Financial Express, August 19, 2013

Can India grow faster again?

India’s slowdown is partly a result of its own policy missteps, and not just global conditions. These factors suggest that India can grow at 8% a year, even in the current economic climate. 

 

India’s growth has slowed dramatically from the global boom years. What can it do to recover? Was the period before the financial crisis just a temporary, lucky window for India, now gone forever? The rich world is saddled with debt. An emerging market slowdown, partly a result of the industrialised countries’ own slowdown, and partly due to internal structural issues in China and elsewhere, is the latest shadow looming over India’s growth prospects. Is the gloom escapable?

There are possibilities for hope. Much as I dislike the idea of Indian exceptionalism, in this case it may be warranted to some extent. Most importantly, India is by far the poorest of the BRIC group, and probably one of the poorest of the more amorphous “emerging market” designation. That means it has more room to grow. It is quite far from having to worry about any so-called “middle-income trap,” that might be an issue for China and Brazil. Secondly, India’s demographics give it an opportunity that does not have to be sabotaged by a global slowdown. Thirdly, India’s slowdown is partly a result of its own policy missteps, and not just global conditions. These factors suggest to me that India can grow at 8% a year, even in the current economic climate. How can this be achieved?

The need to create productive employment at a very large scale is obvious. This is more complicated than just giving away money for rural make-work programmes—that is just a transfer scheme for redistribution-cum-income insurance. India needs to create more new businesses and allow existing ones to expand more easily, and in employment-friendly ways. Clearly, labour market reform is needed, and it is not as difficult as it is made out to be. The core problem is political acceptability, and a grandfathering scheme, where existing employees are protected, but new ones in new firms, or certain classes of old ones, are allowed to be employed under more flexible conditions.

Next, the focus of new business creation should be in second and third tier cities and towns. These are best placed to absorb rural labour most efficiently and flexibly. To make this work, strengthening urban infrastructure at this level is critical—this means empowering urban local governments, increasing their capacity and incentives to raise revenues and build and manage new infrastructure. It also needs continued development of rural roads.

Another way in which India is somewhat different is in its geography. This geography actually makes it easier to develop internal supply chain networks, again provided that the internal infrastructure is in place. Currently, a wholesale review of India’s transportation sector is under way—hopefully its recommendations will be the basis for reform, not just in physical infrastructure for internal movement of goods, but also in the institutional infrastructure of regulation and taxation that often inhibits the development of internal production networks.
India also needs to think about patterns of production. Japan certainly grew by becoming an exporting powerhouse after World War 2, but it also produced for its domestic market. Durable goods industries making appliances and cars for domestic consumers were crucial to Japan’s inclusive growth. India is poorer, bigger and more heterogeneous than Japan. On the other hand, technology has made it easier to set up new industries (smaller-scale factories, for example), to manage production, and even to innovate inside a technology frontier that has itself been pushed out at an incredible rate. The key to inclusive growth is domestic production of consumer goods that are affordable to large numbers of Indian consumers—not just watches and bicycles, but mobile phones, kitchen appliances, energy generating devices and more.

This last point suggests that the idea of Track 1 and Track 2 reforms, so clearly articulated recently by economists Jagdish Bhagwati and Arvind Panagariya, may be dominated by a reform agenda that integrates the need for growth with inclusion, and goes beyond mere redistribution or trickle down.

To support the growth path outlined above, there are three crucial areas where the national government needs to focus, beyond basic health and literacy. First is a large-scale, effective set of vocational training programs: there has been much talk on this front and little achievement. The private sector probably needs to be incentivised to make something happen quickly. Second, the government needs to fix the mess in electric power generation—this is well-documented as a prime constraint on growth. My earlier calculation suggested over a percentage point of growth is lost each year.

Third, and most difficult, the national government needs to overcome its own corruption and inefficiency by devolving responsibility and authority to the states, and from there down to cities. Old fears of national disintegration are no longer valid. Political power at the centre can be just as well sustained through sustained economic betterment, as opposed to short term handouts. Political parties at the national level need to understand that this is possible. A future Indian spring can be a true blossoming, or it can be like the Arab one so far.

