India CAN’T cross over the West without fundamental reform of its governance

On May 8, 2011, in Economics, India, Public policy, by

(I wrote a fairly longish blog post on this topic just now but because of a computer accident I've lost it all. So this will be a brief summary).

Essentially, let's first review this – something I wrote this 13 years ago, here:  

Let us assume that USA per capita income grows at 1.5%, 2%, 2.5% and 3% for the next 250 years (i.e., we have 4 different scenarios).

Given that India's per capita today is 20 times lesser than USA (in PPP terms), and we want India to catch up with USA in 50, 100, 150, 200, and 250 years, what are the growth rates in per capita we need to target in order to reach this cross-over point?
 
We have seen that growth rates of 8-9% in per capita per year are easily achievable (as China has done in the past 15 years), and given two facts:
a) We are at least as smart as anyone else, such as the Korean/Chinese
b) We have recorded all the lessons we learnt from the mistakes of these Asian countries, we can do 10-12% per year for long periods of time.
 
The question is: what is it going to take to beat the USA?
Well, here are the answers.
 
If USA per capita = 20, INDIA = 1, (using PPP), today
The table we need is:
Assumed USA growth rate 
Years needed to cross over the USA 
 
 
50
 
100
 
150
 
200
 
250
 
1.5
 
7.8
 
4.6
 
3.6
 
3
 
2.7
 
2
 
8.3
 
5.1
 
4.1
 
3.5
 
3.2
 
2.5
 
8.8
 
5.6
 
4.6
 
4
 
3.7
 
3
 
9.4
 
6.1
 
5.1
 
4.5
 
4.2

The fundamental lesson to be learnt is that if we could do 9.4% p.a. we could catch up with the USA in ONLY 50 YEARS, even if it were growing at 3% p.a. That is out of the world, however, a growth rate of 9.4% for 50 years. Also, the USA will be unable to grow at more than 2.5% p.a. for the next 50 yrs. Therefore the target gr. rate for India, for a catch up with USA in 100 yrs, if it grows at 2.5%, is 5.6%.

 
Once more, economic theory and practice tells us that this rate is unsustainable for 100 years at a stretch. What can be done is to target very high gr. rates initially, at over 10% for about 20 yrs, and then the economy will in any case slow down, tapering off in the end to about 2% p.a.
 
[See the figures here]
 
Of course if we continue at the Socialist Growth Rate of 1.7% p.a. which we had since independence, even for another 100000 years also, we will never never catch up.
 
Today, the technology (institutional framework) needed to achieve this catch up is available with Economic science. We know that we have to set up minimally regulated markets, and encourage free enterprise, trade, and competition. We have to Banish Bureaucracy.
 
The question is essentially only one: who is going to bell the cat? It is in my self-interest and in your self-interest to only look after our own families. So, who is going to do the hard work required to reform the brilliant, but confused, Indian mind?
 
Who is going to tell the people of India that this is not a fool's fantasy – the catch up with USA, but a sheer inevitability, if we follow the lessons learnt in Economics over the past 250 years.
 
What is needed is political entrepreneurship of an unparalleled scale and magnitude.
 
Now back to today
Convergence is a simple prediction of growth models, and it has been broadly tested and found to hold. The problem is, however, that  growth rates of 10% or more are not sustainable for long without significant reform.
 
There is extensive literature on this subject, but also this recent paper by NBER (btw, if you are in India, please download and send it to me – it is free in India but costs me money to download from Australia). [When Fast Growing Economies Slow Down: International Evidence and Implications for China, by Barry Eichengreen, Donghyun Park, Kwanho Shin, NBER Working Paper No. 16919,  March 2011]
 
A recent article in The Economist summarised this paper and showed how it is almost inevitable that China will start slowing down in the coming decade. Further, I am certain that given India's extremely poor governance model, it will slow down even before reaching China's per capita GDP when it starts slowing down. India's spike in growth rates is very temporary.
 

My message for India

The 'high' growth rates seen in India today are nothing special. These should have happened anyway, 60 years ago – had the economy been let free. But unfortunately, these growth rates, attributable entirely to the 1990s reforms, are not sustainable. To reach the per capita GDP of the West (which would have further increased its GDP by then), India will need to DRASTICALLY REFORM ITS GOVERNANCE. There is simply no choice for India but to follow most of the suggestions in BFN.
 
Once again, let me repeat the same message I sent out 13 years ago: Please stand up to lead India to the future it deserves. Join the Freedom Team and prepare for a national political movement for reform. 
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India’s decline from an unquestioned position of world leadership

On March 21, 2011, in Economics, India, by

A few weeks ago I had written about India's fall from the unchallenged No. 1 super-power position it had occupied for most of the last 2000 years. Here's the actual table (on relative GDP share) from Angus Maddison's Contours of the World Economy 1-2030 AD.

AD
        1
1000
1500
1600
1700
1820
1870
1913
1950
1973
2003
France
2.2
2.3
4.4
4.7
5.3
5.1
6.5
5.3
4.1
4.3
3.2
Germany
1.2
1.2
3.3
3.8
3.7
3.9
6.5
8.7
5.0
5.9
3.9
Italy
6.1
1.9
4.7
4.3
3.9
3.2
3.8
3.5
3.1
3.6
2.7
Netherlands
0.1
0.1
0.3
0.6
1.1
0.6
0.9
0.9
1.1
1.1
0.9
UK
0.3
0.7
1.1
1.8
2.9
5.2
9.0
8.2
6.5
4.2
3.1
Spain
1.8
1.5
1.8
2.1
2.0
1.8
1.8
1.5
1.2
1.7
1.7
Former USSR
1.5
2.4
3.4
3.4
4.4
5.4
7.5
8.5
9.6
9.4
3.8
USA
0.3
0.4
0.3
0.2
0.1
1.8
8.9
18.9
27.3
22.1
20.6
Latin America
2.1
3.8
2.9
1.1
1.7
2.1
2.5
4.4
7.8
8.7
7.7
Japan
1.1
2.7
3.1
2.9
4.1
3.0
2.3
2.6
3.0
7.8
6.6
China
25.4
22.1
24.9
29.0
22.3
32.9
17.1
8.8
4.6
4.6
15.1
India
32.0
28.1
24.4
22.4
24.4
16.0
12.1
7.5
4.2
3.1
5.5
Africa
7.6
11.4
7.8
7.0
6.9
4.5
4.1
2.9
3.8
3.4
3.2

 

(In this table, I've snipped out relatively minor nations, and highlighted in red the approximate period when a particular nation was at its relative peak of global power).

Note that Africa was a relatively wealthy place well after the decline of the Egyptian civilisation. Italy started losing world share of GDP from after 1500 AD. England peaked in 1870, USA in 1950-1970. Note how the UK overtook the ENTIRE India by 1913, and remained wealthier than India for most of the 20th century. Only now is UK's GDP smaller than India's again. What a superlative performer the UK has been, despite its tiny population.

Before you rush to conclusions, let me point out that this supremacy of the UK (or the West, more generally) was NOT motivated by colonialism but by industrial productivity. While Indians kept digging potatoes from the ground, the British invented highly productive machines.

The data suggest that India and China can, together (should they adopt the technology of freedom), rapidly move towards a 50% share of world GDP. This, however, is not going to happen unless both these nations change their policies from socialism to capitalism.

The writing is on the wall for India: change your policies or remain mired in poverty and corruption. The Freedom Team of India is assembling to lead India to its rightful TOP POSITION in the world. Join FTI or otherwise support it.

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The uncertainties in doing business in India

On March 8, 2011, in Current Affairs, India, by

Came across this piece by Jennifer Hewett in The Austarlian (Rocky road to becoming an economic powerhouse). Particularly illuminating was this story about an Indian who quit his business in England and returned to India seven years ago:

One Indian-born, English-raised executive says shutting down his business manufacturing top-end shoes in Britain and moving to India seven years ago on the ground of cost was the biggest mistake he has ever made. He has to constantly pay off a variety of people to ensure his business is not buried alive by surprise new taxes, changed customs rules or dubious labour charges. There is no prospect of appeal in a legal system, which is another bad joke.

"In England, you go to work to run a business and know more or less what to expect during a day," he says. "In India, you have no idea what can go wrong next."

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Can India catch up?

On March 5, 2011, in Economics, India, by

I'm providing below partial extracts from my notes prepared for a talk I gave on 2 March 2011. I propose to refine these notes over the coming months and write a longish essay if time permits, for publication in a serious journal. Suggestions are welcome. (Don't know if I'll find the time!)

The world is rapidly changing. Far more rapidly than most people know or can imagine. When a big huge country like India gets involved in the change process, expect radical surprise.
 

