These must be trying times for anyone concerned with the fortunes of the Indian economy. In manufacturing, the sector of the economy that receives the most attention,

output is crawling. Over April-September, the recorded growth in the index of industrial production (`Manufacturing’) is 2.5 percent. In the Budget for 2001-2 the finance minister had spoken of a second generation of reforms that may be expected to take the economy to overall rates of growth at least three times higher. In February 2001 such hubris would go unchallenged. Internet mania had ruled and anticipations of an economy-wide spillover from the banquet in cyberspace were de riguer. Now all of this seems like distant thunder. Nor has it taken September 11 to trim the sails of the dotcom brigade and their camp followers. The usual delayed release of statistics for the US economy now confirms that it has been in recession since March. Recession is defined as two consecutive quarters of negative growth. By this definition, the Indian manufacturing sector is not in recession even though some commentators use this expression to describe its current state. However, there is little doubt that there has occurred a definite slowing of its rate of growth.

The prevalent tendency to link the slowing of the Indian manufacturing sector to the recession in the US economy needs to be rejected as deluding. We now know enough about the trajectory of manufacturing growth during the last decade to recognise this. After a recession following the external payments crisis of 1991-92 manufacturing output had surged. The rate of growth in 1995-96 was a monumental 14.1 percent, a peak ever. Since that year the trajectory of annual growth has been mildly cyclical but trending downward. This diagnostic points in one direction alone. The slowdown in the Indian manufacturing sector has little to do with the global trend. Actually, the former is synchronous with the heralding of the New Economy in the United States following from the commercial launching of the Internet. The Indian economy began to slow exactly as the American one was belting to its eventual meltdown! This evidence also serves as a reminder that the much envied success of India’s software companies was independent of the performance of its manufacturing sector. We are now able to see clearly that the software boom, largely export of services, was tied to the hyper investment in information-technology related capital equipment in the US in the late nineties. As it had not propelled output growth in the Indian manufacturing in the first place, it could not have contributed to its slowing either.

            The official explanation of the slowing of the Indian economy is that it signals the need for another round of reforms. However, for this to have purchase one needs to be convinced that the first round has succeeded. The bottom line really is an understanding of the drivers of growth. In this context, reforms work when they release the constraints that bind production. It is clear by now that the explanation of the resurgence in the first half of the nineties is that the policy shift of 1991 released supply constraints in place due to the extant policy of restricting capacity. This was eased with the abolition of industrial licensing. A considerable pent-up demand for white goods was then met by increased production of these consumer durables. But what of an underlying demand constraint in this very segment, or, more significantly for manufacturing output, in the wider segment of mass consumption goods? The reforms have proved less succesful in releasing the demand constraint in the economy than they have done in releasing the capacity constraint. An egregious instance is that of that big-ticket consumer durable, the motor car. The automobile industry in India is definitely in an excess-supply mode with severe unutilised capacity.

            Government have thus far acted, oddly enough, to release supply constraints of a certain kind while at the same time constricting the sphere of demand. Not all supply constraints have been released either. Capacity, after all, is only once aspect of production. Production can be hamstrung by infrastructural shortfall even when capacity is in place. It is not entirely clear that bureaucratic discouragement is a thing of the past either. The author of a study undertaken for the Asian Development Bank reports the statement of a trade association in Kerala that an application to start a business in the State must stop at seventeen staging posts. Thus we see that all that has happened since 1991 is that supply constraints that could be eased by the Centre by a stroke of the pen have been done. In this category we have industrial licensing and, for supply-side economists, the personal income-tax rate. However, it is difficult to spot a single action in the past decade that has expanded demand. Indeed, there is sufficient reason to believe that the government by its actions has actually made things worse on this score. One can think of two factors on the demand side that have actually contributed to the slowing of the economy since 1995. These are the decline in public investment and the increase in the price of foodgrains, both firmly the responsibility of the central government.

In complete contrast to the rhetoric of market-determined outcomes the present government have continued the practice of raising the procurement price of foodgrains beyond the inflation rate. This has two consequences, both adverse. First, it imposes hunger as some households tug at their purse strings. Next, it leads to a constriction of demand elsewhere in the economy where potential household-spending declines. The terror that India’s partisan food policy must strike among its poorer citizens may be gauged from the fact that staple food is costly in India by international standards whereas per capita incomes are so much lower. The piling food stock help us see that the increase in price is actually engineered by government policy. The role of agriculture in keeping industry back has been publicly stressed recently by the Chairman of Hindustan Lever. Mr. Banga should know well for his firm sells soap, an item of mass consumption if there is one. However, he has emphasised the importance of agricultural growth, while it is likely that the price of foodgrains is more important. Growth alone cannot unleash purchasing power independently of changes in the price of food, for any increase in money incomes due to rising agricultural growth could be neutralised by a government’s resolute commitment to a rising producer price.

            The second of the demand-side factors, one that has received far too little attention, is investment both public and private. Private investment never really took off after 1991, indicating a certain failure of the reforms to significantly alter the incentive structure. But much worse, public investment – gross fixed capital formation - has fallen since 1991 and is on average lower than that registered in the 1980s. Public investment has two positive influences. In the first instance, it is a source of demand when purchases are made from domestic firms; but it is also eases a supply constraint when it goes to strengthen the infrastructural base. In both instances, in two distinctive ways and contrary to the conservative predilections of the group of economists recently convened by the government, it shifts positively the incentive for private investment. Empirical research on the US economy has found the impact on income much higher in the case of public investment compared to private. This has largely to do with the greater supply-side impact of public investment which, in the United States, is almost exclusively directed towards infrastructure. The demand impact of both public and private investment is about the same for all economies in that they amount to greater purchases, which expands income.

What we see in India today is an economy where production is being strangled by shrinking demand. It is difficult to see how this situation can be rectified by the package of second generation reforms now being unfurled. Of course, some of its proposed components are worthy of consideration. India has an egregiously high average tariff and its labour laws harm workers when it restrains private investment as a consequence. The problem with focussing on these though is that it purveys piecemeal measures without a strategy for growth, which must consider demand-side constraints on expansion.

            It is necessary to see the current economic situation in India for what it is, the unravelling of the logic of recent policies. The reforms had run out of steam well before the current global slowing led by recession in the United States. The Indian economy is unlikely to bounce back following expansionary macroeconomic policy in the US, nor can we reasonably foresee a flood of foreign direct investment as the second generation of reforms are slid into place, for such flows too have an eye on domestic demand. But this much is certain; contrary to the promises of a youth lived in the seventies, 2001 has turned out to be a snail’s odyssey!

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