in agricultural output, is marked by two years of substantial decline in the relatively recent past.
What is interesting is that neither of these two years - 1995-96 and 1997-98 - was considered to be a particularly bad year in terms of aggregate rainfall and weather conditions. It is also worth noting that in the three years of negative growth over this period, value-added has fallen even more sharply than production, and this has occurred despite the general tendency of agricultural prices to move faster than the general price index.
We are therefore witnessing the emergence of a process which could culminate in a serious food crisis. The fact that despite this reduction in output growth rate there has been no actual food shortage till now is little consolation. It merely shows that purchasing power among the workers, especially the rural workers, has increased even more slowly in real terms (i.e. when deflated by an index of the administered prices of foodgrain). The reason for this lies partly in the steep escalation in administered prices of food which occurred in the aftermath of 'structural adjustment' as a part of the so-called fiscal correction (for which subsidies had to be kept down), and partly in the shift of emphasis towards export agriculture and away from food crops. Foodgrain production being more employment-intensive than the exportable commodities which substitute for it in terms of land use, such as prawn fisheries, sunflower, orchards etc., a shift of acreage from the former to the latter that occurs as a sequel to 'liberalization' has the effect of restricting employment growth. In fact this latter process explains inter alia both the decline in foodgrain output growth and some of the decline in employment elasticity of output.
Given the size of India's population, the large incidence of absolute poverty and the continuing agrarian nature of the bulk of the work force, such trends have extremely dire implications. They suggest that the issue of domestic food security is not just a continuing problem but may even become a potentially explosive one. Thus, in the nineties, several of the public policies which contributed to more employment and less poverty in the rural areas in the earlier decade have been reversed.
There is however an additional factor behind the drop in foodgrain output growth. This is the drastic decline in real public investment that has occurred in agriculture over a long period. Gross capital formation (at 1980-81 prices) under the aegis of the government in the agricultural sector was Rs. 17960 m. in 1980-81; it remained way below that level throughout the 1990s, reaching Rs. 11540 m. in 1990-91 and only Rs. 13100 m. in 1995-96. The deceleration had occurred during the 1980s itself, but the 1990s have done nothing to boost public investment. During the 1990s there has no doubt been a step up in real private gross capital formation in this sector from Rs. 34400 m. in 1990-91 to Rs. 49910 m. in 1995-6. But much of the increase in private investment is likely to have been in the non-traditional sectors of export agriculture rather than in foodgrain production. It is noteworthy that the growth rate between 1990-91 and 1996-97 shows a sharp decline not only for the coarse grains from which much land has shifted towards export crops like sunflower, but even for rice (1.52 percent compared to 3.35 percent for 1980-81 to 1995-96). This is symptomatic of a decline in investment in traditional food crops.
In addition, there has been an initial decline and a subsequent overall stagnation of the investment ratio, as indicated in Table 3.
Table 3: GDCF as percentage of GDP
Note: Figures up to 1992-93 are based on old series (Base 1980-81) and from 1993-94 based on new series (Base 1993-94). P = Provisional; QE = Quick estimates.
Source: Economic Survey 1998-99.
But even these figures represent overestimates. The method of estimating capital formation is such that in a period of growing consumerism involving import-intensive durable goods and 'capital goods' like automobiles in the post-liberalization period, the tendency invariably is for an overestimation of investment. (2)It goes without saying that if the actual investment ratio, far from increasing, has been either stagnant or declining, then the acceleration in growth-rate promised by the reforms would not materialise.
This sluggish investment performance is not surprising. The proposition underlying the economic reform policies that if only more surpluses are handed over to private operators they would automatically invest more, is a presumption based on the erroneous belief that there can never be a demand constraint in a market-based system. In fact, private agents invest in response to specific stimuli. In the pre-liberalization regime the main stimulus came, directly or indirectly, from public investment and expenditure in general. This had a "crowding in" rather than a "crowding out" effect on private investment. A "liberalised" economy however entails a loss of this stimulus, compounded by other factors such as high interest rates and loss of domestic markets through liberal imports, which is not offset by any corresponding new stimulus.
