Growth and Economic Policies in India: 1950-2006

Arvind Panagariya

Growth: Summary

1951-88: 3.8 percent per annum 1988-2006: 6.3 percent 2003-07 8.6

Observation:

No miracle, no debacle

Key Questions

Unlike most countries in Africa and Latin America how did India escape prolonged stagnation or decline?

why was India unable to break out of the relatively low rate of growth until the late 1980s?

what accounts for the shift in the growth rate in recent years?

how has the Indian economy managed to sustain the higher growth rate of 6.3 percent during the past two decades?

What accounts for the shift to 8.6 percent?

Distinguishing Four Phases of Growth Table 1.1 How do we divide these 55 years into a small

number of sub-periods (phases) for orderly discussion?

Chart (a few slides later)

Year

Growth

Rate Year

Growth

Rate Year

Growth

Rate Year

Growth

Rate

At 1993-94 Prices At 1999-2000 Prices

1951-52 2.3 1969-70 6.5 1987-88 3.8 2000-01 4.4

1952-53 2.8 1970-71 5.0 1988-89 10.5 2001-02 5.8

1953-54 6.1 1971-72 1.0 1989-90 6.7 2002-03 3.8

1954-55 4.2 1972-73 -0.3 1990-91 5.6 2003-04P 8.5

1955-56 2.6 1973-74 4.6 1991-92 1.3 2004-05QE 7.5

1956-57 5.7 1974-75 1.2 1992-93 5.1 2005-06QE 9.0

1957-58 -1.2 1975-76 9.0 1993-94 5.9 2006-07AE 9.2

1958-59 7.6 1976-77 1.2 1994-95 7.3

1959-60 2.2 1977-78 7.5 1995-96 7.3

1960-61 7.1 1978-79 5.5 1996-97 7.8

1961-62 3.1 1979-80 -5.2 1997-98 4.8

1962-63 2.1 1980-81 7.2 1998-99 6.5

1963-64 5.1 1981-82 6.0 1999-2000 6.1

1964-65 7.6 1982-83 3.1 2000-01 4.4

1965-66 -3.7 1983-84 7.7 2001-02 5.8

1966-67 1.0 1984-85 4.3 2002-03P 4.0

1967-68 8.1 1985-86 4.5 2003-04QE 8.5

1968-69 2.6 1986-87 4.3 2004-05QE 6.9

Table 1.1: AnnualGrowth Rates ofThe GDP

How to Divide into Sub-periods?According to Five Year Plans Decades The Global Economic Environment Changes in the Policy Regime Differences in the Growth Performance

Our Preferred Division

According to the sharpness of differences in the growth rates tempered by the consideration that we want to connect the performance with policy changes.

We distinguish four phases Phase I: 1950-65 Phase II: 1965-81 Phase III: 1981-88 Phase IV: 1988-06

Figure 1.1: Average Growth Rate

4.1

3.2

4.8

6.3

0

1

2

3

4

5

6

7

1951-65 1965-81 1981-88 1988-06

Defending the Phases

Issues raised by Wallack’s work on structural breaks

Cut off between Phases I and II: deceleration, which is especially large if we compare with S. Korea and Taiwan; major shift in the policy regime

Cut off between Phases II and III: not controversial

Cut off between Phases III and IV: Perhaps most controversial

Has India Entered Phase V?

Figure 1.2: GDP Growth: Business cycle effect or a shift in the growth rate?

4.0

7.1

5.2

8.6

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0

1990-93 1993-97 1997-03 2003-07

Dollar GDP has grown 16.3 annually during 2003-06

Figure 1.3: GDP in current dollars ($billion)

452 461 478506

601

696

806

0

100

200

300

400

500

600

700

800

900

1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06

Other highlights during 2003-04 to 2005-06 Exports doubled in 9 years during 1990-2000. They doubled in three

years during 2002-06 from $52.7 billion to $102.7 billion. Services exports doubled in just two years: from $26.9 billion in

2003-04 to $60.6 billion in 2005-06. Share in the world merchandise exports: 0.5% in 1990-91, 0.7% in

1999-00 and 1.0% in 2005-06. Services exports: 2.5% in 2005-06. The exports of goods and services as a proportion of the GDP:

7.2% in 1990-91, 11.6% in 1999-00 and 20.5% in 2005-06. The total foreign investment has risen from $6 billion in 2002-03 to

$20.2 billion in 2005-06. DFI is less. In 1990-91, India had approximately 5 million phone lines in total.

Currently, India is adding more than 7 million phone lines per month. The sales of passenger vehicles rose from 707,000 in 2002-03 to

1.14 million in 2005-06.

Why this growth is likely to sustain Fundamentally altered initial conditions Demographic transition Rising savings rate and excellent prospects for its

continued rise Large stock of foreign exchange means a major

external sector crisis is less likely A pure cycle effect should have begun to show

signs of a return to the 5-6% range by now. There are no signs of such a slowdown.

Sectoral Growth

Agriculture grew consistently slower than the GDP

Industrial growth picked up in Phase I but dropped drastically in Phase II

Services showed a more stable pattern with growth accelerating particularly in Phase IV.

