The Hindu Business Line : Follow East Asian tigers’ export path

Mr Montek Ahluwalia, Deputy Chairman, Planning Commission, dismissed the observations of Mr Alan Greenspan on India saying that “though I have not read Alan’s book, I do not agree with him. We are doing a lot to make growth more inclusive. Our economic scenario is good” (The Hindu, September 23, 2007). Had he read the book, Age of Turbulence, I am sure he would agree with him.

Before turning to his remarks on India* and on China let me start with his enumeration of three universal characteristics influencing global growth: (1) the extent of competition domestically, and especially for developing nations, the extent of a country’s openness to trade and its integration with the rest of the world; (2) the quality of a country’s institutions that make an economy work; and (3) the success of its policymakers in implementing the measures necessary for “macroeconomic stability.” (pp. 250-251)

“But while there appears to be a general consensus that these three conditions are essential to prosperity, I suspect that if economic-development experts were polled, many would offer them in different orders of importance and probably also highlight different aspects of each one. My experience leads me to consider state-enforced property rights as the key growth-enhancing institution. For if those rights were not enforced, open trade and the huge benefits of competition and comparative advantage would be seriously and dramatically impeded.”(p. 251)

Property rights

Mr Ahluwalia would surely agree that India’s pre-reform dismal economic performance amply confirms the consensus and the importance of enforcing property rights. Mr Greenspan rightly notes that “not all democracies protect the private property rights with the same fervour. India, the largest democracy in the world, has so much regulation of business activity that it significantly weakens the right to freely use and dispose of individual property, an essential measure of the degree of property rights protection.” (p. 252)

He argues that even providing some, though not all aspects, of private ownership, can yield remarkable results as evidenced by the tremendous response of Chinese peasants to the shift to household responsibility system away from collective ownership of rural land, and of foreign investors to China’s shift in protecting their property rights.

In the context of the ongoing debate in India about the acquisition of land for SEZs, Mr Greenspan’s reference to the periodic confiscation of the peasants’ land for development and the riots that they spawned in China is irrelevant. He remarks that “granting clear legal ownership and rights to peasants for the land they till would go a very long way toward putting an end to such discontent.’” (p.254)

Mr Greenspan’s summary judgment on property rights is apt “there remain three important nations that cannot quite be seen as a simple trade-off of unfettered competition versus restraints from a social safety net: China, Russia, and India. They all follow market rules to a point, but with significant deviations that are not easy to categorise or forecast. China is becoming increasingly capitalistic, with only partial formal rules on property ownership. Russia has rules, but political convenience dictates the extent to which they are enforced. And India has legal property rights that are so qualified by specific regulations, often discretionarily enforced, that they are not as binding as they need to be to attract foreign direct investment. These countries comprise two-fifths of the world’s population, but less than a fourth of world GDP. How their politics, cultures, and economies evolve over the next quarter century will leave a very large imprint on the economic future of the globe.” (p. 293)

I, and most analysts, would agree with Mr Greenspan’s assessment of India. Let me simply quote him.

“This kernel of modernity [in the Indian economy] appears to have largely leapfrogged the twentieth-century labour-intensive manufacturing-for-export model embraced by China and the rest of East Asia. India has focused instead on twenty-first-century high-tech global services, the most rapidly growing segment of world economic activity. The spark of modernity has triggered advances in the whole Indian service sector, including trade, tourism, and tourism-related construction. The pickup in real GDP growth from 3.5 per cent between 1950 and 1980 to 9 per cent in 2006 has been truly remarkable. These advances have elevated more than 250 million people out of the extreme subsistence poverty incomes of less than $1 per day.” (p. 316)

Nehruvian socialism

Jawaharlal Nehru “was entranced by central planning as the rational extension of human beings acting in concert to produce material well-being for the many rather than the few. As prime minister, he initially focused on state ownership of strategic industries, mainly electric power and heavy industry, while imposing significant controls on all else, administered by a cadre of knowledgeable, ostensibly benevolent government officials.” (p. 317)

“Soon these ubiquitous controls, the ‘license raj’ as they came to be called, had infiltrated virtually all Indian economic activity. You needed a license, permit, or stamp for seemingly every conceivable economic action.

