A Matter of Time: India's Emerging Economic Prowess

Article excerpt

As the world's largest democratic republic and the home to a substantial English-speaking population, India appears poised to establish itself as a powerful engine for global economic growth. Though India, already the fourth-largest economy by purchasing-power parity, is currently believed to be performing below its potential, the following indicators point to a more affluent future: a competitive business environment, a privatization agenda, a thriving services sector, and an increase in foreign direct investment. However, before achieving comprehensive economic sustainability, several key issues must be addressed.

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According to Augusto Lopez-Claros, Chief Economist of the World Economic Forum, "The extent of bureaucratic red tape and excessive regulation remains a serious problem in India." Resembling their previous history of central planning and nationalization, Indian governments have, in many respects, lost key opportunities for achieving economic reforms that could have rivaled the growth of the "Asian tigers." The current prime minister, Manmohan Singh, a Cambridge-educated economist, is attempting to push a liberalization agenda through Parliament, but his efforts are hindered by the socialist factions in his coalition. Perhaps forgetting the reforms instituted by Singh when he was finance minister in the early 1990s, the opposition only hinders the process of removing the excess bureaucracy that constrains the Indian business environment.

Slow Beginnings

Following independence from Great Britain in 1947, India's economy turned to centrally-planned autarky, replete with trade restrictions, industrialization, and state interventionism. Drawing on influence from socialism, especially Fabianism (trends not uncommon today), India achieved a lackluster growth rate, derogatorily referred to as "The Hindu Rate of Growth." The attempts to balance the private and public sectors did not encourage economic growth rates similar to those in Japan and South Korea during the 1970s and 1980s. By thwarting the impersonal mechanism of the price system, state intervention prevented India from realizing its true economic potential. The domestic effect was devastating; the global effect, nominal.

The first Indian prime minister following independence from Great Britain, Jawaharlal Nehru, was responsible for much of the stagnation that plagued India and that continues to haunt it today. Spurred by a vision of a centrally-planned Indian economy tempered by a liberal, democratic government, Nehru's nationalization only impeded growth. As Shashi Tharoor, author of Nehru: The Invention of India, wryly states: "Nehru's India put the political cart before the economic horse, shackling it to statist controls that emphasized distributive justice above economic growth, and discouraged free enterprise and foreign investment." If only such rhetoric were not so relevant today.

India's economic reforms began in 1980, under the leadership of Indira Gandhi. These reforms increased flexibility for India's private sector, opening the door for foreign investment and future innovation. In 1991 Singh, then-finance minister, responded to a macroeconomic crisis by abolishing the "License Raj" (onerous regulations once required to start a business), reducing government involvement in the economy, and enhancing private-sector ownership. As a result, foreign direct investment flourished, leading to today's expanding economic growth.

The Challenges

In spite of the progress effected by Singh's foresight, several factors have inhibited India's economic growth. According to the United Nations Conference on Trade and Development's (UNCTAD) Trade & Development Report 2004-2005, despite substantial tariff reductions, "India remains a relatively protected economy." Currently, India's tariffs average around 22 percent (or 18 percent in trade-weighted terms), somewhat higher than the respective global and Asian average tariff rates of 11.5 percent and 9.5 percent. Such tariffs do not allow Indian firms to compete adequately with international businesses since these tariffs may restrict innovation potential and reduce capital flows. The distortions resulting from tariffs can hamper India's integration into the global economy by reducing its prospects for signing trade agreements with regional neighbors; these internally-created impediments may cause potential economic tension with competitors such as China and Japan.