3.2 Exports
Of course, exports can constitute such a new stimulus and indeed it is frequently argued even today that whenever the domestic market falls short then producers can export their way out of any problems. However, one of the failures of structural adjustment in India has been its inability to stimulate India's exports. After an extremely poor performance in 1991-92 and 1992-93, India's exports (in dollar terms) appeared to gain momentum, growing at an average rate of close to 20 per cent during the three years starting 1993-94. However, exports slumped from 1996-97, with the rate of growth touching 5.6 per cent (Table 4).
Exports by all the major groups of products - agricultural, mineral, and manufactured goods - have declined. Exports of agricultural and allied products have been declining now for the past two years. The performance of manufactured goods exports has been even more dismal. In 1997-98 such exports had increased by 8 per cent, but in the period April-September 1998 they declined by 7 per cent compared to the previous year. This category includes many items which had been part of the government's "thrust sectors" for export, such as textiles, leather goods, machinery and transport equipment, electronic goods, and so on, all of which showed lower exports. Even ready made garments, which had been the great mainstay of the previous year's manufactured exports, have showed a relatively low increase.
Some of this slump can of course be attributed to the deceleration in world export growth and an appreciation of the rupee in real terms. However, this is at best a partial explanation and it is clear that other factors, some of them domestic, must have been responsible as well. There have been some other countries - notably the Philippines - which have been able to weather the deceleration in world export growth, and register creditable export growth rates even when many East Asian countries were faring poorly. Similarly it must be remembered that the real appreciation of the rupee was partly because of the large inflows of capital into the country in the wake of financial liberalization. In the recent period, as well as in the 1990s overall, Indian exports have performed much worse than world exports, and India's share of total world trade has fallen.
It is true that the dramatic depreciation of several of the currencies of the Southeast Asian region has affected Indian export competitiveness in a number of competing sectors such as textiles, garments, leather and electronic goods. Also, the now generalised economic depression in the Southeast Asian region has definitely had an impact on Indian exports to that region. Exports to Asia have fallen by 25 per cent over the period 1996-98. The trend is even stronger if the Southeast Asian countries alone are considered, with huge declines in Indian exports to Philippines (64 per cent). The Republic of Korea (60 per cent) Malaysia (45 per cent) Taiwan, China (29 per cent) and Thailand (19 per cent).
But the very facts that even under such circumstances, exports to the United States have gone up by nearly 10 per cent, and that those to Europe have crashed even though they are mostly in items that not directly competitive with Southeast Asia, suggests that there must be other factors at work. Insofar as these factors are internal to the Indian economy, it is important to address them immediately. And if they reflect the nature of the interaction between India and the world economy, then it may be necessary to rethink the terms of such interaction.
This argument may become clearer if we consider the processes that have been released by trade liberalization and global economic trends in terms of domestic relative prices and incentives for producers. One of the important implications of the liberalization of agricultural trade in India in the nineties has been the increased possibility of crop exports. This in turn has meant that Indian food prices (which in general were below international prices) have come closer to the international standard. Indeed, food price inflation has become the defining feature of price movements in the country in the past few years. Meanwhile, the liberalization of imports has also suppressed rises in the prices of many manufactured goods which are affected by import competition.
In this context, the rise in food prices has an interesting implication, quite apart from whether or not they improve material standards for the country's farmers. They certainly lead to pressures for nominal wages to increase. And it is clear that this has occurred, although in most states this has not been enough to counterbalance the effect of higher food prices, so that real wages have fallen.
However, even though real wages have fallen, product wages are likely to have risen in most non-food producing sectors, for the simple reason that inflation in these sectors has been less marked. This actually squeezes the profitability of producers in non-food sectors, and can also make them less competitive. Such a combination, of falling real wages and rising product wages in the manufacturing sector, would also create a certain pattern of incentives for producers, discouraging productive investment in these sectors. This could certainly form part of the explanation of both domestic industrial stagnation and poor performance in manufactured exports.
Thus the manner in which the process of economic liberalization has unfolded in India thus far suggests that, while it has failed to deliver its promised benefit of a foothold in world markets, it may have actually been working against the acceleration of export growth.
