Indian Economic History(Lecture2)

8/14/2019 Indian Economic History(Lecture2)

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Indian Economic History


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The Beginning

The civilization of the Indus River at Mohenjo-Daro

and Harappa arose at about 2500 BCE and ended

with apparent destruction about 1500 BCE.

The layout of the cities in this civilization of 2500 B.C.

is surprisingly neat and orderly. The cities had not

only brick-lined streets but also a brick-lined sewer

system. The images below give some idea of thesurprising orderliness of the cities.


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The British Raj

The British Empire had a tremendous impact

upon India. In fact, it created India. Had

Britain never come to India there would now

exist a number of separate states.

In particular, the Dravidian language and

cultural areas would not be under the

domination of the Hindi-speaking populationof North India.


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The Economic System of India

Before the last decade, the 1990's, India was probably on the short list of

almost every economist outside of India of the countries with the worst

economic systems.

India had and probably still has a parasitical class of politicians and

bureaucrats that micromanage the economy in the interests of their class.

There has been some official allegiance to socialism with a goal of achieving

it through Stalinist central planning.

The fact that the result has been some horrible mixture of state capitalism

and moribund corporatism is usually attributed to incompetence and

ineptitude on the part of the bureaucracy.


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The policies implemented by the Government of India before the last decade

were brilliant only in maintaining the power and influence of the

bureaucrats. Judged with respect to promoting the welfare of the Indian

people those policies were ridiculously bad, to the point of stupidity.

The bureaucracy has been rather competent in generating excuses for the

failure of their policies.

One of those excuses has been that there is aHindu rate of growth that is

significantly lower than the rate of growth that other countries could achieve.

Nehru chose the goal of economic self-sufficiency with economic development

to be achieved by central planning modeled on that of the Soviet Union.

By cutting off imports India gave a protected market to domestic producers.

India got domestic production but it was production of low quality, obsolete

products. The policies stifled economic growth and India, with its high level

of population and poverty, could ill afford low rates of economic growth.


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The two makes of automobiles produced in India, copied from models ofthe British Austin and Hillman of the 1950's, remained unchanged for

more than forty years. The planning and administration of the economic did not emerge full

blown.

The first five year plan (1951-55) called for the planned development ofonly a few industries, the ones that private industry had not developed forone reason or another. In the first five year plan the other industries were

left to the market. The second five year plan (1956-1961), the product of P.C. Mahalanobis'

work, was more interventionist.

It tried to implement the elements of British socialism and combine themwith the tenets of Mahatma Gandhi.

It sought to eliminate the importation of consumer goods, particularly

luxuries, by means of high tariffs and low quotas or banning some itemsaltogether. The large enterprises in seventeen industries werenationalized. License were required for starting new companies, forproducing new products or expanding production capacities. This is whenIndia got itsLicense Raj, the bureaucratic control over the economy.


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Indian Government require businesses get bureaucraticapproval for expanding productive capacity,

businesses had to have bureaucratic approval for layingoff workers and for shutting down. When a business waslosing money the Government would prevent them fromshutting down and to keep the business going wouldprovide assistance and subsidies.

When a business was hopeless an owner might takeaway, illegally, all the equipment that could be movedand disappear themselves. In such cases the Governmentwould try to keep the business functioning by means ofsubsidies to the employees.

One can imagine how chaotic and unproductive abusiness would be under such conditions


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Government planning also involved requiring businesses to produce inparticular areas, usually economically backward areas. It also might requirethe production of certain goods such as cheap cloth for the poor.

The Indian Economic Plans had to be financed and this often meant takingresources away from agriculture and giving them to pet industries that werenot viable on there own.

Ultimately this meant starving agriculture to feed inefficient industries theGovernment favored. Such a program was not likely to alleviate poverty andso in 1971, under Nehru's daughter, Indira Gandhi, the Government tried toeliminate poverty by promoting small, labor intensive enterprises.

The net effect of the Government programs was to take away resources fromagriculture in the countryside to give it to favored businesses in the cities.

When the effects on agriculture and the countryside became significant theplan added programs to help the countryside (labor intensive smallbusinesses) and programs to aid agriculture such as a fertilizersubsidy.These programs to help agriculture and the countryside generally

came from resources which the Government took away from agriculture andthe countryside. The fertilizer subsidy may have been of greater benefit tothe wealthier farmers than to the poorer farmers


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India's output did grow but not as much as did that of

other countries in the region.

