The Hindu Business Line : Forecasts on the economy

A recent article by Professors Dani Rodrik and Arvind Subramanian is optimistic on the country's growth prospects and its demographic edge in terms of working population. They, however, stress the need for fiscal discipline and point out the dangers of an overly ambitious agenda of liberalisation and privatisation that runs ahead of the supporting institutions or the productive ability of the economy.

PROFESSORS Dani Rodrik and Arvind Subramanian recently wrote in The Hindu about the Indian economy's next two decades. Therein, they referred to their article in the Economic & Political Weekly, where they explain in greater detail the underlying reasons for expecting India's output to grow at close to 7 per cent per annum in the coming two decades.

They had in another recent article (commented on by me in Business Line, April 5) reflected on India's creditable performance, not often recognised, in the 1980s ("From Hindu growth to productivity surge — the Indian growth transition").

The authors' latest piece in the Economic & Political Weekly brings out the clearly-articulated basis for their optimism regarding India's future and raises important issues. At this point of time when India has chosen a brilliant economic reformer to be its Prime Minister, it is fit and proper that we explore what the two economists from the US have to say about India's rich potential for growth in the coming decades.

With an apt touch of irony, the authors quote George Eliot in Middle March to debunk the very art of forecasting: "Of all forms of mistake, prophecy is the most gratuitous". Then, they paradoxically proceed to explain why they forecast what they do.

They concede that one of the cardinal errors of forecasting is to extrapolate the recent past. They discuss the various hypotheses that rank high among the recent rash of predictions that predict a bright future for India in the coming decade.

One of these arguments, which the authors discuss and dismiss rightly, is that based on the decline in interest rates. They point out that "a decline in interest rates can provide some temporary impetus to growth by boosting investments and consumption demand, but it can hardly be a basis for sustaining higher trend growth rates of productivity or output per capita".

They rightly caution that it is unwise to project a low interest rate regime into the future what with the dicey fiscal situation. "Declining real interest rates against a background of high and rising deficits is (sic) somewhat of a mystery in India's recent economic landscape.

They caution that if the fiscal deficit is not addressed, rising rather than declining interest rates are more likely in the future. A cautionary note that is appropriate considering the increasingly populist pressures that are likely to be witnessed in the political situation of an unwieldy (?) coalition that supports the coming Government and presses contradictory demands for subsidies and lower taxation at the same time!

The authors venture a forecast that India will grow at 7 per cent per year in terms of output or 5.6 per cent per year in per capita output over the next 25 years. They concede, however, that the "future is unlikely to indulge their whim for prognostication". However, as they point out, the manner in which we arrive at them may be of residual interest.

In spite of their protestations to the contrary, they naturally depend on what they know about the present in order to forecast the future. They lay stress on the fact that labour productivity growth was the highest in India among various countries, next only to China.

The Table shows that India's labour productivity has grown significantly during the years 1980-2000 and more or less maintained its level in the period of reform. This growth in productivity has happened as a consequence of various reforms initiated in the Indian economy as well as the investments in infrastructure and education.

The authors lay stress on the growth of Total Factor Productivity (TFP), which is economist's jargon for the efficiency with which factors of production are utilised by the economy. Rodrik and Subramanian have shown that while total factor productivity in India has been growing, it has much higher potential to grow faster.

India's TFP, they say, is between 13 and 40 per cent of what it should be, based on productivity improvements on the basis of just catching up. They conclude that as the reforms process continues, these improvements will be further enhanced.

One of the main pillars of the Rodrik-Subramanian forecast depends on the demographics of India. The proportion of working population of India in relation to the total — provided jobs are available — will increase over the decades as India grows "younger". This means the dependency ratio will decline. Dependency ratio is the ratio of the non-working people, which comprises the very old, the children and others not capable of doing work, to the total population.

The authors' estimate is that the decline will be from 0.62 in 2000 to 0.48 in 2025. This 14 per cent decline in the dependency ratio will, in the view of the authors, translate into growth of private savings from about 25 per cent of GDP to about 39 per cent of GDP in 2025.

The authors make this statement without explaining the various logical steps in working out the ultimate result that a decrease in dependency ratio will ipso facto translate into increase in savings of the same proportion. Whether this will actually happen depends obviously on income levels, propensity to consume, and so on, and critically on the economic and political environment remaining propitious.

Be this as it may, the Rodrik-Subramanian thesis builds on an expected decline in dependency ratio to be translated into a 14 per cent increase in savings and a corresponding increase in domestic investment. This growth in capital stock, together with increase in factor productivity, is estimated by the authors to lead to an output growth of 5.4 per cent.

The authors further argue that on the basis that the labour force itself would increase by 1.3 per cent per year, the corresponding increase in output will be the sum-total of the above two factors. It will thus be 6.7 per cent per year or roughly 7 per cent. Rosy prospects these!

The authors deduce further from their forecasts saying that these estimates will imply an increase in the average income per person by a factor of 8 times (All this in real terms)! A truly formidable vision of a panoramic India! If only it is true!

How realistic is the basis of the authors' forecasts? Much depends on the way we use our savings, such as they are, to enhance our productivity.

If we continue to invest our savings, which translate into current account surplus, into improving America's infrastructure and capital stock, as we are doing now, increase in savings is of little use and the authors may well turn out to be wrong. But, hopefully, ways will be found to use our savings for our own good.

Above all, continuing neglect of our rural infrastructure can affect radically — and reverse — the basis of the authors' estimates. Further, they base their forecasts on the continuing trend and performance of our institutional framework — democracy, the institution of justice and Courts, civil society, and so on. Hopefully, the emerging enlightened political leadership of India will ensure this.

While the authors are optimistic about India, they also place before the readers the necessary recipe for fiscal discipline, which is admittedly hard to implement. They point out that India has a number of advantages over China, chief among them being the better quality of institutions.

They, however, omit to mention the national cultural characterisation of discipline, which China has and India misses. Above all, the very structure of democracy also extracts a price in the shape of continuing demands from populist leaders who should, but do not, know better.

There are, however, dangers ahead. The path to growth is not smooth. I cannot conclude better than by quoting from the authors' perceptive piece: "By the same token, it is important for India to avoid the mistakes that Latin America made in the 1990s by hastily embarking on an overly ambitious agenda of economic liberalisation and privatisation that runs ahead of the supporting institutions or the productive ability of the economy.

"Economic growth is best sustained by keeping the private sector excited about investing in the local economy. This requires a pragmatic set of policies towards the private sector that combine carrots with sticks, incentives for dynamic efficiency with market disciplines.

"The knee-jerk reaction of many economists to move as quickly and as broadly as possible in areas such as privatisation (especially in infrastructure sectors), labour market reform, and capital account liberalisation has to be tempered with serious empirical analysis and an appropriate concern for social and distributional impacts.

"The habitual pragmatism and gradualism of Indian policy-making, dictated by the need to manage pluralism and diversity — the organising principle of the "idea of India" — is here more an asset than a liability."

Wise words, which will surely be heeded by the new Prime Minister of India, who has distinguished himself over the years by his capacity to carry out reforms with a human face and without creating social friction.