Thoughts on Innovation, Entrepreneurship and Growth

These four pieces have a common theme of how to encourage innovation and entrepreneurship in India

India's Missing Growth Driver

India’s Union Budget has been presented, the Economic Survey has been published and attention has returned to day-to-day governance and politics as usual. Stories about big business, big sums of money and large-scale corruption are the ones that grab headlines. Ultimately, though, key policies that will shape India’s future may be suffering from neglect. Sustained inclusive growth requires innovation and job creation across a broad cross-section of the economy. This includes labour-intensive manufacturing, but, more generally, an industrial dynamism that extends beyond large incumbent firms, foreign entrants, or the relatively few recent domestic success stories.

A few years ago, prominent economist Anne Krueger labelled India’s problem that of a “missing middle” in its distribution of firms—a gap between small firms in the unorganised sector, and the large firms that grab headlines in billionaires’ lists and mega-mergers and acquisitions.

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India in 2011: What's Next?

What’s in store for India in the new year? The short-term economic outlook is good. Growth of 9% seems to be a reasonable forecast. Looking ahead, growth rates in this range seem to be sustainable for awhile, based on the assumption that investment stays at about 35% of GDP, and that the efficiency of this investment doesn’t decline compared to recent years. In one way, this is a remarkable achievement. The government has struggled to implement new structural reforms, and to do its core tasks more efficiently; yet the economy remains robust. Perhaps this is a tribute to what stability and reasonably adequate governance can achieve, when the private sector is in a position to take advantage of such an environment. The accelerating recovery in the US will presumably help India’s growth rate as well.

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Innovation and Taxes

India is continuing with major reforms of its tax system. These reforms began with liberalisation, and included cutting tax rates and rationalising enforcement and administration. Tax reform has been an important contributor to the country’s improved economic performance. The latest effort on indirect taxes is the move towards a unified national goods and services tax (GST). On the direct tax front, the new direct taxes code (DTC) Bill has just been tabled in Parliament.

A major guiding principle for tax reform is the goal of reducing distortions in economic activity that taxes can create. Tax rates that are too high, or taxes that apply to narrow groups, are more distortionary than lower rates and broader tax bases. Reforms of indirect and direct taxes are meant to cut down on distortions and improve economic efficiency. Lower rates applied more broadly and evenly, without overlapping taxes or exemptions, are part of the GST and DTC. Another principle, aligned with the first, is simplicity. Simplicity makes tax administration easier and more transparent. The GST and DTC are both simpler than their predecessors.

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Schumpeter and Three Idiots

Economic headlines in India focus on macroeconomic management. Soaring inflation, a burgeoning fiscal deficit or gyrating exchange rates all affect the economy’s health, but prudent macroeconomic policies only go so far. Long-run growth depends on factors like investment, innovation and trade (a different expansion of the initials IIT!), which do not receive as much attention. Investment is perhaps the most basic driver of growth, since capital accumulation raises labour productivity and per capita output. High rates of investment helped East Asia grow at rates never seen before. India, too, has seen higher growth associated with higher rates of investment.

International trade in goods and services has also helped India grow faster. According to economic theory, liberalising trade in goods should have just a one-time effect on output, rather than a permanent effect on growth, but the one-time effect could be spread over decades. Openness to trade also brings new capital and ideas along with products and services, and these can give boost to long-run growth.

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