IAPS Dialogue: The online magazine of the Institute of Asia & Pacific Studies

India growth slowdown: An opportunity for reform?

Alan Lewis - PhotopressBelfast.co.uk 21/3/2013 Mandatory Credit - Picture by Justin Kernoghan Women from India - Women working in their rice paddy fields in Orissa in India.

Written by Shreyans Bhaskar.

The slowdown of India’s economy in the first quarter of 2017 to 5.7 percent has attracted the world’s attention. A closer look reveals several fundamental issues with the economy beyond the blame game dominating the media. By global standards, it hardly looks like a slowdown, however, given India’s recent record it certainly is disappointing. The Q1 figure is short of the government’s own target of 7.1 percent (revised down from 7.6 percent in February this year). It is a far cry from the dream double-digit growth, which is often talked off as the ultimate target. It is even more disappointing because of increasing job losses and a lack of job creation.

India does not need fiscal pushes or monetary tweaks, it needs macro-level disruptive innovation in policy and governance. It needs something on the lines of the Green Revolution of the 1960s, and the economic reforms of 1991.

Conventional wisdom attributes the slowdown to a slew of factors. Firstly, the demonetisation drive undertaken by the government, which took roughly 86 percent of the legal tender in the country out of circulation. In a country with very little digital penetration, this caused a serious problem of liquidity. There has also been a dramatic slowdown in output, with reports of idle workers and layoffs dominating headlines. This reported slowdown is exclusively from the organised sector, and does not include the country’s vast unorganised sector which is much more small-scale and operates on a cash basis, and therefore would have been hit harder by demonetisation.

Another significant factor is the shock that the economy has received from tax reforms; primarily, the Goods and Service Tax (GST). While this tax replaces a multitude of state taxes and intends to convert India into a more unified market, the initial shock that the economy received from this reform has definitely played a role in slowing it down. It has been implemented in a tardy manner, it is complex and fraught with red tape and confusion, adding to the poor business sentiment. However, major businesses such as Larsen and Tourbo (which laid off 14,000 employees in Q1) do not lay off thousands of employees after just a few months of poor performance. They spend a lot of time and money training workers, as their businesses require a high degree of specialisation. Further, unlike smaller businesses, they are not affected as much by slowdowns in the short term, as they have a much greater capacity to ride out short term slowdowns in the economy. Moreover, the layoffs came in Q1, (April to June) when the effect of the GST reform had not even kicked in.

These facts points to more fundamental issues with the Indian economy; something that a fiscal stimulus package or minor fiscal or monetary tweaks will not resolve. At the same time, India has had poor job creation. India’s growth has largely been consumption-driven and based on the service sector. However, while most estimates agree that services now constitute 58-60 percent of India’s GDP, its contribution to employment is only about 28-29 percent (there are minor variations between various sources, due to methodological reasons).

What does all this boil down to? Much of India’s workforce (almost 60 percent) is stuck in the overcrowded and relatively unproductive agriculture sector. India needs to move up the global value chain, and as it moves, it needs to carry along with it, its huge workforce. Total factor productivity growth has been stagnating worldwide, and India is not immune to this phenomenon. A World Bank study from 2016, for instance, goes to show how the automobile sector in India, which has generated several million jobs since the 1990s is also struggling with low productivity. This has been highlighted by the Organisation for Economic Cooperation and Development (OECD) report which pointed towards structural distortions in the Indian economy as responsible for this low productivity.

Policy makers have wrestled with this challenge for a long time, and have often looked east, towards China for inspiration. China’s success at job creation has been driven by its thrust towards manufacturing, and India chose to emulate that by setting up its own Special Economic Zones (SEZ) as manufacturing zones. They were granted several benefits, rebates, and exemptions using the 2005 SEZ act. However, they have proven to be an abject failure. From land acquisition troubles (made famous by the Singur-Nandigram agitations in West Bengal) to very poor offtake of businesses within the SEZ, the entire SEZ framework has failed. Attempts have been made to reinvigorate manufacturing in India via the Make in India scheme, however, the results so far do not seem promising. Enhancing productivity growth through the Skill India Mission does not seem to be making much headway either.

India does not need piecemeal initiatives. It does not need legislation that offers businesses certain tax benefits to set up units. We need a paradigm shift in the way the economy works, another round of structural reforms if you will. The 1991 reform did quite a bit to unleash India’s capability, but it failed to address a very crucial issue. It unleashed reforms based on the premise that the state needed to withdraw from the economy. But it failed to address how the economy was run, and at a larger level, how the country was run. It looked at growth purely from an economic point of view, in a vacuum, rather than look at it from a political economy perspective. And it is this sector that needs reforms this time. Essentially, the Indian state is little more than an enforcer. It must become a provider and a facilitator. And it must pick up global best practices to be able to compete globally. It needs radical alterations in its nature and its purpose, moving from being bureaucrat-centric to citizen engagement-centric.

Linked to this is another issue. India’s abysmal performance on human development indicators points towards the poor quality of its human capital. And unless it is fixed, India’s labour force will not rise up the global value chain. To move labour from agriculture to more productive sectors, India will have to ensure that its citizens have the capacity to sustain themselves in more productive sectors. And that requires huge increases in spending on health and education, and also ensuring that the leakages in delivery mechanisms are plugged so that the expenditure on health and education reach the intended beneficiaries.

The results will not show immediately, but they will show. India has long relied on ‘Jugaad’ (quick fix) solutions to fix economic issues as they arise. However, these quick fixes tend to maintain the economy in a low-level equilibrium, as they fail to push productivity and do not fundamentally alter the ways things are done in the country. India does not need fiscal pushes or monetary tweaks, it needs macro-level disruptive innovation in policy and governance. It needs something on the lines of the Green Revolution of the 1960s, and the economic reforms of 1991. And this recent economic slowdown would be a good time to at least initiate a dialogue about the shape and structure of these reforms, and perhaps even start the process.

Shreyans Bhaskar is a Research Analyst working with the Economist Intelligence Unit in New Delhi, India. Image Credit: CC by Indian Economy/ Flickr