India reconnected with the global economy three decades ago. The Indian economy had begun to gather pace around 1980, after at least a decade of stagnation in living standards as economic growth barely kept pace with the rise in population.
The growth spurt was accompanied by tentative changes in fiscal, monetary, trade, tax, exchange rate and industrial policies in the 1980s. However, the policy reforms of that decade were within the boundaries of the earlier system of economic management. July 1991 saw India shift to a new paradigm under a minority government led by P.V. Narasimha Rao, whose centenary year begins this week.
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In his landmark budget speech on 24 July 1991, Manmohan Singh as finance minister said that the severe balance of payments crisis that had taken India close to international default earlier that year was not a temporary funding crunch, but the symptom of a deeper malaise. The underlying problems he identified included macroeconomic imbalances, low productivity of public sector investments, loopholes in the tax system, indiscriminate protection that had weakened the incentive to export, lack of domestic competition, a weak financial system that was not allocating capital efficiently, lack of access to the latest technology, and much more.
A web of interconnected reforms were launched to tackle these problems. Many debates on the impact of it have focused on the growth trajectory before and after the reforms. There is no denying that the average annual growth rate in the 1990s is no different from the momentum of the 1980s. India moved to a higher growth trajectory only after the year 2000, and continued on that path after 2010, despite an economic slowdown before the pandemic struck.
Critics use this record to argue that the impact of the 1991 reforms was overrated. A better way to examine the impact is not by looking at just the rate of economic growth, but also its sustainability. The initial growth spurt of the 1980s was not sustainable, and India ended the decade with a terrible balance of payments mess plus raging inflation. Economic growth since 1991 has been far more stable.
One simple indication of this is the external account. Independent India had a severe balance of payments crisis almost once every decade: 1957, 1966, 1981, 1990. There has been no comparable crisis over the past 30 years, despite a scare in 2013.
Economists with a structural bent of mind used to argue that Indian economic growth has been held back by four major structural constraints: domestic savings, foreign exchange, food and aggregate demand. What has happened to each of them over the past three decades?
The short answer: all four macroeconomic constraints have eased after 1991. The domestic savings rate to fund domestic investments has undoubtedly come down since the peak it hit in 2008, but is still almost eight percentage points higher than the average of the 1980s. The availability of foreign exchange is no longer a major worry, and the occasional balance of payments surpluses in recent years show that India receives more international savings that it can absorb.
The food constraint had already begun to ease after the Green Revolution. India now has excess food stocks as a buffer against sudden shocks to farm production, though this macroeconomic reality does not mean that every Indian household has food security. The aggregate demand constraint—or what was once called the home market problem— meant that there was not enough domestic demand for industrial goods because of high poverty levels. Rising incomes as well as exports have eased this as well.
This potted history of how the structural constraints have eased is not to suggest that they are no longer a worry. A more realistic view would be that they are no longer as dominant as before, and the 1991 reforms played a big part in loosening these structural constraints that had dominated Indian economic thinking for many decades.
In fact, there are newer structural constraints on the horizon. The health and education crises during the pandemic have underlined inadequate investments in human capital. India still does not have adequate state capacity and regulatory capacity for a $3 trillion economy. And ecological stress as well as climate change will create new forms of constraints on sustainable economic growth. A new set of policy responses will be needed.
The implicit goal of the 1991 economic reforms was to create a new economy that had learned the right lessons from the success stories of East Asia. “Our longer-term objective is to evolve a pattern of production which is labour-intensive and generates larger employment opportunities in productive, high-income jobs, and reduces the disparities in income and wealth between rural and urban areas,” Manmohan Singh had said in his 1992 budget speech.
That transformation remains incomplete. In fact, the inability to generate enough jobs in formal enterprises has led to the proliferation of informal employment on the one hand and political pressure to use fiscal resources for subsidies or income support rather than on the creation of public goods. It is now worth repeating a question that this has been asked before: Is India moving in the direction of Latin America rather than East Asia?
