Business, Government, and

Society
PGP Term-3
Indian Economy
Outline
A social history of economic growth and
distribution of the economic product in
independent India
Three main themes will be emphasized
Growth
Poverty and Inequality (equity)
The complicated relationship between growth,
poverty, and inequality
The efficiency-equity tradeoff
Economic Growth: State v. Market
The Market Argument
Rapid growth largely a result of the dismantling
of the license raj that characterized import
substitution policies
Consistent regulatory frameworks help
businesses plan for growth
Reduced tariffs
Latent entrepreneurial talent unleashed
Capital accumulation in economy became easier
Market Fundamentalism Critique
Growth acceleration started a full decade before the
reforms in 1991
Industrial growth was reversed in the first years post
reform
Important parts of India failed to get on the growth
trajectory
Human and social capital creation needs active state
intervention
Contrast with East Asian Tiger economies
Market Fundamentalism Critique
Contd..
Indian reforms (even after 1991) have been very modest and
certainly gradual
Reforms not only have not worked in all parts of India, they
have not worked in other parts of the world (mixed result in
Latin America and reversals in Sub Saharan Africa)
Capital formation for poor states did not change dramatically
Market argument does not take into account initial conditions
Very favorable if 1990 is the starting point
Robust capital goods sector
Early dividends on investments in technical education visible by mid
1980s

Political economy explanations for
rapid economic growth
Emphasizes the interaction between state and
markets and goes beyond unfettered markets or
interventionist states as the sole engines of growth
Eg. Kohlis distinction between pro-market strategy and
pro-business strategy

Former: shrinking the economic role of the state, reducing
subsidies, tariffs, privatising public sector enterprises,
opening economy to foreign investors

Pro-business on the other hand refers to the quality of
state intervention and its relationship to the private sector


Political Economy Explanations for
Rapid Economic Growth
Governing the Market explanations are a better fit
for historical data especially initial wave of high
growth in E. Asia
State guided corporations
Helped usher in a era of growth with well designed,
systematic and well implemented state interventions

Growth acceleration started in
1980
Industrial growth not impressive

Improvement in the overall rate of investment in the
economy
Reforms and Capital Formation
Contd..
Politics of economic growth in states

Higher marginal productivity of capital?

Acceleration or deceleration is at least one percentage point change over 1980s
High and low income are simply above and below national average, 1991

Momentum
Contd..
Summarize:
Post reform period, poor states did not fare too
well
Better off states gained
Capital did not move to capital-scarce areas
Role for initial conditions
Public infrastructure
Social infrastructure
Human capital


Political economy explanation of
growth, contd
Shift in Indias political economy around 1980
towards growth, and moving away from politics
of garibi hatao. Post Emergency, Indira Gandhi
Downplayed redistribution and prioritised growth
Alliance with big business
Brakes on public sector industries
Demoted significance of Planning Commission
Not systematic reform, slow changes
Fuelled by dismal growth rates in 1970s; failure of
the public sector to deliver, hard to implement
land reforms, vote bank calculus

Contd
Three main components:
Growth
New industrial policy
Committees set up to review major transformations
(trade, financial reform, economic administration and
so on). An important signal to private sector
Pro business policy reforms
MRTP diluted allowing expansion in core areas like
chemicals, drugs, cement, ceramics
Financing: liberalised credit, tax relief, raise resources
directly from public

Contd
Attitude to labour:
Strikes, gheraoes, go-slow anti-social
demonstrations of irresponsibility by a few (IG,
1980)
Legislation passed to discourage strikes

