India looks forward

Strong economic growth has given India’s people much to smile about as their country celebrated its 60th anniversary of independence this year. They could achieve much more still, though changes would be needed.   

“At the stroke of the midnight hour, when the world sleeps, India will awake to life and freedom.” So said India’s prime minister, Pandit Jawaharlal Nehru, to mark the occasion of India’s newly won independence in August 1947. Nehru would hardly have guessed that, half a century later, the “world’s largest democracy” would also be among its leading economies.           For the first three decades following independence, India struggled as the impoverished economy notched up very little growth at all, and it was only in the last 20 years that real progress was made. Nowadays India seems far more prosperous and confident, with images of high-tech parks, bustling cities and a vibrant culture flitting across magazines and television screens the world over. The question is how robust has India’s transformation really been?                   The answer is mixed. Certainly, if national income is adjusted for differences in purchasing power between countries, then in 2006 India was the planet’s third largest economy after the US and China, accounting for some 7% of the world’s gross domestic product.                      The country’s sheer size–over a billion people–is a factor to bear in mind, but for the authors of the OECD’s first-ever Economic Survey of India released this October, the main reason behind this new economic strength is clear: successive reforms since the mid-1980s have loosened the state’s grip on whole areas of activity and brought in more of the market. Trade and investment, financial market regulation, industrial and fiscal policies: all have been reformed to help open up the economy and lift potential output, now at an estimated annual pace of 8.5%.                 To be sure, the reforms that began mostly in the early 1990s could have been more complete. The industrial licensing system, for instance, which was relaxed to include just a handful of sectors, such as alcohol, tobacco and defence industries, might have been extended to improve competition among small-scale industries. And import tariffs, despite successive reductions, are puckered with derogations and remain relatively high by ASEAN region standards.                   Global economic buoyancy has no doubt injected some dynamism into the economy. On the other hand, India’s overall share in international trade is far lower than its share in world GDP. Most of the export gains have been in services, particularly those that are IT related, including call centres, outsourced insurance and business administration.                 The main drivers of growth have come from the domestic economy. Fixed investment has boomed, with capital stock rising by some 7.5% a year, according to latest figures. Perhaps the main contributor to demand has been the boost in labour productivity. In fact, productivity growth has outstripped every OECD country except Korea. Much of this gain reflects capital deepening from investment and improvements in human capital formation, leading to higher efficiency through gains in total factor productivity.Two changes in policy are noteworthy too: fiscal consolidation has been addressed, with a deficit target of 6% of GDP in 2008, low enough to bring down public debt. The second is in financial markets. The pace of liberalisation was slower than expected, but bank interest rates are now only subject to control in a few areas, such as savings deposits and export credits, and there are far more private banks than before, including foreign ones.               The upshot of this reform has been a sharp rise in India’s incomes per head, by 7.5% per year in recent years, compared with increases of around 1% per year in 1950-80. This change in fortunes has led to real progress in reducing poverty too, both nationally and within individual states. Indeed, by some measures, there was a fall of 8% in the absolute number of people living below the poverty line in 1999-2004 alone, the first fall over such a period since independence. Reasons for this decline probably include lower relative food prices and a better employment performance–employment growth finally began to outstrip population growth since 1999.                     India’s gains show up in other well-being indicators too: in the infant mortality rate, which fell to 55.5/1,000 in 2005 from 77.3 in 1992; and a rise in electricity supply to households, as well as piped drinking water and toilet access. However, these are still short of the internationally agreed Millennium Development Goals.                   The economic and social gains are huge strides, but GDP per capita is still only around $3,500 in purchasing power parity terms. That is less than half the level of Turkey and a third the level of Mexico. India’s richer states have seen most of the progress, and there has been some increase in inequality between urban and rural areas. Moreover, the north has seen slower income growth than the south or west, and in six states, which together account for 40% of India’s population, incomes per head have grown by just 2.5% per year, with poverty numbers showing little improvement in recent years. In fact, there was a rise in poverty rates in some states, such as Haryana and Rajasthan.                Still, the authors of the India economic survey are confident that the potential for further catch-up in productivity is large. After all, it remains at just 75% the level of China. Also, a rising higher share of workers in the total population and a fall in the dependency ratio point to stronger GDP per capita through a demographic dividend. A more vigorous reform agenda over the next five years would likely raise GDP growth to over 9.5%. And if a potential incomes growth of about 8.5% were sustained, then average incomes would more than double in a decade. Major potential
Growth of potential GDP per capita over the longer term

