PEC4MC01
INDIAN ECONOMIC DEVELOPMENT
AND POLICY
UNIT-III
Growth and Structural Change
• To establish turning points in the performance of the economy, or
structural breaks in the pace of economic growth, most studies focus on
the period since 1950.
• However, any meaningful assessment of economic performance in
independent India need to provide at least some comparison with the
colonial era.
• Therefore, it would be logical to consider the performance of the economy
before and after Independence during the 20th century.
• During the first half of the 20th century, there was a near-stagnation in per
capita income while the growth in national income was minimal.
• There was a steady growth in both GDP and GDP per capita during the
second half of the 20th century.
The most striking fact about India's growth has been the remarkable turnaround in nearly all
measures of growth performance since 1980.
Output per capita, output per worker, as well as TFP (total factor productivity) accelerated
sharply after 1980. For example, TFP which grew at about 0.3 per cent per annum during the
1960-1980 period, grew at close to 2 per cent per annum in the following two decades.
(Subramanian, 2007)
A growth accounting decomposition also shows that the contribution of growth of TFP to
overall labour productivity growth which was meagre prior to 1980 was exceptionally
high-about 60 per cent-between 1980 and 2000, a performance that was only surpassed by
China.
From being a caricature of inefficiency, India has become the model for high and efficient
growth.
This turnaround has also been true at the level of the three major sectors, especially
manufacturing and services. While agricultural growth accelerated by about 2.7 per cent
between the 1970s and 1980s, manufacturing and services posted growth rates of over 6 per
cent in the 1980s and 1990s compared to about 2-3 per cent in the years before that.
India's Growth
Turnaround
The shift to a higher growth path during the course of the 1980s is
referred to as the Indian growth turnaround. Fast growth in India since
the early 1980s has placed it amongst the top nine rapidly growing
economies in the world
The upward shift in India's growth path during the 1980s is significant for
two reasons:
• the turnaround happened well before the BoP (balance of payment) crisis
of 1991 and
• the large-scale macro economic reforms that ensued.
The second puzzling aspect about India's growth turnaround is that it was not
driven by manufactured exports and, therefore, has little in Common with the
East Asian economic miracle.
In particular, there was no industrial policy targeted towards developing
specific industries. It was the service sector that led the increase in the
overall growth rate in the early 1980s.
Since many components of services are income related (such as financial
services, business services, and hotels and restaurants) and begin to
increase only after a certain stage in development, the fact that India's
service sector created the impulse for the growth after turnaround, is
puzzling
According to Subramanian (2012), a number of plausible explanations can
easily be ruled out.
External liberalisation could not have been a factor because the Indian trade
regime actually became more restrictive during the 1980s, and the full impact
of trade reforms implemented in the 1990s was only felt at the end of the
1990s.
Very little internal reform, of product and labour markets, was witnessed in
the 1980s, and the only serious effort in this areas-the delicensing of Indian
manufacturing-started late in the 1980s and was fairly limited in scope; in
other words, it was 'too little, too late' to explain the turnaround in
performance.
An alternative explanation comprises three elements.
First, there was an attitudinal change on the part of the government in the
1980s.
Signalling a shift in favour of the private sector, with this shift validated in a
very haphazard and gradual manner through actual policy changes.
Second, this shift and the limited policy changes were pro-business rather
than pro-competition, aimed primarily at benefiting incumbents in the
formal industrial and commercial sectors.
Third, these small shifts elicited a large productivity response because
India was far away from its income possibility frontier
There were few significant policy changes in the early 1980s, and the
changes later on (beginning in 1985) were restricted largely to some internal
liberalisation relating to the relaxation of industrial licensing.
The limited nature of these changes, as well as the form that they took, is
best understood by appreciating the political logic of Indira Gandhi's (and
later Rajiv Gandhi's) efforts.
These were aimed to gather support from the business establishment rather
than to alienate it.
Hence there was more action where business support existed-for example,
in reducing taxes, easing access to imported capital inputs or liberalising
capacity restrictions-than where it did not-for example, in external
liberalisation.
A distinction can be drawn here between a pro-market and pro-business
orientation.
The former focuses on removing impediments to markets and aims to
achieve this through economic liberalisation. It favours entrants and
consumers.
A pro-business orientation, on the other hand, is one that focuses on raising
the profitability of the established industrial and commercial establishments.
It tends to favour incumbents and producers. Nevertheless, this shift
towards a pro-business orientation was the essential trigger that set off the
boom of the 1980s.
Another strand of opinion downplays what happened in the 1980s, arguing that 'the fiscal
expansionism of the 1980s accompanied by some liberalisation of controls on economic
activity generated real GDP growth of more than 5.8 per cent a year.
This expansionism however was not sustainable and led to the macroeconomic crisis of
1991.
