Table of Contents

For a little more than three decades after India gained independence in 1947, its growth narrative and growth potential were circumscribed by the logic of self-sufficiency, import substitution, and protection. Internally, the focus was on the gradual development of capacity in the public and private investment sectors.

Those policies, however, eventually reached the limits of their usefulness, and their harmful effects became too obvious to be ignored. Indian industry had become woefully uncompetitive. Agricultural production had begun to stagnate, and the economic growth rate was stuck at around 3.5 percent on average. The next two decades, starting with the 1980s, saw a hesitant liberalization as the pendulum swung in the other direction. These two decades were also marked by excess borrowing, a balance of payments crisis that pushed the country into near bankruptcy, and a banking crisis, all occurring in the late 1980s to early 1990s.

In the third phase, which commenced in the 1990s under then prime minister P. V. Narasimha Rao and his finance minister (and future prime minister), Manmohan Singh, and accelerated after 2000 under then prime minister Atal Bihari Vajpayee, the mantra was high growth and financial liberalization. The latter chiefly meant opening India’s capital markets to foreign investors. Deregulation of markets and a reduction in import tariffs, combined with making the economy more market-oriented, would, it was expected, produce high economic growth. As long as the government balanced the budget and kept the country open to the free flow of goods and capital, the thinking went, economic growth would be inevitable.

In the new millennium, particularly in the decade since 2004, this belief in the inevitability of high economic growth gave rise to overly optimistic projections of returns from infrastructure projects, which spawned highly unrealistic bidding supported by heavy bank lending. When the expected growth failed to materialize, bank and corporate balance sheets became bloated, unable to move forward and thus unable to move the economy forward. Companies became overleveraged and burdened with wasteful investment. They became unwilling to invest further. Banks, especially government-owned institutions, were saddled with nonperforming assets.

Unsurprisingly, high growth expectations are likely to result in a long period of subpar growth, and India’s depressed economic picture continued. Though many commentators hoped that the installation of a new government in New Delhi under Prime Minister Narendra Modi in the summer of 2014 would return the economy to a course of near double-digit growth, those expectations have been frustrated. Persistent weakness in underlying economic indicators and the lack of a sustainable recovery to levels experienced before the 2008–2009 global recession have given rise to disappointment. Businesses and opinion makers have become impatient at the lack of “big bang” reforms that would return India to a strong growth path. But such expectations, anchored in part in the memory of China‘s long period of double-digit growth and in part in India’s own brief interlude of similar growth in 2003–2007, fail to take into consideration the powerful domestic and external structural and cyclical growth impediments India faces.

The global background picture of the past quarter century provides context for India’s growth expectations and its current uncertain return to a growth path. The world economy experienced stable and high growth for an unprecedented twenty-five years up to 2007, before the global financial crisis intervened. Nowhere were its benefits more evident than in East and Southeast Asia. Apart from domestic enabling conditions, the long period of regional economic growth benefited from a happy confluence of benign external conditions, including favorable geopolitical dynamics (the United States provided geopolitical stability, which also relieved regional economies of defense spending); the high noon of globalization, facilitated by a sharp fall in tariffs; the unbundling of global manufacturing supply chains; the rapid emergence of trade-facilitating technologies, such as containerization and new information and communication technologies; a receptive consumer market in North America and Europe; the availability of abundant cheap global capital; and so on. These trends either are considerably attenuated or have run their course. But all narratives of India’s high growth prospects are significantly predicated on their continuation.

To these leading trends must be added the potential for job loss and job displacement caused by rising automation’s disruption of the labor market, which looks increasingly plausible. While automation’s immediate effect on India is unlikely to be significant, in the longer term, its potential to disrupt global manufacturing, and thereby the Indian economy, is considerable and worrisome. Therefore, automation is added to the list of trends that the Indian economy will have to negotiate in its quest for growth.

As a South Asian economy, India has been in position to witness firsthand and to reflect on the economic growth enjoyed by neighboring East Asian economies, but its own growth has often lagged behind its neighbors’ for long periods of time. To India, China often epitomizes the East Asian pursuit of growth because the two countries’ per capita incomes were roughly similar when China launched its economic reforms in 1979. Thus, China preceded India on the economic development trajectory and has staged its own opening up campaigns; it has also suffered its own corporate and banking balance sheet crisis, which stalled growth—another resemblance to India’s path. However, India’s experience is sharply distinguished from China’s by the pace of change and the consequences for growth: while India may admire China’s growth rate, and some Indians may harbor expectations of matching it, the path forward will inevitably reflect India’s own economic decisions and national interests.