Table 1.2: Growth Rates of Sectoral GDP (at factor cost)

Period Agriculture & Allied Industry Manufacturing Services GDP

1 2 4 5 6 7

1951-65 2.9 6.7 6.6 4.7 4.1

1965-81 2.1 4.0 3.9 4.3 3.2

1981-88 2.1 6.3 7.1 6.5 4.8

1988-06 3.4 6.5 6.8 7.8 6.3

Sectoral Shares

The share of agriculture declined consistently The share of industry rose initially but

stagnated in Phases III and IV The share of services rose consistently

Growth, Productivity and Policies

We focus on the growth-policy link rather than growth productivity link because

Productivity studies are fraught with data problems—no reliable employment data

Policies work through not just productivity but also reduced underemployment and increased savings and investment

Table 1.3: The Composition of the GDP

Year Agriculture and Allied Industry Manufacturing Services

1950-51 57 15 9 28

1964-65 49 21 12 31

1980-81 40 24 14 36

1987-88 33 26 16 41

2004-05 21 27 17 52

Features Common to the Four PhasesWhy India escaped prolonged stagnation or

decline? Macroeconomic stability Political stability Gradual and predictable policy changes Capacity to implement policies

Growth and Reforms

Phase I: Open foreign investment policy; relatively open trade policy until the late 1950s; investment licensing began to tighten only towards the late 1950s, early 1960s

Phase II: Socialism struck with vengeance Phase III: Ad hoc liberalization during 1975-

79, 1980-84 and then more substantial liberalization during 1985-86 and 1986-87.

Phase IV: Systemic and systematic liberalization

Debates on Growth: DeLong (2003) and Rodrik (2003) Rodrik (2003):

“J. Bradford DeLong shows that the conventional account of India, which emphasizes the liberalizing reforms of the early 1990s as the turning point, is wrong in many ways. He documents that growth took off not in the 1990s, but in the 1980s. What seems to have set off growth were some relatively minor reforms.” (Rodrik 2003).

Critique by Panagariya (2004) Modest reforms and modest acceleration during 1981-88 Spurt during 1988-91 was preceded and accompanied by

important reforms Growth was partially fueled by unsustainable fiscal deficits

and external debt, which set of a crisis the 1991 crisis.

Debates on Growth and Reforms: Rodrik and Subramanian (2005) R-S: An “attitudinal change” on the part of the government in favor

of private business around 1980 rather than liberalizing reforms resulted in a permanent shift in the growth rate. They claim that “pro-business” policies that favor incumbent producers rather than “pro-market” policies that promote new entrants and aim to benefit consumers account for once for all shift in the growth rate that took place in the early 1980s.

Srinivasan (2005): “This is a disappointing paper. It sees a mystery and fails to convince through analysis why it does. Had the authors been familiar with Indian economic literature, they might not have written it! The literature has not only noted the growth acceleration in the 1980s but has also questioned its sustainability on the grounds of its possibly being debt-led and fueled by employment and real wage expansion in the public sector.”

Panagariya (2007) Play by the R-S rules: Define Phase III as 1981-92 and

Phase IV as 1992-06: Growth rates at 5.2 and 6.3 still exhibit acceleration

Pro-business versus pro-market: spurious distinction. Pro-business measures are an integral part of pro-market reforms.

Political-economy dictated reform by stealth—this constrained the government to reforms within the existing policy framework—i.e., reforms R-S call pro-business

Factually, the government did introduce (pro-market) reforms that eased up entry of new firms

R-S also wrong on trade liberalization

Debates on Growth and Reforms: Rodrik and Subramanian (2005) (continued)

Growth and Reforms: Atul Kohli (2006) Kohli also relies on the pro-market and pro-business terminology, but

defines them differently than R-S. He calls “pro-market” strategy as one that allows free play to markets to achieve

efficient allocation of resources and promotes competition. As for “pro-business” strategy, it is viewed as one that has ‘developed more via real world experience, especially from the rapid growth successes of some East Asian economies.’

Panagariya (2007): This distinction also reflects confusion since outward orientation, timely

depreciation to avoid overvaluation of the domestic currency, labor-market flexibilities, and license-free entry of new businesses and expansion of the existing ones, advocated by pro-market economists, were all integral part of the “real world experience” of the fast-growing economies of East Asia.

Giving monopoly of the entire sectors (iron and steel, telecommunications equipment) to the government, as India did during the 1960s and 1970s, cannot be characterized as pro business. Likewise, creating private sector oligopolies through licensing (Ambassador and Fiat cars) may favor specific businesses but is not truly pro-business.

It was the socialist rather than pro-market policies that yielded the most important structural change in India. The shift from less than 1 percent growth during the first half of the 20 th century to

the 3 to 4 percent rate during 1951-80 was proportionately much larger than any shift subsequent to 1980.

Khatkhate (2006): “[A] comparison of the structural change in 1951-80 with the pre-

independence decades is both fatuous and facetious.“During the latter [pre-independence] period there was no autonomous economic policy geared to the interests of a nation. The objective functions were different. It was a colonial policy, addressing the interests of the home country. Any policy, statist or otherwise, with India’s interests at the center, would have achieved better results than under a colonial regime. The real question is whether the statist policies were superior to other alternatives but this question can never be answered for want of counterfactual evidence.”

If socialism is so good, growth during 1965-81 should have been even higher than in 1951-65.

Growth and Reforms: Deepak Nayyar (2005)