According to Bhagwati and Panagariya (2012) perhaps the most surprising myth,
current among a few economists, is that though growth did occur after reforms, it
was not a result of the post-1991 reforms and that it could be traced back instead to
the 1980s.
A silent process of loosening some of the controls began soon after, accelerating
somewhat in the 1980s, especially under Prime Minister Rajiv Gandhi in the second
half of the decade.
This halting partial process of reforms, introduced as it were 'by stealth', was
replaced in 1991 by the reforms package that brought the liberalising process
frontally into the open, made reforms more comprehensive across important areas
like industrial licensing, and represented a fundamental shift in the policy
2003-2008: The Best Phase in Growth
The best phase in growth was witnessed during 2003-2008 when the
annual average growth stood at about 8.5 per cent. India has been among
the fastest growing economies in the world during the last decade.
"from 2003, the Indian economy enjoyed a boom in growth for five years.
The economy grew at a rate rose to 9 per cent per year until it was
punched by the financial crisis of 2008“
Output expansion was underpinned by a sharp rise in the investment rate,
largely domestically financed, boosted by an unprecedented influx of
foreign private capital under benign macroeconomic conditions
What
triggered the
boom?
According to Nagaraj, from the demand side, a sharp upturn in world trade
since 2002. and the technological change in communications, combined with
the deregulation of the financial sector in the US gave birth to the
outsourcing industry, boosting India's services exports.
It was surely an episode of export-led growth, with the export-to-GDP ratio
going up by 9 percentage points in five years. The expansion of bank credit,
topped by a flood of foreign private capital, enabled the expansion of
aggregate supply.
The financial crisis and the world economy slump took away the favourable
conditions after 2008. However, growth after the crisis was mostly restored,
by loosening the monetary policy and stepping up public expenditure, before
it turned distinctively adverse by 2012-13.
The boom has two faces:
the real sector and its financial counter part.
Prima facie, it was an exceptional phase of growth in the industrial and
services sectors for five years.
However, on a closer look, according to Nagaraj, the expansion had many
dark spots:
(i) A narrow base, with most of the incremental output coming from a few
capital-intensive industries like automobiles and a few services like
outsourcing and telecoms.
(ii) Incremental investment was skewed in favour of capital and skill-intensive
registered manufacturing (especially, the automotive industry), with a
marginal rise in infrastructure's share, despite a sharp rise in domestic credit
and abundant access to foreign capital.
(iii) The growth in power generation capacity improved during the boom, yet it
was not adequate to reverse the long-term decline. Modernisation of the
national highway network seems satisfactory, but the record of rural road
construction (which is also part of Bharat Nirman) was abysmal during the
boom, but improved somewhat afterwards.
(iv) By type of assets, share of construction in fixed investment declined, and
its composition changed in some notable ways. Residential construction's
share in the total declined (despite a sharp rise in housing mortgages), at the
expense of residential construction.
(v) The financial crisis hit employment in Labour-intensive manufacturing.
Between 2004-05 and 2009-10, there was no employment growth, but a
distinct decline in female labour force participation rates was discernible.
However, wages went up across the board, though at rates lower than the rise
in per capita income.
The Boom and its Aftermath
Sometime ago, India was a rising star in the global economy, with its annual growth rate
touching 8-9 per cent between 2003 and 2008, with price stability and modest fiscal and
balance of payments deficits.
It was hailed as one of the fastest-growing large economies, nipping at China's heels and
reckoned as the emerging global back office as against China being the world's factory.
That boom is associated with a sharp upturn in the investment rate peaking at 38 per
cent of GDP in 2007-08, with rising domestic saving financing (most) of this investment..
Unprecedented foreign capital inflows-foreign direct investment (FDI), foreign portfolio
investment (FPI) and external commercial borrowings (ECBs)at close to 10 per cent of
GDP supplemented domestic resources.
The Global Financial Crisis in 2008 upended the boom, though it affected
India only modestly for two reasons:
(i) its stricter financial regulations and
(ii) relatively large and closed domestic markets.
After a brief dip in 2008-09, India, thanks to accommodative monetary
and looser fiscal policies (a concerted effort by the Group of 20
countries), witnessed a V-shaped recovery that lasted until 2011-12.
Quantitative easing (QE) by advanced economies meant renewed capital
inflows into emerging markets in search of better yields (that is, higher
returns), until the Wake-up call of the Taper Tantrum' (in May 2013)-when
the US Federal Reserve hinted at raising interest rates took place,
reminding India of the perils of fickle capital inflows.
The lower output growth has translated into job losses, withdrawal of
workers from the labour force (due to a lack of employment opportunities),
a sharp rise in the open unemployment and a stagnation in real wages in
rural India.