The Harvard development economist Dani Rodrik turned a careful lens on the differences between China’s and India’s growth trajectories. In a Project Syndicate column, he wrote,

Being the tortoise rather than the hare in the growth race can be an advantage. Countries that rely on steady, economy-wide accumulation of skills and improved governance may not grow as fast, but they may be more stable, less prone to crises, and more likely to converge with advanced countries eventually.1

Later, in October 2015, in response to a question by his interviewer, Tyler Cowen, as to which of the world’s economies was most overrated, Rodrik had this to say:

I think India, because I think the kind of growth that India has had, I don’t think it’s sustainable. Partly going back to our earlier discussion about premature deindustrialization. I think they have these plans to significantly strengthen their manufacturing base. I just don’t see it happening. I think India can grow at 4, 5 percent per year on a sustainable basis. I don’t think it’s going to be 8 or 9 percent. When this sinks in, I think there’s going to be a negative overreaction, would be my fear.2

Taken together, these two observations, from arguably the world’s most thoughtful development economist, capture the essence of India’s growth problem. Indeed, for India, domestic and international experiences have demonstrated unambiguously that economic growth driven by considerations of self-sufficiency, by lending spurred by overly optimistic assumptions, and by obeisance to financial market priorities is both short-lived and subject to reversion. Dialing back expectations from lofty levels is desirable, for it would avoid wasting resources in the vain pursuit of high economic growth. In an environment where economic growth in advanced economies has stagnated at low levels, such a strategy might entail more costs than it would confer benefits.

Differing from China, India has the potential for a more sustainable and stable period of long, drawn-out economic growth, even if it might not be as high as some would like. That economic growth is best achieved through a realistic assessment of the current potential for growth and of the hurdles that stand in the way of economic growth and prosperity. The hurdles are many and have many dimensions—improvements in education, healthcare, the role of women, state capability, the legal framework, and leadership are needed to provide a strong foundation for growth. But addressing such barriers requires a paradigm shift in economists’ understanding of the country’s growth drivers and potential. The common misperception that India’s demographic advantage would automatically propel its economy to a higher growth path, similar to what East Asian economies achieved in the 1970s and 1980s and emulated later by China, must be acknowledged and replaced.

This report follows a general trajectory of describing India’s current historical and economic status, enumerating the barriers to growth, and proposing solutions. The next chapter looks at India’s economic growth performance over the decades since independence in 1947, the reforms of 1991, the economic boom of 2003–2008, and the recent bout of high inflation that lasted from 2009 to 2014. The purpose is to understand the prevailing mood of dissatisfaction over India’s economic performance and to view India’s long-term economic challenges within the frame of policy choices made since independence and the country’s growth experience before and after the 2008–2009 global recession. The Indian economy’s short-lived, high-growth performance from 2003 to 2007 and its subsequent stagnation reflect the formidable growth hurdles India must surmount.

Chapters 2 to 4 identify the various structural, long-term, and other domestic factors, including the capability of the state, that stand between India and sustained high economic growth. Chapter 5 discusses near-term growth-unfriendly trends, and chapter 6 looks at some helpful short-term developments. If these developments are carefully exploited, they may confer long-term growth benefits on the Indian economy. Chapters 7 and 8 present policy recommendations and process principles that the government could usefully embrace to enable India to emerge from its low-income, low-growth status, while the final section offers some concluding thoughts.

India’s potential to achieve high growth rates is not in doubt. But, first it has to cross the river by feeling the stones, one step at a time before the high growth rate possibility appears on the horizon.

Notes

1 Dani Rodrik, “Back to Fundamentals in Emerging Markets,” Project Syndicate, August 13, 2015, http://www.project-syndicate.org/commentary/emerging-market-growth-by-dani-rodrik-2015-08.

2 Tyler Cowen, “A Conversation with Dani Rodrik,” Medium, posted by “Mercatus Center,” October 21, 2015, https://medium.com/conversations-with-tyler/a-conversation-with-dani-rodrik-e02cf8784b9d.