Indian Economy on a Knife Edge

April 26th, 2015
in Op Ed

by John West, Asian Century Institute

India's new Prime Minister, Narendra Modi, must get cracking, if India is to have any hope of realizing its immense potential.

Follow up:

India is indeed a country with a great deal of potential. For example, Indians who have migrated to the US, and their descendants, earn on average $88,000 a year, compared with $50,000 for Americans overall. Indian companies like Infosys, Mahindra, Mittal, Reliance, and Tata succeed famously on world markets. The Indian movie industry produces more films than any other country. And the Indian Premier League is the world's most lucrative and popular cricket tournament.

And yet, the Indian economy is a chronic under performer. During its first four decades of independence, the Indian economy chugged along at the Hindu rate of growth of about 3.5% (or 1.3% in per capita terms) from the 1950s to the 1980s. Despite a vibrant democracy, India's economic policies drew more inspiration from the socialism of the USSR than the capitalism of East Asia or the West.

A financial crisis in the early 1990s triggered a wave of economic liberalization and reform. This led to period strong economic growth, averaging 6 1/2% from 1990-2010, even hitting over 10% in 2010, before a subsequent slowdown. Despite the strong economic performance, some two-thirds of the Indian population live on less than $2 a day. GDP per capita is a mere $1500, compared with China's $6800. Beyond the glitter of Bollywood and Indian cricket, India remains a rural country, with two-thirds of its population living in the countryside.

In the 2014 national elections, the deeply corrupt and incompetent National Congress Party, the party of Nehru and Indira Gandhi, was soundly beaten by the Bharatiya Janata Party (BJP). Congress is now floundering in political oblivion, as Rahul Gandhi struggles to wear the mantle of his forefathers.

Narendra Modi of the BJP now leads the country. He promises so much, based on his successful pro-business leadership of Gujarat state for over a decade. But more than one year after taking office, Modi still remains a leader of great promise, rather than a pro-active leader with results on the board. While his foreign policy initiatives have been impressive, domestic policy reform to date has been frustratingly timid.

Making India easier for doing business could indeed make a great contribution to the country's development. For example, India ranks an appalling 142nd out of 189 in the World Bank's survey on the ease of doing business, with its ranks of 184 for "dealing with construction permits" and 186 for "enforcing contracts" being virtually at the bottom of the list. The OECD estimates that India has a highly restrictive policy regime for foreign direct investment, and foreign businesses frequently complain of harassment from the tax authorities.

Anyone who has visited India and experienced its frightful infrastructure would not be surprised to learn that the World Economic Forum ranks India 87 out of 144 countries on this score. Nor would they be surprised that Transparency International puts India 85 out of 174 in its corruption perceptions index.

At the heart of the India syndrome is a deep bureaucratic culture that makes everything difficult, especially for international business which has so much to bring to India in terms of technology and international best practices. And while we can rejoice at the democratic electoral process, through which India holds the world biggest elections, Indian democracy is deeply flawed. For example, one-third of Indian members of parliament are accused of crimes ranging from electoral misconduct to rape and murder. But despite the seriousness of the charges, few will ever face judge or jury.

While poor economic governance is holding India back from realizing its potential, social and environmental factors may be an even greater inhibitor. Even in Modi's Gujarat, where there has been an above-average economic performance, outcomes for social indicators, like poverty, nutrition, education, health and so on have been indifferent.

In particular, India's human capital development is hampered by several factors. The country has one of the very worst education systems in Asia. By some estimates, half of the Indian population would be functionally illiterate. Even at the elite level, not one Indian university figures in the world top 200.

India spends next to nothing on public health, and Prime Minister Modi is cutting it even further. Of the 1 billion people in the world without a toilet, 600 million live in India, creating a major health risk for the country.

Compounding India's health risks is a simply atrocious environment. Even without becoming an industrial power, India has managed to have six of the world's ten most polluted cities, according to the World Health Organisation. New Delhi tops the list as the world's most polluted capital city, besting out the notorious Beijing by a long way. Air pollution is the fifth leading cause of death in India, with 620,000 premature deaths in 2010, a shocking sixfold increase from the 100,000 in 2000.

Tap water is undrinkable all over India. And despite some improvement, India's ranking on the global hunger index is unsatisfactory. It is not surprising that India's life expectancy should be a mere 66 years, compared with 75 in China and 83 in Japan.

Social discrimination is rife in India, with a long list of victims like lower castes, religious minorities like Muslims and Christians, indigenous and tribal groups, and women. And as reported regularly in the press, Indian women are all to frequent victims of sexual and other forms of violence. Such discrimination prevents victims from realizing their potential, and contributing fully to the economy.

One of the most visible manifestations of India's plight is its unplanned urbanization and chaotic cities. The urban population has swollen from 26% of total to 33% over the past 25 years, with 30% of urban dwellers living in slums (thankfully down from 55% in 1990). Urbanization can in principle drive economic growth as people move from low productivity jobs in the country to higher productivity jobs in the city. But in India, too many people move from rural to urban poverty -- over two-thirds of the population work in the low-productivity informal sector.

Today, the Indian economy finds itself sitting on a knife edge.

Over the next ten years half a billion young Indians will enter the labor force. At that time, one-quarter of the world's working-age population will live in India. Looking ahead to 2020, India is set to become one of the world's youngest nations, with the average working Indian being only 29 years old, against 37 in China and the US, 45 in Europe and 48 in Japan. India has the potential to reap a large demographic dividend thanks to this large, youthful and energetic labor force, which could give the country a global competitive advantage.

But without better education and training, this could turn into a demographic time bomb. Social unrest in Arab countries and elsewhere shows the social and political risks of large populations of unemployed and frustrated youth. India needs to improve its education system at every level, but least of all at the university level. What is critical is to create an effective vocational education and training (VET) system which would cater to the vast majority of India's young population.

Already, India's potential for rapid economic catchup is being held back by a large skills deficit. Its jobs market suffers from shortages of skilled labor, while unemployment and underemployment are also widespread. The problem is that barely 2 per cent of the Indian workforce has formally acquired skills and only another 2.4 per cent of workers have some technical education. This will be the decisive factor determining whether the country experiences a demographic dividend or a demographic time bomb.

But India needs more than education and skills. It also needs industrialization which can provide jobs. As dazzling as India's IT and business process outsourcing might be, the sector only employs 3 million people. Realistically most Indians could not find a place in this sector.

The timing is right for India to become an industrial power, as China is now suffering from increasing wages, and investors like Japan are looking for new low-cost locations. This is where Prime Minister Modi's business-friendly policies like cutting through red tape, pushing deregulation, opening up markets, improving infrastructure, and cleaning up corruption are necessary.

Today many commentators are rejoicing that India could be the fastest growing Asian economy, surpassing China this year and next. But naturally when a country is coming from so far behind, a few positive moves can achieve a lot. While that is to be commended, India needs at least three decades of 10% growth to even start providing its citizens with a decent life, as China has achieved.

Just three decades ago, India was at about the same level of economic development as China. Today Indians might enjoy many more freedoms than their friends in Communist China. But India is behind China on virtually every other score -- be it GDP per capita, education, health, infrastructure and technological sophistication.

For India to realize its immense potential would require a long period of deep and sustained economic reforms, and together with modernization of its society and politics. Unfortunately, there is no sign yet that India is on a path to long-term economic, social and political progress.

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