The Indian economy, though primarily services-driven, requires an additional boost from its rather diminutive manufacturing sector. As currently typified by China's skyrocketing growth, the manufacturing sector, at least for the short- to medium-term, can be a key driver of national economic growth in developing nations. Since the manufacturing and textile sectors are not too capital-intensive, many developing countries can exploit these opportunities to achieve rapid rates of economic growth, thereby alleviating poverty. India can improve with regards to these sectors. Certain policies, such as what the UNCTAD Trade & Development Report 2005 terms "restrictive labor laws and onerous red tape," heavily restrict manufacturing growth, and can even have a secondary effect on the skills-focused information technology (IT) sector. Therefore, India's manufacturing sector does not contribute to gross domestic product (GDP) as much as it would in other developing countries. The report further reveals that "the dominance of manufacturing was much less pronounced in India than it was in China throughout the 1980s and 1990s." In this sector in particular, India is noticeably behind its Asian competitors; however, in the future, India may possess an advantage in exporting manufactured goods should China's policy shift towards stimulating domestic demand for manufactures, thus lowering their current trade surplus.

Privatization also represents another issue of utmost importance to the future of India's business environment. In 2003, the government was able to sell off a 27.5 percent stake in India's largest car manufacturer, Maruti. The sale of Maruti, which helped to revitalize the Mumbai stock market, was one of India's most successful, resulting in bids from over 300,000 investors. Such favorable privatization has the possibility, if it is not restrained by governmental opposition, to enhance India's competitive business environment in the long term while also improving economic efficiency.

A lack of infrastructure development also poses a great challenge to India's future economic prosperity. Without proper infrastructure, current business endeavors incur higher input and transportation costs which, coupled with a lack of external competition, can only result in a drop in long-term productivity and efficiency. Historically, Indian governments had not properly invested in infrastructure and had not efficiently managed subsequent projects. For example, during the proliferation of "miracle seeds" (improved strains of cereals that lead to higher crop yields) in the 1960s that created the so-called Green Revolution, India's government heavily centralized water distribution, leading to many of today's shortages in the water infrastructure. A lack of proper infrastructure may discourage foreign investment since multinational corporations may be less inclined to utilize capital to develop the necessary infrastructure (such as roads and electrical grids) themselves. Due to the lack of foreign investment, India's export potential may decline in the future. A 2003 World Bank report, authored by economists Marianne Fay and Tito Yepes Delgado, suggests that India, if it wishes to maintain its current economic growth, would need to increase annual infrastructure investment by 3 percent of GDP to around 7 to 8 percent of GDP.

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However, one of the most vital issues facing the Indian government is that of national education, particularly the abysmal rates of matriculation in tertiary education (the World Bank reports a gross enrollment ratio in 2003 of 11.9 percent). Education and skills training provide the impetus for future manufacturing- and services-oriented productivity growth. India's emerging international services sector requires a well-educated population in the future to maintain its intellectual capital and its knowledge-based advantage. Compared with other developing Asian nations, India holds a comparative advantage in pharmaceuticals, basic organic chemicals and information technology. These advantages notwithstanding. India's services risk being limited to relatively basic exports due to a lack of innovation; without a well-educated domestic population, further foreign investment in Indian services may soon plateau.

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Beyond the Horizon

In light of the ongoing frenzy over China's economic development, which conveniently overlooks a checkered human rights record, one is wont to disregard India's quieter, less dynamic "rise to the top." But can we rightfully ignore such economic potential? There are numerous benefits that could come as a result of India's global expansion: more diverse services, cheaper manufactures, increased competition within Asia, and a new market for tourism, to name a few. India will certainly encounter both structural and political challenges in the future. However, a stronger India will greatly influence the economies and political processes of such regions as Europe, East Asia, and North America.