Reforms picked up more pace under Rajiv
Gandhi
New liberal beginning
How Has the Indian Economy Evolved?
23
25% 23%
24%
16%
13%
9%
4%
3%
The Indian
Economy
Arguments &
Ideas of
Intellectuals
Pressures &
Claims of
Democratic
Politics
Influences on Indias
Economic Development
Social &
cultural
norms
Four Phases of Indias Economic Growth
Panagariya (2008)
Phase I (1951-65):
Takeoff under Liberal Regime; Open foreign investment policy;
relatively open trade policy until late 1950s; investment licensing
tightens only towards the late 1950s, early 1960s
Phase II (1965-81):
Socialism struck with vengeance
Phase III: (1981-88):
Ad hoc liberalization during 1975-79, 1980-84 and then more
substantial liberalization during 1985-86 and 1986-87.
Phase IV (1988-present):
Systemic and systematic liberalization
Figure 1.1: Average Growth Rate
4.1
3.2
4.8
6.3
0
1
2
3
4
5
6
7
1951-65 1965-81 1981-88 1988-06
1964-1976
Economy grew at an average rate of little
under four percent per annum.
'stagnation' compared to what was happening to
India's east (The 'tigers' and then China as well)
Public sector, by the end of this period
accounted for over 40% of the organised
industrial sector
In 1981-82, 24 out of thirty top companies
were in the public sector In revenue terms,
the public sector was four times bigger than
the private sector
Most importantly, however,
The public sector not only controlled the
Commanding Heights of the economy:
Until the 1980s, also had a great normative
influence in debates about the relative roles
of state and market in economic and social
transformation
The role of public sector in the economy was
generally accepted
Structural problems with public sector
units
Most units were not profitable
Returns from profitable units almost always
below plan target
The most important among the brewing
trouble was the steady increase in capital-
output ratio (doubled from 3:1 to 6:1 in
through the 1970s)
Growth (in a very limited and simplistic sense) is
simply investment divided by capital-output ratio
Contd...
Through the 1970s, you had a declining
numerator (public sector profitability) and
and increasing denominator (efficiency of
deployed capital)
Beyond public sector inefficiency, there were
other constraints
Lack of domestic market (goes back to failures
with agrarian transformation)
A growing population (despite some success
with turning the corner)
The 1991 crisis point
Balance of payment problems
External borrowing during the mid 1980s pushed
interest payments to 30% of the borrowing
India was borrowing to payback old loans
The first signs of reforms (the famous V.P. Singh
budget of FY 1985-86)
Against prevailing political wisdom
Origins of tax restructuring
Relaxation of key licensing guidelines
Features Common to the Four Phases
Reasons why India escaped prolonged
stagnation or decline
Macroeconomic stability
Political stability
Gradual and predictable policy changes
Capacity to implement policies
Post-Independence: The Agenda in the
Early Years (Phase I)
Multipronged Development => Self-reliance
Rapid industrialization; import subsn; K goods
Prevention of foreign capital domination
Land reforms: abolish zamindari; land to tenant
Introduction of Cooperatives
Growth with equity: therefore positive discrimination and
reservations for SC & ST
State to play central role through direct participation in the
economic process => active public sector
Planned rapid industrialisation within a democratic & civil
libertarian framework (an uncharted path!)
Indira Gandhi Early Years (Phase II)
Fears about Indias external vulnerability
Had to establish herself politically
Used economic policy as active instrument
Success of green revolution created bullock capitalists as
economic and political force
State subsidies to gain their support
Other interest groups flexed their muscles
Economic populism to gain support of poor
Leftward shift bank nationalization
Constraints on pvt. industry (e.g. MRTP)
Indirect taxes to fund populism
Sectoral Growth
Agriculture grew consistently slower than the
GDP
Industrial growth picked up in Phase I but
dropped drastically in Phase II
Services showed a more stable pattern with
growth accelerating particularly in Phase IV.
Growth Rates of Sectoral GDP (at factor cost)
Period Agriculture & Allied Industry Manufacturing Services GDP
1 2 4 5 6 7
1951-65 2.9 6.7 6.6 4.7 4.1
1965-81 2.1 4.0 3.9 4.3 3.2
1981-88 2.1 6.3 7.1 6.5 4.8
1988-06 3.4 6.5 6.8 7.8 6.3

Sectoral Shares
The share of agriculture declined consistently
The share of industry rose initially but
stagnated in Phases III and IV
The share of services rose consistently
The Composition of the GDP
Year Agriculture and Allied Industry Manufacturing Services
1950-51 57 15 9 28
1964-65 49 21 12 31
1980-81 40 24 14 36
1987-88 33 26 16 41
2004-05 21 27 17 52

Inequality, Poverty, and Growth
Key Concepts
Source: Datt and Ravallion, 2002
Dec 11, 2008
Growth and Poverty
Source: Chaudhauri and Ravallion, 2006
Growth and Inequality
Source: Chaudhauri and Ravallion, 2006
Positive v. Normative
What is?

What should be?

Distribution of income v. justice and fairness
30% of Indian population cannot afford a 2,000 Calorie
food intake per day
Nutritional deprivation is the most important public policy
issue in a country where scores go hungry
Moral Philosophy and Economics
Equity and Efficiency
Equity and efficiency are both normative
concepts

Efficiency is a norm for how large the
economic product can potentially be

Equity norms provide benchmarks for how the
economic product should be distributed

Contd
There are often tradeoffs between equity and
efficiency

The tradeoff is determined by beliefs about
the nature of individual, state, and society
Socialists value equity over efficiency
Belief in moral purpose for the state
Libertarians value efficiency over equity
State has no legitimate role in regulating individual
activity
1921 - 2002
Rawls as a Gandhian?
Whenever you are in doubt, or when
the self becomes too much with you,
apply the following test. Recall the face
of the poorest and the weakest man
whom you have seen, and ask yourself,
if
the step you contemplate is going to
be
of any use to him. Will he gain
anything
by it? Will it restore him to a control
over his own life and destiny?