The context

There are two ways to look at the world today: (a) close-up, by looking into its financial crises or business cycles; and (b) overview of trends, by stepping back. I want to set the context by looking at long term trends, and then draw closer to the current situation.
 
It will be useful to begin this talk by noting that somewhere around 100,000 years ago the current human subspecies came into existence. Most likely this happened somewhere in north Africa, following which humans began to migrate across the earth.  
 
Till about 10,000 years ago nothing much happened. Humans, who started as hunter gatherers[1] and expanded steadily across the planet, modifying and adapting to local environments. But while adaptation took place, it was reactive, not pro-active. We did not directly influence the environment. Also, the concept of critical thinking had not emerged. And so lives were generally brutish and short. The head of the tribe was influential: individual was a mere cog in the machine of the tribe.
 
Perhaps somewhere between 10,000 and 5,000 years ago most humans settled into agriculture (many pockets of hunter-gatherers remained). The fact that agriculture could produce a surplus meant that some people could specialize in culture and learning. From this period onwards we notice the emergence of towns, monarchies, and even empires: civilisation as we know it.
 
At this time, India became a specialized agricultural society. It was soon to become the world’s wealthiest, a position it retained (or at least the second-wealthiest) for almost the entire recorded history of mankind till the industrial revolution. Part of the reason for this must have been the specialization brought about through the caste system.
 

The caste system as an efficient solution to the agricultural era

The caste system was perhaps an efficient solution to the agricultural age in India. It helped create an environment for hundreds of millions of people to live harmoniously in villages, and it helped produced sufficient surplus to feed hundreds of prosperous towns and cities. Not for nothing was India the world's wealthiest nation for thousands of years.
 
With the caste system even the smallest village could guarantee itself a blacksmith, traders, cleaners, and priests to conduct marriage and death ceremonies. That meant that just because the local blacksmith died the village did not have to go miles away to get its ploughs and carts fixed. The caste system also produced soldiers when needed.
 
It was a self-perpetuating solution or equilibrium to a difficult problem of living in remote corners of India without the support network of roads, rail-line, electricity and telephones. Not a paradise, by any means – particularly for the 'lower' castes. But it worked. 
 
This model was not uncommon during the agricultural era. European feudalism comes to mind but I'm sure broadly similar social structures must have been created in China. I know that Japan definitely had its own "caste system" of sorts.
 
It also made sense (perhaps!) in the agricultural age to deify the cow and make it a sacred animal, so as to have sufficient proteins available in the village, given that most people could not afford meat and had to eat just rice and coarse lentils. This clearly did not occur all at once. It took time for the culture to stop eating cows and other animals (indeed, in the hunter-gathering era, till about 10,000 years ago, no one could have survived without eating meat).
 
That is why Hinduism took the shape it did in the last 2000 years – basically a way of life to support an agrarian society.
 
Anyway, as a result India became the world’s wealthiest in 12 out of the past 20 centuries (first to 11th century AD, the 18th century).[2] Its first century share of World GDP was 33%, and 11th century share was 28.9%. In the 18th century, India’s economy once again the world’s largest with a 24.4% share of global GDP in 1700.
 
In 1776 Adam Smith noted that virtually all nations were around the same level of per capita income.
 

The change in the rules of the game

Critical thinking arose in India first, with Charvaka and other similar thinkers, 2600 years ago. India, as a result, came out with the most revolutionary atheistic ‘religions’ like Jainism and Buddhism, with some radically modern ways of thinking, that unfortunately seem to have died out in India and China.
 
These spread to Greece with the Sophists, followed by Socrates. However, these radically creative ideas died out till the Renaissance, being rediscovered primarily through the work of Muslim scholars.
 
The next significant change after the Renaissance occurred with Sir Francis Bacon – with his ideas about the scientific method – and the Reformation. Many other things occurred between roughly 1400 and 1750 that changed the rules of the game, such as the introduction of corporations and banking through the Medici family.
 
The main result of this was that the society went to the periphery, and the individual came to the centre.
 
I don’t intend to recount recorded human history here, and will skip straight to 1750, after the work of Hobbes and Locke had been imbibed, and the Glorious Revolution – and American and French revolutions – had occurred.
 
This was the time when Adam Smith documented the changed rules of the game in his 1776 book The Wealth of Nations.  By 1776 we had learnt that certain laws of human nature lead to certain kinds of outcomes for human society. The invisible hand was a radical breakthrough – showing that by doing well for ourselves (in our self-interest) we end up doing the best for society. It was a radical breakthrough.
 
The Industrial Revolution therefore began, using completely different rules than those applicable to an agricultural society. Places like Australia were soon settled, and scientific discovery was begun in right earnest.
 
Adam Smith had outlined what I call the obstacle theory of development.
 
 
The essence of this theory was that the government should step out of the way! Laissez Faire!
 
This fundamental new rule has not changed since then. All centralized planning efforts have failed, and as Hayek showed, later, are guaranteed to fail. Adam Smith’s book remains the Bible for all policy makers worldwide. Nations who don’t follow Adam Smith (broadly speaking) are destined to remain impoverished.
 
The system of wealth creation – being a set of rules general rules and policies – is best described by the word “capitalism”. Adam Smith called this the system of natural liberty. The proof is in the pudding. There is by now overwhelming evidence that Adam Smith as right.Regardless of the many regressions in the past 150 years through Karl Marx and John Maynard Keynes, the average economist today thinks far more like Adam Smith than like Marx or Keynes.
 
While I’m on this subject let me mention the most important economist and political philosopher since Adam Smith: Friedrich Hayek – who in the 20th century, wrote some of the most powerful books ever written so far (The Road to Serfdom, The Constitution of Liberty). I believe that anyone who doesn’t understand Hayek is basically an illiterate. He showed that each of us knows best our own circumstances and there is no way that any planner can get that information. The price system is the single most powerful means of transmitting that information.
 
Freedom works. That is the key message. Let people be free (subject to accountability), and the magic of wealth creation will automatically occur.
 
No doubt there are numerous matters of detail that need to be resolved in terms of the capitalist society, and many of these keep us busy in our jobs. But the broad framework is what I'm referring to here. India has simply NO CHOICE but to adopt this system. Resistance is futile. There is no going back to the medieval era. There is no going back to the caste system that worked so ‘well’ in the past.
 
A new game is being played, and just like India learnt to play cricket well (a game it did not invent) so also it now has to learn to play the game of freedom.
 

The sudden upsurge of wealth in the West

For thousands of years, agriculture hardly generated a major surplus. Human population barely grew. Malthus’s law (which perfectly describes the agricultural epoch) reigned.
 
But after 1750, per capita incomes in the West suddenly shot up. We entered the modern epoch, called Modern Economic Growth. The divergence in incomes across the world created by these new rules is stunning!
 
The idea that each succeeding generation would be twice as wealthy as its preceding generation would have astounded those who lived before this revolutionary break that occurred in around 1750.
While countries like India remained stagnant, the West leaped ahead like a rocket.
 
In around 1776, when Adam Smith wrote his book, India held a 25% share of world GDP and world trade (the combined Indian sub-continent). But because India did not progress during the next 150 years, being a colony of England, by 1947 its share of world trade declined to 2 per cent, and per capita income barely increased from its 1776 levels. In the meantime the West had increased its income by at least 10 times.
 
Growth started picking up after India’s independence (but share of world trade kept dropping) but it was very slow because of Mr. Nehru’s addiction to socialism. It led to a growth of less than 1 per cent per annum in per capita incomes. Only after 1991 did growth pick up to the current rates, of around 5-6 per cent per capita, at which rate real income doubles about every 10-12 years.
 
By now India’s per capita income is around $3000 in purchasing power parity terms, compared with American per capita of about $50,000. In terms of share of world trade, India’s share is likely to reach 2 per cent soon, compared around 20 per cent, which is roughly its share of world population.
 
After over 200 years of the Industrial Revolution the comparative picture between India, China, and Australia, is very revealing.
 
 
Australia
India
China
8
87
78
3
124
135
World Bank Doing Business (June 2010 report)
10 (with 2 for starting business)
134
79
 

Can India catch up?

Is it inevitable, for instance in India will increase its per capita GDP by 10 times or more, or its share of world trade by at least 10 times?
 
I believe that there was nothing to prevent India from overtaking USA decades ago in per capita income, as countries like Singapore have done, after coming from way behind. Today the Singapore per capita income (in PPP terms) is $ 57,238 compared with USA’s $ 47,123 (IMF calculations, 2010). India’s is a mere $3,290.
 
