Some of India's achievements in the past 50 years have been remarkable. To the amazement of many, this vast and complex society has managed to protect national unity, introduce and preserve democracy and dilute traditional hierarchies. But economic progress has been disappointing. Despite the rhetoric of socialism and the pervasive state intervention in its name, poverty continues on a colossal scale. More than one third of India's one billion people live in conditions of acute poverty; and more than one third of the world's poor are concentrated in India. The goal of the next 50 years must be to achieve widely-shared prosperity without sacrificing democracy and civil liberties: the economic reforms initiated in 1991 constitute a beginning, but a long road lies ahead.
Redistribution alone cannot eliminate poverty. For the next two or three decades India needs a sustained increase in the growth rate of national income from the erstwhile ?Hindu rate? of 3.5 per cent per year?and even the rate of 6 per cent achieved since its recent reforms began?to 8 per cent or more. But fast growth is not enough either. If the poor are to benefit, growth should be labour-demanding, not labour-displacing. India?s population increase is finally slowing: from 2.2 per cent per year in the 1970s it has come down to 1.7 per cent and will probably fall further. Even so, for some time India?s labour force will continue to grow nearly as rapidly as before.
The brahmin fabian state
The problem of the post-independence era is that Indian policymakers acted with a mistaken conception of the role of the state. The state was extremely energetic in areas which were outside its competence. Detailed regulation of economic activity created massive inefficiencies and stifled entrepreneurial energies. At the same time, the state neglected to attend to areas where it should have been active. Most importantly, it failed to increase the labour power of the poor by providing them with primary health care and education. The cure for India?s ills follows from the diagnosis. The role of the state must be redefined.
It is now clear that India?s low growth rate was the result not of low saving and investment but of low productivity, and that the latter in turn was the product of excessive and inappropriate state intervention. The root of the problem lay in the philosophy of socialist planning which had a special resonance in post-colonial societies. The role of Jawaharlal Nehru, the dominant figure of the period, was critical. Nehru was a Kashmiri Brahmin and a Fabian socialist with Marxist sympathies who had suffered an upper-class English education. All of these go with distrust of business, some of them with admiration for Soviet planning and scorn for the price mechanism. Moreover, Nehru?s belief in material planning and its associated controls did not conflict with the ethos of the Indian bureaucracy. Before independence, the civil service administered law and order, with little need to understand economics and business. Faced, post-independence, with the extraordinary demands of development, it naturally thought in terms of ?administering? it. Even so, state intervention was fairly light until the mid-1950s when India embarked on a ?heavy industry? strategy. Controls intensified for nearly 25 years to the point where no economic activity, except on a very small scale, could be legally pursued without obtaining dozens of permits and licences.
When people tried to find ways round the controls, the thwarted controllers, following the ethos of the times, felt they must tighten them. Controls generated ?rents?; the recipients of these rents, which included business groups, the controllers themselves and even the intelligentsia, had a vested interest in keeping the system going. By the 1980s the control system had reached a point where it became impossible to discern any good social, economic or humanitarian reason for it. Controls permeated every sphere of economic activity including pricing, investment, credit and employment. The most harmful controls were those on foreign trade and investment. Their consequence was that India became a global backwater, insulated from international markets, competition and technology.
Also, the role of the public sector was extended well beyond the traditional utilities and included many consumer goods industries and even hotels. Public sector enterprises were expected to be highly profitable. But the profits would belong to the state and serve as a spearhead of investment. The reality has been very different. The returns in most public sector firms have been abysmally low. Many of them not only made losses but became ?sick,? a polite Indian word for ?bankrupt.? In retrospect, this is not surprising. The ultimate shareholder of the public enterprise is the nation. But the national interest is interpreted by the responsible minister. He may intrude his personal interests, and the government of which he is part has political interests too. The public sector manager is thus faced with conflicting objectives, many constraints on his freedom to manage and no serious penalties for poor performance. There is an insoluble problem of reconciling managerial autonomy and public accountability. Some countries achieve a better compromise than others. India has been among the worst. The inefficiency of public enterprises goes beyond low productivity. Public money is always scarce, but becomes scarcer when the losses from public enterprises have to be funded.
Fiscal distortions constitute another reason for India?s poor economic performance. This phenomenon has had two aspects: a tendency towards high deficits and an inappropriate pattern of government expenditure. The former is relatively recent in origin. Until the early 1980s, Indian fiscal policies were prudent and the country enjoyed macroeconomic stability. Inflation was low and public and external debt were manageable. Since then there has been a marked slippage. Inflation did not explode but fiscal deficits and external borrowing increased sharply, leading to a severe crisis in 1991 when the country narrowly staved off default on foreign loans. How can we explain the earlier stability and the recent instability? Beneath the details of fiscal and monetary policies, the fundamental explanation lies in the changing nature of Indian democracy, which has been subject to the twin forces of what James Manor has called ?political awakening? and ?political decay.?