In other words, will it lead to freedom
for the hungry and spiritually starving
millions? Then you will find
your doubts and your self melt away.
1869 - 1948
Efficiency v. Equity in Policy
Good policies balance efficiency and equity
considerations
Theories of optimal taxation
Efficiency: Minimise distortions
Equity: Make tax progressive

Urban housing policy
Efficiency: Let markets determine prices
Equity: Zoning laws to ensure equitable access to
housing
Poverty, Inequality, and Development
Study of poverty and inequality provides the
overarching framework for understanding
human and social development

Within v. across nations (global inequality)

Gender and Development
Inequality in wages earned by men and women
Son preference and sex selective abortion
Contd
Environment and Development
Equity in combating climate change
Environmental justice issues

Child Labour
Poverty, an important determinant

Education
Difference in enrollment across regions
Girl child enrollment
Measuring Inequality
Size distributions
Deals with individuals/households and their
income

Lorenz curves

Gini coefficients


Copyright 2006 Pearson Addison-Wesley. All rights reserved.
Lorenz Curve: Shows the relationship
between the percentage of income recipients(
x axis) and the percentage of total income
they receive in a given year (y axis).

Gini Concentration Ratio
Effect of Inequality on Growth
Some level of inequality leads to higher growth
[1950s]
Incentive effects to work hard, innovate, undertake risky
entrepreneurial investments
Higher rates of savings
Absence of well-functioning capital markets and
indivisibility of investment

Thus, grow first and redistribute later the familiar
let the size of the pie increase argument

Source: Birdsall 2007; Stewart 2000
Contd
Point of view contested
More equal initial income distribution would lead
to higher growth OR initial inequality is growth
retarding

An efficiency argument
Inequality has a built in tendency to beget
inefficiency




Source: Birdsall 2007
Contd
Does not allow them to fully exploit their capabilities
Nutrition
Human capital
Lack of wealth and the credit market , indivisibility
of investment in physical and human capital

Contd
Effect of inequality on social institutions
Social capital trust, norms and networks that can
improve efficiency of a society [Putnam 1993]
Evidence that inequality negatively affects social
capital land ownership and cooperatives in India
[Banerjee et al., 1991]
Affects social stability and solidarity
Crime and violence
Homicide rates
Contd
Effect of inequality on political and economic
institutions
Initial inequality and failure of effective institutions
to develop [Engerman and Sokoloff 1997, 2002]
Colonization experience
Leads to poor public policy [Buchanan &
Tollison, 1984; Easterly, Ritzen, & Woolcock
2006]
High concentration of income with little checks and
balances, may resist public services
Weak middle class



Source: Birdsall 2007
Inequality and growth
Kuznets [1955], earliest attempt to correlate
economic inequality with other variables

Kuznets curve
Inconclusive
Problems with cross-section data

Is there a Latin effect?
Do middle income countries have inequality OR
middle income countries are largely Latin
American and they have higher inequality for
other reasons?

Time series regressions, on average do not
support the inverted U hypothesis
Inequality and Growth
Two way relationship
Inequality matters for growth
Growth influences inequality

What policies can reduce inequality while
promoting growth?

Poverty, Inequality, and Growth
The three pillars of development

Poverty and inequality intimately linked
Suppose you make Rs. 100,000 a year, would you
like to live in a society where median income is Rs.
30,000 or, a society where the median is Rs.
500,000?

Redistribution as a anti-poverty measure is
politically difficult (problems with land
redistribution in India, for example)

Contd

Growth has been the fundamental means of
ameliorating poverty (rising tide lifts all boats)

Rapid economic growth can result in greater
inequality (we discussed this previously)

The exact causal nature between growth,
inequality, and poverty is ambiguous
Measuring Poverty: Conceptual Issues
Notion of a poverty line
A critical threshold of income, consumption or
access to goods and services below which
individuals are declared as poor
Normative
Monitoring

Contd
Income or expenditure?

Absolute v. relative?

Temporary v. chronic?

Households v. individuals?
Poverty and Assets
Correlated with lack of ownership of
productive assets
Bulk of poor usually among landless or near
landless
Lack of human capital
Inability to remove themselves from the labour
market
High illiteracy or little schooling beyond primary
levels
Poverty and Nutrition
Source: India Human Development Report 2001
Contd
Poverty line definitions often rely on minimum
food or nutrient basket (plus some margin for
non food items)
However, relationship between increases in
income (expenditure) and increases in
nutrition may not be strong
Positive relationship, especially at low nutritional
levels
Status consumption canned foods etc.
Contd
Importance of going beyond natl averages!
Rural poverty

Ethnic minorities, indigenous populations, and
poverty

Gender and poverty

Source: Jayadev et. al, 2007
Deprivations on many fronts
Dec 11, 2008
Inequalities in Wealth
Dec 11, 2008
Inequalities in Land
Dec 11, 2008
Dec 11, 2008
Source: Debroy and Bhandari, undated
Source: Debroy and Bhandari, undated