The answer to this puzzle, of India’s HUGE underperformance lies in our getting a simple and clear understanding of economic growth. While the following is a gross simplification, it captures the key issues involved:
 
Growth = f(policy(F), governance(F), opportunity(F)) = f(F), where F = freedom.
 
"Opportunity" in the above equation reflects the distance to the technical frontier. For instance, India is very far from this frontier, the West is at the frontier; that is why India is so poor. The opportunity to reach the technical frontier always exists with the poorer nations. They simply need to copy what the leading nation is doing. No effort required to re-invent the wheel. However, they need the right policy and governance to achieve this opportunity.
 
Yes, India has (and has had, at least since 1947), the opportunity to advance to the standards of the Western world. No doubt the technology exists and is simply a matter of implementing it in India. But to achieve results for which an opportunity exists, we need right policies and right governance.
 
Governance is crucial. It is the existence of appropriate institutions of governance that ultimately dictates whether policy can be translated to the grassroots. But on that, India continues with a run-down dilapidated colonial model of governance that was further smashed up by socialists, so that today corruption and incompetence is all-pervasive in India. As I have show in BFN, not only has India’s policy been sub-standard, its India’s governance is a disastrously poor. No, there have been no reforms of India’s governance over the past 60 years. With low quality, corrupt people running its government, bad policy is inevitable. Hence India continues to remain poor.
 
Thus, for instance, the great complaint that we have in India about corruption is merely a symptom of the underlying policy and governance problem. The problem is the poor design of institutions (including policy). Bad policy and governance inevitably lead to corruption. Indians don't have immoral DNA, any more than the Chinese have immoral DNA. The Chinese on the mainland are hopelessly corrupt. In Hong Kong the same Chinese lead the world (!!) on integrity. People in all these places are merely responding to policies and governance. In India and China the people have no choice but to be corrupt (or, like I have done – to leave).
 
Can policies be improved in India? Yes! India was given a policy shock by IMF when it almost went bankrupt in 1991 and flew a large chunk of its gold reserves to the Bank of England. That policy shock, unwelcome as it was in socialist India (and administered reluctantly by Manmohan Singh who claims undue credit for it! – even as he has been HANDS IN GLOVE WITH the deeply corrupt Congress party), jolted India to life like an electric shock can jolt to life the heart of a dying patient.
 
That policy shock showed immediate results but has by now run its course. No further policy reform of significant order has since occurred. With bad policy and shabby governance, India has grown since the 1990s only because it had some spare skilled manpower (and some could return from abroad at short notice). It had some spare capacity in infrastructure in the early 1990s.
 
But today all that has been squeezed out. And existing human resources have been fully absorbed. Its cities are virtually collapsing.
 
Consider communication and transport. The mobile phone revolution overcame many market barriers in India. For instance it is no longer possible to exploit the rural farmer for he knows the precise price of commodities in the wholesale market. Prices of mobile phone calls are so low that people can call each other literally for free.
 
However, while information can be transmitted wirelessly, humans and goods can’t be transmitted wirelessly! We need to move through roads and other physical obstacles. Ensuring this requires good governance, which India simply doesn’t have. And so India's villages/ towns/ cities are congested beyond imagination: choking to the brim. No more capacity. Journeys which at one time took 20 minutes now take up to three hours.
 
And no more skilled people to manage the industries and institutions that lead to growth.
 
This has become a huge barrier to India's productivity. And there are no signs of improvement because the governance system has almost totally collapsed.
 
In brief:
 
1) India’s policy and governance failures have restrained it for 60 years and prevented it from exploiting the opportunity to reach the technical frontier. IMF led reforms in some (not all!) policies have led to some improvement, but these gains are coming to an end.
 
2) Further progress – at least the 10 times catch-up needed for India to become rich – is NOT going to happen unless a lot of things change, in both the policy and governance space.
 
Therefore we can conclude that it is not inevitable that countries like India will advance into prosperity. Current policies will make India a middling power by 2050, important but not powerful enough.
 
I have outlined the precise policy and governance reforms that India needs, in BFN. If ever, India does recover its erstwhile super-powerful status, it will be because it followed those recommendations. That much I can confidently say! There is simply no other way.
 
Should reforms be undertaken, nothing is impossible. Join the Freedom Team of India if you want to change India for the better.

[1] They were omnivores, fully adapted to eating meat. I emphasise this point because some people in India believe otherwise. http://bit.ly/eI3QW5

[2] Based on research byAngus Maddison, a great economic historian, in his 2007 book The World Economy: A Millennial Perspective.

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A forecast of India’s economic prospects

On February 18, 2011, in Economics, India, by

Today, despite all the hoopla surrounding India, an average Indian is 1/10th as rich as an American, and India's share of world trade is 1/10th of what its share should have been based on its population size. India remains a Third World nation on these and MANY other criteria.

A key question before all investors and commentators is this: Can India sustain its current growth and ultimately become a rich country?

I have examined this issue and come to certain conclusions – which effectively are a  forecast of India's economic prospects - given current policies and governance frameworks.

Analysis underpinning the forecast

India was given a policy shock by IMF when it almost went bankrupt in 1991 and flew a large chunk of its gold reserves to the Bank of England. That policy shock, unwelcome as it was in socialist India (and administered reluctantly by Manmohan Singh who claims undue credit for it!!), jolted India to life like an electric shock can jolt to life the heart of a dying patient. 

That policy shock (policies that Swatantra Party had advocated in 1950-70s but no one in India listened to!) showed immediate results but has now run its course. No further policy reform of significant order has since occurred.

The equation of growth can be summarised thus:

Growth = f(policy, governance, opportunity).

"Opportunity" in the above equation reflects the distance to the technical frontier. In this case India is, on a scale of 1 to 10 ("10" representing the average wealth status of developed countries), at 1.There is an opportunity to increase wealth in India by at least 10 times. 

But to achieve the results for which an opportunity exists, we need right policies and right governance. Governance, or institutions, are absolutely vital. It is the existence of institutions of governance that ultimately dictate whether policy is translated to the grassroots. On that, however, India continues with a run-down dilapidated colonial model of governance that was further smashed up by socialists, so that today corruption and incompetence is all-pervasive. 

Corruption is, as I always say, only a SYMPTOM of the problem. The problem is the poor design of institutions (and policy). These two will INEVITABLY lead to corruption. Indians don't have immoral DNA, any more than the Chinese have immoral DNA. The Chinese on the mainland are hopelessly corrupt. In Hong Kong the same Chinese lead the WORLD(!!) on integrity. People in all these places are merely responding to policies and governance. In India and China the people have no choice but to be corrupt (or, like I have done – to leave).

Today even as India is literally collapsing under the weight of its totally rotten system of governance, there is no one administering a governance ‘shock’ to India. [Note that fact that India's governance is collapsing does not mean India is going to break apart! - no India will ever tolerate that.]

India has grown since the 1990s because it had some SPARE skilled manpower. It has some SPARE capacity in its infrastructure. But today all that has been squeezed out. This is easily illustrated by the examples of communication and transport.

The mobile phone revolution overcame many market barriers in India. For instance it is no longer possible to exploit the rural farmer for he knows the precise price of commodities in the wholesale market. Prices of mobile phone calls are so low that people can call each other literally for free.
 
However, while information can be transmitted wirelessly, humans and goods can’t be transmitted wirelessly! We need to move through roads and other physical obstacles. Ensuring this requires good governance, which India simply doesn’t have. And so India's villages/ towns/ cities are congested beyond imagination: choking to the brim. No more capacity. Journeys which at one time took 20 minutes now take up to three hours.
 
And no more skilled people to manage the industries and institutions that lead to growth.
 
This has become a huge barrier to India's productivity. And there are no signs of improvement because the governance system has ALMOST TOTALLY COLLAPSED.
 
In brief: 
 
1) India’s policy and governance failures have restrained it for 60 years and prevented it from exploiting the opportunity to reach the technical frontier. IMF led rforms in some (not all!) policies have led to some improvement, but these gains are coming to an end.
 
2) Further progress – at least the 10 times catch-up needed for India to become rich – is NOT going to happen unless a lot of things change, in both the policy and governance space.
 

 

My forecast

My prediction about India is this: UNLESS India radically changes its governance design, its current policies can’t do much more good. Expect India's economic growth rates to pull back in the next few years. Its stock markets are optimistically priced. That optimism is misplaced. Investment has already started slowing down. You can't possibly invest in a country where there are NO more skilled human resources and NO infrastructure. And NO rule of law. And NO justice. A country that is Third World from top to bottom.

Yes, it is possible that some more 'juice' can be squeezed out of India if people like Nitesh Kumar or Narendra Modi become its leaders – a prospect that is increasingly more likely. 

