A Passage to Prosperity
A Passage to Prosperity
By ARVIND PANAGARIYA
July 14, 2005; Page A10
The Wall Street Journal
Having sustained 6% annual growth since the late 1980s, India is now regarded as an unequivocal economic success. Prime Minister Manmohan Singh, who visits the White House on Monday, initiated many of the key economic reforms during his tenure as the finance minister in the '90s. But his task remains incomplete. India continues to trail well behind China, which has been growing at the annual rate of 10% since 1981. From an equal level in 1980, per capita income in China today is more than twice India's. The proportion of the population below the poverty line has dropped below 5% in China compared with 26% in India.
Though trade has grown rapidly in both countries, it has grown far more rapidly in China. Exports of goods and services grew at the annual rate of 15.2% compared with 10.7% in India. By 2003, China's share in world exports hit a noticeable 5.8% while that of India remained virtually invisible at below 1%. Foreign direct investment (FDI) in India expanded manifold in the '90s over '80s, but it remained less than one-tenth the level achieved by China.
The single most important factor explaining these differences is the relatively poor performance of Indian industry. Whereas the share of industry in China's GDP rose from a high level of 42% in 1990 to 51% in 2000, it remained virtually stagnant in India. By contrast, Indian service grew rapidly, expanding its share from 41% in 1990 to 48% in 2000. This trend has continued in the last five years.
Industrial output is far more tradable than services. True, information technology services have a large traded component, but they are less than 2% of India's GDP. Therefore a low share of industry and slow growth in it translate into slow growth in trade. Moreover, in labor-abundant economies such as China and India, FDI is attracted principally to industry to take advantage of lower wages: A low share of industry means a lower level of FDI; and if the conditions for rapid industrial growth are lacking, growth in foreign investment will also be low.
What can India do to achieve the high level of growth and the low level of poverty achieved by China? Some argue that India can achieve this by specializing in services. If the bulk of the recent growth in services in India had been in formal services such as telecommunications and IT, this strategy would make eminently good sense. But these sectors are currently tiny, with distribution services, public administration, real estate, community services, and transport accounting for 70% of services. Moreover, 60% of India's workers earn their living from farming and cannot be drawn into formal services without being taken through 15 years of education. Therefore, the importance of the IT sector to the economy notwithstanding, the only way India can bring a large chunk of the farm population into gainful employment in a reasonably quick time is through faster expansion of the traditional, unskilled-labor-intensive industry. This suggests that the right strategy for India is to walk on two legs: traditional labor-intensive industry and modern IT. Both legs need strengthening through further reforms; and four specific reforms are of special importance.
• First, under a key law enacted in 1982, firms that employ 100 or more workers in India cannot fire them under any circumstances. This law has understandably deterred multinationals as well as large domestic firms from entering labor-intensive manufacturing. For example, the apparel and toy firms in India remain minuscule relative to their Chinese counterparts. Given that workers may refuse to perform their normal duties in the absence of any fear of being laid off, Tyco can scarcely risk moving its toy manufacturing to India. Large Indian firms have tried to escape the labor law by focusing on skilled-labor-intensive or capital-intensive sectors such as pharmaceuticals, IT, machine tools and auto parts, which principally employ white-collar workers who do not enjoy protection. Restoration of the firms' right to fire workers in return for a reasonable severance is essential if India is to transform into a modern nation.
• Second, the fiscal deficit of more than 10% has starved industry of investment funds. Savings by households and corporations currently average 26% of GDP. After excluding household investment and retained earnings of corporations, financially intermediated savings are approximately 12% to 13% of GDP. Thus, the fiscal deficit absorbs virtually all financially intermediated savings. Foreign savings could fill some of the gap, but they translate into large current account deficits, which bring the risk of macroeconomic instability. Unless savings rise dramatically, bringing deficits down is essential to release investment funds to the industry.
• Third, Indian industry needs better infrastructure. To compete internationally, it needs a reliable power supply at reasonable prices. Congestion at ports due to capacity constraints and poor administration hamper swift movement of goods. Airports in India are an embarrassment: A potential investor who takes a flight from New York to Shanghai and then to Delhi will think hard before choosing India over China. Finally, the movement of goods to and from ports requires the construction of reliable roads, a modern trucking industry, and the removal of restrictions on interstate movement of freight carriers.
• Finally, the most important potential bottleneck the Indian IT sector faces is the state of higher education. Currently, only 6% of Indians between 18 and 24 go to college. Of these, a tiny fraction has the skills necessary to perform tasks related to software and IT-enabled services. Unsurprisingly, competition for scarce skills has brought annual employee turnover rates in IT firms to more than 50% and a doubling of salaries for many in less than two years.
If the growth in the IT sector is to be sustained, India needs to fundamentally rethink its higher education policy. Given the fiscal deficits, the government has virtually no resources to expand and improve the education system. This leaves only two complementary options: the entry of private universities and the introduction of tuition fees in public universities for those capable of paying. The virtual ban on private universities in India is most puzzling. Many students would be willing to spend significant sums of money for a decent education, as shown by the expenditures they currently incur at U.S. universities. Given the high private returns to higher education, there is also a good case for the introduction of significant tuition fees in public universities to generate funds for the expansion and improvement of the quality of education.
Having got India on its feet in the '90s, Mr. Singh must now push reforms further to ensure that it can walk briskly on two legs. He has a historic opportunity to build a modern India and he must not miss it.
Mr. Panagariya is the Bhagwati Professor of Indian Political Economy at Columbia. This essay draws on a longer paper in the next issue of The Far Eastern Economic Review.
