"The ease of living in India," 'The Hindu', May 25, 2016

A quarter century of economic reforms

Pulapre Balakrishnan

 

This month marks the passing of twenty five years since the initiation of a significant changes in India’s economic policy regime referred to as “the reforms”. The reforms led to a revision of some policies that had been in place for close to four decades. As much had been expected of them, and twenty five years is a long period in the history of a nation, it is important to publicly review what has been achieved as the main political coalitions at the Centre all speak of the need for “more reforms”. The point of such an exercise would be to strengthen those aspects of the reforms that have had a beneficial impact and re-think those that have not had the desired ones. In India we see ineffectual policies being adhered to for far too long even when it is apparent that they have failed. This reluctance to change course is partly out of fear of losing control and partly out of fear of a backlash from vested interests. Either way, given the extent of deprivation faced by a large section of our compatriots such paralysis prolongs the hardships faced by them. So it is important not only to appraise the impact of the reforms but also to put pressure on the political class to make the necessary course corrections immediately.

          In 1991 the central plank of the reforms was to allow for a greater role for market forces termed ‘liberalisation’. This amounts to less governmental control over private sector behaviour. Thus, in the first phase of the reforms among the main actions taken had been to free the exchange rate, lower the barrier to imports and to end the licensing of private investment. These aimed to give a greater role to market forces and thus increase competition. In the first instance, these changes were likely to impact the manufacturing sector. It is not as if the strategy overlooked agriculture but the beneficial impact on agriculture was to come about in a roundabout way, by increasing its profitability vis-à-vis industry which was now subjected to international competition. In the second phase of the economic reforms the focus shifted to the services sector. The action was to allow greater private participation in banking, insurance, airlines and telecommunications mainly. 

                At the macro level, at least for India, it is customary to evaluate the impact of a policy change in India by tracking the progress made on the growth of income and the reduction in poverty. We find that the Indian economy has certainly grown faster since 1991, particularly so over 2003-04. But the acceleration of growth is not something new. Growth in India has accelerated periodically in the past four decades. Poverty, measured as the number of persons below the poverty line, has declined since 1991 and particularly since 2004. But as with growth, poverty has been declining since the early seventies. All in all, the reforms have only maintained the existing trend with respect to growth and poverty.     

          So would it be right to say that the reforms have not made any great difference to India’s economy? This would be wrong. Twenty five years on we tend to forget that in 1991 India had faced a severe balance of payments crisis. Our foreign exchange reserves had declined precipitously due to the rise in the price of oil following the invasion of Kuwait and non-resident Indians (NRI) withdrawing their deposits as the country’s reserves declined. Moreover, repayments were due on India’s external debt. There was all round anticipation of a default by the Government of India and our public sector units were unable to get lines of credit to import even oil. Finance Minister Manmohan Singh was primarily motivated by ensuring that India honours all her international commitments. To acquire the necessary foreign exchange he had to go to the International Monetary Fund (IMF), something that was unpopular across the political spectrum, including within the Congress Party. But the reforms have been successful in turning around the balance of payments. As a measure of this consider that today India has reserves of over 350 billion dollars. In March 1991 they had amounted to 6 billion. The period since 1991 has been the longest India has gone without facing a foreign exchange shortage. This is a significant achievement indeed. There are however areas of the economy where the reforms have not succeeded and some others that have not even been addressed though they are very important to us. In the remainder of this article I turn to these.

          As already stated, the first round of reforms had focussed on India’s manufacturing sector. The architects of the reforms had asserted that this would lead to substantial gains based on the idea that exposure to international competition would increase productivity. However, in relation to the size of the economy manufacturing output has not expanded as much as was anticipated. To see why India needs a dynamic manufacturing sector we need only look towards the Asian economies east of us. These economies have grown unusually fast and eliminated poverty on the basis of a phenomenal expansion of their manufacturing sectors. Only a considerable expansion of manufacturing in India today can generate the employment opportunities on the scale needed for India to eliminate poverty. Prime Minister Modi’s initiative ‘Make in India’ reflects precisely this failure of the reforms, even though it is not clear as yet whether what this initiative brings to the table is superior.

          The reason why manufacturing is not growing as rapidly as we would like it to is related to the feature that the reforms have left unaddressed how some of the essential inputs can be harnessed. These are agricultural progress, human capital and physical infrastructure. A prosperous agriculture drives manufacturing by providing the demand for it. However, it is important that agriculture expands without raising food prices substantially for this will kill demand for manufactures as all but the surplus farmers would then have to pay higher prices. Such an expansion also benefits the farmers when there is an increase in the yield of land. Human capital refers to the level of education and skilling of the workforce. As a country’s manufacturing is exposed to global competition, whether it can sell its goods is related to its endowment of human capital. In this context it is salutary to recognise that China had surpassed India’s current level of schooling by 1970. We come next to the physical infrastructure. Without the supporting infrastructure - which includes power, roads, and transportation – Indian firms cannot compete with their Asian peers. Altogether, it is not surprising at all then that India’s manufacturing trade deficit has remained negative even after the reforms.

          Finally, I come to an area of the economy that the reforms have not addressed so far. The reforms have focussed on production. This is of course important. However, there is an aspect of our lives that is at least as important as production. That is the ease with which we can live it. This is determined by civic amenities ranging from pedestrian sidewalks to sewerage, waste management and recreational spaces. While these all contribute to production indirectly they are also important in of themselves as they enhance the quality of our life. Readers in Kerala, reeling under the impact of mounting garbage and polluted water bodies, would be fully familiar with what is being said here. Some part of the level of stress in India stems from this lack of infrastructure. The reforms have not addressed this issue to any significant extent so far. While the present government’s emphasis on the ease of doing business by removing administrative barriers is commendable it can by itself do little to ease the hardships of living in India.

 

          The economic reforms so far have been largely in the nature of removing unnecessary controls on private sector activity. This is necessary, but the private sector is incapable of providing quality schooling and physical infrastructure on the scale required to eliminate poverty and set the economy on the path of high sustainable economic growth. As I have mentioned, a strong economy requires both human capital and infrastructure Twenty five years of reform in India have certainly had some positive outcomes. It has ended the acute shortage of foreign exchange and brought a new-found dynamism to the private corporate sector, notably in the information technology sector. But at the same time, in these twenty five years we have come to understand that liberalisation alone cannot eliminate poverty in India and improve the quality of our life. For this we need an economic policy that addresses the associated deficits directly. All that needs to be done is known to us and India has the resources to back the necessary action. How the economy will shape up will be determined in the space of politics.