But while such people may be able administrators, they have simply have no clue about good governance. They have never understood nor articulated any model of reform that can work. They will perhaps make things work more efficiently, but they, too, can't shift the huge blockage in India – poor governance design (and bad policy!).

So don't be deluded by 'experts' and others who claim that India is going to be a unidirectional growth story. Don't imagine that India's incomes will match those of the West by 2066 or some such date. Its NOT going to happen under the current system. Such "experts" are innocents with no CLUE about what they are talking!

The solution

The solution is clear. It was available 50 years ago when Swatantra Party offered it. India did not listen. A more comprehensive solution is offered in BFN. Most of it is not new. It was known to Rajaji as well. But there are important governance issues on which I've thrown precise light in BFN. 

Whether India follows this advice (medicine!)  today or after 50 years (after much avoidable failure!) is its choice, but if it wants to succeed it WILL have to follow this advice. On that there is simply no choice.

If India does that soon, it will achieve super-rapid growth rates and definitely achieve prosperity. If it does this later, it will delay its growth rates. If it doesn't follow this advice, it will get stuck at a miserable level – including a miserable quality of life – for ever. The choice is yours, India. You decide your fate. Your destiny is in your hands. Has always been so.

The Freedom Team of India aims to offer such governance (and policy) reforms to India. It is looking for members to join. FTI's second annual conference is taking place this weekend. I'll report on it in due course.

Should you be genuinely interested in a dramatically better India, then read BFN and join/support FTI.

Else please carry on dreaming!! Your dreams about India are SIMPLY NOT GOING TO HAPPEN with the current set of political parties.

Period.

My message is very blunt, forthright, uncompromising. I never mince my words. Because there is only ONE way to do things right. There is only ONE way to achieve a healthy wealthy society.  

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Gurcharan Das’s excellent essay on India’s delayed journey to wealth

On February 14, 2011, in Economics, India, by

I am currently preparing for an informal talk for 2 March 2011, that will focus on the rapidly changing global scene and the policy challenges facing both Western and developing nations as the world re-adjusts to a ‘new’ equilibrium which, effectively, is the ‘old’ equilibrium.

For instance there is no doubt that India’s share of world trade (and GDP) could ultimately reach at least around 20 per cent of world trade (and GDP), which is roughly its share of world population. Its current share is around 1.5% on both indicators. The question is how soon India can get its house in order (and that's where I and FTI come in).
 
The book that drives my main perspectives in this regard is Richard Easterlin’s Growth Triumphant, along with many other books that have sharpened my understanding of key aspects of governance. But Gurcharan Das’s work in this area is also pertinent (although I do have a few differences in approach and understanding to his).
 
I had helped organize Gurcharan’s talk in Melbourne in 2008 (the entire talk + PPT here), in which he used many of the insights from his article published in the 2005 book, Developing Cultures: Case Studies, co-edited by Peter Berger and Laurence Harrison, Routledge, 2005. Do go through his talk/powerpoint slides when you find some time. This article, from the above book, is available on his website (here). I'm reproducing it along with a few highlights – and dissenting comments.
 

India: How a rich nation became poor and will be rich again

By Gurcharan Das1
 
Does ‘culture’ in some way help to explain the fact that the same Indian economy that was stagnating for the first fifty years of the 20th century began to grow at a respectable clip after 1980 and was amongst the fastest growing in the world by the end of the century?
 
Consider the following hundred year trend: between 1900 and 1950, the Indian economy grew on the average 0.8 percent a year; but the population also grew at about the same rate; thus, net growth in income per capita was nil and we rightly called our colonial economy stagnant. After Independence, economic growth picked up to 3.5 percent between 1950 and 1980, but so did population growth (to 2.2 percent); hence the net affect on income was 1.3 percent per capita, and this is what we mournfully referred to as “the Hindu rate of growth.” Things began to change with modest liberalization in the eighties when annual economic growth rose to 5.6 percent. This happy trend continued in the reform decade of the nineties when growth averaged 6.2 percent a year, while population slowed to 1.8 percent; thus, per capita income rose by a decent 4.4 percent a year.
 
TABLE: INDIAN GROWTH 1900-2000
Colonial Post-Independence Reform Period
 
1900-1950
1950-1980
1981-1990
1991-2000
 
GDP growth
0.8
3.5
5.6
6.2
 
Per capita growth
0
1.3
3.5
4.4
Sources: 1900-1990: Angus Maddison (1995), Monitoring the World Economy, 1820-1992 (Paris:OECD); 1990-2000: World Bank/IMF. Although 1991 is the celebrated turning point of India’s economic reforms, modest and significant reforms began in the 1980s as I explain below.
 
As a benchmark, recall that the West’s industrial revolution took place at a 3 percent GDP growth and 1.1 percent per capita income growth after 1820. To appreciate the magnitude of the Indian change after 1980, let me illustrate: If India’s per capita GDP had continued growing at the pre-1980 level, then its income would have reached present American capita income levels only by 2250; but if it continues to grow at the post-1980 rate then it will reach those levels by 2066: a gain of 184 years! [Sanjeev Sabhlok's comment: convergence is not linear. See also this and this ] 
 
How does one begin to explain India’s economic performance over the past hundred years? The Indian nationalist blames the first fifty years’ stagnation on British colonialism. But a trade economist will counter this by showing that the world economy was also stagnant in the first half of the 20th century (especially after World War I) when world per capita GDP grew annually at just under one percent.2 The main culprits, he would say, were conflict and autarky. Disgraceful protectionism by most governments between the Wars slowed both the world and the Indian economy.
 
Although the Indian economy picked up after 1950, the neoclassical economist would argue that it performed below the world economy, which experienced a “golden age” driven by trade expansion until 1971. Like the rest of the Third World India did not benefit from global trade expansion because it had closed its economy and pursued ‘import substitution’. Moreover, Nehru’s socialism had shackled the economy with fierce controls on the private sector, pejoratively called ‘Licence Raj’; hence its annual GDP growth was 1.5 percentage points below even the Third World average between 1950 and 1980.3
 
This changed dramatically with modest liberal reforms in the 1980s and more sweeping ones in the 1990s as the Indian economy integrated with the world. In those twenty years it not only outperformed the world economy significantly but it was amongst the fastest in the world.4 Thus, gradual technological diffusion, rising capital accumulation and productivity, and gradual education expansion help economists to explain a good deal of the story. There is also the value of time and accumulated learning through time. “Collective learning” is Hayek’s term, and he applied it to the cumulative experience that generations build up which is embodied in the language, the technology, and the way of doing things.5
 
But economic explanations are not enough. That India adopted democracy in 1950 before capitalism (in 1991) is also significant because democracy’s redistributive pressures, such as free power to farmers and other subsidies, have dampened growth and also explain why India’s reform process has been so painfully slow. Economists also find it puzzling why the liberal institutions of the British Raj did not engender faster growth during the colonial years. The rule of law, the relative peace of Pax Brittanica, a non-dirigiste administration, the railways and canals—all these were market friendly moves, after all. [Sanjeev Sabhlok: Colonial governance was over-burdened with things it was not capable of doing - socialist policy]  
 
I believe that national confidence also plays an important role. The more damaging impact of colonialism may well have been to Indian minds—it created an inferiority complex from which they have only recently recovered. [Couldn't disagree more] Douglass North has rightly emphasized the importance of beliefs.6 Businessmen understand the value of confidence in entrepreneurial success and in creating a climate for investment; Historians too emphasize the power of self-belief in national success–Roman history and Britain’s rise in the 19th century are examples of this. After Independence, India’s confidence certainly rose, especially as democracy took root, but flawed economic institutions of Nehruvian socialism damaged that confidence. Once these socialist institutions began to be replaced by capitalist ones in the Reform period, confidence returned and young Indian minds finally became decolonized. I traveled extensively across India in the 1990′s when I discovered this changed mood, and I think it also explains the current economic success.7
 
I shall now amplify my arguments by taking the reader on a galloping tour of Indian economic history. From this story I shall draw lessons about the role of institutions and culture in development. En passant, I shall touch upon the great questions of Indian history: did the British impoverish India? Why didn’t the railways engender an industrial revolution? Did Nehru’s socialism dampen India’s progress? What is the consequence of democracy preceding capitalism?
 