4: India's trade performance
This was not initially so much of a problem because low world oil prices resulted in a fall in India's oil import bill and the industrial recession slowed the rate of growth of non-oil imports. More recently however imports are once again rising fast enough to more than neutralise the benefit of low oil prices, resulting in a rise in the trade deficit. The export competition from East Asia where currencies have depreciated massively, has accentuated this problem. As a result, despite large inflows of remittances from non-resident Indians, the current account deficit has been rising. If the East Asian experience is indicative, this can become an important basis for a weakening of investor confidence.
3.3 Fiscal patterns
The usual justification for 'rolling back' the State is that the fiscal deficit must be cut, since it is a source of instability of the economy. Not only is this argument questionable, but, what is more, this package tends to intensify the fiscal crisis.
There is an important distinction to be made here. In an economy that is liberalised with respect to the capital account of the balance of payments, and hence open to speculative capital flows, it may well be the case that speculators look at the size of the fiscal deficit which thus becomes a determinant of their state of confidence (so that denouncing fiscal deficits becomes a self-fulfilling prophecy in a liberalised economy), but this is different from saying that the fiscal deficit per se is destabilising. The latter argument is untenable for several reasons.
First, the size of the fiscal deficit, which shows the net demand arising from the government, does not have anything to do directly with 'instability' in the sense of either generalised inflationary pressures or an unmanageable trade deficit, since the latter depend upon ex ante excess aggregate demand. Secondly, while borrowing to meet current expenditures does require scrutiny (though it is not always reprehensible, for example in a recession) since it is indicative of "living beyond one's means", there is nothing necessarily wrong with borrowing to meet investment requirements. If the focus was on a reduction of the revenue deficit, then it might make sense, but by emphasising the fiscal deficit as distinct from the revenue deficit, the IMF and the World Bank deliberately try to negate the role of the government as an investor. Thirdly, a reduction in the revenue deficit, or in the fiscal deficit, can be brought about in a number of different ways, the obvious one being an increase in direct tax revenue. Indeed in any developing economy where glaring poverty coexists with offensive opulence, increased revenue from direct taxes is urgently called for anyway as a means of reducing inequalities. But policies of liberalization or the new-style economic reforms invariably underplay this avenue of deficit reduction and emphasise cuts in investment and welfare expenditures.
Not only is the theory underlying such cuts invalid, but the fiscal deficit which is invoked to legitimise such cuts gets aggravated because of 'structural adjustment'. Since inviting direct foreign investment becomes an overriding objective of economic policy, the rates at which they are taxed gets reduced in competition with other countries. This, for reasons of symmetry, means that direct tax rates on the rich as a whole are lowered. Since customs duties are cut as part of the import liberalization package, and excise duties, again for reasons of symmetry, cannot be raised as a consequence, indirect tax revenues too suffer. This is aggravated by the sluggishness in output growth rate that cuts in government expenditure may engender.
While tax revenues cannot be raised for lowering budget deficits, the increased interest rates, resulting in a larger interest burden on the government, which are another legacy of structural adjustment, add to the expenditure side. Increased interest rates on public sector borrowing are typical results of the financial liberalization process which was discusses above. Two features are particularly significant in this process : first, the removal of interest rate caps and other such restrictions in the credit market, which allow all interest rates to go up; and the raising of norms on the Statutory Liquidity Ratios and other such compulsory holding of government securities, which force the government to take recourse to open market borrowing to finance deficits.
Thus this type of structural adjustment, which aims to restrict the fiscal profligacy of the State, contains within itself processes which work to aggravate further the fiscal situation, through lower taxes on the rich and higher interest rates.
The Indian experience described in Table 5 fully bears this out. Not surprisingly, the fiscal adjustment in India has left the size of the revenue deficit unchanged or even enlarged, and instead impinged heavily on public investment and welfare expenditure. The process of adjustment has further entailed a very specific fiscal regime, which has increased transfers from the State to rentiers in the form of interest payments, and to enforce larger fiscal burdens on the people and cuts in public investment.
5: Some fiscal magnitudes as ratios of GDP
Notes: * refers to Budget estimates
- Revenue deficit refers to current expenditure minus current revenue
- Fiscal deficit refers to all expenditure minus current revenue, that is revenue deficit plus capital expenditure
- Interest refers to all interest payments of the government
- Subsidies refers to all direct budgetary allocations for subsidies, i.e.