The Government of India generally takes credit forgrowth, but when India's performance is compared to

that of other countries one sees that the Government's

contribution to growth was negative. The following

shows the magnitude of the shortfall in growth that

India's oppressive system is responsible for.


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Source: The EconomistMay 4, 1991, Survey page 7

Comparative Growth Rates

of Developing Economies

Average Annual Rates 1960-88

Country IndustrialProduction

GDP

1960-1980 1980-1988 1960-1980 1980-1988

South Korea 15.2 12.6 8.8 10.1

Taiwan 12.8 7.2 9.6 7.4

Singapore 12.1 4.5 9.2 6.9

Hong Kong 10.3 7.5 9.9 7.4

Thailand 10.3 6.6 7.4 6.5

Indonesia 8.9 5.1 5.9 5.7

Pakistan 8.0 7.2 4.4 6.3

Malaysia 9.6* 6.1 7.9* 4.6

India 4.6 7.6 3.5 5.4

Bangladesh 6.1 4.9 5.8* 3.5

Sri Lanka 5.3 4.4 5.2 3.9

Mayanmar 4.2 7.3* 3.5 3.3*

* - 1970-1980


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With the top performers achieving a growth rate of industrial production

of about ten percent while India achieved a growth rate of only at most

about five percent the cost of the License Raj to India's growth rate was

about five percent, or half the rate of growth.

One of the most wonderful things to happen to the world was the genetic

development of high-yielding grain varieties, the Green Revolution. This

development probably put an end to famine from natural causes.

Between 1970 and 1989 agricultural production in India did grow but the

rate of increase was only 2.1 percent per year whereas over the same per

period the annual rates of growth of farm output in Indonesia, Malaysia,the Philippines and Thailand were 3.7%, 4.7%, 3.6% and 4.5%,

respectively.

Again the cost of the License Raj to growth in India was about half the

rate of growth. The cost of the License Raj more importantly is in the

slower pace of alleviating poverty.
http://www.sjsu.edu/faculty/watkins/greenrev.htmhttp://www.sjsu.edu/faculty/watkins/greenrev.htm


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Othercountries

The success pattern of development in Taiwan and othernations of Asia has involved cultivating export industries.

In the case of Taiwan the first export industries were associated

with agriculture, such as processing sugar cane into sugar.

Later light manufacturing emerged as economically viable.

Generally the labor force for manufacturing came from the

surplus labor force in agriculture, often this was young women

from the countryside who moved to the cities to work in the

factories. Economically this was a transfer of labor from

agriculture where labor productivity was to low to higherproductivity occupations in manufacturing.


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The products that could be successfully produced by the

emerging manufacturing sector in Asian countries was

often not technologically sophisticated or prestigious.

For example, one of the early successful export products of

South Korea was wigs made from human hair.

But the successes in the low tech products led to successes

in more technically sophisticated products. One thing that

emerged out of the experiences of Japan, South Korea,Taiwan, Hong Kong and Singapore is that it is difficult to

develop successful export industries without also

importing products.


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In contrast, India virtually shut off

imports with high tariffs, low quotas andoutright banning. The structure of

India's wall against trade is shown below


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Type Regulation License?

Consumer Goods

InessentialBanned

Consumer GoodsEssential (Medicines)

Permitted

Capital Goods

RestrictedPermitted

Certification of Being

Essential

Indigenous Angle Clearance

LicenseCapital GoodsOpen General

License

Permitted No License Required

Intermediate Goods

Intermediate Goods License Required

Intermediate GoodsLicense Required

Intermediate GoodsNo License Required

Banned

Restricted

Limited

Permissible

Open General

License


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In addition to rules concerning the imported goods thereare rules based upon the nature of the importer

Imports are to be brought in only by the actual userwhere

is subject to bureaucratic definition. The Economistcites the case in which vehicle tires cannot be

imported by bus or trucking companies because onlyvehicle manufacturers are deemed actual users.

Some products whose importation is scheduled for

reduction can only be imported by certain governmentagencies called canalizing agencies.

In 1988, 40% of India's imports were of this canalizedvariety. Another 12 percent were in the category ofrestricted, 32 percent were limited permissible and only 16

percent fell into the category of Open General License


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Completely separate from the matter of the regulations on imports

is the matter of tariffs.