 

Let’s begin with the Mughals

India’s nationalist historians have portrayed its pre-colonial economy as a golden age of prosperity, and this fabulous wealth set the Europeans on their great voyages of discovery.8 During the Mughal Empire at the end of the 16th century, India’s wealth did indeed sustain more than 100 million people. With plenty of arable land, its agriculture was certainly as productive as Western Europe’s, and even the subsistence-oriented peasant got a decent return.9 India also had a large, skilled workforce that produced not only cotton but also luxuries for the aristocracy. Consequently, the economy produced a large financial surplus, which was used to support the growing Mughal Empire and finance spectacular monuments like the Taj Mahal.10
 
In 1497, the Portuguese sent Vasco da Gama with a flotilla of four ships to find India’s wealth. But the two-year voyage was not a commercial success and the Indians were not interested in European clothes and goods for they made far ones in India. But Da Gama told King Manuel of Portugal of large cities, large buildings and rivers, and great populations. He spoke about spices and jewels, precious stones and “mines of gold.” He believed that he had found India’s legendary wealth.11
 
It took the English a hundred years to discover this wealth. Initially, they came to plunder but soon discovered the rewards of trade. [There is NO evidence that the English came to plunder. They came to trade] They found that India produced the world’s best cotton yarn and textiles and in enormous quantities.12 What the Indians wanted in exchange from the Europeans was gold and silver, for which they had an insatiable appetite. Hence, there was a constant flow of gold to India, which absorbed a good deal of the bullion mined by the Spaniards in the New World. Having learned about cotton textiles from India, the English turned the tables, and brought an industrial revolution to Britain, but destroyed the lives of millions of Indian weavers.
 

India was a leading manufacturer in the 18th century

India was a leading manufacturing country in the world in the early 18th century. It had 22.6 percent share of the world’s GDP, which came down to around 16 percent by 1820, closer to its share of world population.13 It had a developed banking system and vigorous merchant capital, with a network of agents, brokers and middlemen. Given the enormous financial surplus, a skilled artisan class, large exports, plenty of arable land and reasonable productivity, the question is why didn’t a modern industrial economy emerge in India? Instead, why did India become impoverished?
 
Despite a dynamic and a growing commercial sector which responded to market forces and extensive foreign trade, the truth is that 18th century India was significantly behind Western Europe in technology, institutions and ideas. Neither an agricultural revolution, nor a scientific revolution had occurred, and “[and] in the long run the manual skill of the Indian artisan could be no substitute for technological progress,”14 and this would have needed new attitudes. Notwithstanding the surplus and the trade, mid-eighteenth India had a “per capita product perhaps two-thirds of that in England and France.”15
 
There is no easy answer to the problem that the country was prosperous and the people were poor. One explanation is that even in the 18 century India had a large population and plenty of cheap labor. Prosperity comes with rising productivity and a rise in productivity depends on technology. When the supply of labor is elastic, it is more economical to hire people than to invest in machines. Hence, an Englishman observed in 1807, “In India it is seldom that an attempt is made to accomplish anything by machinery that can be performed by human labour.”16
 

Did the British Raj impoverish India?

India’s nationalist historians have blamed the British Raj for India’s poverty. The classic nationalist case is that India had been rich before the British came and colonialism weakened agriculture and “deindustrialized” India, throwing millions of artisans out of work. Britain’s trade policies encouraged the import of manufactures and the export of raw materials; finally, it drained the wealth of India by transferring its capital to Britain.
 
Nationalists claimed that Lancashire’s new textile mills crushed India’s handloom textile industry and threw millions of weavers out of work. India’s textile exports plunged from a leadership position before the start of the Britain’s Industrial Revolution to a fraction. The indigenous banking system, which financed these exports, was also destroyed. Since the colonial government did not erect tariff barriers, Indian consumers shifted to cheaper English mill-made cloth and millions of handloom workers where left in misery. British colonial rule “de-industrialised” India (a favorite nationalist phrase) and from an exporter of textiles, India became an exporter of raw cotton.17
 
Britain also changed the old land revenue system to the disadvantage of the farmer, who had to now pay revenue whether or not the monsoon failed. This led to famines. The worst one in 1896-97 affected 96 million lives and killed an estimated 5 million people. Although the railways helped in the trade of food crops, the enlarged national market sucked away the peasant’s surplus, which he had earlier stored for the bad years. Moreover, the British government transferred its surplus revenues back to England. Since India consistently exported more then she imported in the second half of the 19th century and early 20th century, Britain used India’s trade surplus to finance her own trade deficit with the rest of the world, to pay for her exports to India, and for capital repayments in London. This represented a massive drain of India’s wealth.18
 
In recent years some historians have challenged this nationalist picture. They have argued that Indian industry’s decline in the 19th century was caused by technology. The machines of Britain’s industrial revolution wiped out Indian textiles, in the same way that traditional handmade textiles disappeared in Europe and the rest of the world. Fifty years later Indian textile mills would have destroyed them. India’s weavers were, thus, the victims of technological obsolescence.19
 
They also found that the land tax had not been exorbitant—by 1900 it was only 5 percent of the agricultural output or half the average per capita tax burden. There had been a “drain of wealth”, but it was only about 1.5 percent of GNP every year. The revisionist historians argued that India’s payments to Britain were for real military and civilian services and to service capital investments. Also, the overhead cost of the British establishment—the so called “home charges”—was in fact quite small.20 If India had its own army and navy it would have spent more. True, India did have a balance of payments surplus, which Britain used to finance part of her deficit, but India was compensated by the import of gold and silver that went into private Indian hands. [Sanjeev's comment: The real issue with British rule was not its 'theft' of 'wealth' but its lack of emphasis on education and growth within India. As the West powered ahead, India stagnated.]
 

India begins to re-industrize

Indian entrepreneurs began to set up their own modern textile mills after 1850 and very slowly began to recapture the domestic market. In 1896, Indian mills supplied 8% of the total cloth consumed in India; in 1913, 20%; in 1936, 62%; and by 1945, 76%.21 Although India did not participate in global trade expansion between 1870 and 1913, Indian businessmen made large profits during the First World War, which they reinvested in after the war. Thus, India’s manufacturing output grew 5.6 percent per year between 1913-38, well above the world average of 3.3 percent.” 22 The British government finally provided tariff protection from the 1920s, which helped industrialists to expand and diversify. [This is NOT what I meant by facilitating growth! Tariffs are ANTI-growth.]
 
By Independence in 1947, Indian entrepreneurs were strong and in a position to buy out the businesses of the departing British. Industry’s share in India’s GNP had doubled from 3.8 percent (in 1913) to 7.5 percent (in 1947), and the share of manufactures in her exports rose from 22.4 percent (in 1913) to 30 percent (in 1947).
 

Why didn’t an industrial revolution occur?

One of the intriguing questions of history is why India failed to create an industrial revolution. Karl Marx predicted that the railways would transform India and usher in an industrial revolution. Indeed, by the First World War, some thought that it was ready to take-off. By 1914, India had the third largest railway network, the world’s largest jute manufacturing industry, the fourth largest cotton textile industry, the largest canal system, and 2.5 percent of world trade.23Although a colony, it had a very liberal regulatory regime–far more investor friendly than the one that replaced it after Independence—and after the 1920s the infant industry was also favored by tariffs. It had a merchant class hungry to become industrialists. Industrialization did, in fact, pick up after the War and industry’s share in national output doubled. But it was not enough to broadly transform an agricultural society. Modern industry employed only 2.5 million people out of population of 350 million.
 
Amiya Kumar Bagchi, the Marxist economist, suggests that the reason was the lack of effective demand during the colonial period, and this limited business opportunity. Indians were just too poor to buy modern goods and services.24 If the domestic Indian market was small, couldn’t the entrepreneur have supplemented it by producing for export? Morris D. Morris, blames supply constraints.25 An Indian entrepreneur was uncompetitive because of a shortage of technology, skilled labor, and capital—all of which raised his cost of his production. The historian, Rajat Ray, argues that Indian businessmen did not export because they made inferior products, unacceptable to the world market. In his view, technological backwardness was the single biggest failing. 26 But surely, they could have imported technology, as Jamshedji Tata, G.D. Birla, and others did.
 
Unlike nationalist historians, I do not think there was a British conspiracy to deliberately under-invest in India or sabotage Indian business interests. Bombay’s textile mills were built with the credit, technical assistance and machines from Britain although they were a competitive threat to the Manchester’s mills. I believe the industrial revolution did not occur because Indian agriculture remained stagnant, and you cannot have an industrial revolution without an agricultural surplus or the means to feed a rapidly growing urban population; second, the international trading environment turned hostile with protectionism after the First World War, followed by the Depression; third, the colonial government did not educate the masses, unlike the Japanese state; finally, a colonial mindset pervaded the Indian middle class–even the hardiest potential entrepreneur lacks confidence when he is politically enslaved.
 

What is the verdict on British rule?