Food and Fertiliser subsidies
Source: Economic and Political Weekly, Budget Number, May 1997 & Budget at a Glance, Ministry of Finance, Govt of India, 1999-2000.
3.4 Poverty and employment
The fourth significant consequence of structural adjustment has been a rise in rural poverty. Using the norm set out by the Planning Commission the head-count ratio measure of poverty for rural India moved as shown in Table 6.
Table 6: Head-count ratio measure of poverty (percentages)
Note : These estimates, which are by S.P. Gupta based on NSS Surveys, differ slightly from those in Table 10, which are by Ravallion-Dutt and Sen, also based on NSS Surveys. However, the directions of change remain the same.
Source: S. P. Gupta, "Globalisation, Economic reforms and labour", ILO-SAAT New Delhi, Mimeo, May 1999 , page 59.
The veracity of these figures may be questioned on the grounds that they are based (except for the three years 1983, 1987-88 and 1993-94) on consumer expenditure data derived from "thin samples". But it is now quite widely accepted that the thin samples are adequate for deriving conclusions at the all-India level, even though they may not be sufficient to infer movements in individual states. The estimates given here are made by a member of the Planning Commission, Government of India, incorporating information about the more recent years that has just been released. The results are fairly robust in the sense that other researchers have come to very similar conclusions (3) and other social indicators show parallel movements. One element underlying the rise in rural poverty was the sharp increase in the cost-of-living of the working class in general and of agricultural workers in particular (Table 7).
Table 7: Increases in the cost-of-living indices (percentages)
Source: Calculated from various issues of the Economic Survey.
This acceleration of consumer price inflation in a period of 'slack' demand was essentially due to hikes in administered prices which were ordered by the government in order to curtail its subsidy bill, and thereby the fiscal deficit. The commodities whose prices were most severely affected in this manner were foodgrains. As we have already seen, the Indian adjustment strategy has been characterised by attempts to cut consumer subsidy on foodgrain supply through the public distribution system (PDS). This subsidy was already very low by East Asian standards : it has been shown that in most Indian states the value of the income subsidy via the PDS was less than one or two person days of employment per family per month. (4)There were steep hikes in the central issue prices of rice and wheat in December 1991, January 1993 and February 1994. As a consequence of these hikes, by February 1994 the issue price of the common variety of rice had increased by 86 percent compared to the immediate pre-structural adjustment level and of wheat by 72 percent. Subsequently, there have been further sharp hikes in the period 1996-98, as discussed below.
Not surprisingly, this has led to a substantial reduction in purchases from the PDS as the poorest groups were effectively priced out. Total offtake from the PDS is estimated to have declined from 20.8 million tonnes in 1991 to only 14 million tonnes in 1994, and even in 1997 was estimated to be only 17.5 million tonnes. (5)
Subsequently, in 1997 the government introduced a Targeted Public Distribution System in which the price paid by families below the poverty line was reduced by 38 per cent in the case of wheat and 35 per cent in the case of rice, while those paid by families above the poverty line were hiked by 12 and 29 per cent respectively. More recently, in February 1998 the issue prices for families above the poverty line have been hiked by a massive 44 and 29 per cent respectively. It is hardly surprising that the cost-of-living of the workers, both in urban and rural areas, went up so sharply, and that the cost-of-living of agricultural labourers, for whom food is an even more important item in the consumption basket than for industrial workers, went up more steeply than for the latter. In addition, this led to a paradoxical situation whereby there was an involuntary build up of large public foodgrain stocks, so that the carrying costs of these stocks amounted to nearly 40 per cent of the total food subsidy expenditure, even as poorer groups were deprived of access. The decline in wage goods availability is a common feature of standard market-oriented adjustment programmes, and the Indian case shows this very clearly.
There was a second element underlying the rise in rural poverty. The level of rural poverty is linked in India not only to the level of food prices relative to wages, but even more pronouncedly to the magnitude of employment opportunities (for which the ratio of rural non-agricultural to agricultural employment is a good proxy, since agriculture is the repository of unused labour reserves). Thus, levels of poverty have been closely associated with not only with overall output and productivity, but also - and critically - with employment generation.