As the boom petered out at the turn of the previous decade, a revolt
against cronyism and capitalist exploitation of (2011-12) land and labour
and scarce natural resources came out into the open.
The judiciary played its part in putting an end to these exploitative
relations.
There were massive protests across the country against land acquisition (in
Nandigram, West Bengal, for instance), there were court cases against
corrupt business houses for getting scarce natural resources at allegedly
throwaway prices (2G, for example). (The Economist, 2014).
The Aftermath of the Boom:
By the middle of the 2010s, the euphoria about reforms got muted with
economic growth distinctly lower than in the previous decade; domestic
saving, investment, and capital inflows likewise trended downwards.
IT exports were tapering off as the US imposed taxes on outsourcing because
of technological changes. Inflation, however, ruled high on account of
international oil prices, and the balance of payments (BoP) deficit became
precarious for a while.
Decelerating output growth affected the earnings of corporates and hence
their ability to service the enormous debt they had accumulated during the
boom. Corporate bad debts got translated into the banking sector's
non-performing assets (NPAs) as firms could not repay loans
restricting banks' ability to offer new loans.
Wilted Outcomes Since 2014-15
Realising the deteriorating economic situation and the discontent with the
previous government the NDA government came to power on the agenda of
development (modelled after Gujarat's supposed success), eradication of
corruption and enforcement of the rule of law.
The collapse of Kingfisher Airlines and then Vijay Mallya fleeing the country
leaving behind the public sector banks bleeding, was, in the public
imagination emblematic of everything that was wrong with economic
management of the previous regime. The incoming Government vowed to use
financial regulation (including enforcement of strict tax laws) to probe and
punish financial wrongdoings. This was an agenda with a broad popular
appeal.
Policy Shocks
To eradicate black money and also to encourage greater use of digital transactions, in
November 2016 the Government demonetized the large-valued currency notes of Rs
1000 and Rs 500, accounting for 86.4 per cent of the total value of the currency in
circulation, It was indeed a macroeconomic shock, devastating the informal/unorganised
sector (which mostly runs on cash transactions), employing up to 90 per cent of the
workforce and contributing nearly half of the domestic output.
There is near unanimity among economists about demonetization’s adverse effects. Many
believe that it contributed to a contraction in economic activity. Nor has the policy shock
led to reduced usage of cash: as a proportion of GDP, it is inching back to its
pre-demonetization level, as per the RBI Annual Report, 2018-19.
The Goods and Services tax (GST) to replace various indirect taxes has been in the
making for quite a while. However, its introduction in 2017 was the second shock in less
than a year, welcomed in principle but widely criticised for its poor design and
implementation. Besides adversely affecting small and informal enterprises (which find it
hard and expensive to comply with GST's numerous computerized filings and leading to a
severe fall in tax collection
Changes in Economic Statistics
Changing the base year of the national accounts every 7 to 10 years is a
routine matter for statistical offices everywhere.
The revision account for the changes in the economic structure and relative
prices.
In early 2015, the then Central Statistical Office (CSO) -now the NSO
introduced a new GDP series with the base year 2011-12, replacing the
earlier one with the base year 2004-05.
Surprisingly, the absolute GDP size for 2011-12 in the new series was
marginally smaller (by 2.3%) than that in the earlier series. But its annual
growth rates in the following years were significantly and systematically
higher than in the older series.
As the new GDP growth rates were out of line with many economic correlates,
there was widespread criticism that the new series seemed to systematically
overestimate the GDP growth rate. The following two example demonstrates
well:
•With the demonetization in November 2016, output and employment
contracted, especially in the unorganised or informal sector. Economists
widely believe it to be so based on theory, empirical analysis and numerous
field reports. Yet, the official GDP estimate for 2016-17 showed an 8.2 per
cent growth, the highest in a decades.
• For the same year, according to the actual tax returns filed by companies in
the private corporate sector, the fixed investment to GDP ratio fell to 2.8 per
cent from 7.5 per cent in the previous year, as per Ministry of Finance's
Report on Income Tax Reforms for Building New India (September 2018).
The fall in the ratio seems understandable as demonetization led to a
contraction in economic activity.
Surprisingly, however, the corresponding ratio according to the CSO's
National Accounts rose to 12 per cent of GDP in 2016-17, compared to 11.7
per cent in the previous year.
The divergence between the two sets of estimates (both the levels and the
direction of the change) suggests that the national accounts-based
corporate investment estimates are out of line with reality.
The GDP growth rates are overstated on account of the kind of
methodological changes used and the newer data sets that have been used.
To illustrate, the annual GDP growth rate for 2012-13 went up sharply from
4.8 per cent in the old series to 6.2 cent in the new series.
Similarly, the manufacturing sector growth rate for same year swung from (-)
0.7 per cent in the old series to (+) 5.3 per cent in the new series.