Did the British impoverish India? There is no question that in the 18th century it plundered and looted India’s wealth, as all conquerors have done in history. But did it create on-going institutions that were to India’s detriment? This has to do with the nature and theory of colonialism. True, its Industrial Revolution threw millions of weavers out of work, but it would have happened any way when the new technology reached India. British government policy could have cushioned the impact by erecting trade barriers and saved enormous amount of human suffering, but protecting handlooms would have been a temporary palliative.
 
Odd as it may seem, I believe that Britain did not “exploit” India enough. Had it made the massive investments in India that it did in the Americas, India would have become more prosperous and a much bigger market for British goods. A richer India would have been a better customer, a better supplier, and a firmer basis of Empire.27 Britain’s main failure was not to educate the Indian masses—hence 83 percent of Indians were illiterate at Independence. Britain’s education system in India produced only a thin upper crust of extremely well educated Indians, while the masses remained illiterate.28
 
Although Britain could not lift Indians out of poverty, nor avert famines, it did give India the institutions of democracy–the rule of law, an independent judiciary and a free press. It built railways, canals, and harbors. It gave India almost a hundred years of peace—the Pax Britannica. Although it gave modern values and institutions, it did not interfere with its ancient traditions and religion. Hence, India has preserved its spiritual heritage and the old way of life continues. Many despair over the divisiveness of caste, but the hold of the Indian way of life is also a bulwark against the onslaught of the global culture.
 

Independence and ‘License Raj’

After Independence, democracy took root in India and gradually the masses acquired a stake in the system, periodically electing representatives even from the lowest castes. The rulers also adopted a Fabian socialist economic path, and Indians did not turn to capitalism until 1991, although there was modest liberalization of the economy in the 1980s. Thus, India embraced democracy before capitalism, which makes its journey to modernity unique and explains a good deal.
 
Jawaharlal Nehru and his planners did not trust private entrepreneurs; so they made the state the entrepreneur, and not surprisingly, they failed to create an industrial revolution. Instead, India experienced an agricultural revolution in the early 1970s. It thus had an important pre-condition for the industrial revolution—an agricultural surplus—but the industrial take-off eluded it. Its investment rate also rose from 6 percent to well over 20 per cent, and yet it did not engender a take-off. Why?
 
I think there were at least six things wrong with India’s mantra: one, it adopted an inward-looking, import-substituting path rather than an outward-looking, export-promoting route; it thus denied itself a share in world trade and the prosperity that trade brought in the post-War era. Two, it set up a massive, inefficient, and monopolistic public sector to which it denied autonomy of working; hence, its investments were not productive and it had a poor capital-output ratio. Three, it over-regulated private enterprise with the worst controls in the world, and this diminished competition in the market; four, it discouraged foreign capital and denied itself the benefits of technology and world class competition. Five, it pampered organized labor to the point that it has extremely low productivity. Six, it ignored the education of its children.
 
Nehru’s strategic planner, P.C. Mahalanobis, made two wrong assumptions. He assumed that there were no opportunities for rapid export expansion in the 1950s, and this turned out to be wrong. India discovered that tiny Hong Kong could earn more from its exports than the whole of India, as India’s share of world trade declined from 2.2 percent in 1947 to 0.5 percent in 1990. He also assumed that competition was wasteful, and this was also a flawed idea because there can be little improvement in productivity without it.
 
Even more damaging were the creeping controls on the private sector. The most bizarre was the licensing system. It began with the Industrial Licensing Act of 1951, which required an entrepreneur to get a license to set up a new unit, to expand it, or change the product mix. A huge number of untrained clerks, engineers, bureaucrats at the Directorate General of Technical Development, operating on the basis of inadequate information vetted thousands of applications on an ad hoc basis. These low level functionaries took months in the futile, micro-review of an application and finally sent it for approval to the administrative ministry. The ministry again lost months reviewing the same data before it sent the application to an inter-ministerial licensing committee. After the Minister’s approval, the investor had to seek approval for the import of machinery from the capital goods licensing committee. If finance was needed from a State financial institution, the same scrutiny had to be repeated afresh. The result was enormous delays, sometimes lasting years with staggering opportunities for corruption.
 
Large business houses set up parallel bureaucracies in Delhi, to follow up on their files, organize bribes, and win licenses. If the entrepreneur did finally get started and made a success of his enterprise, he was again in trouble. It was an offence punishable under the law to manufacture beyond the capacity granted by the license. India became the only country in the world where the production of sorely needed goods sorely was punishable by law.29
 
The system ended in thwarting competition, entrepreneurship and growth, without achieving any of its social objectives. It fostered monopolies and it proliferated uneconomic-size plants in remote, uncompetitive locations, employing second-rate technology. Bureaucrats who did not have a clue about the basics of running a business made the decisions on the choice of technology, the size and location of plants.
 
Although it was becoming clear that India was on the wrong path by the late sixties, instead of changing course after Nehru, Indira Gandhi introduced more controls. She nationalized banks, discouraged foreign investment, and placed more hurdles before domestic enterprise. Hence, industrial growth plunged from 7.7 per cent a year between 1951-1965 to 4.0 per cent between 1966-1980. Productivity of Indian manufacturing declined half a percent a year from 1960 to 1985.30
 
“1966-1980 is effectively the dark period for the Indian economy.”31 It is harder to blame Nehru for adopting the economic wrong model for socialism was the wisdom of his age and dozens of economists visited India and hailed his bold experiment.32 It is right to blame Indira Gandhi, for by then Japan’s miracle was evident, and Korea and Taiwan were following its footsteps. However, ideology is only one part of the story. An important reason for non-performance was poor implementation. Even Nehru’s socialism could have delivered more and did not have to degenerate into “License Raj”. [Sanjeev Sabhlok's comment: I continue to differ from Gurcharan on this issue. Bad policy CAN'T be implemented. I don't know what he has in mind. How can any policy that is bad possibly be implementable? This seems to imply that Nehruvian socialism was good but the people of India were bad.]
 

India after the Reforms

Although there was modest liberalization in the 1980s, the decisive turning point came in July 1991 when the minority government of Narasimha Rao announced sweeping reforms. It opened the economy to foreign investment and trade; it dismantled import controls, lowered customs duties, devalued the currency and made the rupee convertible on the trade account; it virtually abolished licensing controls on private investment, dropped tax rates and broke public sector monopolies. As a result growth rose to 7.5 percent a year for three years in a row in the mid-nineties, inflation came down from 13 percent to 6 percent by 1993, exchange reserves shot up from $1 billion to $20 billion by 1993, and had crossed $100 billion by end 2003. This was as important a turning point as Deng’s revolution in China in December 1978. Surprisingly, the elected coalition governments that succeeded Rao continued the reform process, and despite its slow, incremental pace, it has made India one of the fastest growing major economies in the world.33
 
Indians have traditionally not accorded a high place to making money. Hence, the merchant orbania is placed third in the four-caste hierarchy, behind the brahmin and the kshatriya, and only a step ahead of the laboring shudra. After the economic reforms making money became increasingly respectable and the sons of brahmins and kshatriyas began to get MBAs and wanted to become entrepreneurs. The business pages of newspapers became livelier; chief ministers in the states scrambled for private investment; judges became more even-handed in industrial disputes. As a result, India is in the midst of a social revolution rivalled, perhaps, only by the ascent of Japan’s merchant class during the 1968 Meiji Restoration.
 
There has also been mental revolution. And a changed attitude to English illustrates this new mindset. Ever since the British left Indians constantly carped against the English language. But in the 1990s this carping seemed to die, and quietly, without ceremony English became one of the Indian languages. English lost its colonial stigma, oddly enough, around the time that the Hindu nationalists came to power. Young Indians in the new middle class think of English as a skill, like Windows. This is why Hinglish (Hindi mixed with English) is spreading. Encouraged by flourishing private television channels and supported by their advertisers, the newly emerging middle classes avidly embrace this uninhibited hybrid of Hindi and English, and this popular idiom of the bazaar is rushing down the socio-economic ladder. The purists naturally disapprove, but people are more comfortable and accepting of it today because Indians are more relaxed and confident as a people. Their minds have become decolonized.
 
The world, meanwhile, also changed from an industrial to the information economy, and it seemed to speak to India’s advantage, symbolized by its success in software and business process outsourcing. These “Bangalores” have given Indians confidence and they reflect a new social contract. The new entrepreneurs did not inherit wealth; they have risen on the back of their talent, hard work, and professional skills. A new self-belief has emerged among urban youth that doesn’t need approval from others, especially from the West. Music composers like A.R. Rehman display an exuberant nonchalance, as do the new young Bollywood pop stars. So do new fiction writers like Arundhati Roy, designers of fashion clothes, beauty queens and cricket stars.
 