Source: OECD
To achieve this, the new India economic survey examines several areas for action: easing regulations in product and service markets, which are more restrictive than in a typical OECD country, even in farming; removing barriers to employment for larger firms in particular; and making the financial system more efficient, notably by reducing the high state ownership of bank assets.                  Policy would encourage more growth in the economy if it ironed out remaining tax distortions and loopholes, while fiscal management between individual states and the centre could be tightened up, in part to limit state borrowing and also to improve public services in poorer regions.              Indeed, infrastructure generally could do with more investment. Growth in the capital stock in public utilities, such as electricity, lags well behind that of other fast-growing Asian countries, and an additional annual investment of 1.7% of GDP would be required to close the gap. As for roads, investment of around 0.4% of GDP would need to be raised to over 3% just to match neighbouring China’s effort.          Fiscal constraints are forcing the government to turn to private suppliers to help bridge these gaps and with reason. After all, private companies have already transformed India’s telecommunications, improved the productivity of its maritime ports and succeeded in reinvigorating the aviation market.               Indeed, the authors believe India could do with a bigger dose of privatisation more generally. True, there has been some success in privatising at the state level, but in general, privatisations have tended to be partial. These have improved productivity and profitability, but their overall effect on competition has been negative, with political influence still cramping corporate decision-making. Other than full privatisation, the report pragmatically suggests that at least public sector enterprises should be brought under the control of less bureaucratic investment agencies, as occurs in OECD countries.                 The India report sees several areas in the economy where competition could be improved, such as in farming, by relaxing price controls, and in road transport, where entry to the market is far too restrictive. Market exit is also a formidable problem in India, with rehabilitation procedures painfully prolonging the life of ailing firms. Some reforms are in the pipeline to ease this, but the report nonetheless encourages the government to adopt international bankruptcy standards.               The labour market also requires policy reform. Employment has risen for five of the last six years, both in manufacturing and in services. The trouble for industry is that most of the increases have occurred in the least productive, often informal, parts of the economy. The organised formal sector has in fact lost employment, by about 1% per year. One reason is labour laws, which are more stringent for regular contracts in the formal sector than in most OECD countries. For dismissing staff, India’s stance is particularly onerous, with long authorisation delays affecting plants of over 100 workers. Employment protection legislation (EPL) is therefore costly, leading larger firms to invest in labour-replacing capital, and dissuading small firms from growing any bigger.
There is a way forward though. According to a new OECD index developed for the survey, labour market reform has lagged at the statelevel in particular; from factory and shops reforms, to filing returns and labour contracts, a score of changes that could be introduced administratively have not been brought through. The most pressing need is to reduce the cost of formal employment, and the government could start by simplifying antiquated (often colonial era) provisions. At the same time, they must introduce more fairness in EPL for the treatment of female workers, scheduled castes and migrant workers from other states.              Education, education, education                In the early 1950s some four fifths of the population were illiterate; today that figure has dropped to a third, and many of those are older people. In fact, fewer than 10% of urban and rural 5 to 14-year-old pupils are illiterate.              Improving education is obviously essential for enhancing economic performance, and India faces some rudimentary challenges at every level. For instance, attendance and completion rates will have to be boosted, since some 7 million children missed primary school in 2006. Improving the quality of learning is also important, though the absence of teachers from smaller schools does not help. A wider use of contract-based teachers could be a way forward, the authors suggest, while closer monitoring, including the use of cameras, has also brought promising results.              Allowing more private education may also help. A fifth of primary school pupils in rural areas are enrolled in private schools, with better average class performance. Almost 60% of upper secondary schools are private or grant-aided. However, to prevent inequalities from widening further, expanding private schools would require some type of portability of public funding, such as vouchers or scholarships for lowerincome groups.                 Such measures would also assist secondary schools, whose graduation rates must also be raised, not least for the sake of higher education and competing in today’s global knowledge economy. In fact, though there are well over 10 million tertiary students in India, the tertiary enrolment rate is just 13% of all 18-23 year olds, compared with 18% in other developing countries. And while nearly a tenth of 25 to 29-year-olds had degrees by 2001, quality is mixed. Expanding higher education will be costly, and some student fees, backed up by appropriate loans, should be considered, the report says, alongside encouraging more competition between public and private institutions to improve scholarship and boost R&D.                
Another suggestion for policy action discussed in the report is to strengthen urban local government in a bid to boost local services such as education, and stimulate urbanisation by freeing up property markets held back by poor land title records and other historical arrangements. Stronger local government could also help meet environmental challenges, such as deadly air and water pollution. One official report estimated that 14% of water samples in Mumbai were infected by bacteria, and tied the contamination of domestic water supplies to the fact that the staff tasked with disinfecting the water simply lacked the knowledge needed to do the job properly.              This serves as a reminder that while India’s people have been celebrating independence with an enormous sense of satisfaction, their vast economy retains many features of a developing country. But as the new OECD India report indicates, with the right reforms, that status could change too.  RJC              References     OECD (2007), Economic Survey of India, Paris.      Order the survey at or visit to download a summary and policy brief.       For further comment on the India economic survey, contact, or©OECD Observer No 263, October 2007

Economic data


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