That is to say, even if the importation of a product is approved the

tariff might be prohibitive. India in 1985 had the highest level of

tariffs in the world, as is shown in the following table.


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Source: World Bank, cited in The EconomistMay 4, 1991, Survey page9

Nominal Tariff Rates of Various Countries

As Percentage of Value, 1985

CountryIntermediate

Goods

Capital

Goods

Consumer

Goods

Manufacturing

Goods

Hungary 14.2 15.0 22.6 20.9

Yugoslavia 18.0 20.7 20.0 19.0

Argentina 21.2 25.0 21.9 22.9

Morocco 21.6 18.1 43.0 27.3

Philippines 21.8 24.5 39.0 28.0

Mexico 25.5 23.5 32.2 24.7

Thailand 27.8 24.8 8.5 33.6

Turkey 29.4 54.9 55.3 37.1

Pakistan 75.0 73.8 127.3 89.8

China 78.9 62.5 130.7 91.2

Bangladesh 97.9 80.5 116.1 100.8

India 146.4 107.3 140.9 137.7


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The end result is that India in 1988 had the lowest ratio of imports

to GDP of any country in the Asia and consequently also had a

comparably low ratio of exports to GDP.

It is not impossible to expand exports without having acorresponding expansion in imports but it is as a practical matter

difficult to do so.

India's government, however, decided in the late 1980's to try to

promote exports without loosening its restrictions on imports.

Exporters in India are givenImport Replenishment Licenses whichcan be used to buy imports. Profits on exports were made exempt

from the corporate profit tax.

Because the loopholes created for export industries could be used

to avoid the taxes and restrictions on other parts of the economy

there are numerous rules and regulation to prevent the speciealrules for exporters from being abused.


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The Effect of Protection on Enterprises and Industries

There are some very interesting comparisons to be

made between the protected industries and the ones

that are not protected.


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Comparison of High Protection and Low Protection

Manufacturing Industries in India, 1986

High

Protection

Low

ProtectionNumber of Sectors 21 30

Share of Labor Employed 18.5% 77.7%Share of Value Added 39.0% 54.9%

Share of Capital

Employed53.2 43.1

Capital per Worker 92,500 rupees 17,800 rupees

Average Wage 15830 rupees 9360 rupeesEnergy Consumption 1.93 MWHr 1.13 MWHr


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The notable differences between the high protection and low

protection industries is that the average wage rate is almost 70

percent (69%) higher under high protection.

One consequence of the higher wage rates is greater capital

intensity in the high protection industries and that did occur.

The capital/labor ratio in the high protection industries is 5.2

times that in the low protection industries. As a result the high

tech industries, which produce 39 percent of the value-added only

employ 18.5 percent of the labor force.

The protection system promoted the substitution capital for labor

in a country which has an abundant surplus of labor.

The protection system promoted the substitution capital for labor

in a country which has an abundant surplus of labor.


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Public-Sector Enterprises

In addition to over-regulating the private sector the Government of

India has created socialist enterprises directly.

The Government nationalized heavy industry (the commanding

heights of the economy) and built new state-owned enterprises, SOE's.

The evidence that SOE's were inefficient was abundantly clear before

the bureaucracy created their new ones.

These SOE's are generally more costly to build than privately built

plants. In the case of steel plants the SOE's cost 30 to 40 percent more.


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The excess capital cost should be met out of the return

on the capital for the plant but that is not likely to occur

since, according to a study by the Bureau of Industrial

Costs and Prices, the average rate of return on capital

in SOE's is just 1.5 percent.

The management problems that afflict most SOE's are:

excessive over-staffing

under utilization of capacity

excessive inventories

poor management of materials

obsolete technology

inadequate maintenance wrong selection of products


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Large firms in certain industries, called core industries, have to abideby theMonopolies and Restrictive Trade Practices Act, (MRTP).

Despite the name the effect of the MRTP tends to restrict competitionand protect the monopoly of the firms which are already in an

industry. The worst monopolies are state monopolies and the MRTP does notapply to them and nothing restricts their practices.

The Government of India has a policy of reserving certain productsfor "small" companies.

In the late 1970's there were 800 products reserved for such

companies. A small company was defined as one having plant and equipment of

value less than a specified figure.