Some lessons

Neoclassical economic theory explains a great deal about why the Indian economy that was stagnating in the first half of the 20th century went on to become one of the fastest growing by the end of the century. It tells us, for example, that disgraceful protectionism by governments in the inter-war years in the first half of the 20th century dampened world trade and slowed down the world and the Indian economies. It also explains why India performed below the world average between 1950-1980: thinking that trade had impoverished her in the colonial period, India closed its economy and denied itself the fruits of a “golden period” in world trade between 1950 and 1970; “License Raj” and other institutions of Nehru’s socialism also suppressed growth. Finally, neoclassical economics explains how by dismantling controls and integrating the economy with the global economy, the Indian economy has become more competitive and is growing rapidly after the reforms.
 
But this is not the whole story, and we must turn to institutions and attitudes to understand the incentive structure of the Indian society.60 Indians blame colonialism for impoverishing them. But we have seen that colonialism is a more complex tale. For example, it did not ‘de-industrialize’ India as the nationalists argued; handloom textiles died in India (and the world) because of technological obsolescence. Colonialism’s bigger damage was to the loss of Indian confidence, which inhibited Indian entrepreneurs. This confidence began to grow with Gandhi’s freedom movement in the first half of the 20th century, and industrialization did pick up. However, its impact on society was insufficient to create an industrial revolution.
 
After Independence, India’s confidence certainly rose as democracy took root, but flawed economic institutions of Nehruvian socialism acted as a damper. Once these socialist institutions began to be replaced by capitalist ones in the Reform period, self-assurance returned to the Indian marketplace. Today’s mood in India is opposite to what existed a hundred years ago. Insecurity and inferiority filled colonial India, which is all too apparent in the writings of Bengali writers of the 19th century, such as Bankim Chandra Chatterji. Today, writers like Salman Rushdie and Arundhati Roy exhibit a matter of fact assuredness (almost a cool) that is a reflection of changed national mindset.
 
India embraced democracy first and capitalism afterwards and this has made a difference. India became a full-fledged democracy in 1950, with universal suffrage and extensive human rights, but it was not until 1991 that it opened up to the free play of market forces. For the rest of the world it has been the other way around. In the West, suffrage was extended gradually in the last century, and as mass political parties developed, democracy began to impinge on capitalist institutions and practices.
 
India’s democracy has an overwhelming majority of poor voters–70 per cent still live in rural areas; organized labor constitutes less than 10 per cent of total labor; and the middle class is around 20 per cent of the population. Because of democratic pressures, India tried to redistribute the pie before it was baked. It set up intricate regulatory networks before the private economy had transformed a rural into an industrial society. It began to think in terms of “welfare” before there were welfare-generating jobs. The result, as we have seen, was a throttling of enterprise, slow growth, and missed opportunities. It is the price India has paid for having democracy before capitalism—or rather too much democracy and not enough capitalism.
 
Since politics is a short run game and growth is a long run one there will never be a situation that is completely optimal. This explains why Indian politicians do not bother about education because results take a long time to come. When a politician promises rice for two rupees a kilo when it costs five rupees in the market, he wins the election. Since the mid-1960s politicians have vigorously competed in giving away free goods and services to voters. When politicians do that, where is the money to come for creating schools or improving old ones? India’s damaging fiscal deficit (around 10 percent of GDP for the center and states combined) is a testimonial to the downside of competitive politics, and it teaches that the demand for publicly provided goods and services is insatiable in a democracy.
 
But India’s problems of governance go far beyond the need to appease interests. The weakening of its democratic institutions since Indira Gandhi in the 1970s has caused widespread corruption, political violence, populist giveaways, and a paralysis of problem solving. Conspicuously absent are disciplined party organizations, which help leaders in other democracies to mobilize support for specific programs. Hence, there is an excessive reliance on the personal appeal of individual leaders to win elections. When in power leaders tend to take the easy way out, which is not to act at all.
 
Will capitalism, and its cousin globalization succeed in establishing a comfortable place for themselves in India? The answer depends on their ability to deliver prosperity broadly. It also depends on leaders in the government and in business to champion the classic liberal premises of free trade and competition. It needs leaders to come out say that (1) some people will not fare as well in the competitive market place; (2) the winners will far outnumber the losers; (2) capitalist democracy is the best arrangement we have found; (4) globalization is not only a good thing, it is a great leap forward in history. My fear is that capitalism’s success in India is threatened not so much by the leftists or protectionists but by the timidity of its defenders.
 
The curious historic inversion between democracy and capitalism means that India’s path into the future is evolving through a daily dialogue between the conservative forces of caste, religion and the village, the leftist and Nehruvian socialist forces which dominated the intellectual life of the country for 40 years, and the new forces of global capitalism. These “million negotiations of democracy” slow down the pace of economic reforms, but they also mean that India might have a more stable, peaceful, and negotiated transition into the future than say China. It might also avoid some of the deleterious side effects of an unprepared capitalist society, such as Russia. Although slower, India is more likely to preserve its way of life and it’s civilization of diversity, tolerance, and spirituality against the onslaught of the global culture.
 

Does culture matter?

Cultural explanations have been a vigorous industry in India for more than a hundred years. Colonial officials routinely blamed India’s poverty on the otherworldly spirituality of Hindu life and its fatalistic beliefs. Max Weber attributed the absence of development to the caste system. Gunnar Myrdal, the Swedish economist, found that India’s social system and attitudes were an important cause of its “low level equilibrium” of low productivity, primitive production techniques, and low levels of living.34
 
Deepak Lal, another economist, similarly explained economic stagnation in a low level “Hindu equilibrium” around the caste system, which bought stability in the context of political warfare, monsoon failure and climatic uncertainty, labor shortage, and an under-valued merchant class.35 David Landes, the historian, blames the enervating heat, which is deleterious to work. For this reason, rich countries lie in temperate zones and the poor in the tropics and semi-tropics.36
 
While institutions and culture do matter undoubtedly, we are all skeptical of national stereotypes and easy cultural explanations of the sort that were common hundred years ago. In my experience, successful Hindu entrepreneurs can be both extremely otherworldly in religion and aggressive in business. The Indian farmer, despite being caught in the caste system, responds quickly to market based incentives, as the Green Revolution testifies. Brahmins, who are supposed to have contempt for manual labor, will plough their land vigorously if they have to. And Rajput Thakurs, who never worked for a living, will shed their feudal ways for the sake of a commercial opportunity. Moreover, there are substantial non-Hindus in India and these communities had also been stuck in the same rut of stagnation. Other Asian countries were equally backward, but they had no “Hindu equilibrium” to explain away their stagnation. Finally, the same Indians when they migrate to other countries perform better.
 
Thus, I am uncomfortable with the “otherworldly values of the Hindus” or the “immobilizing effects of the caste system” and the “conservative habits of the merchant caste”. I believe that Sir John Hicks’ Economic Principle does trump in most cases. It states that “people would act economically; when the opportunity of an advantage was presented to them they would take it.”37 It explains not only the diffusion of the Green Revolution across India but also the demographic transitions currently underway in many states.
 
When seeking an explanation for a nation’s wealth and poverty, my preferred method is to begin with economic factors as proximate causes that motivate a businessman to invest–the size of the market, the capability of suppliers, distribution hurdles, and the state of competition. If this does not satisfy, I seek answers in institutions, some of which are, of course, intimately tied to culture. I have found that institutions can evolve rapidly as incentives change in society and can be transferred fairly quickly; for example, during the 1990s India was able to dismantle many of the institutions of Nehruvian socialism and replace them with capitalist institutions. Finally, if none of these factors provide a satisfactory explanation, then I turn to attitudes and social structure.
 
I find Deepak Lall’s distinction between material and cosmological beliefs useful.38 The material beliefs of a civilization are about ways of making a living and are the subject of economics; cosmological ones are about how to live and are in the realm of ‘culture’. The rise of the west was accompanied by a change in both sets of beliefs, but East Asia’s success has needed mainly a change in material beliefs—it has become prosperous without losing its soul. In other words, it is possible to modernize without westernizing. Ever since the British Raj material beliefs have been changing in India unlike our cosmological beliefs.

 

Our continuing inability to distinguish between the “modern” and the “western” in India is surely the cause of some of our grief. If we could only accept that a great deal of modern western culture, especially its material beliefs, are not the West’s property, but are a universal, critical way of thinking, which belongs to all rational human beings. We would not waste our energies on swadeshi (protectionism) hindutva (preserving the ancient Hindu civilization), and futile language debates (“remove English from primary schools”). The debate between modernisation and westernisation, begun in early nineteenth century by Ram Mohan Roy, continues to rage in India. At the root is a fear of the loss of the Indian way of life. The older generation fears it more than the young, whose minds are more decolonised and who are more confident in adopting the West’s material beliefs without fearing the loss in its cosmological ones.