By ARVIND PANAGARIYA
July 14, 2005; Page A10
The Wall Street Journal
Having sustained 6% annual growth since the late 1980s, India is now regarded as an unequivocal economic success. Prime Minister Manmohan Singh, who visits the White House on Monday, initiated many of the key economic reforms during his tenure as the finance minister in the '90s. But his task remains incomplete. India continues to trail well behind China, which has been growing at the annual rate of 10% since 1981. From an equal level in 1980, per capita income in China today is more than twice India's. The proportion of the population below the poverty line has dropped below 5% in China compared with 26% in India.
Though trade has grown rapidly in both countries, it has grown far more rapidly in China. Exports of goods and services grew at the annual rate of 15.2% compared with 10.7% in India. By 2003, China's share in world exports hit a noticeable 5.8% while that of India remained virtually invisible at below 1%. Foreign direct investment (FDI) in India expanded manifold in the '90s over '80s, but it remained less than one-tenth the level achieved by China.
The single most important factor explaining these differences is the relatively poor performance of Indian industry. Whereas the share of industry in China's GDP rose from a high level of 42% in 1990 to 51% in 2000, it remained virtually stagnant in India. By contrast, Indian service grew rapidly, expanding its share from 41% in 1990 to 48% in 2000. This trend has continued in the last five years.
Industrial output is far more tradable than services. True, information technology services have a large traded component, but they are less than 2% of India's GDP. Therefore a low share of industry and slow growth in it translate into slow growth in trade. Moreover, in labor-abundant economies such as China and India, FDI is attracted principally to industry to take advantage of lower wages: A low share of industry means a lower level of FDI; and if the conditions for rapid industrial growth are lacking, growth in foreign investment will also be low.
What can India do to achieve the high level of growth and the low level of poverty achieved by China? Some argue that India can achieve this by specializing in services. If the bulk of the recent growth in services in India had been in formal services such as telecommunications and IT, this strategy would make eminently good sense. But these sectors are currently tiny, with distribution services, public administration, real estate, community services, and transport accounting for 70% of services. Moreover, 60% of India's workers earn their living from farming and cannot be drawn into formal services without being taken through 15 years of education. Therefore, the importance of the IT sector to the economy notwithstanding, the only way India can bring a large chunk of the farm population into gainful employment in a reasonably quick time is through faster expansion of the traditional, unskilled-labor-intensive industry. This suggests that the right strategy for India is to walk on two legs: traditional labor-intensive industry and modern IT. Both legs need strengthening through further reforms; and four specific reforms are of special importance.
• First, under a key law enacted in 1982, firms that employ 100 or more workers in India cannot fire them under any circumstances. This law has understandably deterred multinationals as well as large domestic firms from entering labor-intensive manufacturing. For example, the apparel and toy firms in India remain minuscule relative to their Chinese counterparts. Given that workers may refuse to perform their normal duties in the absence of any fear of being laid off, Tyco can scarcely risk moving its toy manufacturing to India. Large Indian firms have tried to escape the labor law by focusing on skilled-labor-intensive or capital-intensive sectors such as pharmaceuticals, IT, machine tools and auto parts, which principally employ white-collar workers who do not enjoy protection. Restoration of the firms' right to fire workers in return for a reasonable severance is essential if India is to transform into a modern nation.
• Second, the fiscal deficit of more than 10% has starved industry of investment funds. Savings by households and corporations currently average 26% of GDP. After excluding household investment and retained earnings of corporations, financially intermediated savings are approximately 12% to 13% of GDP. Thus, the fiscal deficit absorbs virtually all financially intermediated savings. Foreign savings could fill some of the gap, but they translate into large current account deficits, which bring the risk of macroeconomic instability. Unless savings rise dramatically, bringing deficits down is essential to release investment funds to the industry.
• Third, Indian industry needs better infrastructure. To compete internationally, it needs a reliable power supply at reasonable prices. Congestion at ports due to capacity constraints and poor administration hamper swift movement of goods. Airports in India are an embarrassment: A potential investor who takes a flight from New York to Shanghai and then to Delhi will think hard before choosing India over China. Finally, the movement of goods to and from ports requires the construction of reliable roads, a modern trucking industry, and the removal of restrictions on interstate movement of freight carriers.
• Finally, the most important potential bottleneck the Indian IT sector faces is the state of higher education. Currently, only 6% of Indians between 18 and 24 go to college. Of these, a tiny fraction has the skills necessary to perform tasks related to software and IT-enabled services. Unsurprisingly, competition for scarce skills has brought annual employee turnover rates in IT firms to more than 50% and a doubling of salaries for many in less than two years.
If the growth in the IT sector is to be sustained, India needs to fundamentally rethink its higher education policy. Given the fiscal deficits, the government has virtually no resources to expand and improve the education system. This leaves only two complementary options: the entry of private universities and the introduction of tuition fees in public universities for those capable of paying. The virtual ban on private universities in India is most puzzling. Many students would be willing to spend significant sums of money for a decent education, as shown by the expenditures they currently incur at U.S. universities. Given the high private returns to higher education, there is also a good case for the introduction of significant tuition fees in public universities to generate funds for the expansion and improvement of the quality of education.
Having got India on its feet in the '90s, Mr. Singh must now push reforms further to ensure that it can walk briskly on two legs. He has a historic opportunity to build a modern India and he must not miss it.
Mr. Panagariya is the Bhagwati Professor of Indian Political Economy at Columbia. This essay draws on a longer paper in the next issue of The Far Eastern Economic Review.
posted by Mahesh Shetty at 8:31 PM
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