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Steve Ovett, the famous British middle-distance athlete, won the 800-metres gold medal at the Moscow Olympics of 1980. Just a few days later, he was about to win a 5,000-metres race at London’s Crystal Palace. Known for his burst of acceleration on the home stretch, he had supreme confidence in his ability to out-sprint rivals. With the final 100 metres remaining,
[wptelegram-join-channel link=”https://t.me/s/upsctree” text=”Join @upsctree on Telegram”]Ovett waved to the crowd and raised a hand in triumph. But he had celebrated a bit too early. At the finishing line, Ireland’s John Treacy edged past Ovett. For those few moments, Ovett had lost his sense of reality and ignored the possibility of a negative event.
This analogy works well for the India story and our policy failures , including during the ongoing covid pandemic. While we have never been as well prepared or had significant successes in terms of growth stability as Ovett did in his illustrious running career, we tend to celebrate too early. Indeed, we have done so many times before.
It is as if we’re convinced that India is destined for greater heights, come what may, and so we never run through the finish line. Do we and our policymakers suffer from a collective optimism bias, which, as the Nobel Prize winner Daniel Kahneman once wrote, “may well be the most significant of the cognitive biases”? The optimism bias arises from mistaken beliefs which form expectations that are better than the reality. It makes us underestimate chances of a negative outcome and ignore warnings repeatedly.
The Indian economy had a dream run for five years from 2003-04 to 2007-08, with an average annual growth rate of around 9%. Many believed that India was on its way to clocking consistent double-digit growth and comparisons with China were rife. It was conveniently overlooked that this output expansion had come mainly came from a few sectors: automobiles, telecom and business services.
Indians were made to believe that we could sprint without high-quality education, healthcare, infrastructure or banking sectors, which form the backbone of any stable economy. The plan was to build them as we went along, but then in the euphoria of short-term success, it got lost.
India’s exports of goods grew from $20 billion in 1990-91 to over $310 billion in 2019-20. Looking at these absolute figures it would seem as if India has arrived on the world stage. However, India’s share of global trade has moved up only marginally. Even now, the country accounts for less than 2% of the world’s goods exports.
More importantly, hidden behind this performance was the role played by one sector that should have never made it to India’s list of exports—refined petroleum. The share of refined petroleum exports in India’s goods exports increased from 1.4% in 1996-97 to over 18% in 2011-12.
An import-intensive sector with low labour intensity, exports of refined petroleum zoomed because of the then policy regime of a retail price ceiling on petroleum products in the domestic market. While we have done well in the export of services, our share is still less than 4% of world exports.
India seemed to emerge from the 2008 global financial crisis relatively unscathed. But, a temporary demand push had played a role in the revival—the incomes of many households, both rural and urban, had shot up. Fiscal stimulus to the rural economy and implementation of the Sixth Pay Commission scales had led to the salaries of around 20% of organized-sector employees jumping up. We celebrated, but once again, neither did we resolve the crisis brewing elsewhere in India’s banking sector, nor did we improve our capacity for healthcare or quality education.
Employment saw little economy-wide growth in our boom years. Manufacturing jobs, if anything, shrank. But we continued to celebrate. Youth flocked to low-productivity service-sector jobs, such as those in hotels and restaurants, security and other services. The dependence on such jobs on one hand and high-skilled services on the other was bound to make Indian society more unequal.
And then, there is agriculture, an elephant in the room. If and when farm-sector reforms get implemented, celebrations would once again be premature. The vast majority of India’s farmers have small plots of land, and though these farms are at least as productive as larger ones, net absolute incomes from small plots can only be meagre.
A further rise in farm productivity and consequent increase in supply, if not matched by a demand rise, especially with access to export markets, would result in downward pressure on market prices for farm produce and a further decline in the net incomes of small farmers.
We should learn from what John Treacy did right. He didn’t give up, and pushed for the finish line like it was his only chance at winning. Treacy had years of long-distance practice. The same goes for our economy. A long grind is required to build up its base before we can win and celebrate. And Ovett did not blame anyone for his loss. We play the blame game. Everyone else, right from China and the US to ‘greedy corporates’, seems to be responsible for our failures.
We have lowered absolute poverty levels and had technology-based successes like Aadhaar and digital access to public services. But there are no short cuts to good quality and adequate healthcare and education services. We must remain optimistic but stay firmly away from the optimism bias.
In the end, it is not about how we start, but how we finish. The disastrous second wave of covid and our inability to manage it is a ghastly reminder of this fact.