Although such companies were small compared to the giants ofindustries the amount of wealth involved in the ownership of suchcompanies was large compared to the average wealth of the generalpopulation of India.

The License Raj provided protection for a class of quite well-to-doIndians, a class ideally suited to dealing with and sharing rents withthe members of the License Raj.


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Since the net effect of Indian Government policies are

negative and upwards of two thirds of the economy is

in agriculture the policies are a terrible tax on the poor. Rather than abandon the policies the government and

bureaucracy added another layer of policies to try to

ameliorate the impact of the other policies.

The Government created irrigation projects andfertilizer subsidies for agriculture. In addition there is

a roadbuilding program for the rural areas.

The bureaucracy also created a system of transfer

payments for the rural poor which in its typical fashioncalled rural development.


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In the support of the Indian Government for education

the class interest of the government and bureaucracy

can be clearly seen. The level of education which is most generously

supported is higher education rather than elementary

education.

But it is generally the children of the well-to-do whoattend colleges and universities. Thus the support of

higher education is, in effect, a subsidy for the well-to-

do families.

It is a transfer of income from the poor to the middle

and upper classes, the classes which dominate the

government and bureaucracy.


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Economic reforms under Rajiv Gandhi

Rajiv came into power as the Prime Minister of India in 1984. Rajiv called for a tax reform which cut the income and corporate tax

rates. As a result of the lower tax rates tax evasion was reduced and

the lower tax rates brought in 40 percent more revenue.

He reduced the restrictions on the economy. He modified definitions so

that the limitation imposed by "small company" policy were lessened.

Some industries were removed from coverage by the MRTP Act. He

created broadbandingin the matter of licensing. Broadbanding meant

that a license for version of a product would serve to allow production

of a closely related version of the same product rather than requiring a

new license for the new version.


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The Crisis of 1991

Statistics bear testimony to the fact that the genesis of the economic crisis inIndia, which surfaced in 1991, lies in the large and persistent macroeconomic

imbalances that developed over the 1980s.

Large fiscal deficits emerged as a result of mounting government expenditures,

particularly during the second half of the 80s.

These fiscal deficits led to high levels of borrowing by the government fromthe Reserve Bank of India.

Also, because of the dynamic interrelationship between the fiscal and trade

deficits, the former resulted in large current account deficits in the balance-of-

payments.

In order to meet these deficits, large external commercial borrowings were

undertaken which in turn aggravated the problem of external indebtedness.


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An unprecedented balance-of-payments crisis emerged in early 1991. The currentaccount deficit doubled from an annual average of $2.3 billion or 1.3 percent ofGDP during the first half of the 1980s, to an annual average of $5.5 billion or 2.2

percent of GDP during the second half of the 1980s. The balance-of-payments came under severe strain from one liquidity crisis

experienced in mid-January 1991 to another in late June 1991. On both occasions,the foreign exchange reserves dropped significantly and the government had toresort to measures, such as using its stocks of gold to obtain foreign exchangeIndia had begun to prepare to mortgage their gold savings with the Bank ofEngland to obtain the cash reserves needed to run the country

utilization of special facilities of the IMF, and also emergency bilateral assistancefrom Japan and Germany among others.

Having resorted to these measures, the government was able to avoid a default interms of meeting its debt service obligations and financing of imports.

Subsequently, the government embarked upon a comprehensive program ofeconomic reforms.


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Latin America

Brazil : Brazil once was plagued by chronic inflation

which turned into hyperinflation. The source of this

inflation was the expansion of the money supply. The

government financed its operation and its development

projects not out of taxes or borrowing funds but by

simply creating money.


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Price Levels in Brazil, 1980 to 1997

Year Consumer Price Index

1980 4

1981 8

1982 16

1983 38

1984 111

1985 362

1986 895

1987 2,940

1988 21,435

1989 328,113

1990 100,000,000

1991 500,000,000

1992 5,600,000,000

1993 113,600,000,000

1994 2,472,400,000,000

1995 4,104,400,000,000

1996 4,751,200,000,000

1997 5,080,300,000,000


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Similar policies also lead to hyperinflation in

countries such as Chile, Argentina, Peru and

Bolivia. Thankfully India didnt share the same problem

with these countries as the RBI followed better

money management.

Indian Economic History(Lecture2)

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