One of the major failures of the adjustment strategy in India has been the inadequate generation of employment. The rate of employment generation has been below both the rate of growth of output and the increase in the labour force. In the four year period 1991-97, total organised sector employment increased by a paltry 5.6 per cent over the entire period, even as industrial output has tripled. Estimates of non-formal employment similarly are very low, as discussed below. According to NSS data, the rate of growth of overall employment has been continuously decelerating since the early 1970s, and for the period 1987-88 to 1993-94 was estimated to be only 2.3 per annum. Recent data suggest that the post-reform growth of total employment, that is in the period 1990-91 to 1997, has been only 1.76 per cent per annum, with an overall employment elasticity of GDP at the low level of 0.29, which is exactly the same as that for the period 1983 to 1990-91.
The disaggregation of aggregate employment into self-employment, regular salaried employment and casual wage employment, also show some disturbing trends. As Table 8 indicates, the expansion of self-employment in the 1990s has decelerated in the 1990s compared to the earlier seven-year period. Regular salaried employment has actually fallen quite substantially, indicating a big fall in both public and private regular employment opportunities. The only category of employment that appears to have registered an acceleration is that on casual contracts, which is usually associated with both lower wages and inferior working conditions and poorer protection of labour.
Table 8 : Annual change in employment by category
Source: S. P. Gupta, "Globalisation, Economic reforms and labour", ILO-SAAT New Delhi, Mimeo, May 1999 , page 61
The accentuation of unemployment, notably in rural India, in the nineties, has been related to the shift of acreage from food to non-food crops, import liberalization that has led to a demand-switch away from domestic producers, and, above all, cuts in public development expenditure. The Central government's total development expenditure as a proportion of GDP at market prices declined from 12.54 percent in 1985-86 to 7.74 percent in 1996-7 . Since government expenditure has a crucial employment generating effect, especially in rural areas, this reduction has been employment-contracting. (6) Similarly, there has been a cut in the ratio of social sector expenditure to GDP, as shown in Table 9.
Table 9 : Social sector expenditure of union and state governments (per cent of GDP)
Source: Alternative Economic Survey 1996-97
The 1980s were characterised by a relatively slow expansion of employment, but also by rising real wages and a fairly substantial drop in both the incidence and the severity of poverty, particularly in rural India. It has been argued that this can be related at least partially to the rapid increase in various subsidies and transfers from government to households, the large increase in revenue (rather than capital) expenditure on agriculture by central and state governments, and a very large increase in rural development expenditure. (7)Thus, while there were some linkage effects with modern industry and commerce in the rural areas, these were geographically limited, and the pivotal role in the expansion of rural non-agricultural employment in particular, may have been played by government in this period.
However, since 1991 government economic strategy has implied further reductions in the employment generation capacity of the organised sector as well as adversely affected rural non-agricultural employment. This is because of the following policies : actual declines in government spending on rural development in the central budgets, as well as declines in the fertiliser subsidy; reduced central government transfers to state governments which have thereby been forced to cut back on their own spending; diminished real expenditure on rural employment and anti-poverty schemes; declines in public infrastructural and energy investments which affect the rural areas; reduced spread and rise in prices of the public distribution system for food; cuts in social expenditure such as on education, health and sanitation; financial liberalization measures which have effectively reduced the availability of rural credit.
As a result, there has been an absolute decline in rural non-agricultural employment since 1991. This has been accompanied by a large relative shift towards agricultural work, particularly by women, and since the rate of growth of agricultural output has slowed down after the reforms, and there have been increases in rural poverty, this appears to be evidence of a distress shift into agriculture given the lack of alternative income opportunities. (8)What is probably most significant is the reversal, since the marketist reforms of the 1990s, of a long run tendency towards the decline of poverty. This process, which is indicated in Table 6, has been particularly marked for the rural areas. This development, too, suggests that the post-reform increase in agricultural employment took place not in the context of greater rural prosperity but reflected greater adversity.
Table 10 : Indicators of rural non farm employment and poverty
Source : NSS, Sarvekshana, various issues, and Sen [1996].