A robust and open Indian economy would add another important engine to the global market and a provide low-cost, but relatively educated, workforce that could be utilized as a competitive alternative to China's labor markets. Furthermore, unlike China, India is one of a handful of economies expected to have a growing working-age population over the next several decades. With almost 75 to 110 million new laborers entering the workforce in the next decade, there should be an increase in workers' savings and investments. This increase in investment would lead to better capital goods in the long-run, accentuating a rise in productivity and efficiency in India's manufacturing sector and perhaps most clearly in the services sector. In that case, an increase in India's labor force over the next several decades could be a main driver for attracting foreign investment. Those two variables combined could then have derivative effects on the world economy by enhancing India's productivity, long-run macro-economic stability and international trade relations. Given its foothold in services, India's government bears the responsibility of nurturing a competitive business environment to ensure that India stays at the forefront of technological innovation in the coming decades. The services sector has been quite a large share of GDP for several years, but, since 1990 to 1991, the sector has gone from just over 40 percent of GDP to more than half. By 1998 to 1999, the Indian services sector accounted for 51.2 percent of GDP. The services sector will provide more employment opportunities in the future, and can improve a country's standard of living and global economic status more rapidly than manufacturing.

Similar to the outcry provoked by China's over-quota textile production, an accelerating Indian economy could also kindle political animosity throughout the developed world. However, the long-term benefits of global free trade far outweigh the short-term adjustment costs. The European Union, for instance, has cultivated economic and political relations with India since the early 1960s. The EU-India Strategic Partnership of 2004 outlined several common priorities: strengthening their economic partnership, pursuing dialogue on human rights, and promoting the good management of globalization. Europe especially praised the Indian government's intent to pursue economic reform vigorously, and both committed to augment competitiveness with increased cooperation in technological research and development. Another potential benefit of a vibrant Indian economy would be a paradigm shift in Europe's economic modus operandi. Increased competition and trade from both India and China may cause the geographically expanding European Union to abandon the Gallic social model in favor of the Anglo-Saxon model to prevent severe economic contraction and, thereby, stimulate economic growth in stagnating Continental states.

Even more striking may be India's effect on the United States, a highly innovative, services-oriented economy. Already there is a disproportionate amount of political opposition within the United States towards China's exchange-rate and trade policies; however, both of these issues only represent small fractions of the US trade deficit and only directly affect a dwindling portion of the US manufacturing sector. However, much of the Sinoscepticism seen in the US also stems from China's ambitious rise in military force and potential interventions within the Asian sphere. India's economic rise, on the other hand, can greatly benefit the United States, not least because of India's democratic influence on South Asia. With another major services market, American investment in India should increase, allowing for more efficiency and better productivity. US pharmaceutical research companies should, in theory, benefit from stronger economic relations with India: research can be done at lower costs and there are plenty of educated workers to staff the laboratories. While the short-term adjustment costs of adding a new services-oriented engine to the world economy may seem high, the US economy should be resilient enough, and India's growth gradual enough, to weather the transition properly.

The Unanswered Questions

For the moment, the world must be prepared for India's economic emergence. In particular, oil supplies may suffer drastically to support economic growth on the subcontinent. Access to energy sources is but one of a few transitional problems the world will have to face within the next decade, especially with increased development in Asia.

Therefore, the Indian government must own up to the responsibility of effectively guiding India's economic structure. Can the government evade protectionist bickering and continue on its path to reform? History does not evince any easy alternatives; for decades, socialist factions attempted to optimize economic happiness through central planning, but, inevitably, their efforts were fruitless. Private enterprise, personal savings, a healthy business environment, and robust investment are but a few ingredients to achieving economic prosperity. Will the Indian government succumb to internal protectionism and regress to the foolish idealism of the Nehru government? Can the government fend off political short-sightedness? And how so? Such political opposition would perplex the leaders of any emerging economy or, for that matter, any developed economy.

staff writer

JOSEPH LUNA

RELATED ARTICLE: THE PRIVATE TIGER

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The graph shows the sum of service-sector activities in India, as a percentage of GDP, over a 52-year period from 1950 to 2002. Trade, hotels and restaurants contributed the most growth, jumping from 6.1 percent to 14.4 percent during this period. Public administration and defense, contrary to popular belief, did not contribute significantly to the overall growth in the service sector.

Macroscan 2005

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