From Financial Express, October 30, 2012

Signs of hope for India’s economy

The latest World Bank report on the ease of doing business in 185 economies provides a mixed picture of India, but with some glimmers of hope. India’s overall rank based on a composite index has not changed from last year. It remains at 132, still firmly in the third division of the ease-of-doing-business league. But since most countries are making improvements on this front, India’s stasis in the relative rankings is consistent with some absolute improvements.

Since 2005, the greatest percentage improvements — measured in terms of distance from the global best-practice frontier—in India’s standing in various dimensions of doing business have come in getting credit, dealing with construction permits, and procedures for starting a business. But it still ranks 173rd in starting a business, and 182nd in dealing with construction permits. To the extent that what matters are the levels of various hurdles to doing business, absolute improvements are good. But low rankings matter wherever global competitiveness is an issue.

Comparisons in rankings and levels of barriers across developing countries for different aspects of doing business do not reveal any obvious patterns, or necessarily a tight link between ease of doing business and growth performance. Where India ranks close to dead last, however, is in enforcing contracts, and the major contributor to that ranking is the length of time taken. This suggests that the state of India’s judicial system, particularly with respect to contractual disputes, is a major weak spot for its business environment.

Fixing the judicial system requires a concerted effort by the central government. It has been weakly on the reform agenda, but without making much headway. The sad part of this is that the resources needed to reduce judicial delays in India are probably a fraction of those being thrown by the government at other areas of the economy.

In other cases, there is more hope, because positive change can come at the state level. A recent story in the Washington Post, by Simon Denyer, rediscovers the possibility that, despite the central government’s difficulties in moving economic reforms forward, individual states have considerable leeway to progress, and have been doing so. Arvind Panagariya, quoted in the story, reminds us that decentralisation of economic control was a major theme of the 1991 reforms—he himself is working on a major study assessing the comparative performance of India’s states. Ajay Shah, in the same newspaper story, notes the competition for investment among some states, but also the slow diffusion of lessons on best practices in governance.

Part of the problem is that even when one gets down to the state government level, decision-making is top-heavy. How a state does seems to depend on who is at the top, and discussions of good and bad performance focus on personalities, whether it is Narendra Modi, Jayalalitha, Nitish Kumar, Chandrababu Naidu, or Prakash Singh Badal. Anecdotes abound about the way in which state leaders shape the culture of administration, and set the tone for how civil servants (the elite Indian Administrative Service in particular) carry out their duties.

Of course, leadership matters, but governance at the state level can display over-centralisation, just as at the national level. Ajay Shah notes the need to devolve power to city governments, in the Washington Post story. The 74th amendment set the stage for this 20 years ago, but actual progress has been limited. One of the key problems is the lack of political autonomy, with state-level politicians and bureaucrats able to interfere too much at the local level. Another is a lack of funds.

To some extent, the lack of funds is endogenous—with local politicians finding it easier to rely on trickle-down transfers, however small and unreliable, rather than making effective decisions on taxing at the local level. The urban property tax, in particular, has been eroded by corruption in the real estate market and in local tax administration. The national and state governments need to make a concerted effort to improve the design and administration of urban property taxes, while giving cities more leeway in setting rates—as well as allowing them to piggyback on a future GST—as I argued in my last column.

As I argued earlier, getting the states to decentralise to the local level will require giving them more autonomy and revenue authority. States are exercising de facto autonomy in competing for investment, and that can be good for improving conditions for doing business, but it is important that this not lead to competitive reductions in tax effort, with the expectation that the national government will cover the gap. As the government sets up the 14th Finance Commission, rethinking the inter-governmental transfer mechanism in concert with reconfiguring tax authorities should be an important part of the commission’s mandate. The goal should be to improve marginal incentives for revenue collection at all sub-national levels of government.