In urban areas, there has been a trend increase in casual employment and a trend decline in regular employment for both men and women. For men, the increase in casual employment has largely been at the cost of regular employment; and this trend appears to have continued into the post-reform period, although again with some reversal in 1993-94. For women, on the other hand, both casual and regular work appears to have increased after the reforms. In part, this is reflective of the 'feminization' process where a larger share of new urban jobs go to young female employees. But it reflects also a sharp decline in female self-employment immediately during the adjustment process. Here, factors similar to those governing rural non-agricultural employment appear to have played a part in reducing labour demand from such small enterprises where women are self-employed.
In rural areas, on the other hand, a trend of declining self-employment for both males and females appears to have been reversed with the reforms. This is due entirely to an increase in agricultural self-employment, reflecting the shift away from non-agriculture, and is also, in large part, caused by the distress induced increase in female unpaid family work noted earlier. Regular employment has continued to decline and casualisation of wage employment has continued to increase. There has been a particularly sharp increase in female casual employment following the reforms, confirming the distress nature of rural employment developments. Agricultural wages have declined slightly in real terms over the 1990s in several of the most populous states such as UP and Bihar, and have risen only marginally on others. (9)This is likely to have led to falls in real wage incomes given the decline in overall wage employment in the rural areas.
The Indian pattern of feminization of work differs in several very important ways from that which occurred in the second tier NICs of Southeast Asia during their economic boom. First, this growth in female employment relative to that of males was marked equally in agriculture and industry, and was much sharper for subsidiary workers, and not so for principal workers. The opposite tendency prevailed in the export-oriented industries of Southeast Asia until 1996. Second, it occurred in the context of overall stagnation in non-agricultural employment, rather than the tremendous boom in manufacturing employment found in the second-tier Southeast Asian NICs. Third, much of this increase in female employment, especially in agriculture and other forms of self-employment, appeared to be the result of distress conditions determining the supply of labour, rather than intensification of demand as in the high-growth Southeast Asian countries. What was common to both regions was the growing casualisation of female labour in particular, and the clear indication that the growing use of women in the work force was associated with the greater insecurity of labour contracts and the generally inferior conditions and pay involved in employing women rather than men.
3.5 External vulnerability
One important fallout of the adjustment package lies in the increased vulnerability of the Indian economy to speculative pressures. This makes the balance of payments more fragile than ever before. Despite the obsession with and high expectations regarding foreign direct investment inflows into the economy, the actual inflows under this head have been relatively minor, not more than $ 2 billion per year on average. Most of this has also come into activities catering to the domestic market which displace domestic producers and constitute implicit de-industrialisation (owing to the high import content of FDI-based production) rather than into activities, such as export-oriented production, which genuinely add to domestic output and employment.
What has come in larger measure however is speculative finance capital in the form of `hot money' on the basis of which India's exchange reserves (at the end of January, 1999) of $27.4 billion have been built up. However, even these have been losing steam over the past year. There has been a marked slowdown in FDI and a net outflow of FII portfolio investment in 1998-99. There has also been a large outflow of NRI deposits.
One point which is often missed in discussions on Indian balance of payments is the critical role that has been played by workers' remittances. Such inward flows, which are classified under invisible receipts, have contributed more over the 1990s than all forms of foreign investment (FDI, portfolio capital, Euro-equities and external commercial borrowing and foreign aid) since the early 1990s. The total amount of all form of foreign investment inflow into the country between 1992-93 and 1997-98 amounted to $ 25 billion, while the net receipts on invisible payments on current account in the same period came to $ 36 billion - that is 44 per cent more. In the latest year for which data are available, 1998-99, remittances alone account for more than $ 11 billion, more than all foreign investment inflows put together.
Despite these inflows that have kept the current account deficit under control, the balance of payments situation is not exactly comfortable at present. The deceleration of exports and worsening trade balance suggest that it may be only a matter of time before some degree of payments difficulty is experienced. Also, while the reliance on short-term flows in India has been far short of the levels in the crisis-affected Southeast Asian countries, it remains substantial enough to be a source of concern and to put pressure on domestic policy-making in terms of the need to placate and reassure international investors (who, incidentally, may be domestic in origin as well). But to a significant degree, the controls that still do remain on the capital account, and the absence of full convertibility of the rupee, have constrained both the uninhibited inflow of foreign capital which Southeast Asia experienced, as well as the possibility of reversal of investor confidence leading to huge and sudden outflows. This is not to say that such possibilities do not exist at all, as is considered once again in Section IV below.