“Thus constrained, India settled into a placid rate of growth that came to be known derisively as the ‘Hindu 3 percent.’ The bureaucracy did not know what to do. Its ‘scientific’ system was supposed to elevate growth. It didn’t. Yet to abolish controls would be to abandon the egalitarian principles of Fabian socialism.” (p. 317)

“Since the plethora of licenses, permits, and stamps didn’t seem to help the economy (in fact, they were stifling it), what decisions the bureaucracy made on granting permits soon lost all higher purpose and became arbitrary. But as I noted in describing the Chinese Communist Party’s pyramid of authority, discretion is power. Even the most principled Indian civil servants were reluctant to cede it, and the less principled had something to sell. No wonder India was (and is) rated poorly in every measure of corruption.” (p. 317) (emphasis added)

Bureaucratic stranglehold

“Thus, a bureaucracy encompassing almost every segment of the Indian economy was in firm control and ceded power only reluctantly. That reluctance was reinforced and supported by India’s powerful and entrenched labour unions, and particularly by the communist parties that have always been prominent in Indian politics. Socialism not only is a form of economic organisation but also, because of its fundamental premise of collective ownership, has profoundly important cultural implications, most of which have been embraced by a majority of Indians.” (p. 317-318) (emphasis added)

“Democracy elects people who represent the population, and in India’s case it, as it should, has continued to favour significantly those who believe in the collective principles of socialism. The notion that government intellectuals, driven by the good of society overall, can far better determine the appropriate allocation of resources than can ‘erratic’ free-market forces dies hard in India.” (p. 318) (emphasis added)

“Much of recent global economic history is the story of the centrally planned states of Eastern Europe and China adopting market competition and being rewarded with a rapid increase in economic growth. India’s is not quite that story.

“To be sure, Manmohan Singh introduced much reform, but in many critical areas he was constrained by the enduring socialist inclinations of his governmental coalition. Even today, firms with more than one hundred employees with few exceptions cannot fire anyone without government permission.” (p. 318)

“The liberalisations of Singh, combined with the fall in global communications costs, educated Indians’ English-language skills, and low wages, propelled India into the forefront of internationally outsourced business services.” (p. 319)

“Total employment in India’s information technology industry is currently about 1.5 million, five times its level of 1999. Almost all the increase is export related. Another 3 million jobs have apparently been created in telecommunications, power, and construction as a consequence of the IT surge. Directly and indirectly, that’s barely 1 per cent of total employment in India. And that’s the problem.” (p. 319)

Encourage rural-urban migration

“For India to become the major player in the international arena that it aspires to be, it will need to build factories that entice a very large part of its agricultural workers to urban enclaves to produce labour-intensive exports, the time-honoured path of the successful Asian Tigers and China.” (p. 320)

“Manufacturing in India, however, even high-tech, has been hobbled for decades by job-destroying labour laws, a decrepit infrastructure that cannot provide reliable electric power, and roads and rails that inhibit movement of manufactured parts and finished products between plants and markets.

“Owing to costly labour laws that apply to establishments of ten or more employees, more than 40 per cent of employment in all manufacturing takes place in firms employing five to nine workers. This compares with 4 per cent in Korea.

“Productivity in these small Indian firms is 20 per cent or less of that of large firms; the small firms evidently can’t create the economies of scale available to the larger firms. If mass manufacturing is ever to close the gap in standards of living between India and China, the rival to which it is so often compared, India will need to encourage agricultural labour to migrate to the manufacturing sector in the cities.

“And to encourage workers tied to the land to leave, manufacturing will have to become globally competitive. That will require a major scrapping of the remaining parts of the license raj. In play is the rate of the three-fifths of the Indian workforce who toil inefficiently on farms. They need a dramatic change for the better” (p. 320).

(*Quoted by permission of the publishers, The Penguin Press, a member of Penguin Group (USA), Inc. Copyright (c) Alan Greenspan, 2007)

(The author is Samuel C. Park Jr. Professor of Economics at Yale University.)