Notes

  1. I have borrowed generously from my book, India Unbound (Knopf, New York, 2001).
  2. Angus Maddison (1989), The World Economy in the 20th Century, OECD, Paris 1989. “World” numbers refer to a 32-country average made by Maddison representing 80 percent of world output.
  3. A. Maddison (1995), Monitoring the World Economy, 1820-1992, OECD, Paris.
  4. Arvind Virmani, “Star Performers of the 20th / 21st Century: Asian Tigers, Dragons, or Elephants” Sept 1999. Updated 2004. www.ICRIER.org
  5. Hayek calls it, “the transmission in time of our accumulated stock of knowledge.” Friedrich A. Hayek (1960), The Constitution of Liberty, University of Chicago Press, Chicago, p 27.
  6. “Belief structures get transformed into societal and economic structures into institutions—both formal rules and informal norms of behavior. The relationship between mental models and institutions is an intimate one.” Douglass North (1996), “Economic Performance through Time” in Lee Alston, Thrainn Eggertsson, Douglass North, Empirical Studies in Institutional Change, Cambridge: Cambridge University Press, p 348.
  7. Gurcharan Das, India Unbound, Knopf, New York, pp.228-243
  8. For example, R.C.Dutt, The Economic History of India 1757-1837, Government of India reprint, Delhi, 1963, p.xxv. In the European mind, the name “Golconda” became the symbol of the haunting wealth of India. David Landes, The Wealth and Poverty of Nations, W.W. Norton, New York, 1998, p.60.
  9. According to Irfan Habib, its population was closer to 150 million. “Potentialities of Capitalist Development in the Economy of Mughal India”, Journal of Economic History, vol. 29, no.1, pp.32-37. According to Maddison, “at its peak, it is conceivable that the per capita product was comparable with that of Elizabethan England.” Angus Maddison, Class Structure and Economic Growth: India and Pakistan since the Moghuls, 1971, George Allen and Unwin, London, p.18. See W.H. Moreland, India at the Death of Akbar, A Ram, Delhi, 1962 for a description of living conditions at the end of the 16th century.
  10. The annual revenues of the Mogul emperor Aurangzeb (1659-1701) are said to have amounted to $450,000,000, more than ten times those of (his contemporary) Louis XIV. John Kautsky, The Politics of Aristocratic Empires, University of North Carolina Press, Chapel Hill, 1982, p. 188.
  11. Sanjay Subrahmanyam, The Career and Legend of Vasco da Gama, Cambridge University Press, Cambridge, 1997. See also M.N. Pearson, The Portuguese in India, The Cambridge History of India, vol. 1.1, Cambridge University Press, Cambridge, 1987, p.5.
  12. East India Company’s export of cotton fabrics from India rose from 221,500 pieces to 707,000 pieces in the1680s. N. Steensgaard,”The Growth and Composition of the Long-Distance Trade of England and the Dutch Republic before 1750,” in James Tracy (Ed) The Rise of Merchant Empires: Long-distance Trade in the Early Modern World 1350-1750, Cambridge, 1990, pp102-152.
  13. Angus Maddison (1995), Monitoring the World Economy, 1820-1992, OECD, Paris, p.30. Paul Bairoch confirms that India had a 25 per cent share of the global trade in textiles in the early 18th century. “The Main Trends in National Economic Disparities since the Industrial Revolution”, in P. Bairoch and M. Levy-Leboyer, eds, Disparities in Economic Development since the Industrial Revolution, Macmillan, New York, 1981.
  14. Tapan Raychaudhuri, “The mid-eighteenth century background”, in The Cambridge Economic History of India, edited by Dharma Kumar and Meghnad Desai,Vol. 2, p.32, Cambridge, 1983.
  15. Angus Maddison, Class Structure and Economic Growth: India and Pakistan since the Moghuls, 1971, London: George Allen and Unwin, p.18.
  16. F. Buchanan, A Journey from Madras…(1807), cited in Raychaudhuri, op cit, p.291
  17. Dadabhai Naoroji, Poverty and Un-British Rule, London, 1901; R.C. Dutt, The Economic History of India in the Victorian Age, London, 1906. Sir William Bentinck, a contemporary English observer, wrote, “The bones of the cotton weavers were bleaching the plains of India.”Quoted in Deepak Lall, The Hindu Equilibrium: Cultural Stability and Economic Stagnation, India 1500 B.C.-1980 AD, Vol 1, Oxford 1984, p.184.
  18. Paul Baran calculated that eight percent of India’s GNP was transferred to Britain each year.The Political Economy of Growth, New York, 1957, p.148. Irfan Habib put the drain in 1882 as 4 percent of national income. “Studying a Colonial Economy–Without Perceiving Colonialism,”Modern Asian Studies, 19.3.1985, pp. 375-6.
  19. B.R.Tomlinson, The Economy of Modern India, 1870-1970, The New Cambridge History of India, vol 3, 3, Cambridge University Press, Cambridge 1996, p. 15.
  20. It was less than 2 percent of exports at the end of the nineteenth century and 1 percent of exports in 1913. K.N. Chaudhuri, “India’s International Economy in the Nineteenth Century: An Historical Survey”, Modern Asian Studies, 19.3.1985, pp. 375-6.
  21. Rajat Ray, Industrialisation in India: Growth and Conflict in the Private Corporate Sector, Oxford, Delhi, 1982, p.34 ff
  22. B.R. Tomlinson (1993), op cit, p.143; Rajat Ray (1982) op cit, p. 341
  23. Morris D. Morris, “The Growth of Large Scale Industry to 1947”, in The Cambridge Economy History of India, Vol. 2, p. 553, edited by Dharma Kumar and Meghnad Desai, Cambridge, 1983.
  24. Amiya Kumar Bagchi, Private Investment in India 1900-1939, Cambridge, 1972.
  25. Morris D. Morris, “The Growth of Large Scale Industry to 1947”, The Cambridge Economic History of India, edited by Dharma Kumar and Meghnad Desai, vol. 2, pp. 553-676, Cambridge, 1983.
  26. Rajat Ray, Industrialisation in India: Growth and Conflict in the Private Corporate Sector, Oxford, Delhi, 1982, p.2.
  27. But then “no colonial power helped its colony to industrialize.”Arthur W. Lewis, Growth and Fluctuations, 1870-1913, George Allen & Unwin, London 1978, p. 225.
  28. There were only 9 agricultural colleges in the whole of India in 1946 with a total enrolment of 3110 students, G. Blyn, Agricultural Trends in India 1891-1947, Philadelphia, 1966.
  29. J. Bhagwati and P.Desai, Planning for Industrialization, Oxford University Press, London, 1970. This book has described nicely the pathology of the License Raj.
  30. Isher J. Ahluwalia, Industrial Growth in India: Stagnation Since the Mid-Sixties, Oxford University Press, Delhi 1985.
  31. Rakesh Mohan, “Industrial Policy and Controls,” in (ed) Bimal Jalan, The Indian Economy,Viking, New Delhi 1992, p.107.
  32. A galaxy of world-renowned economists came to India and applauded Nehru’s path. Among them were Rosenstein-Rodan, Arnold Harberger, Jan Timbergen, Ragnar Frisch, Ian Little, Richard Eckaus, Max Millikan, Nicholas Kaldor, Richard Goodwin, Oskar Lange, Brian Redway, Alan Manne, and James Mirlees.
  33. In fact, the first opening can be traced to the last years of Indira Gandhi, when she began to loosen some controls. Rajiv Gandhi’s reforms in the mid-eighties were more important. J. Bradford Delong discusses this in “India since Independence: An Analytic Growth Narrative” in Dani Rodrik (ed), In Search of Prosperity: Analtytic Narratives on Economic Growth, Princeton University Press, Princeton, NJ, 2003, 184-2003.
  34. Gunnar Myrdal, Asian Drama, vol. 2, Appendix 2, Pantheon, New York 1968, p.1843ff.
  35. Deepak Lall, The Hindu Equilibrium Cultural Stability and Economic Stagnation, India 1500 B.C.-1980 AD, Vol 1, Oxford 1984, pp. 2-3.
  36. David Landes (1998), The Wealth and Poverty of Nations, W.W.Norton, New York, p.45.
  37. Deepak Lall, Unintended Consequences: The Impact of Factor Endowments, Culture and Politics on Long-Run Economic Performance, Oxford University Press, New Delhi, 1999, p.14
  38. D. Lall (1999) p.8
 
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