Awakening and decay
?Political awakening? is an inevitable, indeed desirable, consequence of democracy. When India became independent, the dominant elite was exceedingly narrow. Since then, many hitherto passive or silent groups?industrial workers, small farmers and traders and, cutting across economic groupings, backward castes generally?have entered the systems of political trade. (Note, however, that these new groups mostly came not from the severely disadvantaged but from the middle ranges of the social hierarchy.) While ?awakening? has thus increased the claims on the state, it has unfortunately been accompanied by ?political decay,? the erosion of institutions, essential in any democracy, that stand above and mediate or manage conflict. At the time of independence, India had two such institutions?the Congress party and the civil service. The Congress party had deep roots in the country and its leaders had inherited the aura of the national movement. The organisation of the party was a highly complex and resilient network of patronage and bargaining. The civil service, although not development-minded, had a tradition of neutrality and independence and a Gladstonian fiscal outlook. From about the mid-1960s, these great institutions began to deteriorate, largely as a result of the actions of India?s leading politicians. Indira Gandhi, for example, played a big role in destroying internal democracy in the Congress party and in politicising the civil service. At the same time, there has been a grave decline of moral standards in public life and corruption has become an endemic problem.
The effect of these developments was that the various claims on the public purse could not be contained by a process of political bargaining. Instead they were managed by handouts. This explains the growth of a network of subsidies?not only explicit subsidies such as those on food and fertilisers, but enormous hidden subsidies; for example, ultra-cheap water, electricity and credit to farmers, overstaffing in government departments, subventions to cover the losses of public sector enterprises, tax concessions to small business, and write-offs of government loans. The growth of this unproductive spending led to a fiscal crisis. Its visible aspect was the rise in deficits which created severe macroeconomic problems. A less visible but equally pernicious result was the crowding-out of essential public spending on infrastructure and social goods.
It is now well recognised that the success of the east Asian economies (notwithstanding current strains) was based on solid achievements in health and education, in addition to their outward-looking trade policies. But only 50 per cent of India?s population (aged seven or over) is literate. Comparable figures for China and South Korea are 80 per cent and 97 per cent respectively. Worse still, about half the girls and a quarter of the boys in rural India have never been enrolled in school.
These averages conceal much worse figures for poorer states, lower castes and women. The infant mortality rate in India is 79 per 1,000 live births, compared to 31 in China and 13 in South Korea. Life expectancy at birth in India is 59 years; the figure for China is 69 and for South Korea 71. Going back to 1987, one in three children in India had never received any kind of vaccination. Only 14 per cent of villages had medical facilities and only 63 per cent of households in rural areas had access to safe drinking water. It is doubtful if the situation has improved much since then. Of course part of the reason for India?s poor comparative performance is that she started from a lower base than the east Asian economies (other than China). Another reason is low growth itself and the consequent shortage of resources. But these are by no means a full explanation?some Indian states, such as Kerala, have achieved social standards equivalent to those in east Asia. Other states, such as Bihar, have failed miserably. There is little doubt that in these successes and failures, government attention and policy?or lack of it?have played an important role.
Liberalisation begins
The idea of liberalisation began to make some headway in India in the 1980s. There followed some half-hearted and piecemeal liberalisation which contributed to raising the growth rate to 5.5 per cent per year. This was unsustainable, being also the result of excessively expansionary fiscal policies; it ended in a full-scale macroeconomic crisis at the end of the decade. As so often in recent history, a crisis provided the occasion for the change of strategy. In order to stabilise the economy, India had to borrow from the IMF and no loans would have been forthcoming without the promise of a structural adjustment programme. Also, the world had changed. Communism had collapsed and with it the respectability of India?s earlier strategy. One way or another, the ground was sufficiently prepared to use the crisis as an occasion for embarking on a radical transformation of the Indian economy. A programme of reform was initiated in 1991 by the minority Congress government headed by Narasimha Rao, with Manmohan Singh, a distinguished economist-civil servant, as finance minister.
Has there been a transformation? The short answer is ?yes and no.? Stabilisation was achieved with remarkably little pain, and significant progress was also made in unshackling the economy from the iron grip of controls. Industrial licensing has been abolished in most industries and government interference in business decisions has been substantially reduced. Import controls have been mostly eliminated for capital and intermediate goods and tariffs have been reduced, although they remain high. Foreign direct investment is more welcome and has risen substantially from very low levels. Interest rates have been deregulated and financial markets liberalised. Punitive direct tax rates have been lowered and some useful improvements to the highly distortionary indirect tax structure have been made. These changes would have been unthinkable a decade ago. Even so, a great deal remains to be done that is politically more difficult. At the same time, Indian politics seem to be moving in the direction of fragmentation and instability. In the election of 1996, the Congress party continued to lose ground. There was an electoral stalemate; a 13-party minority coalition government was cobbled together. It survived for about 18 months (though with one change of prime minister) but was too weak and divided to pursue a coherent economic programme. That government has now fallen and another election has been called for February 1998. In the states, the rise of regional exclusivist parties with sectional agendas has continued apace.
What more needs to be done? India cannot make a great leap forward with her feet tied by lack of power, transport and telecommunications?and an uneducated labour force. To accommodate the required public and private investment, the tax base must be widened, public enterprises sold off, subsidies eliminated. (The latter have been estimated to exceed 10 per cent of national income and are mostly captured by the rich.)
On liberalisation, too, there is a long way to go. The consumer goods market, and agriculture more generally, remain heavily insulated from the world economy by import and export controls. These controls discourage both the production and exports of labour-intensive manufactures and cereals; thus they also restrict the demand for labour. In theory, the abysmally inefficient public enterprises could be transformed by greater autonomy and competition without a change of ownership. In practice, in India?s political and bureaucratic culture, this is little more than a pious hope. Privatisation is therefore an urgent need, with appropriate regulatory safeguards. So far, the government?s disinvestment programme has had little success. But that is because it has insisted on retaining a majority of the shares for the foreseeable future. It is not surprising, then, that investors have not been enthusiastic about buying minority stakes in enterprises whose profitability would be determined directly or indirectly by the government.
The state must be ready to intervene to deal with the distributional consequences of liberalisation. If, for example, it becomes easier to make workers redundant?which in the long run will encourage the creation of more jobs?then state funding of redundancy and retraining payments is essential. Currently, such provision is quite inadequate. A more difficult problem concerns the distributional impact of agricultural trade liberalisation. On balance, farmers would benefit from the change. The increase in output prices and profits would more than compensate them for the loss of input subsidies. But an undesirable by-product would have to be taken care of. Because food prices would initially rise, poor consumers would have to be protected by anti-poverty programmes.
The state also has a more positive role to play in health and education. Increasingly, only healthy and educated workers will be demanded by the industries which have the potential for rapid growth. Higher public spending on these sectors is certainly needed but existing priorities are wrong. For example, higher education (which should in the main be privately funded) is heavily subsidised, while primary education is neglected. In recent years, expenditure on primary education has increased but it seems to have gone principally into higher salaries for teachers, rather than into employing more of them. Some of the problems of primary education?such as high absenteeism among teachers?cannot be solved by higher expenditure. It is notable, however, that they have been solved in states (such as Kerala and Himachal Pradesh) where governments have made primary education a focus of attention.
There is no doubt that a consistent economic package can be designed which would promote growth and redress poverty. But can such a package be implemented? It is tempting to look to authoritarianism as a political solution, but it is best to look away again. First, democracy and individual rights have intrinsic value, even for the poorest people. Second, it is difficult to imagine a country as complex as India being well run on authoritarian lines. Democracies have a profound informational advantage over authoritarian regimes. Finally there is the old question: who is to ensure that the authoritarianism will remain benevolent? Authoritarianism is a false trail; but it is also wishful thinking to suggest that the present condition of India?s democracy, with its unstable coalitions and weak or predatory governments, will lead to economic transformation. Such governments will not be able to restructure the budget, make advances in health and education, or even withdraw from the areas they should leave alone.
Devolving power
One idea, widely canvassed, is that Indian democracy could deliver economic reform if there was a radical decentralisation of powers from the centre to state and local governments. These sub-national governments, it is argued, would be able to respond more knowledgeably and flexibly to local wants, needs and conditions.
But devolution could be a recipe for macroeconomic disaster unless the states face a tough budget constraint. Whatever the agreed devolution of expenditure responsibilities and tax revenues, the scheme would not work without a credible agreement that the states would not be bailed out of their fiscal difficulties by the central government. This also implies central control of the states? borrowing, because the capital market may fail to impose timely discipline. In any case, there is a limit to how much power can be devolved. In any federation, the centre must be responsible not only for monetary stability, foreign affairs and foreign trade, but also for all matters which affect members of all or several states, including inter-state trade and justice. More fundamentally, even decentralisation cannot by itself ensure the success of economic reform; state and local governments are at least as vulnerable to capture by vested interests as their national counterparts.
Growth of 5-6 per cent per year can probably be maintained in India if investment in infrastructure is increased and recent moves towards liberalisation and fiscal correction are not reversed. The more exciting prospect of (pre-crash) east Asian super-fast growth and elimination of poverty requires deeper reforms which encompass a profound reorientation of the role of the state. But whoever wins the forthcoming election, the management of such a transition within a democratic framework is a project of the utmost difficulty. There is no blueprint, no template, no formula which holds the secret of success.
